APPENDIX 21
Further Memorandum submitted by Northern
Ireland Electricity plc
Thank you for your letter of 1 April 1999 in
which you put further questions to us and invited our comments
on aspects of Ofreg's evidence taken before the Committee on 10
March 1999.
We enclose a further Supplementary Memorandum
which we have structured in two parts, trying from the point of
view of the convenience of the Committee to confine our detailed
technical responses in a separable annex.
We would be pleased to respond to the Committee
if any clarification is required or if there are further questions
arising.
Supplementary Memorandum submitted by
Northern Ireland Electricity to the Northern Ireland Affairs Committee
enquiry into the electricity supply problems in Northern Ireland
over the Christmas and New Year holiday periods
This Supplementary Memorandum addresses a number
of issues which arise from the Minutes of Evidence from Ofreg
of 10 March 1999 as identified by ourselves and/or requested by
the Committee.
1. OVERVIEW
Ofreg in their evidence set out to address five
areas, viz., the ability of the company to minimise supply interruptions
by its choice of network investment strategy; the extent to which
investment strategy is hampered by lack of resources; the company's
communications with customers; the efficiency with which customers
were reconnected; and the goodwill payments to customers for the
inconvenience of prolonged supply loss. They also gave their particular
perspective on the role of MMC.
On the issue of goodwill payments, Ofreg acknowledged
that the company has done very well and that the payments made
by NIE probably exceed even the benchmark of guaranteed standards:
"most customers are going to get more than they would have
got under the guaranteed standards and certainly none of them
will get less". They stated also that the level of customer
benefit "certainly is as good if not better than was achieved
for customers in other parts of the United Kingdom and in the
Irish Republic".
Since a question arose in evidence as to the
costs to be borne by shareholders, it may be helpful for the Committee
to know that NIE currently estimates the total cost of payments
to customers at £8.8 million. These and all other uninsured
costs of repairs will be borne by shareholders under the current
price control. There appeared to be some misunderstanding on this
point in the evidence session: there is no convoluted mechanism
by which these costs are collected from the customer—as
Mr Coulthard clearly understood, this is unplanned expenditure
which was not taken into account in the price control, it exceeds
the allowances set by MMC, and these costs have to be borne by
shareholders.
On the issue of the efficiency with which customers
were reconnected, Ofreg's evidence, set in the context of communications
handling, supports NIE's position. They referred to the problem
that existed in other places, including the Irish Republic, where
there was "a failure to reconnect customers which was at
least, if not worse, than what happened in Northern Ireland. There
certainly was a region in the Irish Republic where there were
400,000 customers of whom 200,000 were off supply. Many of then
were off supply for much longer . . .". From our own contacts,
we are confident that the process of reconnection of customers
was at least as efficient as that of other utilities in similar
circumstances.
On the issue of communications with customers,
NIE recognises clearly that communications handling during the
recent storm was quite unsatisfactory from a customer viewpoint
and we have described the steps we are taking to put in place
a much more effective system of communications for the future.
In the following sections, we have attempted
to respond constructively on the remaining issues of network investment
strategy and the broader issues of regulation, prices and the
role of MMC as they arose within the evidence session with Ofreg.
We enclose a separate Annex expanding on some
of the issues arising in greater technical detail and we respond
there to a number of specific technical questions raised by the
Clerk to the Committee.
2. INVESTMENT STRATEGY
Ofreg in their evidence touched upon a number
of issues, including: the priorities for investment; whether the
rural network was being given the priority it merited; the significance
of past capital underspend; and whether lines are restored to
a 1950's specification or better.
Priorities for investment
In our previous submission to the Committee
we described how investment and maintenance policy relies upon
age monitoring, particularly of poles. We indicated how this is
combined with other condition monitoring to determine the refurbishment
needs of the network, avoiding unnecessary wholesale replacement
of serviceable equipment, and thus reducing costs to the customer.
This is industry best-practice and is fully in line with Ofreg's
Mr Thomas' philosophy: "I am far less concerned about the
age of equipment as I am about its fitness for purpose and its
condition of maintenance". NIE's approach to assessing the
performance benefits of specific categories of work is set out
clearly in paragraph 6.22 and following of the MMC Report.
We provided the Committee also with evidence
of the type provided within our price review to show that refurbishment
can improve reliability performance on individual circuits by
a factor of 3.5. We pointed out that this type of industry-standard
analysis led us to focus a particular effort on 11kV network refurbishment
during the first regulatory period and to propose a continued
programme at a high level in our submissions to the Ofreg price
review and to the MMC.
Ofreg cannot possibly claim now that they are
unclear as to whether the rural network was being given the priority
it merited, given that they were party to our analysis of the
performance benefits and contested vigorously at MMC the specific
merits of the higher level of investment we sought for rural networks
to enhance their reliability.
NIE has not argued that the lower level of investment
allowed in the first two years of the present price control contributed
substantially to the failures on our distribution networks in
the recent storm. They could not possibly have done. The condition
of the Northern Ireland system is a function of pre-privatisation
under-investment which the MMC calculated would take up to 10
years to redress at the rate of refurbishment allowed (paragraph
7.47 of their report).
What we have argued is that, by most standards,
the levels of investment going into distribution networks is actually
high and that, to the extent that Ofreg represents the customer
interest, the evidence from the recent price control review is
that the customer interest has called for lower rather than higher
levels of investment in rural networks.
The view that a lesser level of investment in
rural networks in Northern Ireland is merited could be a perfectly
tenable one, if based on a proper consideration of all the issues.
We accepted it as an outcome of the MMC. What we find difficult
to accept is that having been told that we should not invest at
the level we proposed in rural networks, we should now be told
that, in the light of the recent storms, we as a company got it
wrong and we should have really been investing at a much higher
level.
However, we have also argued that Ofreg have
been extremely slow to recognise the merit of high investment
in rural networks and it is clear from Ofreg's evidence to the
Committee that they still have difficulty in recognising its merit.
It is a fact that we switched substantial resources during the
first price control period specifically into rural refurbishment,
because we were able to demonstrate its importance to reliability.
We attempted to make the case for maintaining those resources
at a high level during the present price period but, despite the
evidence we provided as to the effectiveness of such programmes,
Ofreg opposed the allocation of resources at the level we requested.
Nevertheless, even with higher levels of investment,
as Mr Thomas' evidence indicates: "You will never build an
overhead system which is completely and utterly immune to the
effect of weather", and the statistics from other utilities,
hit by what for Northern Ireland was the worst storm since records
began, will demonstrate that other rural distribution systems
were similarly affected. What we will not accept is that Ofreg,
who argued for lower rates of refurbishment on rural networks,
should now suggest that they were given insufficient priority.
Capital underspend
Capital underspend has not at any time affected
the rate of investment in rural networks. In fact, because the
refurbishment of rural networks is less capital intensive than
other forms of performance improvement, our decision during the
first price control period to give priority to rural networks
contributed to creating the savings in the capital programme.
The MMC Report notes at Paragraph 7.7: "A further factor
(in the underspend) was that NIE had substantially altered its
investment strategy post-privatisation to one of concentrating
on improving the quality of supply in rural areas." This
change in investment strategy occurred under the new management
installed at privatisation and the new major programme of refurbishment
of 11kV overhead lines only began in 1994-95, the financial year
immediately following NIE's flotation.
