Select Committee on Trade and Industry First Report



Criticisms of the RPI-X form of regulation

  42. Criticisms of RPI-X regulation have centred around the implementation and operation of the formula, the main ones being:

    --   the RPI-X caps "have not been tough enough";[72] that the high levels of profits and returns achieved by the companies have not been consistent with a fair distribution of benefits between the shareholders and customers;[73]

    --   the disadvantage that the regulator faces in obtaining accurate information about the company's efficient level of forward-looking costs gives the company scope to obscure the picture leading to a built-in tendency to set price caps which are too lax;[74]

    --   any mistakes made in the setting of prices carry a risk of being magnified by the length of time for which the price control is set. [75]

  43. Both the energy regulators argue that the high levels of profits were confined to the initial controls set by the Government on privatisation.[76] The Eastern Group claimed that the Government set the price caps at a level which would make the flotations attractive to investors, that the price caps tended to understate the possible efficiency gains and that the caps were not set on the basis of detailed comparative and evaluative exercises fundamental to subsequent periodic reviews.[77] Both energy regulators believe the net result was that the initial price controls unduly favoured shareholders over customers.[78] We agree, though we find it hard to see how it would have been possible prior to flotation to have accurately estimated likely efficiency gains.

  44. In subsequent price reviews the energy regulators have set progressively more stringent price controls, partly because they have become more experienced at operating RPI-X controls, and partly because they have accumulated historic data to help them. [79] At the same time it is becoming increasingly challenging for companies to make continuing efficiency savings and, according to National Power, it will become increasingly difficult for companies to beat X.[80] The evidence suggests that the second and subsequent reviews appear to have passed on a proportion of the out-performance of the first period thus redressing to some extent the balance between shareholders and consumers.[81]

  

  45. However, the GCC is "convinced that the consumer still pays too much for gas" partly because the Council believes that TransCo's costs are inflated.[82] United Gas suggested that some 50% of TransCo's costs are charged in from other parts of the organisation.[83] OFGAS admitted that it was "very suspicious that those [TransCo's] figures are inflated".[84] We received no evidence of equivalent concern about NGC. However, the issue here is not the use of the RPI-X formula in principle, but of the valuation of assets and getting the X factor right. The DGES is of the view, that "to the extent that there has been public concern, it seems to have focused on a sub-set of controls of a sub-set of companies in one particular industry, namely the initial and subsequent distribution price controls of the regional electricity companies in England and Wales". This suggests that any problems with price controls are likely to be "associated with the specific circumstances and treatment of those particular businesses, both at flotation and subsequently, rather than being a generic problem associated with RPI-X price controls for regulated monopolies".[85]

  46. With regard to claims that TransCo's cost are inflated, the DGGS told us that "we have never got to the bottom of the charges that British Gas Corporate Centre charges to TransCo or to the public gas supply business".[86] This matter has now been referred to the MMC. This raises a fundamental issue about the amount of information on the regulated business to which the regulator should have access. If the regulator had access to all information available to a regulated company when setting the X factor, the likelihood of forecast performance being exceeded by dint of lower-than-agreed capital and/or operating expenditure could be avoided. While performance better than foreseen by the regulator may be redressed in the following price control round, we do not find it satisfactory that calculating the value of X is, in part, a function of incomplete information. Short-term gain for shareholders through obfuscation is not acceptable and regulators should consider what additional powers are necessary to obtain complete and timely information from regulated companies.


72  Mem. p.68. Back

73  Ev. p.209. Back

74  Ev. p.210, 247. Back

75  Ev. p.247. Back

76  Ev. p.247; "Utilities Regulation Consultation for Change", Professor Littlechild, Industry Forum Conference, 1995, p.7. Back

77  Ev. p.210. Back

78  Ev. p.247; "Utilities Regulation Consultation for Change", Professor Littlechild, Industry Forum Conference, 1995, p.7. Back

79  Mem. p.34. Back

80  Mem. p.34. Back

81  Ev. p.210; "Utilities Regulation Consultation for Change", Professor Littlechild, Industry Forum Conference 1995 pp.6-8. Back

82  Q.428. Back

83  Q.103. Back

84  Q.901. Back

85  "Utilities Regulation Consultation Change", Professor Littlechild, Industry Forum Conference, 1995, p.7. Back

86  Q.901. Back


 
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Prepared 18 March 1997