Select Committee on Northern Ireland Affairs Minutes of Evidence

Further Memorandum submitted by Northern Ireland Electricity plc

  As a result of our written and oral evidence given to the Northern Ireland Affairs Committee, a number of requests for additional information arose as recorded within the transcript document. In addition, we are grateful to have had a copy of Ofreg's submissions dated 3 and 5 February 1999 to the Committee.

  We enclose a Supplementary Memorandum which I hope the Committee will find addresses satisfactorily the requests for additional information. We have also addressed within the memorandum important issues which we believe arise from the Ofreg submissions to the Committee.

  If there is any clarification required on the attached or if there are any further questions arising, we would wish to respond to the Committee as required.


  NIE valued the opportunity to give evidence to the Northern Ireland Affairs Committee on our handling of events following the major storm on Boxing Day and the subsequent disruption to electricity supplies. There were a number of points raised during the hearing on which we were asked to provide further information, and this submission seeks to address those points.

  Question 58 of the evidence dated 8 February 1999, brings together a summary of the main requests for information. These are as follows:

    —  An analysis of the relationship between the age of the network and its vulnerability to storm damage;

    —  Further explanation of the implications of the accelerated and supplementary programmes of refurbishment referred to in paragraph 8.3.2 (page 34) of NIE's Report.

    —  Clarification of the difference between Figure 2, page 9 and Table 2, page 10 of NIE's Report which refer to customer minutes lost on the NIE system and a comparison with other utilities.

  Section 2 of this Memorandum addresses these issues.

  Section 3 provides commentary on some additional issues which were referred to in the evidence and/or in Ofreg correspondence to the Committee and on which we believe the Committee may find it helpful to have additional comment.

  There have been and are continuing significant differences between NIE and Ofreg on some of the major issues affecting customers in the area of capital investment, network refurbishment rates and models of effective regulation. These differences are highlighted particularly in Section 2.1, Section 2.3 and most of Section 3, but particularly Section 3.1, Section 3.4 and Section 3.7. On many of the issues, NIE would be quite willing to accept the MMC's determination. We believe that the differences between Ofreg and the MMC need to be understood and that a public consideration of the issues involved is a very important part of finding a resolution on which all of the parties may move forward in the best interests of the customer.


2.1 Network age and vulnerability

  The Committee requested further information on NIE's analysis of the relationship between the age of the network and its vulnerability to storm damage.

  The overhead distribution network comprises approximately 3,000 km of 33kV lines, 20,000 km of 11kV lines and 6,000 km of low voltage lines—a total of some 29,000 km of overhead network. A substantial proportion of this network was constructed in the period from the late 1950s to the mid-1970s, as rural customers were brought onto the system through new rural electrification schemes.

  The analysis which follows focuses on the 11kV network since it is the most extensive, but the principles of age and condition monitoring extend to all network voltage levels.

  The 11kV network comprises main lines which form the arteries of a very extensive rural distribution system. These arteries service over 240,000 customers who live in mixed rural/urban environments outside of the main cities and over 210,000 dispersed rural customers who also require for their supply what might be described as a complex subsystem of veins, also constructed at 11kV and fed by the main arteries. As new rural customers come onto the system, the 11kV network must be extended at a local level, year by year, across the breadth of Northern Ireland. The main arterial 11kV network also requires periodic extension and reinforcement in order to meet the new load demand as it builds up over a period of years. As a result, poles and system components of widely varying ages are widely distributed throughout the system and the age of poles and components does not adhere to any particular pattern of geography. Thus, for assessing the potential maintenance needs of the system, the age of poles, whose maintenance assessment triggers assessment of the other principal components subject to deterioration, is recorded and monitored at an individual level.

  While age is the principal surrogate for likely condition, actual condition can vary with such factors as the quality of the original preservative treatment of poles as supplied, the foundation conditions, and the degree of weathering and other exposure as determined by the terrain or location. Thus, in practice, the refurbishment needs of a local supply system will vary along the entire length of the specific 11kV circuit, depending on the date of construction of the original main arterial line, the dates of local extensions and reinforcement, and the lifetime conditions and rates of deterioration of individual components. In general, a best-practice approach to maintenance, which ensures a cost-effective result for the customer, necessitates that overhead lines should not be subject to wholesale replacement at a point in time, but should enjoy substantial maintenance and ongoing replacement guided by condition monitoring and assessment of the individual line components—conductors, poles, insulators, steelwork, etc. This is the practice adopted by the industry in general and by NIE. It involves tracking the age of the system but, as indicated in Section 3.2 of our Report on the storm, it also involves an ongoing assessment of the fault history of individual circuits as a further guide to maintenance and refurbishment needs. Once a circuit has been selected for maintenance, a thorough assessment of all the line components is carried out to determine the extent of replacement necessary and the precise schedule of work.

