Ofgem/Ofgem E-Serve 9 Millbank, London SW1P 3GE www.ofgem.gov.uk

ED1 Price Control Financial Handbook

First publication: X 3 February 2015 Contact: Ofgem Regulatory Finance Team

Effective date: 1 April 2015 Tel: 020 7901 7000

Version 1.0 Email: regfinance@ofgem.gov.uk

Overview:

This is the ED1 Price Control Financial Handbook which forms part of Charge Restriction

Condition 4A (Governance of ED1 Price Control Financial Instruments) of the electricity

distribution licence held by each electricity distribution network operator that is a

Distribution Services Provider.

This document consists of:

a) a description of the ED1 Price Control Financial Model (PCFM) and the Annual

Iteration Process for it, used to update the licensees Opening Base Revenue

Allowances during the course of the RIIO-ED1 Price Control Period;

b) an overview of the ED1 Price Control Financial Methodologies under which

revisions to the variable values in the PCFM are determined for the Annual

Iteration Process, in accordance with the Charge Restriction Conditions of the

Licence; and

c) a series of chapters containing the detailed methodologies relating to the

revision of PCFM Variable Values.

The procedures relating to modification of this Handbook and the PCFM are contained in

Charge Restriction Condition 4A.

An up to date version of this handbook and the PCFM (in Microsoft Excel format) can be

accessed on the Ofgem Website.

mailto:regfinance@ofgem.gov.uk

ED1 Price Control Financial Handbook

1

Context

The RIIO-ED1 price control arrangements are the first, in respect of electricity

distribution, to apply Ofgems RIIO framework (Revenue = Incentives +

Innovation + Outputs). The aim of the RIIO approach is to incentivise network

owners and managers to achieve the outputs needed to deliver sustainable

energy networks at value for money for existing and future consumers.

The RIIO-ED1 price control period is longer than the previous electricity

distribution price control (the DPCR5 Price Control), running for eight years

instead of five. This provides for a longer period of price control arrangements

with the aim of facilitating improved strategic planning and a long-term approach

to electricity distribution infrastructure management.

Under the DPCR price controls, base revenue allowances were set up-front for

the whole of the price control period, changing only with RPI indexation, requiring

certain adjustments to reflect activity levels and varying financial conditions to be

left until the subsequent five-yearly review. Under RIIO-ED1, these adjustments

to base revenue, along with RPI indexation, will be made each year in respect of

the licensees network business.

This new approach involves an annual iteration of the ED1 Price Control Financial

Model using updated variable values. This gives rise to a requirement for licence

conditions and methodologies to govern the determination of revised PCFM

Variable Values and the Annual Iteration Process.

This document, The ED1 Price Control Financial Handbook, which forms part of

Charge Restriction Condition 4A (Governance of ED1 Price Control Financial

Instruments), sets out the methodologies for the revision of PCFM Variable

Values. Up-to-date copies of both the handbook and the ED1 Price Control

Financial Model will be maintained on the Ofgem Website.

Associated documents

a. Strategy decision for the RIIO-ED1 electricity distribution price control

http://www.ofgem.gov.uk/Pages/MoreInformation.aspx?docid=120&refer=Networks/ElecDist/PriceCntrls/riio-ed1/consultations

b. Strategy decision for RIIO-ED1 - Financial issues

https://www.ofgem.gov.uk/ofgem-publications/47071/riioed1decfinancialissues.pdf

c. ED1 PCFM

www.ofgem.gov.uk search term ED1 PCFM

http://www.ofgem.gov.uk/Pages/MoreInformation.aspx?docid=120&refer=Networks/ElecDist/PriceCntrls/riio-ed1/consultationshttp://www.ofgem.gov.uk/Pages/MoreInformation.aspx?docid=120&refer=Networks/ElecDist/PriceCntrls/riio-ed1/consultationshttp://www.ofgem.gov.uk/Pages/MoreInformation.aspx?docid=120&refer=Networks/ElecDist/PriceCntrls/riio-ed1/consultationshttps://www.ofgem.gov.uk/ofgem-publications/47071/riioed1decfinancialissues.pdfhttp://www.ofgem.gov.uk/

ED1 Price Control Financial Handbook

2

Contents

Introduction .................................................................................. 7 Terms used in this handbook ..................................................................... 8

1. The ED1 Price Control Financial Model and the Annual Iteration Process ........................................................................................ 10

Section 1 - Overview .............................................................................. 10 Price base .......................................................................................... 10 Temporal convention ........................................................................... 12

Section 2 - The PCFM and the Annual Iteration Process ............................... 12 Section 3 - The ED1 Price Control Financial Model Working Group ................ 16

Terms of reference ............................................................................. 17

2. The ED1 Price Control Financial Methodologies ...................... 19 Methodologies in this handbook ............................................................ 19 Processing of different types of PCFM Variable Value under the Annual

Iteration Process ................................................................................ 26

3. Pension Scheme Established Deficit revenue allowances -

financial adjustment methodologies ............................................ 30 Section 1 - Overview .............................................................................. 30

Price control pension principles ............................................................. 30 Pension Scheme Established Deficit ...................................................... 31

Section 2 - Updating Pension Scheme Established Deficit revenue allowances

through the Annual Iteration Process ........................................................ 34 Reasonableness Reviews ..................................................................... 36 Scheme Valuation Data Set .................................................................. 37

Section 3 Pension Scheme Established Deficit revenue allowances ............. 37 Determination of revised EDE values by 30 November 2017 .................... 37 Determination of revised EDE values by 30 November 2020 .................... 45 Direction of revised EDE values ............................................................ 51

Section 4 - Processing of revised EDE values under the Annual Iteration Process

........................................................................................................... 51

4. Tax liability allowances - financial adjustment methodologies 52 Section 1 - Overview .............................................................................. 52

Annual Iteration Process ...................................................................... 52 Price bases for tax calculations ............................................................. 53 Regulatory tax losses .......................................................................... 54 Group tax arrangements...................................................................... 54

Section 2 - Adjustments driven by tax trigger events - methodology ............ 54 Tax trigger events .............................................................................. 55 Materiality threshold and deadband ..................................................... 55 Notification of tax trigger events ........................................................... 56 Logging of trigger events ..................................................................... 59 Determination and direction of revised TTE values .................................. 59

Section 3 - Adjustments driven by Gearing levels and corporate debt interest

costs (tax claw-back) - methodology ...................................................... 61 Determination and direction of revised TGIE values ................................ 61 Direction of TGIE values ...................................................................... 64

Section 4 - Processing of revised PCFM Variable Values under the Annual

Iteration Process .................................................................................... 64

ED1 Price Control Financial Handbook

3

5. Corporate debt allowed percentage cost - financial adjustment methodology ............................................................................... 66

Section 1 - Overview .............................................................................. 66 Tromboning of index averaging period for corporate debt cost percentage

calculations ........................................................................................ 66 Section 2 - Methodology for determining revised PCFM Variable Values for the

cost of corporate debt ............................................................................ 66 Non-availability of iBoxx or Bank of England data ................................... 69

Section 3