Examination of witnesses (Questions 68
- 79)
WEDNESDAY 10 MARCH 1999
MR DOUGLAS
MCILDOON,
MR CHARLES
COULTHARD and MR
CHRIS THOMAS
Chairman
68. A very warm welcome to you all. We are
grateful for the memoranda we have received, which were provided
for us in advance, and it was also helpful to have advice at the
time that we were taking evidence in Belfast in January. Before
we start asking questions, I do not know if there is anything
you or your colleagues might like to add to what has already been
sent to us in writing, but that opportunity would certainly be
available. We try and take the questions in logical order, but
that does not mean to say we are sitting logically, so the questions
may come from different corners of the horseshoe. If at any stage,
either during this session or in writing afterwards, you wanted
to gloss any answer you have given—perhaps because of the
possibility of misunderstanding or because it has occurred to
you that there was extra information which would be helpful for
us to have—please do not hesitate to do that and equally,
if selfishly, we will reserve the right if there is something
we want to follow up in writing afterwards we would. We are necessarily
a Committee where people do have other obligations in the House
of an afternoon and I know Mr Livingstone is going to be leaving
us shortly. He and I are both serving at the moment on the committee
stage of the Greater London Authority Bill which has generated
more amendments than any Bill of its kind and I think it may be
beginning to show in the faces of both of us! So I am going to
regard myself as held in reserve in terms of asking questions.
We know there is another Member of the Committee who is in the
building and may join us, but I apologise if there is a certain
amount of to-ing and fro-ing as the Committee sits. Is there anything
you would like to add at all to the very helpful information you
have provided?
(Mr McIldoon) Mr Brooke, thank you for the invitation
to be seen by your Committee. May I introduce my two colleagues?
Charles Coulthard, on my left, is my Deputy Director General for
Electricity and Gas. He has had a long experience of being involved
in utility regulation in Great Britain and he has been working
in Belfast as Deputy Director General since 1992. On my right
I have Chris Thomas who is with the Office of Electricity Regulation
in England and has been there since 1990. He is a chartered electrical
engineer and he has been involved in power engineering since obtaining
his degree at the University of Glasgow in 1975. He works also
for OFREG and provides me with professional advice on the state
of NIE's networks and indeed probably knows more about NIE's networks
than anybody certainly outside Northern Ireland and probably most
people inside Northern Ireland. I will turn frequently to them
to provide me with support in trying to answer your questions.
I have prepared a short memorandum, but rather than read it to
you I think I will leave it with you, because I think I would
take up the time of your Committee unnecessarily were I to read
it. What I would like to do is say that there are at least five
major areas of concern which arise from the Boxing Day storm.
These are firstly the ability of the company to minimise supply
interruptions by its choice of network investment strategy. Secondly,
the extent to which investment strategy is hamstrung by lack of
resources. Thirdly, the ability of the company to minimise the
inconvenience to customers by communicating effectively with them
after supply interruption. Fourthly, the efficiency with which
customers are reconnected and fifthly, the compensation payable
to customers for the inconvenience of prolonged supply loss. Those
are, I presume, the five areas you would like to ask us about.
I would like to add one additional thing because it has featured
frequently in discussions about this issue and that is the level
of Capex and I would like to put it clearly on the record because
I have been accused by the company of not allowing them sufficient
Capex. I opposed allowing NIE the level of Capex they sought in
the last price control for two reasons. The first was the £97
million of underspend in the first price control and the second
is that, allowing the company revenue for investments, even when
they do not make those investments, drives up prices and, since
privatisation, as a result of bad price controls, we now have
a 30 to 40 percent structural price divergence in transmission
and distribution costs from Great Britain. We did not have that
before privatisation and that is now locked into our price control
system and it is going to be extraordinarily difficult to get
out of it. Every customer in Northern Ireland will, according
to an internal paper which we prepared in OFREG, by the end of
this price control period, be supporting £250 of additional
assets compared to customers in Great Britain. All the money that
is spent on the network is not NIE's shareholders' money, it is
customers' money and must be financed by customers. Under the
present price control for which the MMC must answer and not I,
we have a strange outcome. The company is investing at the level
I would have allowed, but customers are having to pay MMC prices
and given NIE's history of underspend it is not credible for the
company to argue that resources were the determining factor. Now,
Mr Brooke, we would be happy to answer your questions to the best
of our ability. I appreciate your offer that we can elaborate
on our answers in writing if, on the spur of the moment, we are
not able to give you as full an answer as we would like to, but
we will do our best.
Chairman: Thank you
very much indeed and I think the Committee is fortunate that you
should have brought your colleagues with you.
Mr Grogan
69. Good afternoon. First, may I just establish
how large the Office of Electricity Supply is and to what extent
do you need to draw on staff of the Great Britain office of the
Electricity Regulator and outside consultants?
(Mr McIldoon) It is a combined office of electricity
and gas regulation. Gas regulation was added in 1996 and the gas
regulatory side of it is about three full-time person equivalents.
