Select Committee on Northern Ireland Affairs Minutes of Evidence

Examination of witnesses (Questions 68 - 79)




  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.


  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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