Select Committee on Northern Ireland Affairs Minutes of Evidence


APPENDIX 28

Further Memorandum submitted by Northern Ireland Electricity plc

  Thank you for your letter dated 5 May 1999 in which you sought NIE's comments on the Regulator's performance target, under his Public Service Agreement, to reduce the annual average cost of electricity per household in Northern Ireland to £253 by 2002. (Although it is not clear whether Ofreg's target is quoted in real terms or in nominal terms).

  NIE has had no discussions with Ofreg as to the assumptions underlying this figure, but we would make the following comments:

  Under NIE's current tariffs, the cost to the typical domestic customer using 3,300 kWh per annum is £297 which breaks down into the three main components as follows:
£%
Generation17158
Transmission and Distribution117 39
Supply93
297100

  Therefore, to meet the Regulator's target, the average costs per household will need to fall by £44 or some 15 per cent by the target date.

Supply

  As regards the Supply component, Ofreg has stated in their evidence to the Committee that NIE's Supply Business . . . is now greatly out-performing the GB average and is probably the best value in the UK". Ofreg note that the average domestic customer in NI pays 15 per cent less as regards the supply component than is the case in GB. In light of the relatively small magnitude of this component of the overall domestic bill, and Ofreg's comments, Ofreg cannot be counting on a material contribution from Supply towards its price reduction target.

Transmission and Distribution

  NIE's current charges for Transmission and Distribution (T&D) have been set in line with the level of revenue which the Monopolies and Mergers Commission determined was the minimum necessary to finance an efficient business and to make the network investment which the Commission considered necessary to protect customers in respect of the continuity of supply and quality of service. Implementation of the MMC outcome involved a 28 per cent per unit reduction in NIE's component of the bill which took effect on 1 April 1997.

  The current T&D price control is due to run until 31 March 2002. It contains a factor which reduces T&D revenues by 2 per cent below inflation each year and provides NIE with an incentive to reduce its costs, to the benefit of customers at the next price review.

  It is clear that the differences between the MMC and Ofreg amounted to only 2 per cent (or £6) on final domestic prices, so even by Ofreg's reasoning, there is no significant catch-up" required to recover the ground that Ofreg may believe they have lost in the last review.

  The next price control, which will take effect from 1 April 2002, can only be determined following a review process in which all the public interest issues have been carefully weighed and subjected to detailed and robust analysis. In this regard, the MMC investigation has helped to define a best practice model for Ofreg to follow.

  That process will identify inter alia, any efficiency gains which NIE has made in the five years up to March 2002, the scope for further efficiency gains in the next five years, and the level of network investment required to replace ageing assets, to reinforce the network to meet customers' increasing demands for electricity and to improve the quality and reliability of supplies.

  We have not yet begun our detailed planning of the investment needs of the system for the period beyond 2002. However, we can say that we anticipate investment needs at a level similar to the current level, well into the next regulatory period. Indeed, we anticipate both customer and environmental expectations to continue to increase. We would expect to include investment needed to complete the performance improvement programmes currently underway, including the accelerated refurbishment proposed in our Storm report.

  Ofreg have indicated in the past their view that capital expenditures on the NI system were too high and that the focus of the next review will be more on capital than on operating costs. Their views on capital expenditures may have changed in the light of the Christmas storms but clearly, high capital expenditure does impact on final prices and we will always support any proper analysis of what is an appropriate level of capital expenditure for the NI system.

  We accept totally that any efficiency gains under incentive price regulation should be shared with customers at the next review. However, we believe that these gains will be modest. We would therefore be alarmed if the DG was factoring a further substantial reduction in NIE's T&D revenues to finance his target, because that might imply a reduction in capital expenditures at a level which we could not support. We believe in all of this that there is always a danger that Ofreg attempt to compensate for any failure to secure a meaningful reduction in generation costs by reducing NIE's revenues below the minimum required to finance an efficient business and to satisfy the public interest, including the protection of customers' interests as regards the quality and reliability of supply. This indeed, as we saw it, was the problem which triggered the MMC referral following Ofreg's price proposals at the first price control review.

  Following the 28 per cent unit reduction in NIE's component of the overall bill by which the MMC outcome was implemented, NIE's view is that any further reductions in bills must come from the generation component.

Generation

  It is widely recognised that the greatest scope for further price reductions lies within the generation component of the bill, which represents 58 per cent of the typical domestic bill and up to 85 per cent of the largest industrial bills. The long term power purchase contracts are the obstacle to securing price reductions.

  Ofreg's consultations have suggested that the costs of generation in NI have recently been some 43 per cent higher than in GB. Since generation accounts for 58 per cent of the typical domestic bill, on a pro-rata basis, this gap would translate into a 25 per cent or £74 annual price disadvantage to an average domestic customer. We believe this is a somewhat over-simplified calculation, and domestic customers are not actually exposed to this level of price disadvantage, but it serves to demonstrate where the scope for further price reductions lies and it confirms where efforts must remain focused.

  In their oral evidence to the Committee Ofreg referred to the work undertaken by their consultants which Ofreg say indicated ". . . that there is no reason why we could not generate electricity as cheaply in Northern Ireland as we could in Great Britain". Ofreg go on to say that ". . . the action that is required is action on generation costs . . ." (Question 83 of the evidence given on 10 March 1999).

  NIE has been in discussions with the generators for some two to three years now on modifications to the existing contracts. A problem in these discussions is that there has been no effective pressure on the generators to negotiate. The only real leverage has been Ofreg's threat of an MMC referral but it is not clear that the generators have seen this threat as real. After careful analysis, we have not been able to satisfy ourselves that the proposals currently on the table offer definite and sustained benefits to NI customers. Under the generators' proposals as they currently stand we see very little opportunity for any sustainable cost reduction, never mind the substantial reduction that is required.

  We believe that Ofreg's £253 target for domestic bills must be based on achieving a substantial reduction in generation costs. If satisfactory progress towards such meaningful reductions cannot be achieved then NIE believes that the whole matter of generation costs should be considered for referral to the MMC as soon as possible.

Annual Report

  In the footnote to your letter you asked for copies of Viridian's annual report. Although we announced preliminary results last week, the annual report and accounts will not be published until later in the month. I shall be pleased to arrange for copies to be forwarded to you then, and in the meantime I enclose a copy of our preliminary announcement.[8]

13 May 1999


8   Not reported. Back


 
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