Select Committee on Northern Ireland Affairs Second Report


CAPITAL EXPENDITURE

  46. Two different aspects of capital expenditure arise in relation to the events surrounding the Boxing Day storm:

      ·  whether past capital expenditure programmes have been appropriately focussed, and whether greater investment in the rural network could have reduced the extent of the storm damage; and

      ·  whether the changed priority of NIE in the current capital investment programme to put greater resources into refurbishing 11kV overhead lines to increase future network resilience to storm damage is appropriate and practicable.

  47. Table 1[65] shows that network capital expenditure has risen appreciably in real terms since 1986/87, both before and after privatisation. Allowed capital expenditure in the present period (1997/98-2001/02) is substantially higher than actual capital expenditure in the three earlier five year periods. Throughout the whole period (1982/83-2001/02), 90 per cent of total network capital expenditure has gone to distribution as opposed to transmission.

Table 1:  Transmission and Distribution Capital Expenditure
5 year total, £million, at March 1997 price base
Transmission
Distribution
Total
1982/83-1986/87
3.3
108.4
111.7
1987/88-1991/92
16.9
189.5
206.4
1992/93-1996/97
17.6
225.1
242.7
1997/98-2001/02
55.3
276.2
331.5

Table 2:Comparison of the domestic electricity bill for Northern Ireland, Great Britain and the comparator Public Electricity Suppliers by category (out-turn prices, not including VAT)

Northern Ireland Domestic Electricity Bill
1993 19941995 19961997 19981999
Generation£149 £166£157 £168£170 £167£173
T&D£99 £124£127 £131£141 £117£121
Supply£61 £26£28 £33£29 £17£17
Total£309 £316£312 £332£340 £301*£311

Great Britain Domestic Electricity Bill
1993 19941995 19961997 19981999
Generation£139 £148£155 £155£157 £140£140
T&D£103 £108£111 £102£98 £95£94
Supply£51 £33£18 £21£25 £25£20
Total£293 £289£284 £278£280 £260£254

Comparator Public Electricity Suppliers' Electricity Bill
1993 19941995 19961997 19981999
Generation£140 £149£158 £158£159 £144£140
T&D£125 £133£137 £123£118 £114£114
Supply£49 £30£13 £21£26 £26£17
Total£314 £312£308 £302£303 £284£271

*After a £10 rebate given by NIE at the end of the year

  48. Table 2, which reproduces figures submitted by OFREG,[66] shows that the average domestic electricity bill in Northern Ireland has diverged from that of Great Britain since 1993. It is currently 22 per cent higher as against five per cent then. The main contributory factors are the cost of generation in Northern Ireland, which falls outside the scope of the regulatory process and is now 24 per cent higher than in Great Britain, while transmission and distribution costs are now 29 per cent higher. Even relative to what NIE refers to as 'comparator' PES in Great Britain (those with large rural areas and overhead distribution networks), transmission and distribution costs in Northern Ireland are now 6 per cent higher.

  49. In essence, NIE argues that the difference between the profiles of transmission and distribution costs in Northern Ireland and in Great Britain respec tively reflects two principal factors:

      ·  a combination of one of the smallest customer bases of any UK electricity company and one of the most rural service territories; and

      ·  an investment requirement which reflects the current state of the network, which NIE ascribes in part at least to underinvestment in the 1980s.

  50. The Regulator has statutory responsibility for regulating NIE, including re-setting the price control (usually at five yearly intervals); determining within the framework of the price control the appropriate level of allowed capital expenditure after considering proposals from NIE; and ensuring that NIE has sufficient resources to carry out its licensed activities. In evidence to us, he argued that there are no underlying fundamentals which would justify indefinite continuation of the current disparity i n electricity prices between Northern Ireland and Great Britain. He emphasised the following points:

      ·  By the end of the present price control period, every electricity consumer in Northern Ireland will be supporting £250 more transmission and distribution assets than his counterparts in Great Britain (though this is partly due to the low population density of the rural areas traversed by the electricity distribution network in Northern Ireland).

      ·  Since privatisation, NIE has underspent £109 million of its allowed capital expenditure (£97 million in the first price control period and £12 million in the first year of the current period). Limited financial resources available for investment therefore cannot be the determining factor in the network's performance during the 1998 Boxing Day storm. Alleged under-investment was not, in his view, relevant.[67]

      ·  Regulated monopolies tend to underspend early in a price control period since the 'underspend' leads to increased company profits.[68] Companies tend to justify an underspend in terms of 'efficiency gains leading to consumer benefits', which can be difficult for regulators to audit.[69] Later in the period, they have an incentive to claim that higher allowed capital expenditure is needed in the next price control period, creating the headroom for future 'underspend'.

