Ofgem's City briefing throws up more questions than answers

Ofgem's City briefing throws up more questions than answers

On July 16, Alistair Buchanan, Ofgem chief executive, opened a briefing for City analysts on current regulatory issues. The briefing shed some light on current issues and outlined some key points of progress, but the Q&A session revealed a lot of suspicion on the part of the analysts, especially regarding the RIIO investment plan.

During the briefing, Ofgem's Retail Market Review was presented as an ongoing project that is already showing progress. The specific example given was SSE's decision to reduce the number of tariffs available from 68 to four and to offer free energy audits, but it was also pointed out that this pattern is being seen from all big suppliers in the UK.

The liquidity proposals were also highlighted as already bringing benefits to the market. The three objectives of the proposals are a liquid short-term market, access to products for smaller suppliers, and effective reference prices for energy. Ofgem claims that these points have already been addressed somewhat. The example given was the noticeable increase in day-ahead trading, which applies to the first two of the three objectives especially. Interestingly, Ofgem said that it intends to leave adhering to liquidity proposals to the market, and that a mandatory auction of up to 25% of energy is to be held back, only to be enacted if suppliers do not comply with the proposals' guidelines.

The mood of the presentation changed as capacity margin forecasts were discussed, including a slow growth forecast predicting that the margin would fall below 5% in 2016 and 2017. This dramatic fall in spare capacity will be caused by the Large Plant Combustion Directive. Indeed, 70% of allowed production hours have already been used because of favorable spark spreads, 10% more than Ofgem had predicted at this point.

Investment in new capacity is also being hampered by the spark spread situation, which is preventing investment in new gas plants. Ofgem also revealed that the expected increase in capacity margin from 2018 onwards is now looking less likely due to the uncertainty around new nuclear projects and the Drax/Siemens biomass facility, while the deployment of new wind capacity is below expectations.

Given that the majority of the audience was from investment banks, the financial aspects of Ofgem's "RIIO" (Revenue = Incentives + Innovation + Outputs) investment plan in transmission infrastructure were also questioned. The gearing ratio, cash flow risks, and return on equity were topics of discussion. Although it is clear that Ofgem is trying to be as transparent as possible, City analysts seemed skeptical whether inflation had been factored in to the right degree and some found the indebtedness was too high to accept, despite Ofgem citing the low cash-flow risk.

More light will be shone on the proposals in the near future when they are published in full, but for now, there are plenty of questions yet to be answered on how the investment in infrastructure will progress up to 2025.