The programme of rural refurbishment post-privatisation
was built up as quickly as possible to the rate of 1,500 km per
annum, as now under the current price control. For the current
price period, we had proposed 1,750 km per annum and, as indicated
above, Ofreg argued for a reduction to 1,200 km. The scale of
the 11 kV overhead line refurbishment programme which was capable
of being undertaken 6-7 years ago was limited by NIE's non-financial
resources (principally skilled employees and subcontractors).
It was also constrained by practical limits on our ability to
change direction and to find methods of organising and planning
the rural refurbishment work, including the introduction of new
techniques to minimise the disruption to customers' supplies,
such as live-line working and the use of mobile generating sets.
The issue of past capital underspend, therefore,
is not its impact on rural reliability but rather how to ensure
an equitable split of the benefits of underspend between customers
and shareholders.
This is not a new issue in incentive price regulation:
it has featured in almost every price review to-date covering
some 40 companies which make up the electricity and the water
industries. The MMC has demonstrated how to evaluate the issues,
which are not all to the disbenefit of the customer, and how to
apply mechanisms such as claw-back, taking account of all the
public interest issues involved.
In general, there are two conflicting forces
in the management of capital expenditure from a customer viewpoint,
viz to have a higher spend which ensures more is delivered to
the customer and to have a lower spend which ensures less upward
pressure on price. Incentive regulation deals with this conflict
by scrutinising capital expenditure proposals in detail at the
time of a price review and then providing a specific incentive
within the price control to encourage the company to manage capital
expenditures efficiently and effectively. The price review process
itself tests the legitimacy of any previous underspend.
In our previous supplementary submission we
set out the salient facts in relation to our underspend in the
first regulatory period.
The extent of underspend was by far the greatest
in the transmission network which was relatively unaffected by
the storm. On distribution networks, some 83 per cent of the capital
allowance was fully spent. In the enclosed (and in Appendix 7.1
of the MMC Report), details of the bulk of the underspend are
set out and accounted for in terms of specific actions which were
taken by NIE to manage the capital programme efficiently. These
actions are described under capital efficiency headings such as
demand-side management measures undertaken by the company, delayed
transmission asset replacement, more cost-effective procurement,
improved labour productivity and changes in investment strategy.
In setting NIE's new price control, the MMC
took full account of the level of underspend in the first price
period.
Ofreg's evidence to the Committee appears to
give the impression that they would have handled the underspend
very differently. But Paragraphs 2.108 and 2.118 of the MMC Report
show that Ofreg accepted that efficiency gains in capital expenditure
were a factor in the underspend and Ofreg proposed a clawback
of some £7 million NPV in projected revenues, whereas the
MMC imposed a clawback of £7.2 million, slightly in excess
of the Ofreg proposal.
The benefit to customers of the underspend is
that final prices to customers are now some 1.9 per cent lower
than they would have been if the full capital expenditure which
was forecast at privatisation had indeed been spent. Over the
present five year period alone, this is worth some £50 million
in lower bills to customers in the present five year period, compared
to some £25 million of cost to customers in the previous
five years. If all of the capex savings result in deferments maintained
for a further five years beyond the current period, there
would be a further gain of some £37 million to customers
in lower bills. (All of these figures are expressed to a 1996-97
price-base).
Our response to the Clerk of the Committee specific
questions on the linkage between the underspend and prices is
set out in more detail in the Annex at Section A4.
Overhead Line Design
In their evidence to the Committee, Ofreg laid
particular emphasis on a statement that NIE's refurbishment of
lines is to a 1950's specification and implied that we did not
take advantage of appropriate new technology for insulated overhead
conductors.
In the Annex at Section A2 we show that this
is a completely wrong understanding on Ofreg's part of our policy
on refurbishment. Specifically:
— NIE's Overhead Line Design Specification
has continued to evolve with industry best-practice since the
1950's and the current standard, which is the same as that adopted
by the majority of the GB distribution companies, was newly issued
in 1992;
— refurbishment of overhead lines is
undertaken entirely in line with this standard;
— a range of design improvements which
we will introduce over the next 12 months will result in further
improvements in performance;
— and the experience in GB of the new
insulated conductor technology referred to by Ofreg has highlighted
a range of serious problems which is causing the distribution
companies in GB to review their use of the current design. We
have been involved in the development of an improved specification
and we hope to see it introduced with the benefit of the GB experience,
prudently avoiding the costly development-stage problems which
have been to the detriment of customers on other systems.
3. BROADER ISSUES
OF REGULATION
AND THE
MMC
As the Committee will be aware, NIE's T&D
price control was reviewed by Ofreg in 1995-96, with a view to
the introduction of a new price control with effect from 1 April
1997. In the event, NIE rejected Ofreg's proposals for a new price
control, and Ofreg therefore referred the matter to the MMC for
resolution. In March 1997, the MMC determined NIE's T&D price
control at a level which the MMC clearly considered to be the
minimum necessary to enable NIE to finance the carrying on of
its T&D Business to the standard which they considered to
be what the public interest required. The MMC reached their conclusions
after lengthy examination of the issues, and a minute analysis
of NIE's past and projected expenditure. The MMC drew on their
own resources and expertise gained from other similar inquiries,
and used external consultants to provide additional support on
technical matters relating to NIE's networks.
Despite the thoroughness and rigour of the MMC's
report, Ofreg refused to accept its findings and sought instead
to impose on NIE a price control allowing substantially less revenue
than the MMC had concluded to be necessary and appropriate.
We pointed out to Ofreg as early as May 1997,
that they were bound by the MMC's conclusions as to the appropriate
level of allowable revenues to be factored into the price control.
We do not know what view Ofreg took as to the legal position,
since they declined to reply in substance to our letter. Ultimately,
their refusal to discuss the issue with us left NIE no option
but to apply to the court for a declaration as to the binding
effect of the MMC's conclusions. Although the court rejected our
case at first instance, the Court of Appeal found unanimously
in our favour. Ofreg still refused to accept the outcome, and
sought leave to appeal to the House of Lords. The House of Lords
has refused leave to appeal.
Ofreg's challenge to the role of the MMC is unique
It is clear from the nature and style of their
evidence to the Committee on the role of the MMC in determining
NIE's price control that Ofreg are implacably opposed to the MMC's
authority.
Yet the MMC's authority in relation to Ofreg
is absolutely no different to its authority in relation to any
other Regulator in the UK in terms of resolving disagreements
between the Regulator and the company over licence modifications,
e.g., to give effect to a new price control. Its authority is
provided for on a similar basis within legislation throughout
the UK and, following a recent comprehensive review of the effectiveness
of regulation, the Government has decided to reinforce the MMC's
authority over regulators in relation to price controls in a very
significant way. Its purpose is to make regulation more transparent,
more accountable, more predictable, and thereby to ensure its
stability and its legitimacy.
No other regulatory authority has placed itself
in opposition to the MMC in this way. Ofreg's very prolonged and
continuing challenge to the role of the MMC is entirely unique
within the UK regulatory system and appears increasingly idiosyncratic.
Ofreg's position with regard to the MMC increasingly raises questions
as to whether its own judgement on these matters is well-balanced.
In view of Ofreg's evidence on this issue, the Committee may find
the following alternative perspective helpful.
Ofreg's position with regard to the MMC
Ofreg attempt to portray their challenge to
the MMC as absolute vital in protecting the interest of the Northern
Ireland electricity customer.
To support this, in evidence to the Committee
on the MMC's impact on prices, Ofreg stated: " . . . they
(prices) were not allowed to fall dramatically in 1997 because
the MMC intervened and until that is put right that element (of
price for which NIE is responsible) will not be reduced."
