DD day
Ofgem has published its draft determinations on RIIO3 business plans. Utility Week unpacks the early rulings and speaks to industry figures to gauge the immediate reaction.
By Rob Horgan, Tom Grimwood and Dorjee Wangmo
DD day
Ofgem has published its draft determinations on RIIO3 business plans. Utility Week unpacks the early rulings and speaks to industry figures to gauge the immediate reaction.
By Rob Horgan, Tom Grimwood and Dorjee Wangmo
The half-time scores are in. Ofgem has delivered its initial thinking on business plans for electricity and gas transmission operators (TOs) and gas distribution networks (GDNs) for 2026 to 2031.
The headline news is that the regulator has proposed cutting baseline expenditure in RIIO3 by more than a quarter (26%), compared to what companies had put forwards in their business plans. In total, Ofgem has proposed allowing upfront expenditure of £24.2 billion in its draft determinations – £8.5 billion less than companies requested in their plans. Electricity TOs have had a combined £3.1 billion shaved off their baseline expenditure requests; £3.8 billion has been cut from GDNs’ spending ask; and National Gas has seen a £1.6 billion reduction in upfront spending on the gas transmission network.
Documents released by Ofgem as part of its draft determination add that the cut in baseline expenditure is due to three broad factors. It states: “The first reflects our robust assessment of projects, including unit costs and applying a sharp but achievable efficiency challenge, or in some instances disagreeing outright with the need for the project.
“The second is where the needs case for investment may be understood and agreed but where additional clarity is required to ensure those investments are properly coordinated and deliver best value for consumers. […] “The third reflects our view that a decision to allow additional funding is best made later, during the price control period, when there is more certainty on the specific network interventions needed and their costs.”
Reduction to gas distribution networks' business plans.
Reduction to the gas transmission network's business plan.
Reduction to electricity transmission networks' business plans.
It says: “Under these circumstances consumers are protected from committing too early to investments that are immature in scope and cost whilst also providing a credible route to funding for companies when they are better developed.”
An initial £8.9 billion investment is being committed to the electricity transmission network, with a further £1.3 billion of “use it or lose it” investment. This includes £4.2 billion for National Grid (down 27% on its spending ask outlined in its business plan); £3.1 billion for SSEN (down 26%) and £1.6 billion for Scottish Power (down 23%). The upfront expenditure allowance will cover 80 transmission projects to be completed within the next five years.
A total of almost £2.5 billion has been proposed to operate and maintain the national gas transmission system, with just under £13 billion allocated for the regional gas distribution networks across the country to maintain safe and secure supplies.
In gas distribution, Ofgem has proposed £12.8 billion of baseline expenditure for the four networks. This includes £6.28 billion for Cadent (down 22% on its business plan submission); £4.55 billion for SGN (down 25%); £2.19 billion for Wales and West Utilities (down 31%); and £1.84 billion for Northern Gas Networks (down 15%). In gas transmission, National Gas has been allowed £2.46 billion of upfront expenditure, some 39% less than its spending ask.
The regulator’s draft determination documents add that in relation to electricity transmission, Ofgem “had hoped to give larger baseline allowances and the lack of maturity of projects in the [TOs’] business plans was disappointing”.
It adds: “In 2025, we introduced the Advanced Procurement Mechanism (APM) enabling TOs access to significant funding to secure supply chain capacity in advance of securing full project approval. However, for RIIO-ET3 the TOs asked us to settle the costs for the majority of their load programme during the RIIO-ET3 period when they would have more clarity on project scope and market prices.”
The APM is designed to enable TOs to buy essential equipment years ahead of when it is needed to help mitigate the detrimental impact that supply chain delays might have on the delivery of critical national infrastructure. In March, Ofgem confirmed that the fast-track fund will be worth £4 billion – half the amount originally proposed.
Despite the cuts to the upfront funding, Ofgem still expects capital investment in electricity transmission during RIIO3 to exceed £80 billion – in line with spending estimates outlined in TO business plans. It adds that the “remaining funding will be approved through in-period regulatory mechanisms, once project costs are more certain”.
