Examination of witnesses (Questions 100
- 120)
WEDNESDAY 10 MARCH 1999
MR DOUGLAS
MCILDOON,
MR CHARLES
COULTHARD and MR
CHRIS THOMAS
Mr McGrady
100. Thank you, Mr Chairman. Mr McIldoon,
yourself and your office has been very robust and forthright in
your response to the first press statements by NIE and I would
like therefore to take you slightly further and get some additional
information from you on the question of the capital investment
programme. Before doing so, could you just clarify for me some
answers you gave to Mr McCabe at the very start. Could you confirm
in, layman's language, that that element of the price structure
which is allowed for investment, and which was not spent on investment
or capital projects was, in fact, put into the shareholders' fund
holding and distributed? Is that a simple yes or no situation;
is that what happened?
(Mr McIldoon) I think it is a simple yes or no.
They were allowed the money to finance £97 million of investment
which they did not finance. If they had done it, there would have
been £97 million worth of assets created. They would have
gone to the bank and borrowed the money, but they were allowed
the money to finance that. That meant that they actually collected
from customers £28 million to finance, during the five years,
those assets. The money they received from customers was £28
million and that was all money that they were allowed to keep.
What the MMC said was that they had to give £7.2 million
back. So out of that, by avoiding £97 million of capital
expenditure, they succeeded for their shareholders in making £21
million of additional profits. Now that was over five years but
that is beyond dispute.
101. Thank you for confirming what I thought
was the substance of your answer. In other words, the less NIE
spends on capital investment, the more the shareholder gets. It
is as simple as that. But that brings me to the next question,
when the 1998 storm took place, the response from the NIE was
to publicise the compensation to the customer, etcetera, etcetera.
We had a PR exercise—beneficial as you said. The other element
of NIE's response was that they announced—if my memory is
wrong here, correct me—£25 or £26 million further
expenditure and they said that that would cure the problem or
alleviate the possibility of a 1999 disaster and yet at the same
time, in evidence they gave to us, they said that the lack of
investment in previous years was not the cause of the breakdown
in the distribution system. There is a saying in my country: "You
can't hide behind the bush and shake it at the same time"
but this is what NIE seem to be doing. Could you explain that
to me?
(Mr McIldoon) I wish I could explain it to you.
102. If there is no explanation, there is
no point in wasting time on it?
(Mr McIldoon) It comes back to the answer I attempted
to give Mr Beggs. The reason I cannot publish my report as quickly
as I would like is that there has been a presumption running around
behind a lot of the discussion—and NIE are responsible for
this—that it was lack of capital expenditure which caused
the magnitude of the problem. Now it may have been, but if it
is we need to see the facts. We need to see the relationship between
capital expenditure and age of equipment and liability to fall
down in bad weather. Until we get the information and can process
we cannot come to a definite conclusion on that. So if we look
at the other possibility that there is no fundamental relationship
between the magnitude of the problem and the amount of capital
expenditure, the issue of Capex and how much they were allowed
is largely irrelevant to the problem that we are dealing with,
and I think that would have to be my starting point. The onus
is on them to prove that lack of capital expenditure led to the
size of the problem and I think they actually dip in and out of
this. They say it was lack of capital expenditure when it suits
them to blame somebody else and they say: "Well, maybe it
was not the lack of capital expenditure" when they want to
put it all down to the weather and bad luck.
103. Of course your answer is against a
backcloth where in the six years after privatisation they underspent
their capital funding by £109 million?
(Mr McIldoon) Well, £119 million by the end
of this year according to our latest figures.
104. That is just grist to the mill of dissatisfaction.
This enormous amount of money, which should have been spent on
the network, and on capital reinvestment and improvement, as you
said earlier, simply did not happen. Now in the aftermath of the
1997 storm damage, presumably NIE produced a plan; were you satisfied
with that plan and if not what were the shortcomings in it, in
terms of new and enhanced investment in the capital assets; what
would you require to be done in order to address the severity
of the 1998 storm damage? Obviously one has to prepare for this
sort of eventuality happening again.