It is very difficult to reconcile this statement with the fact
that, as a direct result of the MMC price control, NIE's component
of price fell by 28 per cent per unit in April 1997. Moreover,
the difference between the MMC and Ofreg price controls is stated
clearly within the MMC's Report to amount to just 2 per cent for
domestic prices (Paragraph 2.211): this is around £6 per
annum on the average domestic bill.
For prices to large industrial customers, Paragraph
2.213 of the MMC Report estimates the difference to amount to
around 1 per cent, the effect being lower because generation accounts
for a much higher proportion of the price to commercial and industrial
users. Yet, Mr Mclldoon is quoted in an interview in the 1 April
1999 edition of Utility Week as stating that the MMC decision
would "devastate Ulster's fragile economy" and would
damage the province's ability to compete with the Republic. Of
the fallout from the MMC ruling, Utility Week quotes Mr Mclldoon
as stating: "I wouldn't like the responsibility for screwing
up a regional economy like this."
Ofreg's comments suggest that they have entirely
lost sight of their own objective. They are on record as stating
quite clearly that generation costs are the crux of the electricity
pricing problem in Northern Ireland and that MMC are part of the
solution.
Ofreg have previously estimated generation costs
in Northern Ireland to be some 43 per cent above an open-market
price: if these figures from Ofreg were to be taken at face value,
they would suggest a price disadvantage to Northern Ireland customers
of around 34 per cent in the large industrial sector and over
20 per cent in the domestic sector due simply to generation costs.
The only lever which Northern Ireland has available to encourage
the generators to enter into a real negotiation on their contracts
to resolve this problem is the threat of an MMC referral. As Ofreg
indicated in their evidence to the Committee: ". . . the
Monopolies and Mergers Commission could decide that the existing
arrangements were acting contrary to the public interest in which
case the President of the Board of Trade would be entitled to
restructure the industry . . ."
It is difficult to see how Ofreg can expect
the MMC to produce a solution to such issues, and for the MMC's
solution to command respect, in the face of Ofreg's continuing
assault on the competence and authority of the MMC.
Moreover, it must be borne in mind that the
MMC were themselves critical of Ofreg's own review of NIE's T
and D price control. The following is an indication of some of
the areas specifically mentioned by the MMC.
Ofreg's original price control was based on
two key reports by external consultants—one on the capital
expenditure needs of the networks and the other on NIE's operating
costs. Both of these reports were roundly rejected by MMC, albeit
in diplomatic language. In the case of the capital expenditure
report, MMC stated: "we consider that conclusions drawn directly
from that report are not sufficiently robust in themselves to
form a basis on which we can reach appropriate price control decisions.
We have accordingly sought to reach an independent view . . .";
and in the case of the operating expenditure report: "Although
the DG had described the findings of PKF's report in putting his
proposals to NIE, he had not made the report itself available
to the company. When we did so, NIE submitted evidence on what
it regarded as errors, inconsistencies and unreasonable assumptions
in the report. Having studied the report ourselves (with the help
of consultants), and having taken account of comments by NIE,
the DG and PKF, we believe the conclusions are not sufficiently
robust in themselves to form the basis for the future price control.
We have accordingly sought to reach our own assessment . . ."
(Paragraphs 2.121 and 2.149 of the MMC Report refer).
We believe that it was clear at MMC that Ofreg's
specific opposition to a higher level of spend on rural networks
was poorly informed and represented a serious failure to come
to grips with the real capital expenditure issues. As we indicated
in previous evidence, Ofreg's capital expenditure submission to
MMC was produced by consultants (RKD) who did not even visit Northern
Ireland and were not allowed to discuss their findings with NIE.
As regards Ofreg's management of this aspect of the price review
process, the MMC Report states: "Although RKD sought permission
to contact NIE, the DG considered that that would delay matters.
He was also concerned that NIE would seek to steer the consultants
towards conclusions which justified a higher level of capital
expenditure. While we note the DG's reasons for not letting RKD
contact NIE, the lack of dialogue undoubtedly made it harder for
us to compare information from the DG and the company, who had
not even reached agreement on how the various items of expenditure
should be categorised" (Paragraphs 2.120-121).
In the same context, Ofreg suggested to the
MMC, as they suggested in evidence to the Committee, that the
quality of information provided by NIE was poor or poorly documented.
The MMC rejected this suggestion in the following terms: "..our
own consultants did not experience difficulty in finding the information
they sought during the course of our inquiry. We noted, however,
that the RKD report refers in several places to lack of access
to information and it appeared during the course of our inquiry
that RKD might have misunderstood NIE's approach to some issues"
(Paragraph 7.19). RKD's difficulties clearly related to the DG's
refusal to accede to their request to contact NIE, much less allow
them to visit the province whose system capital expenditure needs
they were to help determine.
Furthermore, Ofreg's evidence to the MMC on
the extent to which customers required the performance of the
system to be improved was supported by a customer survey which
we believe was recognisably defective and clearly damaging to
the interests of the rural customer. This survey, as Ofreg's evidence
to the Committee indicates, set out to demonstrate that the Northern
Ireland electricity customer was largely satisfied with the current
level of service and did not think that the quality of electricity
supply needed to be improved. The obvious defect of the survey
was that it did not distinguish between urban and rural customers
who are exposed to starkly different experiences of customer minutes
lost (CML) off-supply.
While the DG stated to the MMC that there was
no case for NIE to improve its relative level of service, the
MMC very clearly understood the underlying issue and dealt with
it at length in Paragraphs 6.21-26 and in 2. 126-129 of their
Report. Paragraph 2.126 states: "Customers in the more rural
parts of Northern Ireland, who tend to be served from long stretches
of 11kV overhead wire, experience a much higher level of CML than
customers in urban areas. By concentrating its efforts on refurbishing
the worst-performing circuits, NIE can achieve a significant improvement
in overall average CML as well as delivering a better service
to customers who at present experience a relatively high level
of interruptions." Far from being remote from the customer
and the issues, as Ofreg have suggested to the Committee, the
MMC Panel itself visited Northern Ireland to view at first hand
the nature of the investment need and engaged with the issues
in a way which Ofreg and its consultants signally failed to do.
The MMC Report provides an extremely comprehensive
analysis of every aspect of the transmission, distribution and
supply of electricity in Northern Ireland, including a very detailed
evaluation of the real issues which impact upon customers, such
as capital expenditures, investment in rural networks, the treatment
of capital underspends, return on investment, etc. It sets out
in detail the MMC's reasoning in support of their conclusions
and is a model of the transparency of regulatory procedure which
the Government has now set out as a key principle governing the
regulatory process. No such comprehensive document was ever produced
at the time of privatisation of the industry, when the basis for
important decisions taken was entirely opaque to those outside
of the Civil Service and regulatory structure.
The MMC Report not only provides clear recommendations
and conclusions, it also sets clear regulatory guidelines which,
if properly used, will be an invaluable aid to monitoring performance
and to the conduct of future price reviews. A review of this type
would be invaluable to a public understanding of the issues surrounding
the current negotiations on the generating contracts and that
is why NIE has continued to support Ofreg's original suggestion
of an MMC referral. There can never be a substitute for a transparent
process in which all parties are required to address the substantive
issues within the framework of a quasi-judicial process, as at
MMC. The interest of the customer will not be well served by anything
less.