Responding to this, a network regulation expert warns that Ofgem’s decision to approve only 10% of the total £80 billion potential investment in electricity transmission will create an increasing regulatory burden for itself and the TOs.
Amount of electricity transmission capital investment Ofgem expects to approve over the course of RIIO3.
Amount of this £80bn electricity transmission capital investment Ofgem has approved so far.
Nicole Lomax-Gardiner, senior manager and an expert in network regulation at Baringa, says that in addition to the regulatory burden, this will also create uncertainty on future allowances for the transmission operators, impacting their ability to secure supply chains. “The TOs will need to submit separate, detailed justifications for these expenditures to access additional allowances throughout the five-year RIIO-3 period,” she says.
“The RIIO-3 draft determination represents a significant shift in the balance of ex-ante vs. in-period funding, putting more weight on in-period approval. This will create an increasing regulatory burden for both Ofgem and TOs, as well as a lack of certainty on future allowance profiles, which could have implications when it comes to securing workforce and supply chain capacity.”
“This will create an increasing regulatory burden for both Ofgem and TOs, as well as a lack of certainty on future allowance profiles.”
Nicole Lomax-Gardiner, senior manager and an expert in network regulation at Baringa
Immediate backlash
The message from Ofgem CEO Jonathan Brearley is that its draft determinations represent a “record investment [which] will deliver a homegrown energy system that is better for Britain and better for customers”.
In response, most companies’ initial reaction was to offer the obligatory “welcoming” of the funding announcement. However, SSEN Transmission wasted no time in expressing its dissatisfaction with the regulator’s initial rulings. Acknowledging that “there has been some positive movement following the regulator’s Sector Specific Methodology decision in July 2024”, a statement issued by SSEN just hours after the determinations were released gives the impression that it will be forceful in pushing back against the ruling.
Specifically, it claims that “Ofgem’s draft determination does not go far enough to deliver the investible, financeable and ambitious framework required to unlock the unprecedented levels of investment needed to deliver lower and more stable bills”. In particular, SSEN takes issue with the approach to setting baseline total expenditure, claiming that allowances “fail to fund the investment necessary to deliver a clean power system by 2030”.
Its statement adds: “The methodology adopted does not reflect the true, evidence-based costs that are required to develop, build and maintain a reliable electricity transmission network in the north of Scotland.”
The TO also raises concerns about the proposed cost of equity, claiming that it is “not commensurate with globally competitive market rates, robust market evidence, and the significant business risks of investing in electricity transmission”.
“It does not deliver the investible, financeable and ambitious framework required to unlock the unprecedented levels of investment needed.”
SSEN
SSEN also claims that the proposed capitalisation rate, and asset lives, do not provide adequate cash flow measures given the significant increase in uncertainty mechanism expenditure required. And the company states that the proposed incentive regime is not mature enough in its current form and “therefore requires further development to give sufficient confidence this will be a balanced and investable package that incentivises strong performance and delivers for consumers.”
A senior source at a TO adds that while the messaging from Ofgem – to invest £80 billion in RIIO3 – is encouraging, it is disappointing to see such a big cut from baseline expenditure. They add: “We spent months working on these costs and a lot of effort went in to making them as efficient as we thought possible to meet the aims of building and maintaining a clean, resilient grid. We haven’t just plucked numbers out the sky."
In particular, the source is disappointed to see many upgrade projects for existing assets classified by Ofgem as either “not justified” or needing further clarity. They add: “The messaging on building new infrastructure to meet the needs of the country is clear. That clarity needs to be extended to maintenance upgrades and renewals.”
It is a point echoed by iTower Analytics founder and former Cadent analytics and insights manager Daniel Heller, who says that it will be the “main frustration” from the electricity networks in response to the draft determinations. “That's where the frustration from them [TOs] will come, because the biggest burden to any of their networks is the operational expenditure which they go through to maintain the existing network,” Heller says. “It's fantastic to invest in a shiny new car or new appliances, but if the rest of your house is falling down then you're not investing in the right way, and it's not the right approach.”