      ·  In the light of the above, the Regulator was therefore less concerned with whether NIE had been allowed sufficient resources for investment than with the NIE's management of the capital programme and the criteria which NIE uses to examine investment projects.

      ·  He was not satisfied that NIE had proved that loss of supply in rural areas during the Boxing Day storm was due to the age of overhead line equipment, because many factors can cause the loss of a circuit under extreme storm conditions, including wind direction, ground conditions beneath the pole, the quality of the timber and the creosote preservative, overhanging trees, wind blown debris and ivy-encrusted poles.

  51. Mr Thomas commented that, where NIE refurbished overhead lines, it did so very largely to the original, typically 1950's, specification.[70] He maintained that there had been many advances in the technology av ailable in the construction of overhead lines since then, not least of which was the availability of insulated conductors, which in principle might be expected to give an improved standard of performance over bare conductors, particularly in areas prone to tree damage or tree intrusion. As has been pointed out earlier,[71] faults caused by trees were a significant contribution to the overall level of faults.

  52. In view of Mr Thomas' comments, we asked NIE for information on their refurbishment standards. NIE maintained that refurbishment is to current (1992) specifications. Experience with the first phase of the overhead line refurbishment programme, which began in 1994, indicated that the required improvement in performance was dependent on adopting a higher specification, which aims to improve both the mechanical strength and the electrical performance of the lines.[72] NIE is also trialing covered conductor technology but, in the light of difficulties with the use of this technology elsewhere in the United Kingdom, it is seeking to develop a better specification before the technology is used more extensively in Northern Ireland. [73]

  53. We note that OFFER is to consider the quality of supply achieved during storms in the light of the historic capital and operating expenditure of PES in Great Britain. If OFFER deems companies to have been inefficient in their allocation of expenditure, they will be dealt with through the forthcoming distribution price control review. We consider that a similar mechanism would be appropriate in Northern Ireland in the context of the 2002 revision of the NIE price control.

  54. In order to improve the ability of the system to withstand extreme storm condi tions, in the light of the 1998 Boxing Day storm, NIE proposes to accelerate its refurbishment programme and related work by:

      ·  increasing 11kV overhead line replacement from the previously planned 1,500 kilometres per year to 1,750 kilometres for 1999/2000 and 2,000 kilometres per year for 2000/01 and 2001/02. On this basis, 65 per cent of the rural 11kV overhead line system will have been refurbished by March 2002;[74]

      ·  refurbishing 1,100 kilometres of 33kV overhead lines over the period, so that by March 2002 almost 45% of the total 33kV circuit length will have been refurbished;

      ·  replacing, over the next three years, 120 kilometres of low voltage overhead lines and under-eave wiring in urban areas and some open wire systems on the outskirts of urban areas. These will be replaced by underground cabling or, where more appropriate, aerial bundled conductor;

      ·  replacing almost 10,000 poles nearing the end of their useful lives on circuits not immediately scheduled for full refurbishment. By March 2002 this will have covered 750 kilometres of 33kV circuits and 2,500 kilometres of 11kV circuits;

      ·  Since 24% of the faults during the Boxing Day storm were caused by trees interfering with overhead lines, tree pruning on the network will be further increased. By March 2002, tree pruning throughout the network will be established on a five year cycle (20 per cent of the total being pruned each year).

  55. The accelerated refurbishment programme will cost £24 million over the next three years and NIE proposes to finance this by re-allocating expenditure from other categories of investment, which will involve deferring certain other projects.[75] NIE is satisfied that the technical capacity to de liver this programme will be available to it. [76] For the next price control period, starting in 2002, NIE proposes that allowed capital expenditure should be set at a level which would fund the capital expenditure necessary to maintain refurbishment at the above levels as a minimum.[77] In the present price control period, NIE is prepared to forgo the benefit of certain savings, which arguably it would be entitled to retain as efficiency savings, to help fund these works.[78]

  56. Important public interest issues are involved in deciding the appropriate level of capital expenditure to upgrade the overhead line system:

      ·  The Boxing Day storm was many times worse than that of Christmas 1997, not matched in severity over the past 70 years and, according to the Meteorological Office, having a probability of recurrence of once in 100 years or more in any one place. No one knows when such a storm will strike again, but it is, and is likely to remain for the foreseeable future, a statistically rare event. A public interest decision therefore has to be made on how much more it is worth paying for electricity to obtain additional supply security in the event of another storm of equal severity. In the case of the Boxing Day storm, NIE's goodwill payments provided what is widely regarded as reasonable compensation for consumers worst affected by loss of supply. Where continuity of power supply is essential, business users can insure against loss of supply by having their own back-up generators. The first phase at least of the enhanced refurbishment package will have no direct cost to customers, as it does not involve an increase in capital expenditure beyond the level implicit in the present price control;