Regulatory principles and the role of the MMC
as restated by Government
There is a popular misconception that the focus
of Government policy in regulation has been uniquely on the regulated
companies. It was quite clear in the recent review of regulation
that Government has been equally concerned to ensure fundamental
reform of the regulators' offices in order to address the idiosyncracies
and lack of transparency evident to date in regulatory decision-making.
The prevalence of such idiosyncracies and lack of transparency
were clearly viewed by Government as prejudicial to the long-term
stability of the regulatory framework and indeed to its very legitimacy.
This is not just an issue for shareholders—it is also in
the vital interest of customers as the following excerpts from
the Government's Green Paper "A Fair Deal for Consumers—Modernising
the Framework for Utility Regulation" and its subsequent
White Paper show.
The Green Paper emphasises that making regulation
open and accountable is critical to ensuring that decisions are
fair and that the regulatory framework is accepted by all stakeholders
and has long-term stability [Paragraph 1.25]. It indicates that
reform of regulation is important because the regulatory institutions
and processes are important. "They are key to securing better
decisions, better understood and more widely accepted decisions,
and greater legitimacy. With legitimacy and acceptance comes regulatory
stability" [Paragraph 7.1].
The Green Paper sets out the case for protection
against the idiosyncrasies of individual regulators and the lack
of discipline in relation to advisers: "Conferring significant
powers on individual regulators has produced a system where regulators
have a strong element of individual responsibility. It may have
had advantages in a period in which most regulators have been
focused on driving forward competition. But there are risks in
concentrating too much discretion on an individual. There are
few formal checks and balances on the regulators. In practice,
the regulators have made ad hoc use of advisers to assist
them, but there is no statutory obligation on them to do so, and
no disciplines on the regulators to follow the advice given. They
are not accountable to a board of directors or equivalent. There
is a risk, therefore, of unpredictable and unaccountable decision-making"
[Paragraphs 7.5-6].
The Green Paper sets out the role of the MMC:
"The Monopolies and Mergers Commission (MMC) plays an important
role in the regulatory framework where regulators and utility
companies cannot agree a licence modification (e.g., to give effect
to a new price control). In these circumstances, the matter may
be referred to the MMC. It is important, therefore, that MMC procedures
for handling licence modifications are considered along with the
other aspects of regulatory process to establish whether they
can be improved to secure better and more transparent outcomes
while not compromising the timeliness of MMC processes" [Paragraph
7.47].
The Green Paper goes on to explain how in a
price reference the MMC may frame their adverse findings in such
a way as to limit the regulators' discretion on remedies (as the
MMC did in the case of NIE's review) so that the MMC's conclusions
are then final, as they always are in price references in the
water sector. The paper recognises the view that MMC panels are
not as well placed as regulators to specify the technical details
of the licence modifications necessary to give full effect to
their conclusions but goes on to state: "However, giving
regulators wide discretion over how to remedy adverse effects
(subject only to judicial review) is regarded by many observers
as unsatisfactory" [Paragraphs 7.54-55]. The Government considered
two possible remedies for this problem—one was to require
the regulators merely to consult with the MMC on such licence
modifications, the other was to require actual reference of the
regulator's proposals back to the MMC for final endorsement. The
Government chose to reinforce the position of the MMC unequivocally
through a requirement for final endorsement [White Paper Conclusion
7.14 Paragraph 93].
The White Paper sets out policy for the future
structure of regulation, noting that the results of their consultation
process shows "strong support for reforming the top-level
structure of the regulators' offices, in order to ensure the right
checks and balances exist on individual regulators . . . . The
Government has concluded, in light of detailed consideration of
the responses, that small executive boards of three full time
members should provide the most effective regulatory model for
all the sectors covered in the Green Paper. This model offers
the advantages of collective but streamlined decision-making by
a small cadre of high calibre, professional regulators; greater
accountability; scope for greater continuity and consistency when
new regulators are appointed; and an ability to spread the regulatory
burden—this is particularly important in energy and telecommunications,
given the increasing complexity of these sectors" [Paragraphs
69 and 70].
Ofreg have attempted to characterise their challenge
to MMC as seeking the necessary power to enable them to implement
Government policy. It is crystal clear that Government policy
is to ensure the pre-eminence of MMC as the ultimate appeals body
to ensure regulatory stability and to replace what has been termed
the out-dated cult of personality.
Ofreg's relationship with NIE
The relationship between NIE and Ofreg is conducted
successfully at all levels on many different issues. However,
it is clear that Ofreg's challenge to the MMC and the company
on the price control has been conducted in such a way as to cause
inevitable damage to the overall working relationship. Ofreg's
highly adversarial and idiosyncratic approach to these issues
is unique in UK regulation.
The regulator has available extremely wide powers
in proposing a new price control and within the process is effectively
answerable to nobody. The decision by a company to reject the
regulator's proposals is not taken lightly and the MMC process
from a company viewpoint is extremely demanding of senior management
time and carries many risks of an unsatisfactory outcome. NIE's
purpose in going to the MMC was clearly stated as two-fold viz
to address the issue of the level of resources to operate and
maintain the system and, equally importantly, to ensure a greater
level of discipline and consistency in the regulatory process
than we had experienced within the Ofreg price review. The Electricity
(Northern Ireland) Order 1992 provides for the MMC as a formal
appeals mechanism to resolve disputes over licence modifications
between the regulator and the company. Ofreg's problem is not
with the nature of the existing legislation, which is common throughout
the UK, but with its own capacity to operate successfully within
it.
The MMC reduced NIE's revenues to what they
described as "the minimum level consistent with securing
that NIE is able to finance the carrying on of its licenced activities
and protecting the interests of customers in respect of continuity
of supply and quality of service". The impact of the combined
price control was to reduce NIE's revenues by an immediate 28
per cent per unit with an efficiency factor going forward reducing
revenues by a further 2 per cent per annum below inflation. NIE's
profitability is a function of the massive amount of capital invested
in the business and its profitability is entirely in line with
MMC assumptions.
NIE is entirely open to a constructive dialogue
on how best to address the interplay between the important public
interest issues of investment strategy, resources for investment,
quality of supply and price, as we were required to do by the
MMC. Our concern, stated over a period to Ofreg, is that the failure
to be able to sustain a focused and objective dialogue within
the framework of regulation as it operates in Northern Ireland
can only be damaging to the customer interest. It fails to address
coherently and consistently key issues in such away as to find
a resolution on which all of the parties may move forward. This
failure not only impacts the resolution of issues in the transmission,
distribution and supply side of the industry, but also the effective
resolution of issues in relation to the generator contracts where
NIE has been concerned that Ofreg's pursuit of its disagreement
with the MMC has risked being a serious distraction from finding
a solution to the high generation costs which hold the key to
achieving much more significant reductions in customers' bills.
We perfectly appreciate that the law relating
to the regulation of licensed utilities is complex and relatively
new; it is therefore bound to raise difficult issues which sometimes
need to be referred to the courts for resolution.
However, we are concerned that, in this instance,
Ofreg's opposition to MMC goes beyond that. We are now more than
two years into the present price control period, and the matter
has only now been finally resolved by the courts, yet the DG persists
in his attempts to discredit the MMC's conclusions and continues
to rake over the issues in every available forum, frequently in
terms which we find quite objectionable in areas relating to our
own business ethics.
We regret that the DG cannot simply accept that
NIE's new T&D price control is settled, and move on to address
some of the other issues facing the NI electricity industry.
