Case study (UK): Price controls in net zero energy networks

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Distribution Network
Transmission Network

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Watch on-demand: Net zero networks event – 3 August 2021

In Great Britain energy networks are privately owned monopolies funded through consumer bills. Consumers can’t choose their local network providers and have no choice but to use their services. So we regulate the networks to make sure companies running the infrastructure invest intelligently and efficiently, while keeping costs to consumers as low as possible. 

We use price controls to do this, which we call ‘RIIO’ (Revenue = Incentives + Innovation + Outputs). Through this process Ofgem sets how much revenue network companies can recover from their customers, ensuring fair prices and a quality service. 

Gas and electricity network companies have been regulated in GB since the UK government privatised them in the late 1980s.

The case study is provided by Steve McMahon, Deputy Director for Electricity Distribution at Ofgem.

  1. The challenge

    The UK government announced in April a new world-leading climate change target to cut our harmful carbon emissions down by 78% on 1990 levels by 2035, on a pathway to net zero emissions by 2050. The Welsh and Scottish governments have also made net zero commitments, with targets in Scotland for 2045. Meanwhile, cities and councils are setting out targets at local levels across the UK. 

    The UK has come far in reducing its emissions, achieving faster cuts than any other major economy. But for over 200 years we have largely built our economy on carbon-based energy infrastructure. So we will need new and ongoing investment to reshape the energy system to support the government’s climate change ambitions, while maintaining the excellent security and reliability that consumers deserve. 

    The government has already set out ambitious goals through its 10-point green plan, including: 

    • building 40GW of offshore wind by 2030 
    • ending sales of petrol and diesel cars by 2030 
    • deploying 600,000 electric heat pumps per year by 2028 to replace fossil-fuelled heating systems.  

    All of this is leading to major changes in how we generate electricity and manage the grid. Energy networks will have an unprecedented role. They will need to seamlessly integrate new technologies like electric vehicles (EVs) and heat pumps, and through signals across the full-chain of the energy system make low carbon, often weather-dependent, power available in the right places and at the right times. 

    We expect investment in the energy networks will need to rise in response. But companies will also need to invest in a way that works for current and future generations, so no single generation is burdened with the cost.

  2. The approach

    Policy for net zero will continue to evolve at pace and regulation will need adapt. Accordingly, we’ve designed our next generation of network price controls (known as ‘RIIO-2’) to be more agile, allowing companies to dial up investment and innovation to deliver good value green energy projects on the networks when needed. 

    But within this we are also challenging network companies to strike a more balanced settlement in their allowances, so less consumer money is spent on how companies finance themselves and more goes to transforming the networks to meet the country’s climate goals.

    Our new controls started in April this year for the transmission and gas distribution networks and the electricity system operator. The next electricity distribution controls start in 2023.  

    Two forces have shaped the design of RIIO-2: our experience and evaluation of the RIIO-1 controls and the need to prepare the energy networks for net zero at the lowest possible cost to consumers.  

    Through independent evaluation, we’ve learnt that we’ve achieved many of our key ambitions for RIIO-1: network innovation is buoyant and networks are providing a high quality of service to consumers. However, we also know that networks have tended to outperform in the returns they have made and consumers may have paid more than necessary.   

    This is due to a range of factors, including an imbalance in the cost of service and quality of delivery targets, alongside an overestimation of the returns needed to attract investment. The eight-year length of the price controls also meant there was a long wait before we could apply corrections. We have addressed this for RIIO-2. 

    Getting to net zero must be fair and affordable so all consumers can benefit. Central to the new price controls is ensuring no one is left behind, particularly people in vulnerable situations.  

  3. Outcomes

    To boost Britain’s progress to net zero, we have baked the switch to a greener energy system into the new price controls. For the transmission, gas distribution and electricity system operator controls that started in April, we’ve allowed for £30bn of upfront investment now. A further £10bn could be unlocked during the five years of the price control, to help make new ideas a reality and adjust to any changes across policy, technology and the markets. We won‘t set a limit on future green energy funding. We’ll provide more funding if companies can justify every pound they’re intending to spend.

    In electricity distribution, Distribution Network Operators (DNOs) have now submitted their draft spending plans. These will be finalised later this year, with our final determinations on the price control allowances to come in 2022.

    But with the clock ticking on climate change, we aren’t just waiting for the price control to begin. 

    Last year, we invited DNOs to come forward with proposals to speed up green investment in local grids under the current price control. Following an extensive stakeholder engagement process to identify the best value projects for consumers, we approved over £300m additional investment for over 200 projects that will put spades in the ground this year. 

    It’s an important net zero down-payment. For example, this investment now will allow the market to deliver over 3,500 new electric vehicle public charging points and triple the number of ultra-rapid chargers at motorway service stations, supporting more clean transport on our roads.

    This approach, together with the wider design of the RIIO-2 controls, ensures the energy networks have immense flexibility in adapting to changes in net zero policy as it evolves. 

  4. Next steps

    Over the next 16 months we will determine the funding settlements for the next set of RIIO-2 controls for the electricity distribution sector. This is a nationally significant project that will go a long way to accelerating our path to a greener, fairer energy system fit for net zero.

    Further information and decisions on Ofgem’s network price controls can be found on our RIIO-2 network price control programme pages. 

Consumer benefits

  • RIIO promotes network investment while keeping costs to consumers as low as possible, allowing network companies to make a fair return on their activities through efficient operation and quality service. Funding mechanisms are built into the price control designed to facilitate early design work on net zero-related projects.
  • The price control regime ensures GB energy networks are safe and reliable. Britain boasts one of the world’s most reliable energy systems – the network ran at 99.9% reliability during the RIIO-1 price control. 
  • RIIO-2 is making sure no one is left behind in the transition to net zero. We’ve increased funding allowances to bring more direct, cutting edge support to consumers in vulnerable situations. For the price controls starting 2021, this includes a £132 million allocation plus £660 million for green energy and vulnerable support innovation projects.