      ·  The options for improving quality of supply in rural areas during severe storm conditions are strictly limited. Installing high voltage distribution cables underground in rural areas is said to be nine times more costly than overhead lines and is therefore not a realistic option on a large scale on these grounds alone. A high level of refurbishment of the 11kV overhead network would reduce its vulnerability to storm damage to some extent, but could not prevent extensive damage and loss of supply in rural areas in a storm as severe as that on Boxing Day 1998;

      ·  The price of electricity for domestic consumers is the same throughout Northern Ireland. Urban consumers (who are being supplied by underground cables and are therefore far less vulnerable to supply losses caused by storms), as well as rural consumers, would have to pay a higher price for electricity if refurbishment of the overhead line system were accelerated substantially. This would tend to increase the cross-subsidy from urban to rural consumers which is implicit in the electricity price structure;

      ·  Electricity prices in Northern Ireland are already higher than in almost all parts of Great Britain and the European Union,[79] according to the Regulator.

  57. The storm undoubtedly had a very serious effect on many electricity consumers in Northern Ireland, some 246,000 in all.[80] It is now clear that, over the period 26 to 31 December 1998, some 65,000 consumers (about a quarter of those who lost their electricity supply as a result of the weather conditions) were off-supply for more than 24 hours, rather more than originally estimated.[81] A particularly unfortunate 4% lost their supplies for more than three days. How ever, as Mr McCracken pointed out: [82]

      ". . . This was purely a rural network problem we faced. There were half a million customers in Northern Ireland who did not experience any loss of supply as result of this storm and they were all the customers on the urban network. The issue is about how to prioritise investment out of a total capital programme which allows the customer the maximum benefit at least cost . . ."

  His contention was that the refurbishment programme, the cost of which is borne by al l customers, urban and rural, does that.

  58. An OFREG standards of performance market research survey, conducted in January 1997, revealed that 93% of those domestic customers polled were either quite satisfied or very satisfied with NIE's electricity supply service, 87% did not think that the quality of supply could be improved and, crucially, that 92% would not be willing to pay more for improved service.[83] NIE has expressed doubts as to the validity of such surveys.[84] The Deputy Director General for Scotland of OFREG commented[85] that "there is a fine judgement to be made between increasing expenditure to improve reliability and increasing costs, particularly as it is unclear how far customers are willing to meet these costs."

  59. There is a paradox between the attitudes revealed in the OFREG survey and the general assessment of NIE's response to the storm. Attitudes are clearly a function of experience. Also, some Northern Ireland members of this Committee receive representations from consumers who allege that they are regularly subject to multiple interruptions in their supplies. Yet data supplied to us by NIE reveals that, of customers exposed to faults on the 11kV network (itself the source of around 70% of all faults affecting customers[86]), around 90% experienced on average no more than two interruptions per annum and that less th an one hundred customers in all (out of a total of 680,000) experience on average ten or more faults per annum. [87] It is nonetheless the case that the level of security of supply through the overhead supply network is, and will remain, lower than that through the underground network: customers served through the overhead high voltage network suffer on average an annual level of Customer Minutes Lost nearly ten times greater than those served through the underground network.[88] Given that customers pay the same price for their electricity whatever the means of supply, we believe that NIE's concentration on enhancing the resilience of the overhead supply network is reasonable.

  60. As with the law, extreme cases do not necessarily make for good policy. We would, non etheless, like to see more clarification - and, hopefully, a consensus emerge, on capital expenditure priorities - in discussions between the Regulator and NIE leading to the next price control. We therefore hope that NIE will, before that, extend the scope of their present consultations with their customers. In particular, we support the Regulator's idea of finding out how much more per kWh consumers are willing to pay to obtain a somewhat better quality of service in rural areas under infrequent sever e storm conditions. This exercise needs to be carefully structured through consumer surveys or focus groups, given the comments we have made earlier about a previous survey. It should include urban as well as rural consumers since, other things being equal, both would have to pay a higher price for electricity. It should also include the involvement of the Northern Ireland Consumer Committee for Electricity and NIE in order to build a consensual approach. Establishing how much more consumers themselves are willing to pay is an essential input to decisions on what consumers should be prepared to pay. We emphasise that this exercise should be completed before the price control and the allowed level of capital expenditure are re-set in 2002.