14 April 1999
ANNEX
This Annex to NIE's Supplementary Memorandum
dated 14 April 1999 provides further technical details on the
issues of capital underspend and overhead line design as referred
to in the main body of the submission. It also responds to the
further questions put to NIE by the Clerk of the Committee, in
his letter dated 1 April 1999. Finally, it deals with a number
of other points raised by Ofreg's evidence.
A1. CAPITAL SAVINGS
WHICH GAVE
RISE TO
THE UNDERSPEND
In the paragraphs which follow we set out a
description of the range of specific management actions which
were taken by NIE during the first five-year regulatory period
with the specific intention of producing lower costs or higher
quality than had previously been anticipated and which gave rise
to capital expenditure savings.
Those management actions encompassed a range
of measures such as demand side management, delayed transmission
asset replacement, more cost effective procurement, improved labour
productivity, and changes in investment strategy. Each of these
are explained more fully below in the form in which they were
presented to the MMC.
Demand-side management allowed network reinforcement
to be deferred or avoided
Even against the background of approved programmes
of expenditure, it is not in customers' interests for NIE to incur
capex on system reinforcement any earlier than is strictly necessary.
If capex is incurred during one regulatory period, future price
controls will need to be set to remunerate investment in the new
assets, and prices will be correspondingly higher.
Following privatisation, NIE therefore set out
to promote customers' interests by taking steps to defer the need
for network reinforcement.
Principal among these was the introduction of
new cost-reflective tariffs incorporating a very strong cost signal
during the narrow daily time window in which peak demand on the
system occurs. It is this peak demand which determines the peak
loading and capacity constraints on transmission and distribution
equipment and hence a significant part of the overall capital
expenditure requirements. The resulting tariff signal was sufficiently
strong as to cause many customers to reconsider load management
measures in a very active way.
In conjunction with the tariff signalling measure,
NIE devoted new resources to a focused Key Account Management
programme in which all large account customers were given individual
advice on load management measures specific to their process needs.
Evidence of the effect of tariff signalling
can be seen in the system load factor which improved from 56.8
per cent in 1991-92 to 60.4 per cent in 1995-96.
Through its key account management programme
and through use-of-system tariff signalling to encourage a reduction
in the growth of peak demand, NIE successfully deferred capex
projects to beyond the end of the first regulatory period.
At transmission voltages, various projects were
deferred including the following:
Voltage compensation at Enniskillen (£2.3
million), Omagh transformer replacement (£0.3 million), Belfast
transmission (£14.7 million), Coolkeeragh interbus transformer
(£3.9 million), Newtownards development £6.0 million),
Tyrone development (£1.8 million), various others (£3.4
million).
These savings were partially offset by other
minor schemes amounting to £2.1 million giving a net savings
in Transmission of £28.3 million.
The largest item of deferred expenditure shown
above relates to Belfast transmission reinforcement as an integrated
development scheme which could not be implemented in part or in
stages. This deferral arose because of uncertainty about possible
future developments at Power Station West. NIE believed that it
was in the interests of customers to delay the final decision
on proceeding with the development until this uncertainty was
reduced.
At distribution voltages, reduced expenditure
of the order of £6 million resulted from load management
or more effective schemes being implemented.
Schemes deferred included: Eniskillen Main Reinforcement
(£1.2 million), Newtownards Main (£0.8 million), Coleraine
South (£0.3 million), Newtownards Central (£0.4 million)
and Nelson Drive (£0.5 million). Schemes cancelled included:
Drumahoe West (0.2 million), Cairnshill (£0.5 million), Newtownards
North (1.6 million) and Stranmillis (£0.5 million).
Delayed transmission asset replacement
As a result of research undertaken by NIE, the
assets on the network are no longer replaced on the basis of age
alone. Since privatisation, NIE has worked with external suppliers
to develop and procure equipment to enable more accurate assessments
of asset condition to be made. As a result, asset replacement
in the sum of £9.6 million was postponed on the transmission
network, after condition assessment demonstrated that the plant
could remain in service. This consisted of savings in projected
replacement costs of 275 kV circuit breakers (£4.7 million),
275 kV overhead lines (£1.7 million), 110 kV switchgear (£1.0
million) and transformers at Power Station West, Ballymena and
Newry (£2.2 million).
More cost-effective procurement
NIE made further capex savings owing to its
efficient procurement programme. There is evidence to show that
in an industry-wide comparison of costs, NIE outperformed the
average of the electricity companies in GB.
NIE engaged consultants to develop new functional
specifications which would permit open tendering on the international
market. NIE was one of the first electricity companies to take
this initiative. NIE estimates that during the first regulatory
period some £2.7 million was saved against the transmission
budget for this reason.
Examples of such savings are: £0.7 million
on transformer procurement, £0.3 million on 275 kV protection
equipment, £0.6 million on 110 kV line refurbishment/build
and £0.5 million on 110 kV switchgear.
Distribution plant and equipment has always
been more competitively priced due to the large volumes in use
and savings in this area are estimated at £0.6 million largely
due to the purchase of high voltage cable on the international
market.
Improved labour productivity
By increasing the productivity of its own staff
during the first regulatory period, NIE estimates that it saved
a further £0.4 million against its transmission budget, and
a further £2.0 million against its distribution budget.
Changes in investment strategy improved network
performance at lower capital cost
In the T&D Business, much of NIE's capex
budget is allocated to sustaining and improving network performance.
Before incurring capital expenditure on network projects, NIE
assesses the proposed expenditure against four output tests:—
improved safety, improved reliability, greater economy (i.e.,
lower maintenance costs) and higher environmental standards.
During the first regulatory period, NIE decided
to concentrate its resources on improving network performance
(in a manner which took account of the other output measures identified
above).
Network performance may be improved by different
methods (e.g., general worn asset replacement, reinforcement,
and refurbishment). Of these methods, worn asset replacement is
the most expensive way of achieving a given level of performance
improvement (i.e., requires the highest capex spend), while targeted
refurbishment on rogue circuits requires the lowest capex spend.
However, targeted refurbishment requires a higher level of skilled
labour and engineering input.
Thus, in some cases, it is possible to achieve
the same outputs (i.e., a measurable improvement in network performance)
by different methods which are less capital-intensive.
The assumptions underlying the capex budget
factored into the initial price controls envisaged a general programme
of worn asset replacement.
During the first regulatory period, NIE ultimately
pursued a programme of network refurbishment and improved protection
(concentrating on rogue circuits in order of priority) to achieve
the maximum possible improvement in network performance in return
for its capex spend. There were nett capital savings from this
strategy even though some £3.7 million of expenditure was
incurred on protection equipment not identified within the original
budget.
Some high risk decisions on Supervisory Control
And Data Acquisition systems and metering were also postponed
pending technical developments because of specific concerns as
to the unproven nature of the equipment on offer from suppliers.
Other utilities delayed their purchasing decision on similar equipment
for similar reasons.
By contrast, unanticipated environmental costs
arose during the first regulatory period where overhead lines
in urban areas attracted considerable criticism. A programme for
undergrounding of overhead lines in urban areas was introduced
incurring additional expenditure amounting to some £11.3
million.
The changes in investment strategy described
above resulted in a reallocation of capex to projects where it
was most effective in delivering benefits to the customer.
