Ofgem’s RIIO-ED3 SSMC

On 8 October 2025, Ofgem published its Sector Specific Methodology Consultation (SSMC) for the forthcoming RIIO-ED3 (ED3) price control for GB electricity distribution networks. We look at some of the key themes emerging from the consultation ahead of the final methodology decision, which is expected to be published in December of this year.

The current price control for the electricity distribution sector (ED2) is due to end in March 2028, with the ED3 regulatory period starting on 1 April 2028 and running for five years up to 31 March 2033.¹ Prior to this SSMC, Ofgem published its ED3 Framework Decision in April 2025, setting out the regulatory framework for the upcoming ED3 price control.²

The UK plans to decarbonise its power system by 2030 and achieve a net zero economy by 2050. The ED3 price control is an essential enabler of investment and development of the distribution network infrastructure that is needed to enable the electrification of heat, transport and industry, thereby supporting the transition to net zero. As such, investment will be required in anticipation of a steep increase in electricity demand and volumes of distributed generation, as is expected over the next five to ten years.

As with price controls in electricity transmission (ET3) and gas distribution and transmission (GD and GT3), Ofgem must establish an ED3 price control that offers sufficient certainty to companies, investors, customers and other stakeholders. At the same time, the framework must remain flexible enough to accommodate the evolving demands of the energy transition.

Owing in part to the timing of the ED3 period—following the draft determinations for ET3, GD3 and GT3—the ED3 SSMC presented a notably greater level of detail than previous iterations, such as the ED2 or the ET3 and GD&T3 SSMCs. This reflects both the increasing complexity of the energy transition and the growing importance of robust regulatory design and investor certainty in supporting the UK’s decarbonisation objectives.

Efficiency and cost assessment

The SSMC builds on Ofgem’s ED3 Framework Decision, setting out a more detailed approach to assessing efficient costs. It has proposed to consider a wide range of alternative methodologies, drawing on precedents from other sectors as well as theoretical approaches. Notably, the Competition and Markets Authority (CMA) in its provisional redeterminations of Ofwat’s PR24 final determination explored novel and more sophisticated techniques in the cost assessment process, deviating from established regulatory precedents in this area. The most striking proposed changes in the SSMC related to the construction of the TOTEX models, which have historically differed from the modelling suite used in the ET, GD and GT sectors. We outline the most relevant changes below.

The use of new cost drivers

Compared with ED2, Ofgem’s consultation on the use of new cost drivers in the TOTEX models is considerably more extensive, which suggests that it has already undertaken an initial assessment of a wide range of alternatives. Among the proposed metrics is a ‘units distributed’ variable, which is intended to better capture load impacts (similar to peak demand) while also accounting for increases in Low Carbon Technologies (LCTs) over time. Additional complexity drivers under consideration include the ‘share of overhead network length’, the ‘share of high-voltage network’ and ‘population density’. The latter builds on previous attempts during ED2 to introduce a density metric and takes the form of a Weighted Average Density (WAD) variable, similar to that adopted by Ofwat at PR24. Lastly, Ofgem is also proposing a set of activity-based drivers, such as ‘assets additions MEAV’ to capture the DNOs’ CAPEX programmes, ‘number of unlooped properties’ and ‘number of new connections’.

The use of Composite Scale Variables (CSVs)

In contrast to ED2, where CSVs derived using both top-down and bottom-up methods served as primary cost drivers across all three TOTEX models, Ofgem proposes to consider a larger set of models, each incorporating different cost drivers separately.

The final allowances would be determined through triangulation across these models similar to Ofwat’s approaches since PR14. Ofgem notes that this change could simplify the interpretation of coefficients, as variables would be assessed separately, and reduce the need for assumptions on the relative importance of multiple drivers (which would no longer need to be weighted within a CSV). The downside of an increase in the number of models is also being considered and consulted upon.

It is notable that the CMA has significantly reduced the number of models used in its provisional redeterminations—for example, on wholesale water, the number of models has fallen from 24 under Ofwat’s approach to just two. However, similarly to Ofwat, the CMA treats the different cost drivers separately rather than combining them into a composite, with the individual cost drivers being identified through a mechanistic statistical approach.