  61. Capital 'underspend' and the deferment of proposed investment have featured prominently in the evidence to this enquiry. This is not unique to Northern Ireland: capital underspends are widespread among regional distribution systems in Grea t Britain also. [89] Three things are clear: consumers must have confidence that the capital expenditure they are paying for in their electricity bills is resulting in actual capital assets rather than swelling NIE's profits through capital underspends; NIE must have freedom to manage its investment programme efficiently; and investment priorities are bound to change through time according to changing conditions and expectations both within and between regulatory periods. Given the difficulty of ascertaining how far capital underspends are due to genuine efficiency gains, we support the Regulator's proposal that NIE should provide cost- benefit evidence that proposed changes in the capital expenditure programme during a given price control period are economically efficient and more beneficial for consumers than the original capital expenditure programme approved by the Regula tor. Like any well run company, NIE is certain to make such calculations before it decides to defer particular projects.

  62. The recommendations above should improve consumer confidence in the regulatory system and allay suspicions of under-investment by the monopoly provider of transmission and distribution services. We also wish the Regulator all success to his endeavours to secure substantially lower generation costs from the generators, who, at privatisation, were allowed long-term contracts that were not subject to regulation. Good news on this front would lead to lower electricity bills in Northern Ireland[90] and might affect the context for determining the level of NIE's allowed capital expenditure when the price controls are re-set in 2002.

  63. According to the Northern Ireland Departmental Report,[91] one of the performance targets of the Regulator, included in his Public Service Agreement, is to reduce the average annual cost per household of electricity to consumers in Northern Ireland to £253, net of VAT, in 1998-99 pounds (a reduction of 19% on the present level) by 2 002. [92] This target is based on the average annual bill charged to the average customer in Great Britain on the standard domestic electricity tariff in 1998-9. In view of the assessment[93] of NIE that investment needs at a level similar to the current level will continue well into the next regulatory period, we asked the Regulator how he proposed to achieve this. He has informed[94] us that the bulk of the reduction would co me from re-negotiation of the generator contracts at Kilroot and Ballylumford, but that his calculations had assumed a modest contribution (about £6) [95] from the implementation of his original price control for transmission and distribution, rather than the MMC price control, which is now in force following successful legal action by NIE. Beyond that, he did not expect any further contribution to achieving the target to come from transmission, distribution or supply costs. The calculation also assumed that the Government would use the £40 million available to reduce electricity prices to buy down the generator contracts, although the principal beneficiaries of this would be industrial customers.

  64. Given our general support for measures to improve the resilience of the overhead distribution system to storm damage, we welcome the assurance from the Regulator that meeting his target for reducing domestic electricity bills, which, if achievable, will no doubt be widely welcomed in the Province, does not depend on a substantial reduction in transmission and distribution expenditure. [96]

  65. When our predecessors examined electricity prices in Northern Ireland, they were informed that the Government was to allocate £60 million to reduce the cost of electricity from 1996.[97] These funds, to be made available over the three years from 1 April 1996, were designed to ensure that NIE customers would share in the benefits that their counterparts in Great Britain would enjoy from the abolition of the nuclear levy earlier than originally planned.[98]

  66. We understand that a wide-ranging consultation exercise conducted in Autumn 1995 revealed a consensus that the £60 million would best be used to help all electricity consumers to meet rising costs and reduce energy consumption through the promotion of energy efficiency.

  67. In the event, the first tranche of £15 million was paid to NIE in the 1996/97 year to peg tariffs by 3% to below the then rate of inflation and the remainder paid into a Trust Fund to be administered by NIE und er the direction of the Department of Economic Development. Subsequently, Lord Dubs announced on 25 November 1997 that a further £5 million had been allocated to fund energy efficiency measures. A payment of £75,000 was made to the Northern Ireland Housing Executive in February 1999, with Ministerial approval, to fund insulation measures on the Beechmount housing estate in Belfast. This is an interim programme designed to signal the commitment of the Department of the Environment to deliver two pilot ene rgy efficiency schemes in the Beechmount and Willowfield areas of Belfast, for which the release of further funds has been agreed in principle.

  68. The Trust Fund balance currently stands at just under £45 million, of which £40 million remains unallocated. The Northern Ireland Departmental Report comments that:[99]

      ". . . Consideration is being given to a number of options for allocating, in the most beneficial manner, the balance of £40 million in this fund. A decision must await an assessment of the responses to the Regulator's December 1998 consultation paper on reducing generation costs. Some or all of the £40 million may be used to facilitate the proposals in the Regulator's paper . . ."[100]

  69. On 1 July, the Rt Hon Adam Ingram MP, Minister of State, Northern Ireland Office, launched a detailed energy action plan for Northern Ireland, responding to the energy recommendations in the Economic Development "Strategy 2010" report. In the course of this, he announced [101] that the Government was prepared, subject to appropriate legal and financial appraisals, to use the resources of the fund to buy out contracted capacity provided this can be done in a way which secures significant customer benefits.