The table below shows how the MMC summarised
the reasons for the capital underspend during the first regulatory
period.
| Details of capital expenditure underspend for period 1992-93 to 1996-97
|
| £ million | |
| | |
| Reason for underspend | Trannsmission project
| Value | Distribution project
| Value |
| | |
| |
| Demand management | Eniskillen voltage compensation
| 2.3 | Enniskillen main reinforcement
| 1. 2 |
| Omagh transformer | 0.3
| Newtownardsmain | 0.8 |
| Belfast transmission |
14.7 | Coleraine south | 0.3
|
| Coolkeeragh interbus transformer
| 3.9 | Newtownards central
| 0.4 |
| Newtownards development |
4.0 | Nelson Drive | 0.5
|
| Tyrone development | 1.8
| Drumahoe West | 0.2 |
| Various | 3.4
| Cairnshill | 0.5 |
| Less additional schemes |
-2.1 | Newtownards south | 1.6
|
| | |
Stranmillis | 0.5
6.0 |
| Sub-Total | | 28.3
| | |
Delayed asset replacement
or change of strategy
| 275kV CBs | 4.7 | Asset replacement
| 10.4 |
| 275kV O/H line | 1.7
| SCADA | 10.0 |
| 110 kV switchgear | 1.0
| Meters | 9.2 |
| Transformers for Belfast
West Newry and Ballymena
| 2.2 | Additional U/G of O/H lines (due to public pressure)
| -11.3 |
| | |
Additional protection | - 3.7 |
| Sub-Total | | 9.6
| | 14.6 |
| Planning delays | | 2.1
| | 3.6 |
| Better procurement | | 2.7
| | 0.6 |
| Better productivity Contributions |
| 0.4 | | 2.0
|
| | |
| |
| Totals | | 43.1
| | 29.3 |
In addition to the items of underspend in the above table
there were further unidentified underspends of £8.1 million
for Transmission and £16.5 million for Distribution. Set
against these were amounts which NIE must incur if it is unable
to proceed as quickly as it had wished with a capital project.
For example, planning delays which result in additional operating
costs in repairing and maintaining the old assets pending the
receipt of planning consents and completion of a project.
A2. OVERHEAD LINE
REFURBISHMENT SPECIFICATION
In their evidence to the Committee, Ofreg laid particular
emphasis on a statement that NIE's overhead line refurbishment
programme was based largely on a 1950's specification and implied
that we did not take advantage appropriate new technology and
were not following a policy of upgrading to a modern standard.
In the paragraphs which follow we explain that this is a
wrong understanding on Ofreg's part of our policy on refurbishment.
— NIE's Overhead Line Design Specification has continued
to evolve since the 1950's, the current standard was issued in
1992 and is the same as that adopted by the great majority of
distribution companies in GB;
— refurbishment of overhead lines is undertaken
to the standard of the 1992 design specification;
— a range of design improvements which we will introduce
over the next 12 months will result in further improvements in
performance;
— and the experience in GB of the new insulated
conductor technology referred to by Ofreg highlighted a range
of serious problems which is causing the distribution companies
in GB to review their use of the current design. We have been
involved in the development of an improved specification and we
hope to see it introduced with the benefit of the GB experience,
prudently avoiding the costly development-stage problems.
Design specifications have been evolving continuously
Our previous supplementary submission explains that a substantial
proportion of the overhead distribution network was constructed
in the period from the late 1950's to mid-1970's as rural customers
were connected to the system through new rural electrification
schemes.
The overhead lines constructed during that period were designed
to meet the requirements of the statutory Overhead Line Design
Regulations and the national specifications in force at the time
of construction. Over time, these designs have been subject to
review and improvement in the light of operational experience.
Since the mid-1970's, the overhead network has continued
to expand with the building of additional lines required to connect
new customers to the system. New lines are constructed to the
current NIE Overhead Line Design Specification which is based
on the requirements of the 1981 Regulations and standard EA-TS
43-10, a technical specification produced by the Electricity Association.
NIE's current design specification which was issued in 1992 is
the same as that adopted by the great majority of distribution
companies in GB.
Refurbishment specifications bring lines up to current standards
NIE's overhead line refurbishment programme began in 1994.
Experience with the first phase of the programme indicated the
need to adopt a higher specification for the refurbishment work
in order to deliver the required improvement in performance (which
was the primary objective driving the programme).
The current refurbishment specification covers a range of
measures aimed at improving both the mechanical strength and the
electrical performance of overhead lines. It includes the repair
of all known defects and the replacement of all insulators over
30 years of age. The structural performance of the line is improved
by replacing all decayed poles together with the majority of wire
stays which have deteriorated. The scope of the work also includes
measures required to ensure compliance with new health and safety
legislation.
In addition to the work described above (which is primarily
asset replacement work—replacing like for like), the refurbishment
specification calls for alterations to be made to the design of
the line to bring it up to the standard specified in NIE's 1992
Overhead Line Design Specification.
Enhancement measures include:
— the application of a new fusing schedule to improve
electrical performance;
— the introduction of new, more mechanically robust
switching devices to replace less reliable air break switches;
— the replacement of all high voltage (HV) fuses
which were prone to mal-operation with a more reliable device
having better mechanical and electrical properties;
— the installation of pole mounted switching devices
(reclosers) based on modern SF6 technology which has reduced maintenance
requirements; and
— the application of new connection methods to facilitate
live-line working to minimise the need to interrupt supplies to
customers.
In the case of lines which have been built to the early specifications,
(e.g., BS1320 and Henley type construction), further alterations
are carried out such as:
— repositioning of low voltage (LV) fuses to facilitate
access to the LV system without the need to isolate the HV system
in order to minimise the disruption to customer supplies; and
— the removal of pilot insulators which have been
a cause of electrical problems in the past.
In the case of lines originally constructed to the 1946 Overhead
Line Regulations, additional poles are also inserted to reduce
span lengths and wider cross-arms are fitted. Both these measures
reduce the likelihood of faults occurring due to conductors clashing
in high winds.
New technology requires a prudent approach
We are aware of the insulated conductor technology which
Ofreg referred to in their oral evidence. We are also aware, through
our ongoing contact with the other UK distribution companies,
that this technology has not yet been fully proven and companies
who have used covered conductors extensively have experienced
serious problems and failures due to design shortcomings. For
example, there have been a significant number of failures caused
by vibration problems, broken conductors, failed connections,
broken insulator ties and radio interference. These problems become
worse as the construction reaches 5-years-old and in some companies
it appears that consideration is being given to reverting to bare
wire construction.
In order to gain our own experience of covered-conductor
technology we have been piloting a trial scheme over the last
four years on an 11kV overhead line fed from Coleraine West. We
have also been involved in the development of a UK specification
for a covered-conductor system and development work is currently
nearing completion within the company for an NIE specification
for covered-conductor lines. This will be an improvement on the
current GB design as we learn from the GB experience.
Given the problems experienced in GB with the new covered-conductor
technology, we believe the prudent approach which we have adopted
is the correct one.
Future enhancements are planned
We are planning further design changes to improve the reliability
of our overhead lines based on design work carried out over the
last two years. These changes include:
— the introduction of polymeric insulators instead
of glass discs as these have a greater life, they show improved
electrical performance and are more resilient to vandalism;
— the introduction of steel or concrete poles at
critical positions along an overhead line will remove the need
for stay wires as the failure of stays has had a significant effect
on performance. Arrangements for a trial are in hand;
— the use of new connectors, crimping tools and
the introduction of all aluminium alloy conductor which will increase
the capacity and electrical performance of new and rebuilt lines
while reducing the likelihood of corrosion and mechanical failure.
Most of these changes will take place over the next 12 months.
