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Select committee inquiry

Network Costs

Closed

Energy and Climate Change Committee · Opened 12 February 2014 · Closed 30 March 2015

6 recommendations · 4 conclusions
Inquiry on parliament.uk ↗

What the inquiry looked at

“Following the evidence session on Energy Prices on 29 October 2013, the Energy and Climate Change Committee will undertake an inquiry into energy network (transmission and distribution of gas and electricity) costs, as part of ongoing parliamentary scrutiny into energy prices, profits and poverty. Network costs Ofgem estimate that network costs currently make up around 23 per cent of a dual fuel (gas and electricity) bill. 20 per cent of the bill represents the cost of transporting gas and electricity on local power and gas mains (or distribution) networks. Three per cent of the bill is the cost of transporting gas and electricity through the high voltage grid and the national high pressure gas main (or transmission) network. While network charges reduced by 50 per cent in the first 15 years after privatisation, they have been rising again as new networks are built to help connect low carbon energy, replace old gas mains and renew ageing parts of the network. Both Ofgem and DECC have indicated that energy bills are likely to rise in the future as a result of increased network costs. Ofgem have stated, however, that network costs are expected to remain stable in real terms (i.e. excluding inflation) until at least the start of the next decade. Despite this, questions remain on how transparently current and future network costs are determined and how effective Ofgem is at monitoring and scrutinising the charges and profits of network companies. These are some of the issues, among other things, this inquiry will explore.”

The committee's words, from the inquiry page on parliament.uk ↗.

What it found

In the committee's words, from the summary of 6th Report - Energy network costs: transparent and fair? ↗

Network costs (which cover the transmission and distribution of gas and electricity from power stations to households and industry) are a very significant component of household and industrial energy bills. Ofgem has created a new regulatory framework (RIIO) that was designed to ensure that costs were competitive and that profits weren’t excessive, but there is clear evidence that network companies are making higher profits than expected. This suggests that the targets and incentives set by Ofgem are too low, barriers to market entry are high and that Ofgem needs to monitor RIIO more effectively and to equip RIIO with stronger, corrective measures.

While we recognise that the new RIIO framework is an improvement on its predecessor, Ofgem has not yet created the conditions for the market to thrive and provide consumers with best value for money. In the short-term, market conditions can be improved if:

• an interim independent audit of price controls is conducted; • the 40-day notification period for price changes is increased to 15 months; and • stronger, corrective measures are applied to companies that have received incentive payments for reducing leakages when such reductions have not taken place.

In the medium term, simplifications to charging methodologies would enable greater market efficiency; complexity prevents the market from making informed decisions.

These could be achieved, for example, by conducting an in-depth study on the pros and cons of replacing the regional variations for network charges with a standard national tariff. Greater incentives to connect new and smaller energy generators to the grid would increase market competition too. Stronger incentives towards innovations in network technology would see an improvement in the UK’s energy infrastructure and attract necessary investment. We recommend that the Government and Ofgem continue to scrutinise network operators and remove market barriers to drive down costs for consumers.

What the government said

The government responded on 26 March 2015.

Summary written by Accountability Index from the government's response.

The Government supports Ofgem's RIIO framework and agrees with much of the Committee's direction, but at this stage does not believe the formal 'connect and manage' scheme needs extending to distribution networks.

  • On price controls, the Government agrees that Ofgem "should set challenging targets for the network companies and bear down on costs", and notes that RIIO includes "provisions for mid-period reviews" offering "a limited form of flexibility".
  • On a national tariff, it agrees this would require major changes to the charging system, and says any decision "could only be sensibly considered" on the basis of robust, evidence-based analysis. It states that Ofgem is "working to inform the issue in the Summer".
  • It supports Ofgem's decision to modify the Distribution, Connection and Use of System Agreement to give suppliers 15 months' notice of changes to distribution charges.
  • On locational charges for losses and leakages, it "is considering the material already published by the CMA" and "will await the CMA's provisional findings report before drawing any conclusions".

Read the government's response ↗ Read the report ↗ Report an error

How the inquiry ran

Each dot is a dated item listed on this page, from the inquiry's opening on 12 February 2014 to its close on 30 March 2015.