There are about 17 full-time person equivalents in electricity
regulation, so it is a very small office. The result is that we
do not have in-house legal services or indeed in-house engineering
services which is why I have to turn to Mr Thomas for that kind
of advice, and we do get a lot of professional technical advice
from OFFER in Birmingham.
70. How would you characterise your overall
relationship with NIE and to what extent do you both agree about
the challenges facing the electricity supply industry in Northern
Ireland and the means of meeting them and where would the differences
lie?
(Mr McIldoon) The relationship with NIE exists
at many different levels and at most levels, I think, it is a
very good and constructive relationship. Most of NIE's employees,
the overwhelming majority of them I think, still see themselves
as first class public servants, dedicated to performing a first
class public service and certain parts of the organisation are
extremely imaginative and creative and show a lot of flair. One
of the few satisfactory outcomes of the post-privatisation period
has been the way in which the supply business has performed. The
supply business actually delivers supply, the retail part of electricity,
to customers at a lower price than any supply business in Great
Britain and offers a range of products that I do not think are
fully matched by any supply business anywhere else. For example,
they now have an ECO tariff which not every company in England
has. You can buy renewable electricity, if you want. If you want
it for 10 percent of your supply, you can do that. If you want
it for 100 percent you can do that. They offer a whole range of
energy efficiency services which are not readily available perhaps
on the same scale everywhere else. So that is a great success
story and my staff co-operate very well in devising new products
and facilitating the movement of the company into new areas, like
combined heat and power, which they were originally not allowed
into until I changed the rules to allow them into it. So at that
level it is fine. There are issues about control of the network
where NIE has traditionally been responsible for the network,
believes it should manage it in its own way and yet with the opening
up under the IME Directive, of the internal market, there has
been a need to loosen their control of the network to create third
party access, to reduce the requirement that all electricity must
be bought and sold by the company and frankly there has been,
as when any power structure is challenged, a protracted form of
trench warfare by which they have had to have control prised from
them. There does not seem to be an ability to make the imaginative
leap into a competitive world in which the owner of the T&D
system is inert, passive, simply making money from collecting
it from the electrons which flow up and down the wires, but not
in a predominant role within the business and able to dictate
the fortunes of other companies. So that has been rather disappointing.
But there is underlying a lot of what goes on in Northern Ireland
a control issue. Is this industry going to be run in the public
interest or is it going to be run in the interest of a self-perpetuating
clique of people who do happen to run a monopoly but are not answerable
to anybody? I think it is a fundamental question of public accountability
that is not adequately addressed in our present privatisation
structure. You come finally to the issue of money. The company
is extraordinarily profitable, much more profitable I think than
it ever expected to be, and yet until it started voluntarily offering
people goodwill payments following the storm, it had shown a tenacity
in taking every penny from customers that it was legally entitled
to to a quite extraordinary extent. Coming to this from a public
service background, I have just been frankly amazed at the unwillingness
of the company to contemplate the long-term position it was getting
itself into because it now is presiding over a price control and
a charging system for transmission and distribution which is not
sustainable in the long term because it has created a 30 to 40
percent price gap between the position in Northern Ireland and
the position in Great Britain, and indeed in the Irish Republic.
71. You mentioned one or two differences
between the electricity supply business in Northern Ireland and
the United Kingdom. Do these differences affect the way you discharge
your functions?
(Mr McIldoon) Well, I have one company to regulate
whereas Callum McCarthy has got 12 Recs and two companies in Scotland
and therefore there is much more direct relationship between me
and the company that I regulate. The other companies are regulated
with a degree of comparison between them; there is benchmarking
and so on, whereas we regulate a single company and to that extent
I think the relationship is inevitably to a considerable degree
more adversarial than it should be. I suppose the analogy is probably
with the last gas regulator and British Gas. When you have a single
company and a single regulatory relationship it seems inevitable
that if the company itself is not prepared to embrace change in
an imaginative way, that the relationship becomes adversarial.
Mr McWalter
72. I am sorry; I did not hear the last
word?
(Mr McIldoon) The last word was adversarial.
Mr McCabe
73. I have been reading your memorandum
Annex A which sets out your responsibilities. I just wondered,
could I be absolutely clear, what it is that you do have power
to regulate and if there are areas where you do not have power
to regulate, that you think you should have, or you would like
to have?
(Mr McIldoon) I have powers to regulate prices
through the price control mechanism and we had a price control
of NIE in 1996 which came into effect, in theory, in 1997. That
power of course is challenged through the company going to the
MMC and therefore that power is considerably attenuated in so
far as the current legal position seems to be that the MMC has
the final word and obviously a company only goes to the MMC if
it thinks it is going to do better out of the MMC and that of
course turns out to be the case. So the power that I have in regard
to prices is a very circumscribed power. It is no more circumscribed
I suppose than the power in England, but in England companies
have been more pragmatic in their approach; they have not challenged
the regulator by taking him to the MMC on price control issues.
The powers on other issues, I think I will call on Mr Coulthard
on this because he has a much better background and if I start
to list them I will leave something out which I am sure he would
cover more effectively than I would.
(Mr Coulthard) The powers that the Director General
has are largely concerned with ensuring that the company complies
with its licence, which is the legal basis on which it operates.
