CMA upholds challenges to Ofgem price controls

01/11/21

The Competition and Markets Authority (“CMA”) has found errors in the licence modifications made by the Gas and Electricity Markets Authority (“Ofgem”) to implement the price control decisions for the period 2021-2026 (“RIIO-2”) setting the allowed revenue for electricity transmission, gas transmission and gas distribution in Great Britain. Those decisions collectively provide for over £30 billion of funding.

Nine licensee companies, including SP Transmission plc (“SPT”), the licensee which owns the electricity transmission network in the South of Scotland, appealed against Ofgem’s licence modification. Such appeals are made to the CMA. On 28 October 2021, the CMA  announced its final determination in which it upheld or partially upheld the following grounds of appeal which raised issues common to several of the modified licences:

• Outperformance wedge: After conducting a detailed assessment of the cost of equity, Ofgem had then sought to apply a downwards adjustment of 25 basis points to the result because of a claimed expectation that the licensees would “outperform”. The CMA found that Ofgem was wrong to apply this novel discount. Ofgem had not demonstrated why the extensive set of tools it used for RIIO-2 should be regarded as providing insufficient protection for customers. Based on the evidence provided, the CMA found that: (a) there were a number of errors in Ofgem’s analysis of the extent to which operational outperformance in RIIO-2 should be viewed as probable; (b) even if Ofgem’s concerns about the likelihood of operational outperformance had been substantiated, the outperformance wedge would be a poorly designed mechanism to address these concerns; and (c) given these problems, the outperformance wedge, if introduced, might also undermine broader regulatory certainty which could result in increased costs to consumers over time. The 25bps “outperformance wedge” has therefore been quashed.
• Ongoing efficiency: “Ongoing efficiency” is a cost reduction applied by Ofgem to account for expected productivity improvements in the sector over the price control period. As part of its calculation of the level of ongoing efficiency which was to be expected, Ofgem added 0.2% to account for claimed benefits from past funding provided to licensees for innovation. The CMA found errors relating to important aspects of Ofgem’s evidence base, and that without this evidence Ofgem could not have supported an innovation uplift of 0.2%. The “innovation uplift” has therefore been removed.
• Licence modification process: Ofgem sought to introduce licence conditions which provided for the possibility that they could themselves be modified during the price control period, at Ofgem’s direction, rather than by use of the statutory modification process. Ofgem called this “self-modification”. SPT and certain other appellants submitted that the potential use of such directions to modify the licence denied them their statutory rights, in particular the right to appeal licence modifications to the CMA. The CMA concluded, accepting the arguments of SPT, that a licence condition may contain a mechanism for its later modification but only provided that the condition specifies with adequate precision and predictability both the  circumstances in which such a modification may be made and the manner of such future modification. The CMA reasoned that only if such matters were properly set out in the condition would the licensee in question be able to understand the potential impact of a future modification and be in a position meaningfully to appeal the condition to the CMA at the outset of the price control. On this basis, the CMA held that several of Ofgem’s attempts to provide for “self-modification” were ultra vires and had to be be quashed.

The CMA did not overturn Ofgem’s determination on the cost of equity. 

A summary of the CMA’s final determination is available here.