Appendix 1: Response from the Department
of Trade and Industry
Introduction
The Department welcomes the Select Committee's Report
and its conclusions that the companies themselves and the public
sector bodies responsible for the industry—DTI, Ofgem and
energywatch—have worked hard to draw the correct lessons
from the October 2002 storms and to implement appropriate changes
to practice. The Department is pleased to note the Select Committee's
commendation of the work of the Network Resilience Working Group
(NRWG), and supports its conclusion that the distribution companies
are now significantly better prepared to deal with the aftermath
of severe weather than they were in October 2002. This is borne
out by preliminary impressions of the performance of the distribution
companies most affected in the restoration of supply in recent
storms, although the Department has yet to complete a full assessment
of that experience.
In considering the Committee's report, account needs
to be taken of the respective roles and responsibilities of the
Department and Ofgem the independent regulator. The Department's
role is to set the regulatory framework within which Ofgem and
the industry operates as well as determining the overall policy
direction. This includes regulations dealing with the safety,
quality and continuity of supplies. Ofgem's role is to protect
the interests of current and future consumers, by promoting competition
where appropriate and in regulating monopoly businesses where
necessary. This will include provisions that gas and electricity
markets work effectively and that Britain's gas and electricity
supplies are secured.
Against this background, therefore, detailed responses
to many of the points raised by the Committee in a number of its
conclusions and recommendations are primarily matters for Ofgem
rather than the Department. The Department therefore proposes
not to respond to recommendations 4 and 8-26, which deal with
such matters. However, the Department would make the following
comments on the remaining recommendations
Conclusions and Recommendations
Lessons from the October 2002 storms
1. We commend the work of the Network Resilience
Working Group, which produced a comprehensive assessment of best
practice for companies to follow to reduce the impact of severe
weather incidents and to improve procedures for recovery from
such incidents. (Paragraph 35)
We are pleased to note the Select Committee's commendation
for the work of the Network Resilience Working Group. The Group
put forward a number of proposals aimed at improving resilience
of the distribution networks to storms. These included: a review
of weather patterns, resources (both numbers of staff and skills),
operational communications, initiatives for long term network
investment and a "toolbox" for network improvements.
The Department is pleased that the Select Committee has based
its conclusions around some of these issues. As joint signatories
to the group recommendations, together with the industry, Ofgem
and energywatch, we are currently taking forward those of its
recommendations which were targeted at the Department.
On the issue of skills, for example, the Chairman
of the Select Committee will be aware of the joint Industry-Government-Academia
Skills and Recruitment seminar held at the Department's offices
on 8 December 2004. Work is in hand within Government to take
forward the issues discussed there with the industry.
2. It would seem that companies have worked to
improve their performance during and after severe weather incidents
both in the development of emergency plans and in their implementation.
(Paragraph 42)
Distribution Network Operators regularly test their
operational readiness and emergency planning policies. The Department
is aware of the details from the tests carried out by some companies
during the last quarter of 2004 and indeed was invited to participate
in some of the scenarios. On this basis we have the same impression
of general improvement as the Committee.
Weather forecasts
3. The relative infrequency of events such as
that on 27 October 2002 should not preclude DNOs from being required
to build into their emergency plans procedures to ensure proper
consideration of severe weather warnings. We endorse BPI's recommendation
that, if they have not already done so, DNOs should develop robust
methods of predicting how forecast severe weather conditions are
likely to damage networks and create a demand on resources and
how to mobilise those resources accordingly. (Paragraph 14)
The Department notes the Committee's comments and
also agrees with the BPI recommendations on consideration of severe
weather warnings. We believe that, in general, all DNOs have become
more "weather wise" and now have more resources ready
to deal with adverse weather conditions. Emergency planning exercises
also help test companies' readiness.
Communication with the public
4. Ofgem intends to develop an additional incentive
for improving communications with the public during exceptional
events. We welcome this development. (Paragraph 24)
This is a matter for Ofgem, the independent regulator.