The move to middle-up modelling

Alternative mid-level models are also being proposed as a way to bridge the gap between the current TOTEX and disaggregated models. These models broadly align with the main categories used in the ED cost reporting—such as load-related CAPEX, non-load-related CAPEX, non-operational CAPEX, Network Operating Costs (NOC), Closely Associated Indirects (CAI) and Business Support Costs (BSC)—and effectively ‘aggregate’ disaggregated models into a smaller number of multi-driver econometric models while retaining the underlying operational rationale.

Within Ofgem’s proposed modelling suite, mid-level models would sit under the broader ‘disaggregated models’ category, which carries a 50% overall weight, with the remaining 50% allocated to TOTEX models. Accordingly, middle-up and bottom-up models would each account for 25% of the total weighting.

The application of workload adjustments

At ED2, workload adjustments were applied only within the disaggregated models, while TOTEX models did not incorporate such adjustments. The demand-driven post-modelling adjustment was the only exception, which Ofgem is intending to remove in ED3.³

For ED3, Ofgem aims to ensure that, whenever possible, efficient allowances are determined on a comparable basis, in terms of both workload and outputs, aligning with the approach adopted at GD2 and GD3.

Other cost assessment issues

Additional views were also made regarding the use of historical-only data in modelling, alternative specifications for time effects, and the potential adoption of random effects estimation. Collectively these developments could result in materially different modelling framework from the ED2 precedent, where none of these alternatives was applied. By contrast, less change appears to be envisaged for the disaggregated models, which are expected to build directly on the ED2 formulations.

Uncertainty and incentives

Ofgem’s ED2 toolkit of uncertainty mechanisms included a combination of the TOTEX Incentive Mechanism (TIM), volume drivers, use-it-or-lose-it (UIOLI) allowances, pass-through costs and re-openers. While acknowledging the need for these tools in ED3, the SSMC is also consulting on changes to their current design, especially in terms of a reduction in their scope of use.

Such changes are rooted in the expected development of Regional Energy Strategic Plans (RESPs) and, more generally, in the ED3 Framework Decision. In the latter, Ofgem set an expectation for the development of long-term, proactive and integrated network development plans.

In particular, the main proposals concern:

• bringing pass-through costs (especially where partly under DNOs’ control) within baseline allowances, hence including them in the cost benchmarking process. This would couple with the adoption of a ‘generic’ pass-through category, allowing flexibility in including costs that were not initially anticipated;
• reducing the scope of application of volume drivers, primarily as a consequence of the move to a more proactive planning approach, with allowances set ex ante;
• similarly, reducing the number of re-openers following the additional certainty provided by strategic planning and the ex ante setting of network investments. In line with the RIIO-3 framework, the introduction of a new resilience re-opener is also proposed.

Consistently with these changes, the incentives framework included in the SSMC presents a strong focus on planning, delivery and efficiency. As stated by Ofgem, ‘a strategically planned and funded approach to network investment is only effective if it is matched by robust delivery’.⁴

In particular, the SSMC presents a Business Plan Incentive (BPI) that, while similar to the structure developed in RIIO-3, is centred on the elements of the business plans that are most relevant to ED3 outcomes (for example, incentivising early investment proposals from companies). Moreover, while Ofgem maintains that the TOTEX Incentive Mechanism (TIM) will continue to apply to the totality of TOTEX, we also note increased conditionality of TIM application on delivery, particularly through the introduction of a greater number of Price Control Deliverables (PCDs) and new mechanisms incentivising delivery. In particular, in addition to potential financial penalties in case of non-delivery of capital projects, PCDs would allow Ofgem to adjust TOTEX, thus removing the benefit of sharing underspends through the TIM, in case of non-delivery of outputs.

Climate resilience

While Ofgem recognises that climate change is already affecting the resilience of energy networks, it considers that there have been no robust, agreed metrics that capture how well network operators prepare for, withstand, and recover from climate-related hazards. According to Ofgem, existing indicators, such as Customer Minutes Lost, often exclude the outages due to severe weather events and therefore underestimate the impact of climate-related events, whereas the Network Asset Risk Metric (NARM) lacks a clear focus on climate resilience.

To address this, Ofgem is proposing the introduction of a Climate Resilience Metrics and Indicators (CRMI) framework, which has been developed following engagement with the industry. This framework is expected to be instrumental, alongside NARM, in informing investment decisions and the development of business plans, considering long-term climate scenarios and relying on adaptation pathways.