  Industry norms, based on long run statistics, assume a distribution of probability of failure of wood poles centred on an asset life of 35-40 years. The expectation of failure is higher in the higher age range but failure can occur earlier in a significant percentage of cases due to the more rapid deterioration of individual poles or particularly onerous wind-loading conditions in a storm, and also due to the nature of the local terrain and the wind direction relative to the particular orientation of the line. For example, if wind direction is at right angles to the line conductors, maximum force is exerted on the pole. Conversely, there are poles on the network of more than 50-years-old which have been assessed as to condition and have been found to be sound and perfectly serviceable and have withstood the force of the recent storm.

  Thus, in practice, age is used as an important factor in guiding maintenance need but it is not the single determining factor. In addition, in order to effectively manage the process of maintenance and, in particular, in order to minimise the number and duration of interruptions of supply to customers, it is necessary to plan and focus resources circuit by circuit in a maintenance cycle which extends over a period of years. It is not acceptable or effective to progress the refurbishment of circuits on a strictly age-of-pole basis.

  When focusing on age-of-pole as a guide to maintenance need, likely failure rates may be modelled based on the industry model for pole decay/failure rates. The number of poles likely to fail in a given age category may be predicted as the total number of poles in that age category multiplied by the probability of failure corresponding to the age point on the failure distribution curve.

  The graph below compares predicted pole failures calculated on this basis for the HV distribution network and the actual pole failures which occurred during the Boxing Day storm, against their age profiles. There is reasonable correlation between the two sets of data. Any mismatch may be ascribed to the fact that age is not an absolute proxy for actual condition of all line components and, as explained, local wind conditions, terrain, etc., can be significant contributory factors.

  Overall, the graph clearly shows that network refurbishment must take particular account of poles in the 30-45 year age category. On the 11kV network, some 57 per cent of the pole population of 240,000 lies between 20 and 40 years old. It is this knowledge, combined with the above type of analysis, and allied to condition monitoring of individual circuits, which led us to focus a particular effort on 11kV network refurbishment during the first regulatory period and to propose a continued programme of refurbishment at a high level in our submissions to the Ofreg price review and to the MMC. It has been clearly shown that the network of refurbishment programmes carried out to date have been very effective in improving network performance. Table 2 in the storm Report confirms the underlying reliability improvement since the refurbishment programme began and Figure 3 in that Report shows, on the basis of the circuits in the sample, that refurbishment can improve performance by a factor of 3.5. Despite the evidence, the case for higher levels of expenditure to enhance reliability was contested vigorously by Ofreg at our MMC review. It is clear from paragraphs 2.126-2.131 of the MMC report that, in considering our plans for the refurbishment of 11kV overhead lines to improve network performance, the MMC felt it necessary to restrict that programme in the light of Ofreg's arguments against it. It is in the light of the demonstrated experience of the recent storm that we intend to engage again with Ofreg on their approach to this issue. We are concerned that any inability to see a resolution to the issue of high generation costs, which have by far the greatest impact on prices to the customer, should not lead to an inappropriate focus on the relatively weak impact on price of this type of refurbishment programme.

2.2 Implications for Subsequent Work

  The second question referred to in question 58 of the evidence is specific to the implications of the accelerated work programme proposed, i.e., "What the implications would be for subsequent work once you have brought it up to that state".

  The full overhead line refurbishment programme is based on a 15-year cycle. The asset replacement work performed on each circuit once during a cycle ensures acceptable component reliability until the next time the circuit is due for refurbishment. When all the circuits have been fully refurbished in line with the investment plan, it will be time to recommence the cycle.

