Appeals in energy and water - the final say

Over the last two years regulator Ofgem has been working with the electricity distribution networks and wider stakeholders to set the price control for the next 5 years (known as RIIO ED2). In its Review of Economic Regulation, the government is proposing to make water appeals more like those in energy. But we think the energy arrangements are flawed too. 

We would like to see a more comprehensive review of the appeal arrangements for both sectors to ensure that they work in the wider public interest. 

“Cherry pick”

On RIIO ED2 it had seemed as if Ofgem had moved quite a long way in its final decision to accommodate the concerns of the companies around its draft decision. If companies are not happy with the outcome of a price control they can appeal to the Competition and Markets Authority (the CMA). 

The companies were allowed significant additional revenues and there are automatic uncertainty mechanisms which provide additional money in period if, for example, the level of demand for electric vehicles and heat pumps is higher than Ofgem’s base forecast.

However, one of the distribution networks, Northern Powergrid (NPg), remains unhappy and is appealing against the decision. Its issue is a technical one about Ofgem’s cost modelling. Because Ofgem only decided late in the day to specifiy a scenario. And the scenario they decided to specify was based on a conservative scenario in terms of an increase in electricity demand, it had to adjust the cost forecasts the companies submitted in their business plans.

They had all based their plans on different scenarios about how the energy system would evolve and NPg in particular had assumed a high rate of electrification. It therefore lost out compared to the other networks from Ofgem’s adjustments with a higher proportion of its efficient costs put into the uncertainty mechanism rather than base costs.

The nature of appeals in energy is that the company can appeal against specific elements of Ofgem’s decision – allowing companies to “cherry pick” elements where they aren’t happy and hang onto the bits where they have done well. They have to prove that Ofgem was “wrong” (which is quite a high bar) but they can’t end up worse off as a result of appealing (apart from the cost of advisers and management time).

The fact that it is a one-way bet was one reason why in the last round of price control decisions for transmission and gas distribution, all of the affected companies appealed.

This had followed on from the PR19 water company price control where four companies appealed and got an uplift in their cost of capital as a result (as well as increased allowances for additional investment). However, in water the appeals process is in effect a full re-hearing with the CMA deciding what it thinks is the right approach – and in some cases that can result in companies coming off worse off than when they went in.

Public interest 

Having seen the result on the cost of capital in water, the energy companies were hopeful of being able to secure a similar uplift themselves. But faced with a different panel and a different set of rules they didn’t succeed. Ofgem was able to argue that their approach was not “wrong” even it if wasn’t what the CMA had done only a short time before in water. This marked difference between the two regimes (which is hard for investors to understand) prompted calls for a review of the appeals regime which the government has responded to in its Review of Economic Regulation.

However, in our view simply moving water onto the same appeals basis as energy is missing a trick when the energy regime is also flawed.

As well as the point made above about it being a one-way bet, the energy appeals process is far from consumer-friendly. Having pushed the companies to place a heavy emphasis on stakeholder engagement in developing their plans, the appeals process feels very much as if it is simply a legal dispute between Ofgem and the company rather than a process to determine a matter of wider public interest. 

There is no consultation with stakeholders and although Citizens Advice has a right to intervene as the statutory consumer body other groups do not – and the legal nature of the process makes it costly to do so, with interveners like Citizens Advice unable to recoup their costs.

Hybrid model

The water appeals took a year to run and will have been a significant distraction for Ofwat and the companies through that period. The costs were significant – amounting to £26m across the four companies in external costs alone and a further £6m for the CMA / Ofwat’s costs. 

For the companies the investment will have been worth it but highlights the difficulty in ensuring that the consumer voice is heard over the well-resourced petitioning of companies. Although the energy appeals process is more streamlined it still places a huge resource burden on Ofgem.

Some sort of hybrid between the water and energy appeals arrangements would seem to offer a better way forward – building on the energy model of a focussed appeal and keeping the bar appropriately high, but allowing the CMA to look more “in the round” at the proposed changes and seeking wider input from consumers and stakeholders as happens on water.

But there’s also a case for a more fundamental rethink about how the regulatory model itself impacts on the role of appeals. In a previous blog drawing on our Fair for the Future work we argued for looking at how to make the whole price control process less adversarial, reducing the need for appeals at all. Having looked in depth at the current arrangements we set out three specific suggestions:

  • The creation of some sort of Commission to set (and regularly update) the cost of capital across sectors, which the CMA would be expected to have regard to;
  • Placing more reliance on a “negotiated settlement” type approach for local social and environmental activities;
  • Taking more decisions on major investments outside the price control as part of a move to more adaptive regulation as Ofgem have started to do (through what they call their Accelerated Strategic Transmission Investment programme) and Ofwat are also committed to. However it is harder to see how this would work for distribution networks where there are a larger number of smaller investments involved.

We also suggested exploring pre-action protocols which require parties, before commencing proceedings, to try to settle the dispute and to consider a form of Alternative Dispute Resolution.

With Ofgem consulting on a radical new approach to price controls a key question in this context must be whether it will make the process less adversarial and what it means for appeals.

In the meantime – and assuming that price controls in some form are here to stay – we support the government’s intention to review the appeals process but would argue that this should not simply mean adopting the energy approach in water. 

To help inform this debate we have re-published a set of articles written over the past five years by Associate Maxine Frerk in an independent capacity. These follow through blow by blow the recent appeals in energy and water and draw out lessons for reform which Sustainability First endorses.

This reinforces our key message about the positioning of this review. Wider stakeholders need to be assured that the appeal regime strengthens rather than undermines the regulatory process. Price control appeals are not simply a set of bilateral disputes (involving a tightly defined set of interested parties) – we all have a stake in the outcome. Given the challenges we face in both energy and water over coming decades we need an appeals regime that supports, not hinders, that transition.