He adds: “It's full steam ahead for the shiny new stuff to deliver Clean Power 2030, which is absolutely essential. But look closer, and you see a worrying trend. Ofgem is squeezing the funding for the boring but crucial stuff. Even as electricity transmission gets billions for new projects, its funding for core maintenance and asset health is being cut with networks being pushed to drive efficiency. At the same time, the gas networks, are being asked to manage a slow decline on a reducing budget where operational pressures still remain.”
Heller adds that this approach creates a “huge strategic risk” with Ofgem taking “a massive, single-vector bet on electrification”. “This isn't just about efficiency, it's about whether the whole strategy is sustainable,” he adds. “Are we creating the HS2 of the energy system - a one-way bet that, once we're committed, we can't back out of, no matter the cost or risk to the resilience of the system we rely on today?”
Heller expects to see Ofgem row back on cuts in electricity transmission between now and financial determinations – adding that the regulator’s draft determinations actively encourage TOs to put forwards their case for further baseline investment. He is, however, not so optimistic when it comes to the gas networks. Having been actively involved in Cadent’s submission, he says that the general mood within the gas sector will be glum on the back of the draft determinations.
He adds the “message from Ofgem [to electricity TOs] is clear: build, build, build, but do it efficiently”. However, while it is “full steam ahead” for the electricity TOs, “it’s a different story for gas networks”. “It appears Ofgem's focus is on funding the absolute essentials while managing future uncertainty. They've backed core safety work but have been tough on areas with weaker justifications,” Heller adds.
50“Even as electricity transmission gets billions for new projects, its funding for core maintenance and asset health is being cut with networks being pushed to drive efficiency.”
Daniel Heller, founder of iTower Analytics
Cost of capital
In terms of making the sector investible, Ofgem has proposed real-terms cost of equity allowances of 6.05% for gas networks and 5.64% for electricity transmission networks. The figures are based on the CPIH measure of inflation and notional gearing levels for the sectors of 60% and 55% respectively. The rates proposed in networks’ business plans (based on a notional gearing of 60%) ranged from 6.3% (Cadent) to 6.89% (WWU).
In its final determinations for their RIIO2 price controls, Ofgem set the cost of equity at 4.55% for gas networks and 4.25% for electricity transmission networks. It also subtracted an “outperformance wedge,” worth 25 and 22 basis points respectively, to give allowed returns on equity of 4.3% and 4.02%. However, this deduction, which was intended to reflect networks’ historical tendency to outperform the baseline, was later overturned by the Competition and Markets Authority.
For the RIIO3 price controls, Ofgem has decided to set nominal allowances for fixed rate debt and de-link the proportion of networks’ Regulatory Asset Values covered by fixed-rate debt from outturn inflation. The changes are intended to prevent network companies receiving windfall gains when inflation is higher than anticipated. In February, Citizens Advice claimed energy networks had already seen £3.9 billion in windfall gains over the RIIO2 price controls as a result of short-term spikes in inflation.
Ofgem has proposed to set the notional assumptions for the proportion of total debt that is index-linked at 30% for gas networks and 10% for electricity transmission networks. In the case of the latter, this would be a reduction of 20 percentage points when compared to the RIIO2 price controls. On this basis, the regulator has proposed semi-nominal cost of debt allowances of 4.45% for gas networks and 5.43% to 5.81% for electricity transmission networks.
Ofgem said this would result in semi-nominal weighted average cost of capital (WACC) allowances of 5.09% for gas networks and 5.53% to 5.73% for electricity transmission networks. These equate to real-terms WACC allowances of 4.22% and 4.49% to 4.7%.
Real-terms cost of equity for gas networks.
Notional gearing level assumed for gas networks.
Real-terms cost of equity for electricity networks.
Notional gearing level assumed for electricity networks.