  In the storm Report, apart from accelerating our programme of full refurbishment, we proposed to supplement full refurbishment work with a programme of partial refurbishment work, to target the replacement of poles nearing the end of their useful life on those circuits which are not immediately scheduled for full refurbishment. With the replacement of some 10,000 additional poles, partial refurbishment will help to minimise the potential effects of future storms on these circuits. When all these circuits have been partially refurbished in line with the investment plan, they will enter the normal maintenance cycle and will be fully refurbished in accordance with the normal 15-year cycle, requiring attention to other line components without the need for the pole replacement element of the work.

  The cost of any refurbishment programme will always be minimised to the extent possible. In the particular case of lines which have benefitted from early pole replacement due to prior partial refurbishment, this element of cost will not arise in the normal refurbishment programme. However, programme costs vary over time for other reasons. For example, currently, the full refurbishment of overhead lines requires about 10 per cent of the conductors to be replaced, the remaining conductors being in an acceptable condition. As the age profile increases for conductors, future refurbishment cycles will need to increase the amount of conductor replacement. This work is very cost-intensive and tends to increase the average cost per km for full overhead line refurbishment. Conversely, NIE attempts to use best practice international procurement and strategic sourcing partnerships with suppliers to minimise materials costs where possible.

2.3 Customer Minutes Lost

  The third question referred to the analysis of customer minutes lost figures quoted in the Report, i.e., "It would be quite useful to know if there is either an update of Figure 2 by which we can compare NIE by Figure 2 calculations or, alternatively, whether there is an update for other utilities which compares with the figures which appear in Table 2 . . . it would be helpful so that we get away from comparing apples with pears".

  The figure and the table appear under two separate sub-headings and each attempts to explain a separate issue.

  Figure 2 simply demonstrates that the overall performance of the NIE network at privatisation was at the bottom end of all of the regional electricity companies and required higher levels of investment. This indicated that pre-privatisation investment in the system was inadequate. The consequent new investment need was a major area of discussion at MMC. Paragraphs 6.20-6.22 of the MMC Report summarise the evidence we submitted to MMC as to the need for targeted improvements in Customer Minutes Lost (CML) to keep pace with the projected improvements of the broadly comparable regional electricity companies (South Western, SWALEC and Hydro-Electric) which, like NIE, have much higher levels of overhead network per customer than the GB average. Table 6.6 of the MMC Report shows how CML may be improved by specific rates of 11kV line refurbishment. Figure 6.4 of their Report illustrates that the large improvement envisaged by NIE depended primarily on improving CML in the rural districts. Paragraph 2.127 of their Report indicates Ofreg's evidence against higher levels of capital investment and Appendix 6.2 summarises the main findings of an Ofreg survey which purported 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.

  Figure 2 simply attempts to establish a sense of understanding as to the need for higher levels of capital investment in network refurbishment in order to improve quality of supply. Against the background of what we believe to be an inadequate recognition on the part of Ofreg of the specific capital investment needs of the rural network, we would be concerned that there should not be an inappropriate focus on this as a pricing issue in the context of an inability to see a solution to the over-burdening issue of high generation costs.

  Table 2 shows the improving underlying trend in CML arising only as a result of 11kV network performance. It is through 11kV network refurbishment on rural circuits that NIE aimed to obtain significant CML improvement. The Table shows a reduction by 50 in CML due to normal 11kV faults in the period from 1993-94 to 1997-97 and a reduction by 52 to 1997-98. Total CML fell from 268 to 209, a reduction of 59, in the period to 1996-97. The 1997-98 figure was 319 but this was heavily distorted by the 1997-98 storm. The higher figure in the year of a storm is not just a measure of network vulnerability, it is heavily distorted by the sheer scale of the number of customers off-supply due to the loss of arterial lines even for a limited duration, combined with long delays in reconnection times for some customers due to the sheer scale and complexity of network faults. These lead to an exceptional impact on customer minutes lost and could distort the view of the underlying investment need leading to inappropriate levels of investment.


  It may be helpful to the Committee to have the following additional comment on other issues referred to in the transcript and/or in Ofreg correspondence. As suggested during the evidence hearing, where possible, we have made cross-reference to the MMC Report of March 1997 which has very fully documented the entire range of issues affecting investment and performance. We hope this may provide the Committee with a useful independent reference.

