BEFORE THE COMPETITION AND MARKETS AUTHORITY AN APPEAL UNDER SECTION 23B OF THE GAS ACT 1986 BETWEEN: NORTHERN GAS NETWORKS LIMITED Appellant and THE GAS AND ELECTRICITY MARKETS AUTHORITY Respondent NOTICE OF APPEAL GAS DISTRIBUTION LICENCE MODIFICATION RIIO-GD2 PRICE CONTROL Linklaters LLP One Silk Street London EC2Y 8HQ Tel +44 20 7456 2000 Fax +20 7456 2222 Table of Contents Contents Page PART I INTRODUCTION ................................................................................................................... 2 1 Overview ................................................................................................................................. 2 2 Request for permission to appeal ........................................................................................... 2 3 Scope of the Appellant’s appeal .............................................................................................. 2 4 Key documents........................................................................................................................ 3 5 Contact details......................................................................................................................... 3 5.1 Appellant ................................................................................................................................. 3 5.2 Appellant’s address for receipt of documents ......................................................................... 3 5.3 Solicitors to the Appellant ........................................................................................................ 4 6 Structure of this Notice ............................................................................................................ 4 PART II CONTEXT OF RIIO-GD2 AND THIS APPEAL .................................................................... 5 1 Overview ................................................................................................................................. 5 2 Pathway to RIIO-GD2 and incentive-based regulation ........................................................... 5 2.1 The RPI-X regime from 1990-2015 ......................................................................................... 5 2.2 The RIIO-GD1 regime ............................................................................................................. 5 1.1 The RIIO-GD2 regime ............................................................................................................. 6 3 Context to this appeal ............................................................................................................. 6 PART III SUMMARY OF THE GROUNDS OF APPEAL AND RELIEF SOUGHT ........................... 10 1 Overview ............................................................................................................................... 10 2 Appeal Ground 1: Cost of Equity........................................................................................... 10 2.1 Risk-free rate ......................................................................................................................... 10 2.2 Beta ........................................................................................................................................11 2.3 Total market return .................................................................................................................11 2.4 Aiming-up .............................................................................................................................. 12 2.5 Legal consequences ............................................................................................................. 13 3 Appeal Ground 2: Outperformance Wedge .......................................................................... 15 ii 3.1 Legal consequences ............................................................................................................. 16 4 Appeal Ground 3: Ongoing efficiency ................................................................................... 16 4.1 Base ongoing efficiency challenge ........................................................................................ 16 4.2 Innovation uplift ..................................................................................................................... 17 4.3 Legal consequences ............................................................................................................. 18 5 Appeal Ground 4: BPI Stage 4 .............................................................................................. 18 5.1 BPI Stage 4 ........................................................................................................................... 18 5.2 Efficient cost benchmark ....................................................................................................... 19 5.3 Legal consequences ............................................................................................................. 20 6 Consequences for the Appellant ........................................................................................... 20 7 Consequences for customers ............................................................................................... 21 8 Relief Sought ......................................................................................................................... 22 9 The facts and reasons supporting the appeal ....................................................................... 23 PART IV STATUTORY FRAMEWORK ............................................................................................ 24 1 Overview ............................................................................................................................... 24 2 Statutory grounds of appeal .................................................................................................. 24 2.1 Sub-section 23D(4)(a): GEMA failed properly to have regard to any matter in sub-section (2) .............................................................................................................................................. 24 2.2 Sub-section 23D(4)(b): GEMA failed to give the appropriate weight to any of its obligations .............................................................................................................................................. 28 2.3 Sub-section 23D(4)(c): GEMA’s decision was based, wholly or partly, on an error of fact ... 29 2.4 Sub-section 23D(4)(d): The licence modifications fail to achieve, in whole or in part, the effect stated by GEMA .......................................................................................................... 29 2.5 Sub-section 23D(4)(e): GEMA’s decision was wrong in law ................................................. 29 3 Standard of review ................................................................................................................ 30 4 Materiality .............................................................................................................................. 31 5 Relief sought ......................................................................................................................... 32 PART V APPEAL GROUND 1: COST OF EQUITY ......................................................................... 34 1 Overview ............................................................................................................................... 34 iii 2 Framework for setting the cost of equity, NGN’s Business Plan approach and subsequent developments ........................................................................................................................ 38 3 The risks facing GDNs .......................................................................................................... 39 4 GEMA’s errors in its approach to cost of equity .................................................................... 40 4.1 RFR ....................................................................................................................................... 40 4.2 Beta ....................................................................................................................................... 44 4.3 Total Market Return ............................................................................................................... 48 4.4 Setting a point estimate of cost of equity .............................................................................. 52 5 Conclusion ............................................................................................................................. 56 6 Relief sought ......................................................................................................................... 58 PART VI APPEAL GROUND 2: OUTPERFORMANCE WEDGE .................................................... 59 1 Overview ............................................................................................................................... 59 2 GEMA’s approach and decision on the outperformance wedge ........................................... 61 2.1 Development of GEMA’s approach ....................................................................................... 62 2.2 GEMA’s position at Draft Determinations .............................................................................. 62 2.3 GEMA’s position at FD .........................................................................................................