  1. Oral evidence 3 sessions
  2. Report 23 Feb 2015
  3. Government response 26 Mar 2015

What it recommended 6 recommendations · 4 conclusions

1Ofgem has agreed price control settlements with the gas and electricity transmission companies and gas...
Recommended (the committee's words)
Ofgem has agreed price control settlements with the gas and electricity transmission companies and gas distribution companies until 2021 and with electricity distribution until 2023. We believe that the price controls are too generous and the targets are too low. We want Ofgem to utilise the RIIO price control frameworks to put more pressure on the networks to limit their costs and provide better value for consumers, for example through a mid-term review, ideally supported by an independent auditor to enable more accurate calculations of future price controls. We also recommend that DECC and Ofgem introduce an effective “connect and manage” policy for distribution-connected generation to clear the backlog and enable more connections. We recommend that the Government and Ofgem submit data on the number and regional variation of the backlog of connections, an analysis of the reasons behind it, and proposed solutions with a clear timeframe for network companies to address the backlog.
2To introduce a national tariff for gas and electricity transmission and distribution would require major...
Recommended (the committee's words)
To introduce a national tariff for gas and electricity transmission and distribution would require major changes to the existing charging system for network costs. For this change to be considered, further evidence must be gathered and a robust analysis undertaken. We recommend that the Government and Ofgem publish an evidence- based analysis of the advantages and disadvantages of introducing national tariffs for transmission and distribution network charges. These national and regional charges should include data on the costs for connecting different energy types, such as renewable energy sources.
3A standard form of reporting would bring clarity to the performance of the network companies...
Concluded (the committee's words)
A standard form of reporting would bring clarity to the performance of the network companies and the impact of the RIIO price framework. We welcome Ofgem’s approach to ensure that network companies provide comparable information at fixed, regular times. We would like Ofgem to provide a clear timetable to phase in this standard form of reporting, and more information on the interim arrangements. We also recommend that Ofgem continues to encourage network companies to engage more directly with consumers and include qualitative and quantitative information on consumer engagement in their reports.
4The levels of volatility of network costs are unnecessary.
Recommended (the committee's words)
The levels of volatility of network costs are unnecessary. The risk premiums that suppliers are compelled to add to mitigate the costs of volatility raise consumer prices. We recommend that Ofgem adopts the proposal to provide suppliers with 15 months’ notice of network price changes. Network companies must also provide clearer explanations for the reasons behind such changes.
5Benchmarks have an important role to play in helping Ofgem set meaningful targets 28 Energy...
Recommended (the committee's words)
Benchmarks have an important role to play in helping Ofgem set meaningful targets 28 Energy network costs: transparent and fair? 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.
6While gas distribution leakages have improved, the current incentives to reduce energy losses and leakages...
Recommended (the committee's words)
While gas distribution leakages have improved, the current incentives to reduce energy losses and leakages are not fit for purpose, particularly for electricity networks. We were concerned to hear that Ofgem had paid incentives to network companies who had not reduced losses in proportion to those incentives. Consumers are losing out. We recommend that Ofgem develops explicit loss reduction targets and incorporates tougher penalties for network companies that fail to meet them. Introducing locational charges for leakages rather than uniform losses would encourage network companies to be more rigorous about cutting leakages.
7Greater public scrutiny would also assist market performance, so we recommend that Ofgem publish the...
Recommended (the committee's words)
Greater public scrutiny would also assist market performance, so we recommend that Ofgem publish the network companies’ performance against loss reduction strategies alongside the UK’s performance against international rankings of losses and provide a commentary on good and poor performers. This combination of information on individual and macro performance on loss reduction should help the market to hold the sector to account, which in turn can spur on energy efficiency and market effectiveness.
8Overall, British energy network regulation is in transition.
Concluded (the committee's words)
Overall, British energy network regulation is in transition. The migration from RPI-X to RIIO has led to significant framework changes. It is important to build market confidence for the stability of the framework. RIIO is an improvement on its predecessor, and there are positive signs that the framework has brought about a more robust negotiation process involving a wider group of stakeholders. However, RIIO has not gone far enough in providing value for money for consumers of energy. We are particularly concerned by the greater than expected profits by the network companies after the first year of the new framework. As set out in this report, a number of changes are needed to provide greater transparency of how network costs are calculated and passed onto consumers. Greater transparency will allow more scrutiny for this often overlooked aspect of the UK’s energy market and help to ensure that it is held to account. This is needed particularly in view of the absence of any real competition in the transmission and distribution functions.
9We are concerned that the network cost recovery framework is excessively complex with barriers which...
Concluded (the committee's words)
We are concerned that the network cost recovery framework is excessively complex with barriers which hinder the development of a competitive market. Simplifications to charging methodologies would strengthen the market’s ability to scrutinise costs, and increase pressure for more efficiencies.
10We recognise the need to balance investment in network infrastructure against cost reductions, but we...
Concluded (the committee's words)
We recognise the need to balance investment in network infrastructure against cost reductions, but we want to see Ofgem both develop more incentives focussed on the roll-out of network technology, such as smart grids, and connect more consumers and smaller energy providers to the grid.

Evidence

Oral evidence sessions 3