3.1 Investment levels

  Reference is made in question 56, of the evidence, to investment levels: " . . . many people would regard the level of investment that you made as utterly insufficient given the age of the system that you are trying to operate".

  The investment in network expenditure post-privatisation has been at a level approximately double that pre-privatisation. The present level of expenditure amounts to around £90 per customer compared to an average of £60 per customer in the other electricity utilities in the UK. Extensive analysis of the type indicated earlier has determined that it is primarily 11kV refurbishment which impacts on network performance and NIE has focused on a major programme of refurbishment since 1994. This is the largest programme of its kind in the UK and addressed the legacy of a poorly performing network inherited from pre-privatisation.

  The challenge at MMC was to be able to maintain programmes at their current level in the light of the way in which capital investment was contested by Ofreg, with what purported to be supporting evidence from customer surveys as indicated in Section 2.3 above. Ofreg appear also to challenge the suggestion that there has been under-investment prior to privatisation by referring to the levels of capital investment pre-privatisation and lay a particular emphasis on the impact of high nominal levels of network investment on the quantity of assets which the customer in NI has to finance (Ofreg letter of 3 February to the Committee).[2]

  We underlined to MMC the importance of ensuring that customer surveys are properly constructed to obtain information which supports reliable conclusions. We believe that the customer survey format included as Appendix 6.2 of the MMC Report and referenced at paragraph 2.127 of the Report in the discussion of distribution asset replacement does not deal with the complexities of the issues as dealt with by the MMC. For example, the survey indicates no distinction between urban and rural customers who are exposed to starkly different experiences of customer minutes lost. As the MMC Report indicates at paragraph 2.126 "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."

  The full range of capital investment issues is largely covered in the MMC Report in Chapter 2: Conclusions (paragraphs 2.106-2.144) and in Chapter 7: The Capital Investment Programme of NIE. The issues are complex and were determined by MMC only after a careful investigation which occupied a substantial portion of the six month review process and took account of very detailed submissions made by Ofreg and NIE, supported by the work of engineering consultants Rust Kennedy & Donkin (RKD) for Ofreg and Merz & McLellan for NIE, and the MMC's own consultants Electrowatt. We believe that the process of arriving at conclusions on what was an appropriate investment programme for the Northern Ireland system was severely inhibited by a poor understanding and presentation of the issues by Ofreg and their consultants. Very surprisingly, RKD prepared their report for Ofreg without visiting Northern Ireland and without discussing their findings with NIE. Indeed, as paragraph 2.120 of the MMC Report makes clear, we had not been aware of RKD's involvement before the MMC inquiry took place, and, as clearly stated in paragraph 2.121 of the MMC Report, the MMC itself felt the need to take a newly independent view of the issues. "Given the circumstances in which RKD's report was produced and our own findings from studying it, . . . we consider that conclusions drawn directly from the report are not sufficiently robust in themselves to form a basis on which we can reach appropriate price control decisions".

  The MMC went on to undertake a detailed assessment of the capital expenditure needs of the system in the light of a full knowledge of the issues and consideration of the public interest issues, including the impact of capital expenditures on price.

  In their evaluation of operating expenditures, which include cost allowances for repairs and maintenance on networks, the MMC encountered a similar problem. Paragraph 2.149 of the MMC Report, which deals with operating expenditures, states. "Although the DG [the Director General of Electricity Supply] had described the findings of PKF's report [PKF was the DG's consultant in this area] 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 Electrowatt in respect of R&M), 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 . . . "

  We believe that the process of effective utility regulation is a complex one and that the interests of the customer will be best served by the fullest possible understanding of the issues by the regulator's office. It is essential that the regulatory authority has available to it the best possible expertise. It is essential also that the work of external consultants is not accepted uncritically. We believe that the interests of the customer in Northern Ireland may be very badly served in the future if the expertise available to Ofreg for their evaluation of these issues and their own interpretation of the work of their consultants were to continue to follow the pattern of that evidenced at MMC.

3.2 Refurbishment rates on the 11kV network

  Reference was made in question 57 to the possibility of supportive material being made available for the case for an annual rate of 11kV refurbishment programme of 1,750 km.

