Select Committee on Northern Ireland Affairs Minutes of Evidence

Examination of witnesses (Questions 100 - 120)



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!


  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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