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:
| £ | %
|
| Generation | 171 | 58
|
| Transmission and Distribution | 117
| 39 |
| Supply | 9 | 3
|
| 297 | 100
|
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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