  In our submission to the MMC we indicated that our target was for an improvement in customer minutes lost to 107 CML by 2002-03 based on a proposed refurbishment of 1,750 km per year. The background to this target is set out in the MMC Report in Paragraphs 2.126 and 6.20-27 along with supporting graphs of comparator companies and Table 6.6 which sets out our estimate of the projected availability improvement as a result of various levels of 11kV line refurbishment. Paragraphs 2.126 and 6.21 state clearly the importance of this refurbishment on rural networks. Paragraph 2.122 and Appendix 6.2 indicate the evidence submitted by Ofreg for a lower level of refurbishment.

  The figure of 1,750 km is deleted at Paragraph 2.128 of the published version of the MMC Report and we do not believe that Ofreg would dispute it but we can provide evidence of the figure if required. Ofreg's recommendation was for a figure just below 1,200 km a year and again we believe that they would accept that.

  The MMC determined that a less ambitious target of 120-140 CML by the end of the price control period, consistent with refurbishment at the rate of 1,500 km/year, would be better justified in the particular circumstances of Northern Ireland (Paragraph 2.129 of the MMC Report). Following the damage sustained during the recent storm, NIE has taken the view that the better performance of the refurbished circuits was such as to justify an accelerated programme of refurbishment.

3.3 Capital expenditure programmes and past underspend

  Reference was made in question 58 to capital expenditure in the last price control period of £243 million, that being less than the capital expenditure proposed by Ofreg for the present five year price control period.

  In addition, in his letters of 3 and 5 February, the Director General raises concerns in this area relating to the level of capital expenditure, the underspend in the first regulatory period, the setting of priorities and the lack of accountability.

The level of expenditure

  It is important that customers can be confident that the right level and type of investment is being put into the electricity network. Our storm report explains that we are investing almost twice as much in the network as we did before privatisation and at a much higher rate per customer than electricity companies in GB.

  In defining the level of total capital expenditure to be adopted for the purpose of setting the new price control, the MMC weighed carefully the public interest issues associated with each category of investment.

  The Director General's proposals to the MMC were based on cutting NIE's proposed investment in the network by 20 per cent. However, the MMC rejected the work of Ofreg's consultants, regarding it as "not sufficiently robust" to form a basis on which price control decisions can be reached. After conducting their own extensive investigation into NIE's investment proposals, with the assistance of their own engineering consultants, the MMC based the new price control on an overall capex figure which was 10 per cent lower than what NIE had proposed and which they considered balanced the various public interest issues.

The underspend

  The salient facts pertaining to the underspend are as follows:

    —  The reasons for the underspend were very fully explained at the MMC and are largely documented at Appendix 7.1 of the MMC Report.

    —  The extent of underspend was by far the greatest in the transmission network which was relatively unaffected by the storm. Within the transmission capital underspend detailed in Appendix 7.1, some 32 per cent is explained by the delay of a single project viz Belfast transmission project, and some 60 per cent was attributable to demand management measures which are widely regarded as necessary performance management on the system.

    —  Over 80 per cent of the distribution capital budget was fully spent.

    —  In our evidence to the MMC, we explained how we had responded to the incentives within our price control to increase the efficiency of our investments. We quoted, as examples, the introduction of better procurement practices to enable us to purchase equipment at cheaper prices and the modification of our tariffs to introduce price signals designed to slow the rate of growth in customer demand in order to defer the need for certain types of investment.

    —  Any investment impacts on prices, since prices must be set at a level which covers the financing costs of the investment including the cost of capital and the depreciation charges over the life of the assets. Customers benefit from efficient investment, since prices will be lower than they would otherwise be if investments were inefficient, unnecessary or premature. It is crucially important in proper regulation that the incentive not to invest the allowed capital if it is not to customers' benefit is maintained. This was clearly recognised by the MMC.

    —  The effect of the underspend which arose by investing efficiently in the first price control period is that prices are now 2 per cent lower than they would have been if the full capex which was forecast at privatisation had been spent. The Director General's comments that . . . the underspend was " . . . more than enough to have paid for the Scottish Interconnector at no extra cost to customers" is quite incorrect. If the full forecast capex had been spent, then customers would be paying for it for the next 40 years. Since the money has not been spent, and customers are not paying for it, the interconnector could not be said to be capable of funding at no extra cost.

    —  The MMC recognised the force in our arguments about maintaining incentives to invest efficiently. The MMC resolved the issue of the underspend by allocating the benefits between the company and customers.