(Mr McIldoon) In 1997, the first thing was that
there was a certain amount of feeling that they had not been very
generous about compensation payments. They had been begrudging
and they certainly seem to have learned that lesson. There has
really not been a serious issue this time about compensation payments
and those compensation payments will come out of the company's
profits, so that is a major step forward. The main issue though
in 1997, as far as their own capital expenditure is concerned,
seemed to be their ability to communicate with customers and they
had assured us that they had set up various processes and were
investing money in a call centre and it was all going to be much
better in the future. To be fair to them, the full blown works
were only going to be installed by the end of January so they
were not claiming that they would be in for Christmas, but the
system would have been considerably enhanced and they gave us
assurances at several times in the course of the year and I think
possibly we are open to criticism because we took those assurances
at face value. There is, in any case, an issue as to what extent
we try to second-guess the company. We are not the company's Board
of Directors. The whole reason it was privatised was so that an
imaginative private sector management free from the trammels of
interference by civil servants and politicians would be able to
make decisions quickly and get on with the job. I mean, that was
the proposed philosophy of privatisation. So it would have been
going against the grain of that if we had attempted to get into
much detailed involvement with the management decision. So we
say: "There is a problem. You go and solve it. You have the
resources. We are not going to stand looking over your shoulder
all the time". So we took their word for it and the result
was, of course, that the outcome was—in admittedly very
adverse circumstances—that it failed again. May I just add
one other thing, that as far as the network is concerned, and
I do have amongst all these papers the minutes of a meeting we
had with them in July of last year where one of their engineers
is quoted as saying that there were no network lessons to be learned
from the 1997 storm.
105. I assume you find that a remarkable
statement?
(Mr McIldoon) Well I think my engineering colleague
finds it an even more remarkable statement than I do, but in retrospect
it does seem rather strange that in 1997 they were not saying
there was a Capex issue. In 1998, which was only a sort of ratcheting
up by a number of factors of the same problem, they are saying
there is a very major Capex issue.
106. In the new proposals, as it were, for
the Capex expenditure, there is obviously a difference in problem
of continuity of supply between rural and urban areas, in the
sense that the urban areas have substantively more underground
cabling and that the rural areas have more overhead cabling, with
all the additional problems attached to lines through forestries
and trees referred to earlier. How do you assess the ability of
the NIE authority to ensure that there is a proper allocation
of the proposed capital expenditure to those who are most often
cut off, that is, the rural communities as distinct from the urban
communities. That there is in a sense, local discrimination in
order to give an even playing field to all the consumers who are
paying equal prices?
(Mr McIldoon) There is an obligation in the Electricity
Order to ensure that all customers pay the same price for electricity
whether they are rural or urban and of course it is more expensive
to deliver electricity to rural areas and clearly there is a much
worse quality of supply in rural areas and it is worse in some
areas than in others. The company gets its Capex allocation and
the way it was done in the price control, the way the MMC did
it, is it is built up of building blocks. They get so much money
for a particular kind of capital investment for network expansion
because of new connections, for example, for refurbishment of
the transmission network, for replacement of the wires in urban
areas that are running under eaves. There are a whole lot of categories
by which the building blocks of their total capital allowance
are built up. But once they get that and it adds up to the sum
of £300 million or whatever—£350 million in this
case—they have up to now been free to spend that as they
choose. Now there is an argument as to whether I as the customers'
representative should be more involved in deciding how they will
spend that money. Up to now I have not been, but we have been
concerned about the quality of some of their investment decisions
and we appointed consultants recently to ensure that they were
making good investment decisions and that will feed into the next
price control, because up to now if they have been making bad
investment decisions they are still allowed to get a return on
their investment. No other business in the world does that. If
you are a businessman and you invest money and it is a bad investment
you lose your money, but if NIE up to now puts money into a bad
investment it still gets a return on its capital. So I wanted
to challenge that. Now what I think we may need to go further
and do is involve customers in deciding whether the balance between
urban and rural is right and I think that requires a process of
consultation. There clearly are going to be conflicting interests
and we need to find some way of managing those opinions and aspirations
so that we get a balanced outcome. One of the things that we are
doing now—if I can find the right page—is we are going
to ask the company to produce an annual Quality of Supply Report
and this annual Quality of Supply report will show by area what
are the differences in the quality of supply in specific localities
and that will enable us, for the first time really, to identify
those areas where the quality of supply is significantly worse,
and that will be a very useful policy making tool for prioritising
expenditure, and that of course will be in the public domain.