  70. We note the NIE has expressed doubts as to the benefits offered to customers by the proposals presently put forward by the generators. NIE commented:[102]

      ". . . Under the generators' proposals as they currently stand we see very little opportunity for any sustainable cost reduction . . ."

  We also note that the Regulator estimated the benefit to domestic customers of using the £40 million in this way at about one per cent (or £3 per annum off the average domestic bill).[103]

  71. We therefore consider that the scope for using some of the £40 million to improve the resilience to storm damage of the overhead electricity supply network in Northern Ireland should be investigated. Obviously, any such contribution should not lead to an increas e in NIE's asset value (and hence future revenues and profits). Customers dependent on the overhead network would have a twofold benefit - an improved quality of supply and no corresponding cost increase, and customers with underground supplies would be spared meeting the costs of improving the overhead network. We recommend that, before any of the £40 million is allocated to reducing generation costs, a thorough study be carried out of the case for investing some at least of that sum in strengthening the resilience to storm damage of the overhead supply network.


65  Ev. p. 48. Back

66  Ev. p. 44. Back

67  Mr Thomas commented that during the 1980's, very little maintenance had been done on some of the overhead lines and it was his view that "... there is an element - or more than an element - of catching up to be done..." (Q85). Back

68  Conversely, a capital over-spend is unlikely to occur because the company cannot assume that the regulator will agree that any additional assets financed out of the company's own money will be included in the regulatory asset base. Back

69  This is because allowed capital expenditure is not a list of projects agreed in advance. According to the Regulator, it is a sum of money derived from an iterative bargaining process between the company and the Regulator. In practice, allowed capital expenditure tends to be an affordable 'black box' in which underspends are mostly deferrals, though with some element of efficiency gain which is difficult to quantify. See Appendix 26, p. 107. Back

70  Q85, 97 and 98. Back

71  Paragraph 26. Back

72  Appendix 21, p. 90 and 96-8. Back

73  Appendix 21, p. 97-8. Back

74  Ev. p. 6. Back

75  Appendix 21, p. 101 and Appendix 27, p. 109. Back

76  Appendix 21, p. 98. Back

77  Ev. p. 7. Back

78  Appendix 27, p. 109. Back

79  Ev. p. 40 and 47. Back

80  Appendix 33, p. 119. Back

81  Appendix 33, p. 119. Back

82  Q55. Back

83  See MMC Report, para. 6.31 and Appendix 6.2. The percentages for commercial customers were slightly different. Back

84  Ev. p. 32. Back

85  Appendix 24, p. 105. Back

86  Appendix 27, p. 108. Back

87  Appendix 31, p. 116. Back

88  Appendix 33, p. 118 and Appendix 21, p. 92. Back

89  Review of Public Electricity Suppliers 1998 to 2000: Distribution Price Control Review Consultation Paper, OFFER, May 1999, Chapter 4. Back

90  The implementation of the European Union Electricity Liberalisation Directive (Directive 96/92/EC) in Northern Ireland on 1 July 1999 enables the 240 largest industrial consumers in Northern Ireland to purchase their electricity from a generator or supplier of their choice in Northern Ireland (or in the Republic of Ireland, when the Directive is implemented there next year). Back

91  Cm 4217, p. 110. Back

92  Appendix 29, p. 112. See also Ev. p. 46. Back

93  Appendix 28, 110. Back

94  See Appendix 29, p. 112. Back

95  See also Appendix 21, p. 91. Back

96  Appendix 29, p. 112. See also the Regulator's consultation paper Reducing the Cost of Generating Electricity in Northern Ireland: The Generator's Proposals - the basis for the future, p. 4. Back

97  See Second Report from the Northern Ireland Affairs Committee, Session 1994-5, (HC 395) para 162. Back

98  The nuclear levy did not apply in Northern Ireland. Back

99  Cm 4217, p. 100. Back

100  "Reducing the Cost of Generating Electricity in Northern Ireland: The Generators' Proposals - the basis for the future?" The Regulator envisages the use of the £40 million to provide the proposed first phase of a Ballylumford buy-out and the proposed interim changes to the Ballylumford contracts (p. 41). Back

101  Northern Ireland Information Service Press Release, 1 July 1999. ("Energy Action Plan Announced - Ingram"). Back

102  Appendix 28 p. 111. Back

103  Appendix 29, p. 112. Back


 
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