Protection for vulnerable customers
5. Compilation and maintenance of the Priority
Service Register should be a core task for all companies. Ofgem
should undertake a review of the adequacy of the PSRs held by
network operators and ensure that appropriate action is taken
to rectify any deficiencies. (Paragraph 27)
This is a matter for Ofgem, the independent regulator.
Operational communications
6. The rapid restoration of an interrupted electricity
supply is of primary importance to consumers, particularly if
the interruption is on a large scale, as it is likely to be if
the cause is severe weather. In such circumstances, the maintenance
of reliable communications is so vital as to warrant the classification
of electricity field teams as an 'essential service'. We support
the industry's call for access to the Emergency Service Communications
Network for those DNOs, which can demonstrate that such access
is necessary to provide efficient and cost-effective repair and
recovery. (Paragraph 30)
This is a matter for Ofcom together with the DNOs.
We understand that negotiation on the industry's application
to join the Airwave network is currently under way.
Control of Vegetation
7. We are pleased to note that Ofgem proposes
to make a specific allowance of about £22.4 million a year
for increased control of vegetation during the next price control
period, 2005-10. No allowance has been made for any backlog as
Ofgem considers that this expense should be borne by shareholders
rather than customers. From absence of criticism, we deduce that
the DNOs are satisfied with the size of the tree-cutting allowance.
(Paragraph 34)
The price control is a matter for Ofgem, the independent
regulator. However, by way of additional background the Department
would note that the Electricity Safety, Quality and Continuity
Regulations 2002 already require tree cutting for reasons of public
safety (regulation 18(5)), and it is intended that these regulations
will be amended to include a requirement to maintain tree clearances
to avoid interruptions of electricity supply, so far as is reasonably
practicable. Officials have developed a Regulatory Impact Assessment
and Guidance to support this change and carry out a public consultation.
The consultation is expected to commence in mid/end-February 2005,
to be followed with the usual 12-week response period. The impact
of such a change is likely to deliver an improvement in storm
performance of distribution companies and would be intended to
be phased in to allow for current tree cutting cycles.
As for the national transmission system, although
historically there have been relatively few problems with trees
coming into contact with National Grid's tower lines, it should
be noted that contact with trees was a significant causal factor
in the major power failures in North America on 14 August 2003
and in Italy on 28 September 2003. It is therefore proposed
that transmission companies in Great Britain should also comply
with the proposed requirement to cut trees for continuity of supply.
Officials have also explored with the Industry promoting
usage of covered conductors as a measure that would improve storm
performance as well as improving public safety. Those discussions
concluded that widespread adoption of covered conductors in all
circumstances for reliability purposes is not likely to be cost
effective in addressing the combination of improvements such as
increased circuit automation and better vegetation management.
There appears to be no economic case for the widespread application
of covered conductors on safety grounds. However, we understand
that all companies are undertaking targeted installations of covered
conductors of overhead lines where they believe this would have
the maximum impact on overall circuit reliability.
Compensation to customers
8. The special storm payment offered by 24seven
to those customers who suffered most from the disruption to their
electricity supply was, no doubt, welcome to those eligible to
receive it. It was, however, considerably less than the sum that
would have been due to them had the company not chosen to claim
exemption from the normal compensation mechanism. (Paragraph 49)
This and all subsequent recommendations deal with
matters for Ofgem, the independent regulator on which the Department
does not propose to comment.
9. It was regrettable that consumers had to wait
so long for a decision from Ofgem on the validity of their compensation
claims. However, this was perhaps inevitable given the scale of
the problem and the large numbers of cases to be considered. We
consider that the strategy developed by Ofgem to produce the determinations,
although a significant departure from usual practice, was a pragmatic
and effective solution to a difficult problem. (Paragraph 52)
10. We consider that, although the proposed new
compensation mechanism is rather complex, it and the interim arrangements
from which the new system has been developed represent a marked
improvement on the previous compensation scheme. DNOs should be
able to give clear, unambiguous advice to customers about their
entitlement to compensation. In addition, greater precision in
the definition of the circumstances under which compensation is
payable should reduce the number of disputed cases to the regulator
for determination, so settlement of compensation claims should
be faster. (Paragraph 62)
Future investment in the networks: Consumer views
11. We understand that Ofgem did not want to base
its whole approach to the 2005-10-price control review on the
results of one survey. However, Ofgem seems unwilling to accept
that British consumers may place a significantly higher premium
on improved network resilience than other consumers do and than
Ofgem appears to consider that they ought to. We would be unhappy
if we thought that the regulator was insisting that it knew better
than consumers what they wanted. (Paragraph 72)
12. We note, however, the regulator's assurance
that the results of the survey have been taken into account in
setting Quality of Service targets for the distribution companies.