Essentially it boils down to the Director General having power
to ensure that there is no discrimination in treatment of different
customers, there is no discrimination in terms of access to the
network and there are no cross subsidies between non-competitive
parts of the business and competitive parts. In addition there
are powers to set prices subject, as my Director General has said,
to any reference to the MMC, but not of course to set profits.
And the prices are set in terms of the allowed revenue the company
can collect rather than an individual price per kilowatt hour.
Those very briefly are the powers the Director General has.
74. Thank you. Would it be fair to assume
that the right which the company has to go to the MMC impacts
on or restricts your overall effectiveness in terms of the regulation
of electricity prices?
(Mr McIldoon) I think it undoubtedly does because
they were very successful at the MMC and, if they had not had
the right to go to the MMC, prices in Northern Ireland would be
lower. Prices to customers in Northern Ireland would be, in fact,
if I had not lost in the High Court—and I am still waiting
to hear whether or not I can get to the House of Lords—and
my price controls had taken effect, customers would be looking
forward to a price reduction in the beginning of the new tariff
year on 1 April, whereas in fact the probable outcome is that
prices will diverge even further from prices in Great Britain.
75. So, just to make sure I am not putting
words in your mouth, but it would be fair to say that you are
charged with the power of regulating the electricity prices and
that you are to some extent obstructed from doing that because
of the rights of the company to appeal to the MMC?
(Mr McIldoon) Yes.
76. Thank you. May I just ask one other
thing? I have been struggling to try and understand this issue
about the capital spend or the underspend in past years. I am
really trying to understand what its practical effect is on customers.
Am I right in thinking that what happens is that the company can
charge as if it is spending, say, £X million on capital expenditure
but it can actually spend £X-100 million and simply accumulate
the balance? Is that what happens?
(Mr McIldoon) The company is allowed in its price
control the amount of money—in the case of the first price
control it was £330 million or something like that; I can
clarify these figures for you. It is allowed to collect that money
in its tariff each year during that five year period. If it does
not spend the money then it has collected the revenue as if it
had spent it for the five years. In the following five years obviously
the amount of assets that it has in its asset base is smaller
than it would be if it had spent the money, so therefore the revenue
in the following 35 years is less than it otherwise would be.
But it has always suited companies to claim to spend more than
they are going to spend to get the revenue for that during the
five years and then in the next period of course they claim they
need a lot more money because they have not spent the money in
the previous period. It is very much a case of heads we win, tails
we do not lose as far as the company is concerned and the exact
opposite for customers. They lose out both ways.
77. So NIE has charged its customers based
on a particular level of capital expenditure, but it has actually
spent less and it has either given that money to its shareholders
or it has accumulated it?
(Mr McIldoon) Yes, the underspend of £97
million in the first price control period was worth—well,
it was worth £28.2 million in the company's revenues for
that five years. Now the MMC agreed with me that some of that
should be given back to customers so we clawed back £7 million.
But the company made £21 million of additional profit over
that five years by not spending money they had claimed they needed
to spend to bring the network up to an appropriate standard. Now
that is not just an NIE problem. That is something that applies
to utility regulation across the United Kingdom and all companies
do it. NIE was the first company actually to be required to give
something back, but NIE possibly did it to a larger scale than
the other companies and in the present price control, which has
been going now for two years, they have underspent again. They
have underspent by £12 million. They were allowed £70
million in the first year, they spent £57.96 million. They
underspent by £12 million. That £12 million is worth
money—even if they spend it later in the period, that is
worth additional money in profits to their shareholders and customers
do not get the benefit which would have flowed from any investment
they had made.
78. So the shareholders get the benefit,
but the customers do not. Is it your judgment that the way things
are organised means that there is actually a built in incentive
to skimp on capital expenditure?
(Mr McIldoon) I think there is an incentive to
claim more capital than is required. There is then an incentive
to claim that you do not need to spend all the capital because
you have been clever enough to find other ways of solving problems.
They call it efficiency gains.
Mr McCabe: Thank you
very much.
Chairman
79. Because I am treating myself on this
occasion as a reserve, may I ask in the context of the answer
you have just given, what is the price that the institution has
to pay or is likely to pay subsequently in terms of any subsequent
regime as a consequence of not having spent the money the first
time around?
(Mr McIldoon) I do not see that it has to pay
a price at all. This is the trouble. In a sense it is going to
be able to demonstrate that it needs Capex the next time round
because Capex has not been spent in the first period.
(Mr Coulthard) The price it pays in effect is
if it does not invest the money in capital expenditure, although
it gets the financing charges and depreciation for the current
price control period, it does not go into the subsequent asset
base so it will only get the depreciation and finance for five
years rather than the 40 which is running it through the period.
The only other way it would pay, if you will, by not investing
is if there was a clawback which is what happened in the current
price control review when it was decided that some of the underspend
was not due to efficiency gains but was essentially because the
company took its eye off the ball because of privatisation, so
there are two if you want highly hypothetical costs of not getting
money that they would normally have got had they spent.
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