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National Grid slams 'errors' in UK regulator's plans to reduce investor returns

National Grid PLC is urging the British energy regulator to rethink its plans for cutting allowed returns for investors in the U.K.'s electricity and gas network companies, slamming "errors" in the proposals and predicting that the framework would scare away investors at a critical time for network upgrades.

As part of its so-called RIIO-2 price control reform, the Office of Gas and Electricity Markets, or Ofgem, has proposed to slash the baseline rate of return for operators of power transmission and gas transmission and distribution networks to 4% for a five-year period starting in 2021, down from 7% to 8% currently. The move would generate billions in savings for customers, according to Ofgem.

But National Grid, which saw its shares tumble by almost 10% after the proposal was released, said in its response to the consultation that, although base returns are now lower than when the previous price control period was settled, the rate of return should be set at 5.5% for transmission networks. Reducing incentives as proposed would otherwise lead network operators to focus on risk aversion and penalty avoidance rather than innovation and efficiency, National Grid said.

"This will lead to five years of missed opportunities for consumers at this critical time in the transformation and decarbonization of the energy system," Chris Bennett, National Grid's director for U.K. regulation, said in a letter to the regulator dated March 14, adding that the low proposed returns are "supported by errors in approach, arbitrary adjustments and the selective use of available evidence."

As a result, "Investors are likely to find U.K. energy networks less attractive investments and the industry could miss the opportunity to attract new money into the sector," Bennett wrote. "Companies would be forced to become more cautious on investment, needing funding security before beginning any work leading to risks being passed onto consumers."

Such an approach in the previous regulatory period would have impacted hundreds of millions of pounds of National Grid investments in network resilience and renewable generation connection, he said.

National Grid owns and operates the electricity and gas transmission network in England and Wales, and operates the Scottish networks. The company also balances power supply and demand across Britain as the Electricity System Operator but said it will submit a separate response to the Ofgem consultation as such, given an imminent legal split of that function from the rest of its business.

Network costs are recouped from consumers via their energy bills and Ofgem has said its proposed reforms would save a total of £6.5 billion, reducing individual bills by an average of £30 a year. Consumer advocacy group Citizens Advice has claimed that wrong assumptions in Ofgem's last price control period have led to £7.5 billion in unjustified profits at U.K. energy network companies.

The regulator has suggested that companies could cut their shareholder dividends to retain more cash as one way to mitigate the effect of the reforms, although analysts think companies are unlikely to do so.

A spokesman for Ofgem said the regulator will not comment on individual submissions before it announces a final decision, expected in May. The RIIO-2 consultation process for transmission networks is now closed and the reforms would take effect in April 2021. Ofgem's proposal also includes shortening the price control period from eight to five years and changing the inflation index used from RPI, or the retail prices index, to CPIH, or the consumer prices index including housing.