107. I think there are lots of customers
who would be interested in that quality of supply analysis and
indeed they will probably give it to you off the top of their
heads quite quickly as they have recorded the number of breakdowns
over the past year. However, an element of what you were saying
was the need for customer involvement, customer opinion, talking
in terms of where investment should take place. This I would be
enthusiastic about, but somewhat puzzled about how it could be
achieved because the ordinary customer, the end product customer
if you like, would not have the technological knowledge to address
this in a serious way. So how do you propose implementing this?
And the second part of the question, not directly related to it,
is how would you propose having a cost analysis benefit of the
current proposed expenditure carried out in relation to what we
have been talking about?
(Mr McIldoon) If I can answer the second part
of that first, and if NIE want to come to me as they say they
do and ask my permission, which they do not technically need,
to switch more expenditure into the rural network, they really
do have to say what they are proposing to sacrifice to do that
and if they are proposing to sacrifice one lot of projects in
favour of another lot of projects they really would have to produce
some sort of appraisal of those two sets of projects to show that
there was a greater benefit from switching the money from what
they were currently proposing to do to what they would prefer
to do in the future. Now as far as involving customers is concerned,
I think it is difficult. You cannot just have a referendum and
if you ask everybody what would they like, would they like a better
supply at a lower price of course they will say yes. One of the
things we did in leading up to the last price control was ask
customers through survey work: "Do you want a better quality
of system or lower prices? Would you rather have lower prices
now, and the same quality or would you rather have a better quality
and the same or higher prices?" and customers were quite
clear, given the price gap between Northern Ireland and the rest
of the British Isles you would expect this, customers were quite
clear that they would prefer the present quality of supply and
lower prices. That was information that was totally ignored by
the MMC and of course there was no other information available
to the MMC or the NIE or anybody else apart from that information.
When I publish my consultation paper I will put out some sort
of ideas as to how we might involve customers. I think surveys,
discussions with district councils, requiring NIE to publish its
own proposals for different areas, and focus groups and so on
will at least give us some kind of information about what customers'
priorities are. I think customers understand that if you want
an improved service it has to be paid for and that there are trade-offs
to be made between the price of electricity and the quality of
service. I would expect that over a period of time we could create
a more informed dialogue between the company and its customers
as to what the priorities and the options should be.
108. One final short question. You referred
to the long term contracts which, if my memory serves me right,
some of them go up into the second decade of the 21st century
and these are obviously the contracts which were allowed to happen
to fatten the calf for privatisation. Could you advise the Committee
whether you have any power whatsoever to mitigate the horrendous
consequences of those contracts which were entered into at the
time of privatisation?
(Mr McIldoon) No, I have no power to change those
contracts or to abrogate them. I have two options with regard
to those contracts. One is to seek to persuade the owners of them
to change them. Well, I can cancel them in 2010, but one of them
runs to 2024, but I can seek to persuade the owners of those contracts
to improve their terms and I now have proposals from the holders
of the two contracts which would substantially change the price
at which those contracts would deliver electricity. The other
option, should that not prove satisfactory, is to refer the generation
arrangements to the Monopolies and Mergers Commission and if I
do that then the outcome could be that the Monopolies and Mergers
Commission could decide that the existing arrangements were acting
contrary to the public interest in which case the President of
the Board of Trade would be entitled to restructure the industry
or the Monopolies and Mergers Commission could decide that they
were not operating against the public interest in which case nobody
could do anything.
109. Have you an inclination to do that?
(Mr McIldoon) Well, I published a document before
Christmas showing that if we modelled all the generators' proposals,
on the basis of the modelling that was done by my consultants,
we could get electricity prices and generation pretty close to
English prices and there were one or two items, for example, a
long term gas contract, which were mitigating against that. The
generators are now discussing those contracts with NIE. I have
told NIE and the generators that I am subjecting the generators'
proposals to an economic purchasing obligation to see whether
or not their proposals do represent an improvement on the conditions
in which NIE is currently buying electricity from them and I will
have that report by the end of the month.
