Utility regulation – Changes afoot

08 Aug 2022 / Insight

By Nigel Hawkins

Download the report
utility regulation

Patching up a tainted model

Executive summary

  • While the gas supply crisis – and its price implications – have dominated the UK price regulated sectors in recent months, other issues have arisen that have seriously tainted the price regulation system itself. Indeed, it is fair to ask whether it is ‘’fit for purpose’’.
  • Back in 1984, price regulation, via an unsophisticated RPI-x formula, was introduced to prevent the privatised British Telecom (BT) from abusing its market power. A similar price regulatory formula applied to British Gas, which was privatised in 1986. In the latter’s case, a full “cost pass through” (CPT) mechanism was permitted so that end users directly bore the cost of higher gas input prices.
  • More than 35 years later, we have turned full circle, with a new energy price cap being set at £1,971 for households on a default tariff – some 22m consumers. By October 2022, that figure is expected to exceed a shocking £3,200. Admittedly, for a regulatory regime to absorb such a massive turnaround in input costs, is unprecedented; in time, the cap should fall back.
  • Ofgem has just announced a review of the existing electricity market arrangements, in which gas prices play a pivotal price-setting role, especially at the margins. The electricity distribution review is also under way for the 14 Distribution Network Operators (DNOs). It will be applied between April 2023 and March 2028. With most of the DNOs now part of larger companies, the financial impact of the distribution review will be far less wide-ranging than was the case in the mid-1990s.
  • Although the intervention of the Competition and Markets Authority (CMA), as the appeal body, in adjusting Ofwat’s Weighted Average Cost of Capital (WACC) for the 2019/20 periodic review was widely – and rightly – criticised, not least by Ofwat itself, the latter is already undertaking preparatory work for the 2024/25 periodic review. A 25-year capex span is planned, with storm overflow issues assuming higher priority than previously. Leakage levels will also be to the fore.
  • On the telecoms front, rolling out broadband is crucial, as the COVID-19 experiences highlighted, especially for enhancing work-from-home (WFH) opportunities. However, BT’s RPI+3.9% pricing formula seems very generous, all the more so with current inflation being close to 10%. Hence, broadband bills will rise sharply. In time, Ofcom may have to intervene and curb such increases, especially if high inflation persists.
  • Heathrow Airport has become a new regulatory battleground – memories of the long-running Battle of Transco in the 1990s between Ofgas and the then British Gas abide. As today’s ringmaster, the Civil Aviation Authority (CAA) is trying to adjudicate between the highly geared Heathrow Airport, which is seeking to ramp up landing charges, and the airlines, which are seeking far more modest increases. The gap between the protagonists remains very wide.