A3. RESOURCING THE
ACCELERATED REFURBISHMENT
PROGRAMME
As regards to the Clerk of the Committee's request for our
comments on Mr Thomas' assertion (at Q116 in the Minutes of evidence)
about NIE's capacity to refurbish more than 1500 km of 11kV overhead
line per annum, we respond as follows:
The MMC said that it believed that NIE should now have the
organisation and systems needed to implement effectively a programme
of work of the size envisaged by the Commission [Paragraph 2.143
of the MMC Report]. This programme included 11 kV refurbishment
at the rate of 1500 km per annum. In recommending an acceleration
of that programme we have given careful consideration to the additional
resources which will be required to deliver the additional work.
The arrangements we have in hand include the following components:
— The proposed programme will be resourced both
by resources internal to the Viridian Group and by NIE's strategic
partner for overhead line work, Northern Utilities (NUSL).
— Within the Viridian Group, Powerteam, an affiliate
company of NIE, will recruit additional manpower and secure additional
contractor resources through Eastern Contracting.
— NUSL will increase their output by approximately
30 per cent and have embarked on a recruiting exercise to fill
their management and manpower requirements.
— Additional NIE and contracted switching resources
will be nominated, trained and authorised to facilitate the programme.
— NIE will train three additional live-line teams
which, in addition to the one existing team, will be deployed
on the pole replacement programme. This will make a significant
contribution to the mitigation of the effects of the programme
on planned interruptions to customers' supplies.
— The proposed programme will be managed by a Steering
Group reporting to a Programme Directorate comprising the Managing
Directors of the NIE business involved and Northern Utilities.
— We are confident that these arrangements will
provide us with the capacity to deliver what is a challenging
programme.
A4. LINKAGE BETWEEN
CAPITAL EXPENDITURE
AND PRICE
The Clerk to the Committee requested NIE's response to two
sets of questions on the linkage between capital expenditure and
price, as follows:
— "Looking at the capex underspend for the
last regulatory period, what estimate can be made to the extent
to which, in cash and percentage terms, customers' bills were
higher during that period than they would have been if the agreed
level of expenditure had exactly equalled, both in amount and
timing, the amount actually spent; and to what extent are customers'
bills lower in the current regulatory period, both in cash and
percentage terms, than they would have been if actual capex in
the previous regulatory period had exactly equalled the capex
allowed for at the beginning of that period (and the asset base
had been correspondingly higher)?
— What are the consequences for customers' bills
if NIE overspends on its capex within a regulatory period? Would
the company be required to absorb the cost over the remainder
of the regulatory period, with the additional assets being taken
into account only in the next regulatory period? (What I am seeking
to establish is whether there is a symmetry about this process
and whether, in the event of an overspend, the respective positions
of consumer and company are reversed compared to an underspend.)"
Underspend
We have used a cash flow model approach to estimate the effect
on customers' bills if revenues for the first regulatory period
had been calculated on the basis of a capital expenditure forecast
which matched the amount actually spent in that period. (Although
the cash flow model methodology has been widely adopted by UK
regulators for the purposes of price control reviews, NIE's regulated
revenues during the first regulatory period were set on a different
basis. Nevertheless, the cash flow model provides a suitable basis
on which to indicate the linkage between capital expenditure and
prices.)
We calculate that had revenues been set using the cash flow
model and on the basis of forecast capex equal to the actual capex,
customers' bills over the first regulatory period would have been
some £25 million lower. This translates into an average reduction
of 0.08p/unit which is approximately a 1 per cent reduction in
average tariffs.
If steps had not been taken to manage the programme efficiently
and if the full expected capex had been incurred in the first
period, tariffs in this second period would have been 0.15p/unit
(1.9 per cent) higher than they actually are. The increase is
due to:
(i) the higher opening regulatory asset base, and
(ii) the deletion of the capex clawback which represents
money returned to customers in the April 1997 price cuts.
Over the present five year period alone the current saving
is worth some £50 million to customers in lower bills. If
all the capex savings result in deferments maintained for a further
five years beyond the current period, there would be a further
gain of some £37 million to customers in lower bills. (All
of the figures quoted for bill reductions are expressed to a 1996-97
price base.)
Overspend
An overspend on capex within a regulatory period could arise
for a number of reasons such as the need to increase expenditure
on environmental aspects of a project, e.g., undergrounding in
order to secure planning approval.
The higher costs of financing any additional investment over
the period would be borne by the company.
Although the MMC have established the principle of clawback
where, in NIE's case, some of the underspend was returned to customers
in the form of price cuts, it does not necessarily follow that,
in the event of an overspend, the company would be able to recover
retrospectively the additional financing costs through an increase
in tariffs in the subsequent period.
Although an underspend automatically results in a reduction
in the regulatory asset base, any overspend would not automatically
find its way into the regulatory asset base. The company would
be required to demonstrate that the additional amount represented
a prudent investment and did not arise, for example as a result
of inefficiencies.
In summary, as regards (i) clawback and (ii) the regulatory
asset base there is not necessarily a symmetry in treatment of
an underspend and an overspend in capital expenditure—the
balance being in the customers' favour.
A5. OTHER QUESTIONS
The Clerk of the Committee's letter contained four further
questions as follows:
"Is it possible to give any breakdown of the number of
poles that were replaced as to the number which failed structurally
(i.e., snapped) and the number whose mountings failed (i.e., were
uprooted)?
The graph submitted on pole failure suggests that, if anything,
it was newer poles that failed disproportionately. Is this a reasonable
conclusion, and if so, are there any generic reasons (such as
particular locations where specific circumstances (such as local
wind conditions) may significantly shorten the life of a pole)?
To what particular factors do you attribute the improved performance
of the refurbished 11 kV circuits?
The additional capital works now proposed in the light of
the storm will, as I understand it, displace other works from
the capital works programme. What will be displaced, and what
studies have you carried out to establish the relative overall
benefits of the revised programme, as compared to the original?"
Pole replacement statistics
As a result of the storm a total of 1,133 poles required
replacement, either because they had been broken or because they
had been pulled out of the ground. This represents a failure rate
of less than 3 per 1,000 in a total population of around 400,000
poles.
Our analysis shows that 91 per cent of these poles had been
broken and 9 per cent had been pulled out of the ground.
In order to make the complete distribution network more resilient
to storm damage as quickly as possible we have proposed a programme
of selective pole replacement on those circuits which are not
immediately scheduled for full refurbishment but which contain
poles nearing the end of their useful life. Since the majority
of pole failures involved broken poles, the above analysis supports
the proposed programme of supplementary refurbishment.
Pole failure profiles
Firstly, we apologise for a scaling error which went unnoticed
in the pole failure graph contained in our previous supplementary
submission. A correct version is presented below.
Figure 1. Actual and predicted pole failure profiles
The chart exhibits a significant degree of correlation between
the actual failure profile and the predicted failure profile.
As explained in the previous submission, the predicted failure
profile is derived by:
(i) modelling the probability of pole decay by assuming
a normal distribution for pole decay as a function of the age
of the pole and
(ii) applying that result to the age profile of the network.
The following points explain differences between the actual
and predicted pole failure profiles. We consider that such differences
are not statistically relevant in the context of the less than
perfect relationship between age and pole failure, since pole
failure is not related uniquely to age alone, and as explained
in Section 2.1 of our previous submission, other factors impact
on the likelihood of failure.
