The review period
56. The DGGS has set a 5
year price control for British Gas TransCo,[107]
while the DGES has opted for a 4 year duration for transmission
and 5 years for the distribution price controls of electricity.
The DGES believes that a price control period has to be sufficiently
long to give the company a period of relative certainty within
which it can work to reduce costs, and undertake investment, with
the knowledge that the cost savings are not going to be taken
away from it, but not "so long that conditions can change,
so the control can turn out to be far too lax or far too tight".[108]
In his opinion "a period of 4 to 5 years is about the sort
of time".[109]
57. Companies generally
disagreed with this, claiming that they need a longer period to
improve efficiency and undertake investments. The only persuasive
argument for a longer price review period was that put forward
by the NGC. NGC claimed that the "periodic reviews of prices
which the company is allowed to charge for use of its system are
on a far shorter time-scale than the asset lives".[110]
"Accordingly, significant change by the regulator from one
review period to the next of one or more key financial variables
which determine the final RPI-X price control can considerably
undermine the capacity to ensure a stable background for continuing
investment".[111]
We are not convinced. NGC's argument appears to be based essentially
on the lack of consistency in the regulatory framework, particularly
with regard to the calculation of the asset base and the cost
of capital which determines allowed revenue. If the regulator
were to adopt a more consistent approach to calculating NGC's
valuation of assets and allowable revenues (see paras 67 onwards),
then there would be no reason for extending the price control
period beyond 4 or 5 years. In any case there is a risk that,
if the review period were to be extended, there would be greater
temptation to revisit it in between the reviews if any of the
variables or assumptions were to change significantly.
58. NGC argued very strongly
for a 5 rather than a 4 year price review period, during the recent
transmission price control review. After consideration and consultation,
the DGES rejected their proposal and concluded that a 4 year price
review period should remain. His arguments were based on the
fact that there was scope for considerable change in the transmission
business, and there was uncertainty about the level of new competition
entering the market and the level of NGC's non-controllable operating
costs and that he took developments further ahead than 4 years
into account in his price control review.[112]
59. The length of the review
period chosen depends very much on the circumstances within the
industry. For example, with further liberalisation of the gas
and electricity markets, the regulators may think it appropriate
to review some sectors more frequently until the markets settle.
There are nonetheless strong arguments for 5 years in transmission,
particularly as experience is gained with the passage of time
and forecasts improve and the amount of inefficiency remaining
is reduced.
60. There has only been
one occasion when an energy regulator has reconsidered a price
review. The DGES, in March 1995, decided to reconsider distribution
prices less than 12 months after completing the first review but
before the new regime was formally in place. This occurred because
the DGES came to the view that the price control he had proposed
in August 1994 was no longer appropriate, as circumstances had
changed sufficiently since setting the original controls. He
argued that essential new information had come to light concerning
share price movements and the terms of the Trafalgar House bid
for Northern Electric.[113]
The DGES believed that "although re-examining the proposed
controls might increase uncertainty in the short term, I considered
that this was preferable to the risk that, if I did nothing, the
implemented controls might need to be re-opened before the end
of their five year term."[114]
We examined the DGES's decision to re-open the price control
review at length in our report Aspects of the Electricity Supply
Industry, July 1995 (HC 481-I) in which we were critical about
the rigour with which the DGES had scrutinised distribution and
transmission revenue and costs. We concluded that, on balance,
the DGES was right to re-open the review, mainly because "the
review was reopened before the revised price control had come
into effect and during the period allowed for representations
or objections, and the very idea of inviting representations or
objections must indicate that a reconsideration is possible".[115]
We then recommended that "such a procedure be avoided in
the future", so as not to create regulatory uncertainty and
undermine the credibility of the regulatory system.[116]
61. Several witnesses argued
that, if the regulators were to re-open a review as a matter of
course, price regulation would deteriorate into a complicated
form of rate of return regulation,[117]
it would undermine the regulatory contract, affect investors'
legitimate expectations and "will tend to increase the cost
of capital, to the ultimate detriment of customers".[118]
The DGES told us that the circumstances have to be "pretty
exceptional" before a price review can be re-opened and
he does not see "major events occurring over the next few
years that would necessitate re-opening a price control".[119]
We recognise that revisiting a price review can cause instability,
which could be detrimental to the industry given the need for
long-term investments; however, no one reported to us any significant
adverse affects resulting from the re-opening of the electricity
distribution review. Our conclusion remains the same as before.
We believe that regulators should not in general re-open price
reviews, for reasons of consistency, equity and the maintenance
of incentives, although we cannot rule it out completely where
there have been significant and exceptional changes in circumstances.
107 OFGAS press notice, 21.7.96. Back
108 Q.1013. Back
109 Q.1013. Back
110 Ev.
p.44. Back
111 Ev.
p.41. Back
112 OFFER,
The Transmission Price Control Review of the National Grid
Company: Proposals, 1996, pp.6-7. Back
113 OFFER,
Annual Report 1995 pp.28-29. Back
114 OFFER,
Annual Report 1995 p.7. Back
115 Eleventh
Report from the Trade and Industry Committee, Session 1994-95,
on Aspects of the Electricity Supply Industry, HC 481-I,
para 94. Back
116 Ibid. Back
117 eg.
Mem. p.96. Back
118 Ev.
p.209. Back
119 Q.1014. Back