    —  The MMC set guidelines as to how to judge future capex savings by focusing on whether the outputs have been met (e.g., targets for customer minutes lost), rather than focusing on whether the envisaged inputs in terms of forecast capital expenditure have been spent. The MMC regarded the absence of output measures as a deficiency in Ofreg's price review.

  In returning to the underspend theme in his letter of 5 February, the Director General suggests there has been a £12 million underspend in the first year of the new price control, and he says that this shows NIE did not even spend the amount he would have allowed under his proposals:

    —  The concept of calculating an underspend on a year by year basis is not meaningful since certain network investments are by their nature "lumpy". No underspend can be said to have occurred until the full 5-year term of the price control has elapsed. Annex C of the DG's own submission to the Committee shows the phasing programme of expenditure.

    —  The capex levels inherent in the Director General's proposals are not a suitable benchmark. The MMC rejected the work of Ofreg's consultants upon which the DG's proposals were based, describing their conclusions as being "not sufficiently robust".


  Our report explains how, shortly after privatisation, we made the refurbishment of the 11kV circuits an investment priority in order to improve the performance of our network which in 1992-93 was, by comparison with the GB companies, at the bottom end of the performance scale. We engaged in an investment programme which the MMC considered was adequate to balance the public interest issues of quality of supply and price. The priorities that we are now re-emphasising are the ones we have maintained throughout the first price review period and throughout the discussions at MMC.


  In defining the level of total capital expenditure to be adopted for the purposes of setting the new price control, the MMC weighed carefully the public interest issues associated with each category of investment. At the same time they were not prescribing an investment programme. They recognised that there would be competing demands on NIE's capital budget and it would be for NIE to determine its priorities among those demands.

  In recommending the reallocation of £24 million to the network performance improvement category, we wish to discus with Ofreg their approach to higher levels of investment in this category given:

    (i)  the MMC's careful consideration of the public interest issues surrounding this; and

    (ii)  the fact that Ofreg had argued for significantly lower levels of expenditure in this category.

  In returning to the issue of lack of accountability for capital expenditure in his letter of 5 February, the Director-General indicates that he has appointed consultants to examine NIE's capex programme and he intends to consult with customers as to their involvement in determining the size of the capex programme and the priorities within it. He also indicates that he now intends after a very short time to change his previously stated policy of allowing management to organise priorities on the basis of their own judgment and in the light of network performance. It is precisely this type of inconsistency in regulatory approach in Northern Ireland which led us to argue at MMC for a detailed understanding of the basis upon which our original capital investment programmes were constructed. This was in the context of what we understood from MMC was a preference on the part of Ofreg not to deal with capital expenditure in an itemised way—what was discussed within the hearing as the "bucket" approach.

  The MMC investigation included a very detailed assessment of the public interest issues relating to the capital investment requirements over the current price control period to March 2002. It is for that reason that NIE wishes to discuss with Ofreg its approach to slightly increased levels of investment in measures to improve network performance.

  At the time of the MMC referral there were significant differences between NIE's view and the Ofreg view. Although, in the context of setting the new price control the Director-General has agreed to adopt the MMC's level of capex, when it comes to discussing an actual investment programme, particularly areas relating to performance improvement, NIE will be mindful of the difference in views which were presented to the MMC, for example:

    —  The proposals which Ofreg put to the MMC were based on cutting the amount which NIE proposed to invest in the network over the current five years by 20 per cent.

    —  As regards the specific investment in refurbishment of the 11kV overhead lines, Ofreg's proposals would have cut NIE's proposed expenditure by 50 per cent. In terms of the numbers of km to be refurbished each year, he considered that the rate which NIE proposed should be cut by over one third. If the Director-General's arguments had been fully accepted on this specific point, the network would have been deprived of an investment essential to its performance improvement. NIE's report into the Boxing Day storm now proposes that the rate of refurbishment for the remaining three years of this price control period should be increased to an annual average of 1,750 km/yr which would bring us back to the figure we proposed to the MMC.