Chairman: I am conscious
that because of the Division which we took on the Floor of the
House we are likely to go a little beyond 6 o'clock, which is
the normal indicative time which we give, but we on our side will
seek to curtail our own enquiries. Mr McWalter?
Mr McWalter
110. Thank you, Chair. I feel that most
of the questions have been dealt with actually one way and another,
so I might just act as sweeper really and we might even finish
by 6.00 p.m. There are a couple of things you have mentioned which
I think I would like to draw attention to. I think it would be
helpful to you if you read the evidence that NIE gave to us; I
do not know if you have had a chance to do that yet? One of the
things is they have come out pretty badly from what you have said
today. I have to say that when they gave evidence to us, you came
pretty badly from what they said to us; hence I wanted to get
the precise word by which you described that conflictual relationship.
One of the things that they did was to suggest that, in fact,
your activities had depressed the price that they could charge
to customers as a result of which the network was not at the standard
it would have been if you had not interfered. I would just like
your comment on that?
(Mr McIldoon) I am sorry to be obtuse but I do
not understand that? Could you say it again?
111. They indicated that because you had
acted to keep pressure down on the price which they could charge
customers that hence they had not been able to carry out the extent
of programme that they would have liked to have carried out and
hence, in a sense, some of the failures of the system were your
fault?
(Mr McIldoon) I think this is one of the most
extraordinary things I have heard in a long time. There is no
disputing that they underspent their capital allowance by £97
million. Now if they had spent all that money and asked me for
more and I had refused them more there might be some justification
for that statement, but given their inability to spend their Capex
I really do not understand it. They seem to now have got themselves
into the position where when they are given a certain amount of
capital expenditure there is a sort of handling charge. They are
no longer even pretending they will spend all their Capex in the
present period and yet they abuse me roundly for not allowing
them enough money. In fact they are only spending the amount of
money that I would have allowed them.
112. You might like to know that they abused
you roundly to us and they then indicated that in fact if they
were not living in a more regulated regime they would be able
to plan better the whole more illuminated and more effective capital
expenditure programme? As I say, I would recommend you to read
their report to us and you may wish to pass scrutiny on that?
(Mr McIldoon) It almost sounds as if libel writs
will be flying after this!
113. Well that might be quite fun. The other
thing is that you mentioned that these compensation payments would
be out of company profits. I thought you might like to know that
we worked very hard on that question and it seemed to become very
clear that the compensation payments would, in the end, come out
of the money that consumers were paying. I thought you ought to
know that as well. We again pressed them very hard and it became
clear that actually in the end the circle was such that those
compensation payments would in the end come from the price that
they were able to charge consumers?
(Mr Coulthard) In so far as all the company's
revenue comes out of customers' pockets, then obviously the £5
million comes out of customers originally through their bills
and then goes back to customers in compensation payments. The
point is that the allowed revenue over this period will not be
increased by virtue of the compensation payments. To that extent
they were, if you want, unplanned expenditure which was not taken
into account at the price control and therefore they will have
to reallocate that £5 million from wherever.
114. But they have no intention, so it was
clear, of seeking to raise that money from shareholders?
(Mr McIldoon) I was possibly being too generous
to them in that case because I did not realise that that was quite
the way they thought, but as Mr Coulthard has said, they are allowed
a certain amount of money during this period, this famous figure
of £575 million which the MMC say I cannot allow them less
than, and that amount of money is a ceiling on what they can earn.
But they are allowed within the price control period in their
T&D business £575 million over the five years adjusted
in various ways. If they only require £400 million to provide
their services, then the other £175 million is profit. Now
if as well as the £400 million for their services they have
to give £5 million to customers in compensation, then that
reduces the £175 million of profit to £170 million and
I always thought it was that simple. Now what they might be doing
is saying: "Well, now we realise that we have to give this
£5 million to customers in compensation, we are going to
find another £5 million in savings, so we will hack £5
million of value that customers would otherwise have got out of
our allowed revenue. So our customers are going to be, in net
terms, no better off and our shareholders are going to be, in
net terms, no worse off". That is certainly a conceivable
outcome.