— The predicted pole failure distribution assumes,
as a first approximation, that the failure rate is directly related
to the extent of pole decay and therefore can be predicted on
the basis of age-of-pole alone. The assumed probability of pole
decay is based on a normal distribution centred on an average
pole life of 35 years. As with any statistical distribution, there
is lesser confidence in the prediction at the extremities of the
curve where small variations in absolute numbers appear as a more
significant effect when expressed in percentage terms.
— The application of a normal distribution to represent
the probability of age related failure is a first approximation.
In practice, the probability of pole failure will be affected
by variations in design and equipment specifications that have
been applied over the course of the last 50-60 years. In particular,
it is generally recognised that poles added to the network in
the 1970's and 1980's were of a standard that would tend to disproportionately
increase their chances of failure.
— Furthermore, pole decay is not an absolute proxy
for pole failure. In practice, pole failure is due both to age
related failure and, to a lesser extent, to random failure associated
with external influences which bear no age dependency e.g., interference
from fallen trees, windborne material etc. This has a disproportionate
effect on the failure of newer poles, particularly the first 10
to 15 years. In absolute terms, we would expect a similar number
of such failures in each age category and, as such, account for
a more significant number of the newer pole failures because of
the small number of failures predicted by the age relationship.
For example, on the basis of recorded information, over half of
the failures of poles less than ten years old were due to external
influences. This compares with only 10 per cent of pole failures
in the 20-30 year old group.
In summary, while it would appear that of the poles which
failed, a greater percentage were in the young age category than
would have been predicted, it would be more reasonable to explain
the apparent discrepancy between predicted and actual pole failures
in terms of the limitations of the failure prediction model.
Improved performance of the refurbished circuits
The improved performance of the refurbished circuits is directly
attributable to the various components of the work carried out
under the refurbishment programme according to the specifications
described in Section A2 of this Annex. As explained therein the
two main categories of work involved are:
(i) the replacement of worm assets on a like-for-like
basis and
(ii) alterations to the design of the line to bring it
up to NIE's current design specifications.
The various elements taken together combine to improve both
the mechanical strength and the electrical performance of the
circuits.
Reallocation of Capex
The MMC gave careful consideration to the various public
interest issues surrounding the capex requirements for the current
regulatory period, and particularly so in the category of measures
to improve the performance of the network. In adopting a particular
overall level of capex for the purpose of setting the price control
(a level to which Ofreg is now in agreement), the Commission said
they were not prescribing an investment programme and they recognised
that there would be competing demands on the capital budget which
would give rise to a need to determine priorities among those
demands.
Following the storm, NIE sought and received feedback from
customers, media, district councils and Assembly Members from
which it is evident that there was a strong feeling that NIE should
re-examine investment priorities. Having listened to what customers
were saying to us in terms of the dissatisfaction, frustration,
inconvenience and hardship created by the widespread interruption
of supplies, particularly to rural customers, we believe that
any addition that we can make now to our programmes to make the
network more resilient to future severe weather would be strongly
welcomed. In proposing an acceleration in the rate and scope of
the refurbishment programme above that adopted by the MMC after
their careful consideration of the public interest issues, we
are engaging with Ofreg in a discussion on their approach to the
higher levels of investment in measures which will make the network
better able to withstand extreme conditions such as those experienced
on Boxing Day.
The estimated cost of the accelerated refurbishment programme
detailed in Section 8.3 of the Storm Report requires the reallocation
of £25.7 million within the capital expenditure plan for
the current regulatory period. It is proposed that this will be
funded from a combination of efficiencies and reprioritisation
between components of the capital programme. The reallocation
will involve a reduction in expenditure in the following categories:
Transmission Load Related System Work (£12.2 million), Distribution
System Development and Performance Related Work (£11 million)
and other Asset Replacement categories (£2.5 million).
The impact of the reallocation on each of the categories
will be managed in the following ways:
— The transmission network in the north and west
will be reinforced by a more efficient scheme than previously
envisaged, based on 110 kV reinforcement from a new 275 kV substation
at Dungannon as an alternative to the previously proposed Tyrone
275 kV substation at Omagh. This will enable funding to be released
from the transmission load related category, while ensuring that
NIE continues to comply with the relevant standards for transmission
system security as specified in our licence.
— A review of distribution network investment priorities
facilitates the reallocation from the distribution system development
and performance related work category in respect of 11 kV automation
and undergrounding of 33 kV and 11 kV overhead lines. While 11
kV automation remains an important strategy for improving average
network performance, NIE now considers that there is a greater
priority in making the distribution network more resilient to
severe weather in as short a timescale as possible.
— We propose to reduce the programme of undergrounding
HV overhead lines to facilitate an expanded programme of undergrounding
of LV overhead lines. While overhead lines in urban areas give
rise to ongoing safety, maintenance and legal difficulties, it
is considered that the proposed reallocation will not prevent
the effective management of these issues. Undergrounding is also
undertaken to address environmental issues such as visual amenity,
noise and bird nuisance. The proposed reduction in HV undergrounding
will require the careful management of environmental issues with
the removal of some problematic lines being delayed to the next
period. This will be offset by the removal of additional LV lines
which will also provide environmental improvement in addition
to the primary benefit of improved network resilience.
— A review of asset replacement priorities has facilitated
reallocation of asset replacement work, principally from a rephasing
of the meter replacement programme. The meter certification programme
will now begin in 1999-2000 and will continue into the next regulatory
period. This rephasing will not prevent NIE from complying with
its meter certification obligations.
A6. OTHER COMMENTS
There are three further points from the evidence on which
we would offer comment.
Transmission and distribution cost comparisons
Ofreg refer to a 30 to 40 per cent structural price divergence
in transmission and distribution costs in Great Britain. This
comparison is on the basis of average GB costs. In our previous
submission, we made the following points:-
— Price comparisons on the basis of average GB transmission
and distribution costs are not meaningful since the size and nature
of our customer base and service territory are key determinants
of the costs involved in providing the network. NIE has one of
the smallest customer bases of any UK electricity company and
one of the most rural service territories serving a widely dispersed
rural customer base.
— NIE's charges for transmission, distribution and
supply compare favourably with those of the GB companies whose
networks are comparable to ours.
— To the extent that transmission and distribution
costs per customer have moved out of step with comparator REC's
since privatisation, a reason can be found in the different investment
profiles. NIE's higher rate of investment on a pounds per customer
basis is entirely consistent with the needs of a network which
had severe under-investment while in the public sector.
— Following the March 1999 announcement of new tariffs,
end prices to customers will have reduced in real terms in three
consecutive years, giving a cumulative 21 per cent real reduction
for the typical domestic customer using 3,300 units per annum.
The recently announced removal of standing charges means that
the 90,000 NIE customers who have low consumption (less than 2,000
unit pa), among them customers who are fuel poor, old age pensioners
and lone parents, will benefit from even greater savings. Very
low users (less than 1,000 units pa) now have one of the lowest
tariffs in the UK.
Opex and capex figures for 1997-98
We cannot reconcile some of the figures quoted by Ofreg on
page 42 of the transcript in respect of operating expenditure
and capital expenditure for 1997-98. However we realise our copy
of the transcript is an uncorrected one and Ofreg may have corrected
the figures by now. If the Committee would like us to comment
further on this we would be happy to do so.
The cost of regulation
Ofreg states that they have about 17 full-time person equivalents
in electricity regulation, describing it as a very small office.
A comparison of the costs of regulation, based on estimated
licence fees for 1998-99 indicates that the cost of regulation
per customer is of the order of five times higher in NI than in
GB.
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