Ofgem softens but Competition and Markets Authority appeals still in prospect

Energy regulator, Ofgem, compromised on the cuts to returns it had proposed for transmission and gas distribution network companies in its draft determinations for when it published final determinations for RIIO-2 last week.


The energy regulator put forward an 18 basis point increase in appointee weighted average cost of capital compared to the draft, as well as a £6bn rise in totex allowances, which left an 8.6% totex gap compared to business plans, down from a 32% gap at the draft stage. Fitch Ratings observed: “This is due to better engineering justifications provided by the companies to Ofgem related to capital spending, replacement expenditure and IT. Furthermore, Ofgem included some of the investments related to net zero in the baseline totex allowances.”


Fitch argued the cuts would still significantly reduce the companies’ cash flows and that: “We anticipate most rated companies will need to implement remedial measures to improve their credit metrics in order to maintain their current ratings.”


RBC commented: “We believe investors were expecting some element of a softening from Ofgem in the FD, especially in the context of the CMA's early view on returns within UK water where it suggested an RoE of 5.08%…We note the allowed RoE of 4-4.3% suggested by Ofgem still sits below the 4.5% we assume in our models (largely due to the outperformance wedge) and is at a significant discount to the early view from the CMA. Therefore, at this stage we cannot rule out an appeal to the CMA from the network operators early.”