115. As I said, I think it would be worthwhile
reading the record and from our point of view we did press them
very hard on that point. Having been a little critical of them,
there are just a couple of things that one might suggest might
not reflect so well on you. One of them is that the view taken
by MMC was that in some ways you yourselves lacked the technical
expertise to be able to make a proper appraisal of NIE's investment
plans and I think you indicated that numerically you are pretty
thin on the ground and you do obviously have to avail yourself
of external advice. Was the MMC right or was it wrong?
(Mr McIldoon) As it happens, if you look at the
MMC's record of second guessing regulators and second guessing,
as it were, actual outcomes, the MMC has probably been wrong on
every occasion and regulators right on every occasion. I think
it is simply a question of gullibility and one of the tragedies
I think in terms of public administration of having privatised
monopolies is that the people who run those companies have actually
an incentive to tell lies. It is difficult for people in our public
administration tradition to cope with that because it is an honest
public administration tradition and you cannot tell a lie in a
competitive environment because the market finds you out. There
is not much point in telling a lie in the public sector anyway
because you do not make any money out of it. So we have this very
unique piece of relatively new landscape where you have somebody
who has a monopoly but is owned in the private sector and if they
can pull the wool over somebody's eyes for five years they get
away with it. The MMC is much less exposed to any individual company
than the regulator who is dealing with it. Now, as it happens,
if you look at what the MMC was prepared to allow them and what
I was prepared to allow them in both Capex and Opex, in both cases—and
certainly in the first year of the price control—the outcome
was that I was right and the MMC was wrong. The MMC allowed them
£67.4 million of operating expenditure in 1997/1998. NIE
actually spent £64 million. I would have allowed them £63.9
million, so I was within £100,000 and they were £3.5
million out. If you look at Capex, MMC allowed them £70 million,
they spent £57.96 million. I think I would have allowed them
£60 million. So the notion that MMC has any greater expertise
is, I think, totally erroneous, but in any case it takes us a
long way from the storm and the aftermath. It is back to muddying
the waters by saying that it is lack of Capex which caused the
problem and, as I say, sometimes they duck into that argument
and sometimes they duck out of it and there is no rational thread
running between all these different assertions.
116. Certainly one of the things they were
worried about was the timescale for capital. They might actually
have an underspend but have clear projects for that money but
may just not have been able to bring the contractors and so on
on line in time to be able to use it, so that they might justify
the £70 million in the end on the basis that external influences
have prevented them spending it where they would have spent it
if they could. I guess there is that kind of line, and if there
is then a regulated environment they might say that hence they
cannot project to have plans which are as ambitious as would be
in some ways appropriate, but I think this is——
(Mr McIldoon) Well there is absolutely nothing
to say: "We would like to talk to you about a Capex programme
over a longer timescale." I have a concern about the overall
level of Capex in Northern Ireland being so much higher than anywhere
else because I think it is placing a competitive burden on Northern
Ireland customers and on the Northern Ireland economy and I would
be much more interested in them not having an incentive to maximise
their Capex expenditure. The existing price control system gives
them an incentive to maximise it and it is far from clear that
we are getting value for money in our Capex and it is the efficiency
of the Capex programme that is much more important than the volume
of the Capex programme and that is why I have appointed consultants
who are going to go through that with a fine tooth comb.
(Mr Thomas) If I might add a bit to that please?