Our analysis of Ofgem's proposals confirms this in particular
the emphasis on speeding up restoration of supplies after unplanned
interruptions. This is enough at present. (Paragraph 73)
Investment for the future: Quality of service
targets
13. On the basis of the ENA's and Ofgem's figures,
an allowance of £2.30 per customer produced a 7 percent improvement
in quality of service over 2000-05, while Ofgem's targets for
2005-10 are a 12 percent improvement on an allowance of less than
£1 per customer. This comparison may be misleading, however,
if Ofgem's proposals achieve less, but better targeted, expenditure.
Ofgem has balanced requirements for improved standards with financial
allowances for achieving these improvements. However, given the
recent rate of improvement, Ofgem's targets appear ambitious.
Without a very detailed analysis of the position of individual
companies, which we are not in a position to do, we cannot say
whether given that the targets are coupled with higher potential
penalties for failing to meet them—they are nevertheless
fair. (Paragraph 79)
Capital expenditure: Effect of Ofgem's proposals
on individual DNOs
14. Although we agree with the principle that
shareholders should not benefit from previous low levels of investment
at the expense of customers, we would be very uneasy if applying
this principle meant that the company would be hindered from making
the capital investment necessary to provide its customers with
as reliable an electricity supply as comparable customers elsewhere
expect and receive. At the worst, there would be potential for
a vicious circle of under-investment followed by penalties for
failing Quality of Service targets, which would leave even less
money for necessary capital investment. However, we have received
no evidence that the customers of the companies concerned on this
occasion would suffer as a result of Ofgem's proposals; and we
note that the proposed allowances would enable these companies
to invest more than they have done in the recent past. (Paragraph
86)
15. We take even more comfort from the inference
that Ofgem intends in future to deter any similar under-investment
by companies by means of the sliding scale mechanism. Both for
the sake of the customers and for the promotion of efficiency
of the electricity industry, we would much prefer that under-investment
be prevented rather than punished. (Paragraph 86)
Special provision for putting power lines underground
in National Parks
16. We are pleased to note that Ofgem has changed
its views on whether it is appropriate for the regulator to make
an allowance for investment to improve visual amenity. (Paragraph
94)
Capital investment to improve network performance
17. While we acknowledge that companies will be
able to choose which particular projects will give the greatest
benefits—and that it is always open to them to finance projects
at the expense of the shareholders rather than the customers—the
regulator does, and must, make a judgement on what companies need
to do in order to decide how much money they need to do it. By
refusing to make specific allowance for improvements to the network,
Ofgem is, in effect, deciding that such improvements are not necessary
from the customers' point of view: they are something which can
be left to the discretion of individual DNOs. (Paragraph 90)
18. Ofgem argued that the companies' proposals
for specific investment to improve network performance did not
represent value for money given the few customers who would benefit.
