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Citizens Advice Application for Permission to Intervene in Energy Licence Modification Appeals 2021

23 April 2021

Citizens Advice Application for Permission to Intervene in Energy Licence Modification Appeals 2021 [ 0.71 mb]

Allowing these appeals would grant the appealing network companies significant additional revenue, to be funded by consumers, without any related improvement in service or investment. We do not believe that this is justified. We do not accept companies’ claims that Ofgem did not follow due process; that Ofgem has limited scope to use its judgement in applying the Capital Asset Pricing Model (“CAPM”) model (for determining the companies’ allowed returns), or that the Final Determinations will materially impact the companies’ financeability. Thus, we present a case that the appeals are not in the best interests of either current or future consumers. 

UK regulated networks companies have generally and consistently enjoyed high returns through regulatory settlements that have proved too generous. This now needs to be addressed and, although we believe Ofgem could have gone further, RIIO-2 represents a step change in the right direction. It would not be in consumers’ interests if Ofgem’s approach was undermined by these appeals.

We focus our response on the evidence for a lower Cost of Equity, including the importance of addressing structural outperformance by making a downwards adjustment to the Cost of Equity (the Outperformance Wedge). We also make limited comments on the Cost of Debt. These issues are important both for these appeals and for setting appropriate expectations for future price controls.

We consider that the structural outperformance, as seen in previous price controls, and the revealed investor acceptability of reduced Cost of Capital are evidence that the implementation of the CAPM model in the energy sector has structurally favoured investors over consumers. The evidence suggests that the econometric components of the model to calculate the Cost of Equity do not properly reflect the risks associated with the price controls, thereby overstating non-diversifiable risk and so fair costs of financeability. 

We will outline the important consumer context for the RIIO-2 determination and explain how overestimation of the Cost of Capital and associated continued structural outperformance risks consumer detriment in multiple ways. 

Accepting these appeals and unduly rewarding networks is a high risk approach for consumers in the current UK economic context. We are particularly concerned about the impact on affordability by any undue increase in prices - at a time where evidence is growing that affordability is worsening - as well as the potential detrimental impact on Net Zero delivery by the energy industry.