National Grid 2016 Annual Report Download - page 178

UK Regulation
Our licences are established under the Gas Act 1986 and Electricity
Act 1989, as amended (the Acts). They require us to develop,
maintain and operate economic and efficient networks and to
facilitate competition in the supply of gas and electricity in Great
Britain (GB). They also give us statutory powers. These include
the right to bury our pipes or cables under public highways and
the ability to use compulsory powers to purchase land so we can
conduct our business.
Our networks are regulated by Ofgem, which has established price
control mechanisms that set the amount of revenue our regulated
businesses can earn. Price control regulation is designed to make
sure our interests, as a monopoly, are balanced with those of our
customers. Ofgem allows us to charge reasonable, but not excessive,
prices. This gives us a future level of revenue that is sufficient to meet
our statutory duties and licence obligations, and makes a reasonable
return on our investment.
The price control includes a number of mechanisms designed to
help achieve its objectives. These include financial incentives that
encourage us to:
• efficiently deliver by investment and maintenance the network
outputs that customers and stakeholders require, including
reliable supplies, new connections and infrastructure capacity;
• innovate in order to continuously improve the services we give
our customers, stakeholders and communities; and
• efficiently balance the transmission networks to support the
wholesale markets.
Our UK Electricity Transmission (UK ET), UK Gas Transmission
(UK GT) and UK Gas Distribution (UK GD) businesses operate under
eight separate price controls in the UK. These comprise two for our
UK ET operations, one covering our role as transmission owner (TO)
and the other for our role as system operator (SO); two for our UK GT
operations, again one as TO and one as SO; and one for each of our
four regional gas distribution networks. While each of the eight price
controls may have differing terms, they are based on a consistent
regulatory framework.
In addition to the eight price controls, there is also a tariff cap price
control applied to certain elements of domestic metering and daily
meter reading activities carried out by National Grid Metering.
Interconnectors derive their revenues from sales of capacity to users
who wish to move power between market areas with different prices.
These sales revenues are called congestion revenues because
market price differences result from the congestion on the finite
interconnector capacity, which limits full price convergence. European
legislation governs how congestion revenues may be used and how
interconnection capacity is allocated. It requires all interconnection
capacity to be allocated to the market through auctions.
There are a range of different regulatory models available for
interconnector projects. These involve various levels of regulatory
intervention ranging from fully merchant (the project is fully reliant
on sales of interconnector capacity) to cap and floor (where sales
revenues above the cap are returned to transmission system users
and revenues below the floor are topped up by transmission system
users, thus reducing the overall project risk).
The cap and floor regime is now the regulated route for interconnector
investment in GB, which sits alongside the exemption route (whereby
project developers apply for exemptions from aspects of European
legislation).
RIIO price controls
On 1 April 2013, Ofgem introduced a new regulatory framework
called RIIO (revenue = incentives + innovation + outputs), with the first
price control agreed under the new framework lasting for eight years.
The building blocks of the RIIO price control are broadly similar to
the historical price controls used in the UK. However, there are some
significant differences in the mechanics of the calculations.
How is revenue calculated?
Under RIIO the outputs we deliver are clearly articulated and are
integrally linked to the calculation of our allowed revenue. These
outputs have been determined through an extensive consultation
process, which has given stakeholders a greater opportunity
to influence the decisions.
There are six output categories:
Safety: ensuring the provision of a safe energy network.
Reliability (and availability): promoting networks capable of
delivering long-term reliability, as well as minimising the number and
duration of interruptions experienced over the price control period,
and ensuring adaptation to climate change.
Environmental impact: encouraging companies to play their role
in achieving broader environmental objectives – specifically, facilitating
the reduction of carbon emissions – as well as minimising their own
carbon footprint.
Customer and stakeholder satisfaction: maintaining high levels
of customer satisfaction and stakeholder engagement, and improving
service levels.
Customer connections: encouraging networks to connect
customers quickly and efficiently.
Social obligations (UK GD only): extending the gas network
to communities that are fuel poor where it is efficient to do so,
and introducing measures to address carbon monoxide
poisoning incidents.
Within each of these output categories are a number of primary and
secondary deliverables, reflecting what our stakeholders want us to
deliver over the coming price control period. The nature and number
of these deliverables varies according to the output category, with
some being linked directly to our allowed revenue, some linked to
legislation, and others having only a reputational impact.
Ofgem, using information we have submitted, along with independent
assessments, determines the efficient level of expected costs
necessary to deliver them. Under RIIO this is known as totex, which
is a component of total allowable expenditure, and is the sum of what
was defined in previous price controls as operating expenditure
(opex), capital expenditure (capex) and, in UK GD controls, mains
replacement expenditure (repex).
A number of assumptions are necessary in setting these outputs,
such as certain prices or the volumes of work that will be needed.
Consequently, there are a number of uncertainty mechanisms within
the RIIO framework that can result in adjustments to totex if actual
prices or volumes differ from the assumptions. These mechanisms
protect us and our customers from windfall gains and losses.
Where we under- or over-spend the allowed totex for reasons that
are not covered by uncertainty mechanisms, there is a sharing factor.
This means the under- or over-spend is shared between us and
customers through an adjustment to allowed revenues in future years.
This sharing factor provides an incentive for us to provide the outputs
efficiently, as we are able to keep a portion of savings we make,
with the remainder benefiting our customers.
This sharing factor is one of the ways that RIIO has given innovation
more prominence. Innovation includes traditional areas such as new
technologies, as well as the broader challenge of finding new ways
of working to deliver outputs more efficiently. This broader challenge
has an impact on everyone in our business.
176 National Grid Annual Report and Accounts 2015/16 Additional Information
The business in detail continued