However, the charges that would be passed on to customers in their
bills would amount to significantly less than several hundred
pounds per year per affected customer. Moreover, as these costs
would be spread over the whole customer base of the DNOs concerned,
as such capital costs would be a relatively small proportion of
DNO charges to customers as a whole, and as the cost of electricity
distribution forms about 25 percent of domestic electricity bills,
the actual increase in individual customers' bills would probably
amount to at most a few pounds per year. (Paragraph 91)
19. In March we stated our belief that customers
would be prepared to spend a modest amount extra to obtain a better
network and more reliable electricity supplies, and we are confirmed
in that view by the research subsequently undertaken into consumer
preferences. However, while we are sympathetic to the companies'
arguments for being allowed to undertake capital investment to
increase the resilience of the network, we understand that—not
least in view of previous under-investment by some companies—Ofgem
is inclined to proceed cautiously and wishes to see a robust case
for such extra investment. We cannot say that Ofgem is wrong in
its approach, but we emphasise that Ofgem should keep an open
mind about the need for further investment in the infrastructure
if it wishes to increase Quality of Service standards. (Paragraph
95)
Overall conclusion on capital expenditure
20. Overall, we welcome the fact that, in its
proposals for capital allowances, Ofgem has clearly acknowledged
that extra investment to replace infrastructure is needed. The
regulator may not have gone as far as we wished, but a gradual
approach is justifiable. We simply reiterate our view that, just
to enable ageing equipment to be replaced, investment in the electricity
infrastructure will have to be significantly higher than in recent
years and over an extended period, probably about 20 years. We
urge Ofgem to view this five-year review as the opening of a long-term
project to ensure the resilience of the UK electricity network.
(Paragraph 96)
Operational expenditure
21. We do not propose to comment on the theoretical
basis of Ofgem's approach, other than that setting price controls
is arguably more of an art than a science. We note also that Ofgem
itself has conceded that benchmarking has become increasingly
difficult, as mergers within the industry have reduced the number
of comparators. (Paragraph 103)
22. We appreciate that Ofgem's fine tuning of
capital and operational expenditure allowances has produced the
overall result that, with the exception of a small increase (1.3
percent on average) in the first year, the companies' revenue
should rise only by the rate of inflation, as measured by the
RPI, over the next four years. We also accept that there may still
be efficiency savings that DNOs could make, and that Ofgem has
made provision for costs over which companies have no control.
However, this means that the areas in which Ofgem expects the
cuts in operational expenditure to take place would be things
such as staff costs and maintenance, which companies do control.
We are still concerned that the age of the UK network and the
rate of replacement of equipment means that, at least over the
next few years, there may well be a need for more, and more expert
(and therefore, in salary terms, dearer), maintenance. Unlike
Ofgem, we therefore doubt whether current levels of performance
can be maintained on smaller and smaller maintenance budgets.
(Paragraph 104)
Accommodating renewable generation
23. The incentive scheme for distributed generation
is complex, and its effects will vary from DNO to DNO depending
on how much, when and where renewable generation capacity is built.
However, we consider that Ofgem's incentive for such investment
of an additional rate of return of one percent above the current
allowed cost of capital of 6.9 percent represents a real 'bonus'
to companies. Moreover, the regulator has moved to address one
of the specific criticisms of the scheme made to us by the ENA,
which was that DNOs would be penalised for any problems generators
had with network access after they had been connected. (Paragraph
109)
24. Estimating demand from new renewable power
generators is difficult. However, the DNOs are much better placed
than Ofgem to make these judgements. Moreover, the construction
programme to accommodate renewable generation will take many years,
possibly a couple of decades. We are at the start of the process
now, and, while we recognise that Ofgem is committed to the five-yearly
review process and does not wish to operate continuous adjustments
to price controls, we are confident that Ofgem would be willing
to adjust its incentives/penalties schemes if there was real evidence
of a need to make extra investment during the price control period.
(Paragraph 110)
Funding of R&D
25. We are delighted to note Ofgem's proposal
for an Innovation Funding Incentive to cover most of the cost
of development projects that would provide real benefits to end
consumers. (Paragraph 111)
Cost of capital
26. We understand that Ofgem had to wait until
the proposals were in their final form to come to a definite decision
on the cost of capital allowed for. We note the real danger, indicated
even by Ofgem, that the 4.6 percent rate would seriously compromise
at least some companies' ability to raise the capital they would
require. We are therefore pleased to note that, in its final proposals,
Ofgem has suggested a higher allowance for overall cost of capital
of 4.8 percent post-tax, 6.9 percent pre-tax. This compares with
the allowance under the existing price control of 6.5 percent
before tax. Moreover, recognising that, under its modelling assumptions,
EDF-SPN was likely to find it difficult to maintain a comfortable
investment grade rating in the later years of the control period,
Ofgem has proposed to adjust the price control proposals for this
company to enable it to maintain its credit rating. (Paragraph
114)
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