The ability of the company to spend its Capex and the ability
of the company to manage its investments and manage the physical
activity of works is a subject that was central to the last round
of price control review. The NIE have made much of the fact that
they spend more per capita than anyone else and they have made
much of the fact that they are refurbishing 1,500 kilometres per
year of 11KV overhead line. Given the size of their system it
is extremely doubtful if they could actually manage to refurbish
much more than that per year because to do so they would have
so much circuit out that they would actually have customers off
supply. It is very easy to say: "Well, we can throw more
money at it and refurbish more line", but if the result of
that is that you are actually taking customers off supply to do
it, or reducing the security of supply to customers because you
have so little plant left live and working, then that itself could
be a counter-productive expenditure. The system has to be maintained
while it is still running. There is redundancy built into the
system to allow for failures and to allow for maintenance without
interrupting supply to customers, but clearly there is only so
much that you can take out without jeopardising customer supply
and certainly, on this side of the table, we have all heard from
NIE at various levels that 1,500 kilometres is about the limit
that they can cope with in any one year. So what are they going
to spend this extra money on? We have already heard that they
are not spending that which they have already been allowed, so
they had scope to spend more than they did. It seems a little
unusual, to say the least, to say that they needed more money
when in fact they had it and did not spend it.
117. We asked whether they might be willing
to have a long term programme for improvements in the underground
system, which obviously does give you security of supply, and
also gives you major environmental benefits and they seemed reluctant
to do that?
(Mr Thomas) Undergrounding causes problems of
its own. Undergrounding costs substantially more than overhead
lines. You can justify it quite readily in city areas where you
have a lot of customers per circuit kilometre. Where you come
out into rural areas sometimes the entire equation turns upside
down and it is number of circuit kilometres per customer. Yes,
NIE have to charge all customers the same for electricity, but
it is probably true to say that there is far more infrastructure
supplying rural customers than there is urban ones and to that
extent the rural customers already have more money spent on them
per head than urban ones might. Overhead supplies do at least
have the benefit that they can be seen, they can be inspected
quickly and often the cause of the problem is all too obvious.
Underground systems do not work like that; unless you actually
get smoke coming up through the pavement—which does happen
occasionally—you do not necessarily know where an underground
fault has occurred and it can be quite a long job, not to mention
a disruptive job digging up streets, unearthing pavements and
such like in order to do this, carrying with it the risk that
you might carry out more damage to the cable you are looking for
in the course of unearthing it, and you can also disrupt other
utility supplies that are buried in the same pavement. The only
utility I am aware of in the world that has ever set itself the
target of a 100 percent reliable supply in fact makes all its
urban supplies overhead and the consequent wirescape is quite
hideous to behold. Also, of course, underground cables are themselves
prone to damage, not only from excavation from any Tom, Dick and
Harry. They can be prone to damage by burrowing animals, they
can be prone to damage by such unconsidered things as bricks or
large stones which do move through the ground, particularly if
there is a road over them, the vibration of passing traffic will
cause quite large lumps to move through the ground and eventually
they will come up against cables.
118. It sounds a little 1950's because there
are now quite a few optic cables running alongside which gives
you sensing devices for detection of faults?
(Mr Thomas) Indeed you can. If you put new cable
in, yes, you can do that.
119. That is what I am talking about?
(Mr Thomas) But the vast amount of existing cable
is not new, it is very old and even then it costs, as I say, a
lot more to put in. If we are looking at the backbone of the system,
the 33KV, it costs nine times as much to put it underground as
it does overhead and someone has to pay for that.
Mr McWalter: Out of
their profits!
Chairman
120. The metaphor about muddying the waters
was a happy one in the context of the storm. I once worked for
an American who had, I have to say, a very strict moral upbringing
who argued that one of the strongest arguments for telling the
truth was that it was a great deal easier to remember. The evidence
which was given to us by NIE, to which Mr McWalter referred, has
not actually yet been published, but it has been cleared by NIE.
They have issued their corrections to it and so it would be perfectly
possible for us to afford you sight of a copy. Finally, is there
anything we have not asked you which has surprised you?
(Mr McIldoon) No, there is nothing you have not
asked us that I would have expected you to ask. There are undoubtedly
things that we would have answered better if we had thought a
little more about them before we answered them, but when we read
the transcript if there is additional information we feel we ought
to give you obviously we will do so.
Chairman: Well, I
think, speaking for the Committee, the Committee felt that they
had a very good run and it is very kind of you to offer that coda.
Thank you very much indeed and it has been of profound assistance
to the Committee.
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