    —  There were other areas of performance improvement expenditure where Ofreg disagreed with NIE, for example Ofreg proposed:

      —  to cut NIE's bid for expenditure on system development and performance-related work by 41 per cent;

      —  to disallow all of the proposed £12.7 million for system development work;

      —  to cut 24 per cent of the proposed undergrounding programme; and

      —  to disallow all of the proposed expenditure to replace undereave wiring.

  We believe there is a much wider issue of accountability at play in this discussion. The Director-General is seeking to cut NIE's revenues below the level which the MMC considered was the minimum necessary to enable the company to finance its activities including the level of capital expenditure which the MMC considered justified to improve continuity of supply to customers. We are concerned that further price cuts would call into question our ability to fund the revised plans to improve the resilience of the network to future storms.

  We believe that this wider issue of regulatory accountability has been satisfactorily addressed in the recent DTI White Paper on Regulation referred to in Section 3.7 below.

Reallocation of capex

  The Director General thinks it is disingenuous of NIE to give the impression that the problem is being solved by the company at its expense.

  In recommending the accelerated refurbishment programme, our report makes it clear that the extra cost will be financed through a reallocation of expenditure. Page 34 explicitly states that the necessary £24 million will be funded by a reallocation from other categories of expenditure reviewed by the MMC.

3.4 Prices

  Reference is made in question 65 to the issue of electricity price increases as a result of the capital expenditure programme.

  The reallocation of capital expenditure to improve the resilience of the network during storm conditions will not impact on electricity prices in this present price control period and overall we believe that the capital investment requirements of network performance improvement are entirely justified and in the long-term interests of the customer.

  The Director General also addresses prices in his letter of 3 February.

  It is widely recognised that the costs per customer of providing a transmission and distribution (T&D) network are influenced to a very significant extent by the size and nature of the customer base served by the network. In this regard, NIE's service territory is characterised by having one of the smallest customer bases, connected to a widely dispersed rural network. Therefore the assets employed per customer, and hence the costs per customer, will be correspondingly higher. This relates to the well recognised problem of economies of scale. Comparisons of NIE's T&D charges should therefore not be made on the basis of the average of all the GB companies but rather on the basis of those companies whose customer bases are most similar to NIE's. There are similar price differences within GB, between our comparator companies and the GB average.

  Our charges today (1998-99) for the network, at £120 per domestic customer per annum, are very similar in real terms to what they were in 1992-93, the year the industry was vested. In the intervening period we have invested £257 million in the network. What this means is that NIE's efficiency gains in this period have funded a considerably more reliable network at no additional cost to the customer.

  A further check on the efficiency of NIE's network activities is the fact that the charge of £120 per domestic customer is almost identical to our comparator GB companies, i.e., ones with similar large rural networks—Manweb, SWEB and Swalec. It is in fact quite surprising that we are able to deliver this comparative figure on a customer base which is much smaller than our comparator companies. The fact is that NIE has more assets employed per customer by virtue of its smaller customer base, yet is able to hold its costs per customer at a similar level. As a large proportion of the costs in these businesses are fixed costs, the only conclusion is that NIE is a more efficient company than its comparators.

  To the extent that costs per customer may have moved out of step with comparator RECs since privatisation, a reason can be found in the different investment profiles. Since 1992-93, the RECs' investment per customer has fallen from £66 per annum to £58 per annum. Over the same period, NIE's investment per customer has risen from £52 per annum to £90 per annum because of the specific needs of the network.

  This level of investment is entirely consistent with the needs of a network which had severe under-investment while in the public sector, giving rise to some of the poorest reliability figures in the industry. This was the situation we faced in 1993 when we decided to embark upon our major refurbishment programme. This inherited situation is now being turned round. The figures we have for capital expenditure today and going forward have been fully validated by the MMC.

  NIE's current charges have been set in accordance with the outcome of the MMC's investigation into NIE's price controls which resulted in price cuts to domestic customers of 13 per cent real since 1 April 1997. The Director-General notes that the current price regime is of the MMC's devising and he is seeking leave to challenge it in the House of Lords.

  The difference in impact between the Director-General's price proposals and those of the MMC is, we believe, about 2 percentage points on domestic prices. Paragraph 2.211 of the MMC Report and Table 2.14 show the MMC's estimates of their proposals as producing a 28 per cent reduction in the Transmission, Distribution and Supply component of the domestic bill, resulting in a 14 per cent real reduction in the domestic prices between 1996-97 and 1997-98. Paragraph 2.211 goes on to state that the effect of the DG's proposals, calculated on the same basis, would have been to reduce domestic electricity prices by 16 per cent in real terms between 1996-97 and 1996-98, a difference of two percentage points.