Impact on bills
Ofgem estimates that RIIO3 spending will increase network charges on bills by £104, going from £220 per year today to £324 by 2031. Gas networks account for £30 of the increase and electricity networks for £74. The latter figure covers the more than £80 billion of total electricity transmission expenditure expected over the period.
Amount of a current energy bill accounted for by network charges.
Amount of an energy bill accounted for by network charges by 2031.
Proposed increase network charges on customer bills.
The regulator said £44 of the increase will go towards ‘business-as-usual’ spending to maintain and operate networks, whilst £8 will allow for the accelerated regulatory depreciation of gas distribution networks to ensure remaining customers are not left to pick up the tab for past investment as others electrify their heating and disconnect.
The other half (£52) “will be used to expand the capacity of the electricity grid to deal with the rising demands of a more electrified energy system, as we move away from gas".
However, Ofgem estimates that this investment is expected to lead to around £80 of savings for consumers by 2031 – £55 from reduced constraint costs and £25 from lower wholesale prices due to the ability for more renewable generation to connect to the power grid and displace more expensive gas generation.
Taken all together the estimated net cost of these investments on bills amounts to around £24 a year – or less than 40p per week – by March 2031.
Heller adds that this creates “a confusing bill narrative for consumers", particularly given that distribution network costs will also rise in a few years.
Gillian Cooper, director of energy at Citizens Advice, adds that “news of bill increases from next April will worry many already struggling with sky-high energy costs”. “When setting how much companies can make for this investment, Ofgem must get the best possible deal for billpayers by ensuring company profits don’t end up too high,” she adds.
Meeting the gas depreciation challenge
One area where Ofgem has attempted to shield customers is on gas depreciation. As a result, new investments by GDNs will be paid back faster to prevent a future surge in bills as the electrification of heating leaves these costs to be recovered from a shrinking pool of customers.
Under the RIIO3 price controls starting in April next year, new additions to their regulatory asset values (RAVs) will have an accelerated sum-of-digits depreciation profile that ensures they are fully paid back by the government’s net zero target date of 2050. Ofgem says the change will add £8 to the typical annual household bill by the end of the price controls in 2031.
This was the last of four options proposed by the regulator in its sector-specific methodology in July last year. The other options were to:
- Fully depreciate the entire RAV by 2050 with a sum-of-digits profile
- Fully depreciate the entire RAV by 2050 with a sum-of-digits profile, but with an acceleration factor being applied at each price control to vary the pay back speed
- Fully depreciate the entire RAV by 2050 with a straight-line profile
In response to the proposals, Ofgem says GDNs raised concerns that accelerated depreciation may undermine investor confidence in the sector and discourage further investment. They also warned that there would still be a significant risk of asset stranding due to the decarbonisation of the energy system, regardless of Ofgem’s approach to depreciation.
Given the uncertainty over the future of gas networks, Cadent urged the regulator not to make any drastic changes, which it said could lead to current customers being overcharged if RAV is depreciated too aggressively. It identified the option chosen by Ofgem as the fairest of the four.
Northern Gas Networks instead suggested reducing asset lives to 35 years, saying this would have a small short-term bill impact whilst allowing more time for uncertainty to be resolved. It said the issue could then be revisited for the RIIO4 price controls.
And SGN proposed a “calibrated” approach whereby the depreciation rate would be adjusted annually based on the actual number of customers that have switched from gas to electricity.
For the RIIO3 draft determinations, Ofgem says it considered eight total options, including maintaining the current policy, the proposals by NGN and SGN, and several variations of the first option from the sector-specific methodology, for example, fully depreciating RAV by 2060 or depreciating 90% of RAV by 2050.
Ofgem claims its chosen option strikes the right balance between protecting current and future customers: “By accelerating depreciation for new assets only, we can begin the process of accelerated depreciation based on the facts and outlook available to us today, without locking in a more aggressive policy that may later prove unnecessary or misaligned with government direction. This approach also avoids a sharp increase in consumer bills in the short term, which is particularly important given current affordability concerns.”
