Energy companies network costs estimate 10 times larger than Ofgems
Government plans to upgrade the electricity and gas grid could add as much as £180 to energy bills over the next decade, according to a report promoted by the energy industry last week. But energy regulator Ofgem suggests the cost could be less than a tenth of that.
At its annual conference last week, industry body Energy UK presented the conclusions of a report that suggests the costs of transporting electricity and gas will increase by more than 50 per cent by 2020.
The claim comes from financial services company UBS. Ofgem – which sets controls on the amount of money network operators can charge suppliers to use the grid, projects that network costs will go up by just a fraction of UBS’s prediction, however.
How network costs work
Energy suppliers pay to transport electricity and gas around the country using the electricity networks and the gas grid. The money is paid in the form of rent to the companies that own the grid.
National Grid is the best known of these companies, but it doesn’t own the whole grid. It owns and operates the main electricity and gas transmission ‘highways‘, while smaller companies distribute the electricity and gas directly to homes and businesses through regional networks.
Contrasting predictions for rising network costs
The rents the network companies charge suppliers have been rising, because more money is needed to renew ageing parts of the network, replace old gas mains and connect up low carbon energy sources like windfarms. But there is disagreement about how much network costs will go up in the future.
UBS’s report doesn’t give a specific figure for future network cost rises. But based on a graph from the report, it looks like UBS thinks they will increase by about £180 between now and 2020:
Image - Screen Shot 2013-11-22 At 15.18.53 (note)
Source: UBS report , UK Utilities: Freezing energy tariffs without the gimmicks, November 2013. The blue bar shows the impact of network costs on the average household energy bill. It appears to rise from about £300 to about £480 between 2013 and 2020.
Ofgem makes a very different estimate, however. It suggests network costs will rise by £15 over the next twelve months, and then remain stable until the rest of the decade. That’s quite a difference.
UBS includes inflation, Ofgem doesn’t
So why has UBS come up with such a different figure to Ofgem? The first thing to note is that UBS’s estimate includes inflation, and Ofgem’s doesn’t.
Earlier in the year, energy supplier RWE Npower predicted that network costs will go up by £114 between 2013 and 2020. UBS has taken the figure and added inflation at 2.75 per cent a year, according to its lead author, Stephen Hunt.
Even excluding inflation, RWE Npower’s prediction that network costs will rise by £114 by the end of the decade is still seven times larger than Ofgem’s prediction they will rise by £15 over the same period. Why?
Ofgem’s price controls
There’s one good reason why Ofgem’s estimate might be more accurate. It sets price controls on the amount of money that network operators can charge suppliers. Networks are ‘natural monopolies’ – in other words, there is no realistic way of introducing competition to the sector – so Ofgem imposes limits on the rent the networks can charge instead.
Earlier this year, Ofgem agreed a set of controls with network operators, covering the period 2013 to 2021. The controls – which allow £30 billion of investment in the grid between now and the end of the decade – are based on business plans network operators submitted to the regulator, which explain how they plan to make the necessary investment and keep costs down.
Today, Ofgem gave more information on another set of controls covering 2015 to 2023. It told five of the six electricity distribution companies to change their business plans in order to bring costs down over the next few years.
Ofgem doesn’t limit how much money suppliers pass on to consumers as a result of having to pay more rent to network operators. Its estimate for the impact on consumer bills is based on modelling – and doesn’t tell us much about what individual companies might do. But the price controls mean it has looked at the costs in great detail, so it would be surprising if its projections were far off the mark.
Is Ofgem being optimistic?
It’s still possible Ofgem is being optimistic. Can network companies really make major investments in infrastructure and the network grid, while keeping network costs down?
The regulator tells Carbon Brief there are two reasons why its prediction is realistic. First, it is allowing network companies to spread the cost of investment in new assets over a long time period. Network operators could pay for new infrastructure now, but then pay for that by raising rents over 45 years. This reduces the impact on bills by spreading the cost over a long time period.
Second, Ofgem says its price controls have given companies more certainty. This means they can borrow money from investors at a lower rate, making the whole process cheaper.
Is Npower being pessimistic?
We’ve asked Npower to tell us why its estimate is so different. The company gave us two reasons.
First, Npower explains that its report assumes no demand reduction as a result of energy efficiency measures. It therefore assumes that more electricity and gas is flowing through the grid than Ofgem does, and therefore that network charges are higher.
Second, it says Ofgem had not yet published any information on the new price controls for electricity distribution companies in July, when the report was launched. These were published today.
The predictions are STILL very different
Npower’s explanation doesn’t really seem to account for the difference between the two projections. The price controls announced today for electricity distribution companies don’t look like they will have a significant impact on bills. And while excluding energy efficiency will make some difference, it shouldn’t increase the figure by such a large amount.
In conversation with Carbon Brief, UBS’s Stephen Hunt suggested a few further reasons why Ofgem’s prediction could be wrong. The planned investment programme will increase the values of network companies’ assets by around 50 per cent by 2020, argues Hunt.
Ofgem controls the rents network operators can charge, but not the absolute amount of money they make. So if the value of infrastructure network companies own goes up, so does the amount of money they will make. Given the increasing uncertainty in required network investment up to 2020, higher investment levels would lead to higher costs than Ofgem forecast.
Second, Hunt says a large proportion of the new investment will go into maintaining and upgrading old infrastructure – not building it. Investment in existing infrastructure has a shorter 20-year payback period, which Hunt says won’t reduce consumer costs in the short-term.
Based on this, Hunt says he finds it difficult to see how Ofgem’s prediction of flat network costs in real terms can be achieved.
What the contrasting predictions mean for the energy debate
At Energy UK’s annual conference last week, energy minister Ed Davey implied that the ‘big six’ energy companies are using their customers as “cash cows” to be milked for profits. Angela Knight, chief executive of Energy UK, responded that the minister was wrong. She said consumer bills are expected to go up by 46 per cent by 2020 – and 95 per cent of that rise will be caused by government policy.
The two claims comes from the UBS report. But if the rise in network costs is closer to Ofgem’s estimate, then the total increase in bills will be smaller. When we asked Energy UK what it thought of the difference between UBS’s projection and Ofgem’s, it told us it’s “not best placed to comment on the differences between the two reports”.
In defending themselves against accusations of excess profits, energy companies have an interest in talking up the costs imposed by government measures and market fluctuations. But in doing so, they probably need to provide a more detailed explanation of why their numbers differ so markedly from the market regulators’.
Npower has said it will give us more information, but hasn’t yet done so. We will update this blog if and when it does.