  Domestic prices have reduced by less than the MMC's estimated reduction because of a number of cost increases, the level of which could not be anticipated at MMC—the most easily identifiable example was an increase in the cost of rates on NIE facilities and on the generating stations.

  The difference of two percentage points on domestic prices between the MMC's and DG's pricing formulae is dwarfed by the potential impact of lower generation costs. These are estimated by Ofreg to be over 40 per cent above an open-market price. Their reduction to an open-market rate would impact domestic electricity prices by some 20-24 per cent.

3.5 Customer/Shareholder balance

  The balance between customers and NIE's shareholders was very fully considered by the MMC. The MMC price control reduced NIE's allowed revenues by some 28 per cent per unit. As a result NIE's allowed revenues were reduced by some £57 million with effect from April 1997. In making this reduction, the MMC took full account of cost reductions achieved by NIE to-date and the level of profitability which should be allowed for the very high installed asset base required to service the Northern Ireland customer. The MMC made it clear in paragraph 2.215 of their Report that they regarded the targets within the price control as "challenging but achievable".

  The Director General acknowledges that since privatisation customers have benefited from improved levels of customer service.

  Given the difficulty in making any real impact on generation costs, which are not subject to regulation and which Ofreg have suggested are some 43 per cent above an open-market price, we find it strange that the Director General should suggest that the generating companies in the electricity sector in NI have demonstrated a greater willingness to remedy the customer pricing imbalance which clearly arises predominantly from excessive generation costs.

3.6 Attribution of blame

  The Director General in his letter of 5 February suggests that we have attempted, by highlighting the relatively low level of network expenditure pre-privatisation, to attribute blame to parties other than NIE's management for expenditure decisions. We would wish to reject this suggestion.

  As we listened to the concerns expressed by our customers and their representatives following the storm, we met the suggestion that the level of network investment had fallen since privatisation, this could have been a contributory factor to the extent of the damage sustained during the storm. Our report simply draws attention to the fact that we are investing almost twice as much in the network as was invested before privatisation. The intention behind this comparison was simply to make the public aware of the facts. There was no attempt to attribute blame.

  The data on Customer Minutes Lost demonstrates that we inherited a network whose performance was at the low end of the performance scale. It was our decision, shortly after privatisation, to refocus our investment programme on performance improvement measures, in the form of the 11kV refurbishment programme. On the basis of the evidence available, we embarked on the largest network refurbishment programme of any UK electricity company. If we had not made this decision, we are convinced that the effects of the storm would have been considerably worse. We remain fully convinced that this was the right decision and best served the public interest and this was confirmed at the MMC. We are equally convinced that an increase in that programme will make the network more resilient to future storms.

  The crucial point to note is that if investment prior to privatisation had been adequate, then the network would not have been so poorly performing in 1992-93. As we have previously indicated, this situation is now being turned around. The low levels of expenditure in the early 80's is not irrelevant, as the DG suggests in his letter.

3.7 Protecting the customer interest through effective regulation

  In their very detailed consultation Green Paper entitled A Fair Deal for Consumers, March 1998, the DTI set out to examine how to modernise the framework for utility regulation. Section 7 of the document dealt with "Better Regulation" and the constituent requirements of an effective and legitimate regime of regulation.

  In the context of the powers of the regulators, Paragraph 7.6 of the Green Paper goes as follows: "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. There is also a risk of discontinuity in decision making when new appointments are made".

  The Green Paper put forward alternatives to the present structure, for consultation. The subsequent White Paper publication of the response to consultation states at Paragraph 69: "The response to the Green Paper suggests there is 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 Paper goes on to state at Paragraph 70: "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 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".

  NIE believes that regulation of the NI electricity industry, particularly because of the so far intractable issue of high generation costs, is a very complex and onerous task. We would be anxious to see the NI regulatory model continuously evolve to meet the best practice models defined for the UK. We believe that this evolution will best ensure that the interests of Northern Ireland customers are fully protected for the future.

6 March 1999

2   Ev. p. 39. Back

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