It continues: “Allowing the RAV to grow unchecked would place an unfair burden on future consumers—who are likely to be fewer in number and potentially more vulnerable—as they would bear the cost of legacy infrastructure. Accelerated depreciation for new assets helps to moderate this risk while still allowing for flexibility in future regulatory decisions.”
Under the current arrangements, gas distribution assets have a 45-year sum-of-digits depreciation profile. Ofgem has decided to retain this profile for gas transmission assets. The regulator notes that gas transmission depreciation “currently constitutes less than 1% of customer household bills and will remain at less than 1% of consumer bills by 2040 with no action. Therefore, there is minimal consumer impact in adjusting based on future evidence on the usage of the network or potential repurposing beyond 2050".
Totex Incentive Mechanism
Ofgem has opted to introduce a new ‘Stepped’ version of the Totex Incentive Mechanism (TIM) for electricity transmission, whereby the sharing rates vary depending on the size of the overspend or underspend.
Under this Stepped TIM, transmission owners will cover/keep 25% of any overspend/underspend up to 5% of totex and then 5% of any additional overspend/underspend between 5% and 15% of totex. There will be no sharing of any overspend/underspend beyond 15% of totex, which will fall entirely to customers.
Even within the first of these bands, the sharing factor is significantly lower than the current rates. The RIIO ET2 rates were set based on Ofgem’s confidence in TOs’ costings at 33% for National Grid, 36% for SSEN and 49% for SP Energy Networks.
The regulator has made the change in response to concerns raised by TOs that the current arrangements would expose them and their investors to unacceptable levels of risk because of the huge growth of the investment pipeline, which is primarily composed of large projects that are more susceptible to cost overruns due to the economic environment, supply chain constraints or planning delays.
Ofgem adds: “Forcing the TOs to be exposed to this risk within the price control (i.e. through the TIM) may create consumer detriment if it resulted a higher cost of capital or TOs investing in projects more conservatively and delaying delivery.
“We consider that this stepped approach will ensure that TOs have an exposure to cost overruns that is commensurate with the risks that they are able to manage, while retaining a strong incentive to keep costs efficient when they are in control of those costs,” the regulator adds. “It also provides for a capped and transparent level of exposure to cost overspends, providing investors with certainty of a worst-case scenario.”
Ofgem also revealed that the Stepped TIM will be applied to ASTI projects, which it previously planned to treat differently to other expenditure. In its decision on the ASTI licence conditions, the regulator states that it intends to apply the current flat version of the TIM to ASTI projects but only to the first 5% of any overspend/underspend.
As the sharing rates under the Stepped TIM will be lower than is currently the case, Ofgem says it is no longer necessary to treat ASTI projects differently, particularly as doing so “would allow TOs to artificially move costs to an area where they are less exposed to overspends, in order to profit on the area where they receive most from underspends".
Ofgem says it will continue to use a flat TIM for gas networks, with the sharing factors set at 50% for all gas distribution networks and 39% for the sole gas transmission network National Gas. These rates are pretty much the same as they are under the current price controls.
TOs lack ambition on losses
Ofgem’s draft determinations also reveal that the regulator is disappointed by a lack of ambition within transmission operators’ business plans towards tackling electricity losses.
Specifically, the regulator calls out National Grid and SSEN for failing to provide detail on tackling losses within their respective plans. It adds that while losses are estimated to increase significantly during the RIIO3 period, it is still unable to put an exact figure on anticipated losses due to a lack of detail in National Grid and SSEN’s plans.
Scottish Power has forecasted a 335,876 MWh annual increase in losses, equivalent to 37%, by the end of the price control. It has committed to reducing losses on its network by an estimated 4,781 MWh.
While National Grid committed to implementing a strategy to efficiently manage both technical and nontechnical energy losses, SSEN said it would reduce the carbon intensity of transmission losses on its network by 50% by 2030.
Ofgem’s documents add: “The TOs also noted some forecasting uncertainties and areas for improved measurement. Current uncertainties limit insight into what opportunity there is for the TOs to influence losses.”