The CRMI would rest on three objectives:

1. capturing resilience theory and hazards, with metrics reflecting resilience phases across both acute shocks (i.e. severe events) and chronic changes;
2. ensuring comparability across networks, relying on indicators controlling for both physical and operational resilience, and which account for new risks arising from the net zero transition;
3. deliverability, with metrics that are practical, affordable and resistant to gaming, and ideally build on existing tools such as stress-testing.

The initial focus of the consultation is on the development and roll-out of a suite of indicators, rather than a single composite metric. The next steps will include further stakeholder engagement and refinement of candidate metrics, followed by pilot data collection and testing.

Financial parameters

In relation to the cost of capital allowances, Ofgem has largely reiterated the methodologies set out in the ET3 and GD&T3 SSMD and DDs.

This is the case for the cost of equity, although, at this stage, Ofgem leaves a few methodological choices open. For example, Ofgem does not specify a beta comparator sample, but rather states that it intends to keep UK water and energy companies in the sample and may consider including relevant other European utility comparators—consistently to the approach that it applied in ET3 and GD&T3 DDs.⁵ Another example is that Ofgem continues to reserve the right to adjust the RPI–CPIH inflation wedge in estimating the risk-free rate, to take into account the higher OBR long-term forecast of the CPIH–CPI wedge.⁶ As both the cost of debt allowance in relation to index-linked debt and the risk-free rate allowance are expressed in CPIH-real terms, a higher CPIH assumption would lower these allowances in CPIH-real terms.

Ofgem’s discussion of investability is brief, with a proposed approach in line with the ET3 and GD&T3 SSMD and DDs.

Both for the proposed cost of debt and cost of equity methodologies, Ofgem’s approach is broadly aligned with the methodology established for ET3 and GD&T3. The cost of debt allowance is proposed to be set in semi-nominal terms, calibrated to the forecast sector-average and then annually set in line with the trailing average of the iBoxx GBP non-financial A/BBB 10+ indices. Notably, Ofgem has committed to using this index instead of iBoxx Utilities 10+ as used in RIIO-2—a detail that Ofgem specified only at the DDs stage for other sectors.⁷ Ofgem has not specified at this stage whether it would calibrate the index against the ED sector or would take other sectors into account. In line with the approach for ET3, Ofgem is proposing to apply RAV weighting, to account for the significantly greater amounts of debt that DNOs may be expecting to raise compared with historical issuances.⁸ While no infrequent issuer premium for smaller networks has been allowed in ET3 and GD&T3 at the DDs stage,⁹ Ofgem continues to consider whether this allowance should be provided, and the size of the allowance for ED3.¹⁰ Ofgem will continue to provide allowances for additional costs of borrowing and is reviewing whether the methodology from ED2 will need to be updated in line with the approach in ET3 and GD&T3.

On financeability, Ofgem has largely proposed a financeability assessment approach that is broadly consistent with the DDs. Key highlights include:

• incorporating long-term modelling into the financeability assessment using the extended form of the Price Control Financial Model (PCFM), as established in the RIIO-3 DDs;¹¹
• assessing financeability on both baseline TOTEX allowances and additional TOTEX allowed through variant ex post expenditure.¹²

Ofgem is also considering potential incremental improvements to the financeability assessment for ED3 as compared with ED2, in line with the changes introduced in the ET3 and GD&T3 DDs. These include refining the calculation of simulated credit ratios, incorporating additional credit metrics from S&P and Fitch, assessing broader indicators of equity cost such as dividend yield expectations, and reviewing the equity issuance cost allowance.¹³

Depreciation profile is a key area for discussion in ED3, as depreciation policies affect cash flows over multiple price control periods and influence how the costs of the ambitious investment programme are shared between current and future customers. At this stage, Ofgem has not proposed any specific depreciation policy, but has commissioned a review of depreciation in ED3 to build its evidence base ahead of the ED3 Sector Specific Methodology Decision (SSMD).

Next steps

Stakeholders have until 3 December 2025 to respond to Ofgem’s SSMC, in terms of commenting on Ofgem’s proposals and contributing to its thinking.

Ofgem will then finalise its Sector SSMD and issue its business planning guidance. In the SSMD, which will also be influenced by developments in both the RIIO-T3 and GD3 Final Determinations (FDs) and the PR24 CMA redeterminations, we expect early view estimates on the cost of capital, as well as a more defined position of the preferred approaches to be proposed for cost assessment at ED3.