Energy network costs: transparent and fair? Contents

4Benchmarks and incentives

35.Under the RIIO framework, the onus is on companies to demonstrate that their proposed charges are a reasonable reflection of their individual costs, and that they are running their businesses in a cost efficient manner. For example, for RIIO-ED1, the price control for the electricity distribution businesses due to commence in April 2015, Ofgem is drawing on historical and forecast data of individual Distribution Network Operators (DNOs) to inform its price controls.

36.We explored the role that benchmarks could play in helping to set better and more robust targets under the RIIO price framework controls. We heard about the challenges that make benchmarking difficult in this sector.52 There is a lack of obvious proxy companies given the monopoly nature of the sector. With only three transmission owners for electricity and one for gas in Great Britain, the lack of comparators makes it challenging to set valid industry benchmarks for costs. It is difficult to identify “proxy” companies they could be compared with, as these may be international companies with different frameworks. These differences within a small group makes it hard to compare “like with like”.

37.However, although network costs themselves have a unique regulatory framework which makes it hard to replicate, there are other aspects of the industry which could be scrutinised against other sectors. Andy Manning, Head of Network Regulation, British Gas, said:

I think there are certainly areas where you can use external benchmarks more than we currently do. While network assets might be fairly unique in their characteristics, many of the things that networks do around answering calls, customer service, dealing with complaints and offering connections are generic customer service tasks that exist in quite a lot of different industries. For those I think there is probably quite a strong case for benchmarking the networks not simply against each other but against other parts of the economy that carry out those roles to get a better sense of how they compare.

In other areas, too, in terms of the kinds of cost allowances that are applied to different factors, I think you can benchmark against wage growth or wage deflation in the wider economy and aspects like that to try to get a better sense of how the networks are comparing.53

38.There are also inter-sector benchmarking opportunities available. Wales and West Utilities and the Energy Intensive Users Group told us that regulators in different sectors such as aviation and rail “talk to each other” in order to compare benchmarks. EDF stated in their evidence that part of the recently established UK Regulators Network’s work should be to benchmark across different industry networks (aviation, finance, telecoms, energy, rail, water) to build best practice and identify benefits for customers.54

39.It is not clear how far Ofgem has optimised inter-sector benchmarking for network companies.55The Government said that it drew on some international benchmarks to compare overall network costs. For example, in relation to energy losses from the network the UK fell below the EU average and ranked 101 out of 185 countries.56 However, it is unclear if the full range of network costs is benchmarked by the Government and Ofgem. SP Energy Networks suggested that there could be more to learn from not-for-profit energy companies about their efficiency benchmarks.57

40.RIIO is also a national-specific framework, which adds to the complexity of making international comparisons. Basil Scarsella, CEO, UKPN, argued that Britain’s network cost regulatory regime leads the world:

I have experience in other parts of the world, on the regulatory regime in Australia and I have reviewed the US and the European regulatory regimes, and it is important to point out that those other jurisdictions are following the UK regulatory regime. On balance, we should always be striving to improve but the regulatory regime has served the UK very well in the last 25 years.58

41.In addition to a lack of comparators, we heard from Citizens Advice Bureau that different accounting practices add further ambiguity when assessing the efficiencies that network companies make under RIIO. For example, some network assets are now being depreciated over 45 years rather than 20 years.59 So network costs may be reducing because of efficiencies or because of the short-term savings made from a longer-depreciation method. But 45-year asset depreciation is not standard across all network companies, adding further complexity when trying to benchmark and compare like-with-like. Maxine Frerk, Interim Senior Partner for Smarter Grids and Governance, Ofgem explained the regulator’s reasons for the recalculation:

That change [from 20 to 45 years] is something that we have agreed to as part of the RIIO process because it better reflects the life of the asset. These are long-term assets, so it is right that they are depreciated over 45 years rather than 20 years. The process of changing for that will be only for new investment and it will be phased in. Clearly, there is a balance there between what current customers pay and what future customers pay, but we think the regime is doing the right thing in reflecting the length of the lives of the assets that are in the ground.60

42.Benchmarks have an important role to play in helping Ofgem set meaningful targets for network companies. We recommend that Ofgem further develop its use of national and international benchmarks when evaluating the impact of the RIIO framework on network companies. These benchmarks should be drawn from other regulated and non-regulated industries in the UK as well as overseas in addition to not-for-profit/mutual energy companies. These benchmarks should be developed well ahead of the next round of RIIO performance reporting. We also recommend that standard accounting practices be applied to encourage more robust benchmarking. Ofgem should provide a clearer timeline for extending depreciation of network assets from 20 to 45 years, and propose interim measures during this process to allow more ‘like-for-like’ accounting comparisons.

52 Q56, (Basil Scarsella), Q175 (Frank Mitchell), Q176 (Graham Edwards)

53 Q56 (Andy Manning)

54 EDF Energy (NTC0033)

55 Q177 (Graham Edwards), Q178 (Jeremy Nicholson)

56 Q298 (Matthew Hancock), Q310 (John Fiennes)

57 Q178 (Frank Mitchell)

58 Q4 (Basil Scarsella)

59 Q16 and Q27 (Richard Hall)

60 Q254 (Maxine Frerk)