Examination of Witnesses (Questions 1-19)|
MONDAY 8 MAY
Q1 Chairman: Good afternoon and welcome
to the Committee of Public Accounts where today we are looking
at the Comptroller and Auditor General's Report Sale of gas
networks by National Grid. We welcome Mr Alistair Buchanan,
who is the Chief Executive of Ofgem, and Mr David Gray, who is
the Managing Director of Networks you are both very welcome. If
you look at the summary of this Report, particularly paragraph
12, page six, I was intrigued by what it says here "Ofgem
clarified its role during the sales. In March 2004, Ofgem decided
that it would recommend the approval of sales if they did not
result in a net detriment to customers. This stance was consistent
with legal advice obtained by Ofgem on the scope of its statutory
objective to protect the consumer interest, but differed from
an earlier commitment to maximise consumer benefits". Why
did you embark on this project apparently without knowing whether
you needed to maximise benefits for consumers?
Mr Buchanan: I should like to
address two issues here. The first is our responsibility under
Section 3 of the Utilities Act which is to seek to protect and
promote the interests of consumers. That is something that we
always do and in the regulated business our opportunity primarily
to do that is at the five-year price review situations, whereas
clearly in markets we have a monitoring of markets role. With
that comment about the importance of the consumer to us, may I
move on to this deal? This deal was fairly unique and it is covered
extremely well on page 37 in paragraphs two and three. It is outlined
in those paragraphs that this is a commercial transaction, a transaction
that had a unique transfer of assets under licence condition 29
and it was because of that uniqueness that we took legal advice
from a leading QC and that advice was to use a no-net-detriment
test. It was on the basis of that that we proceeded on this deal.
Q2 Chairman: So did this legal advice
force you or encourage you to take a narrow view of your responsibilities
on other projects as well? How important was this legal advice,
which is mentioned in this paragraph and which you have just mentioned
Mr Buchanan: It is a very good
question and we wanted to know that as well. The legal advice
is narrow to this deal because it was such a unique situation.
As I said, it related to the transfer of assets under a licence
condition and that is therefore how we shall treat it going forward.
Q3 Chairman: If I ask you how you
prove yourselves, if you look at paragraph 14 it says there "...
in November 2003, Ofgem delayed the sales timetable to ensure
sufficient time for full analysis and consultation on the impact
of sales on consumers' interests. The industry faced a large burden
of consultation and many gas companies were concerned that Ofgem
added complexity and costs by unnecessarily including a separate
project". Why did you do this? Why did you add delays, complexity
and cost to the industry?
Mr Buchanan: One of the lessons
learned that we shall take away from this excellent Report from
the NAO is that possibly within the process, and it is in paragraph
2.17, we may have made the process more complex than it should
have been. That is a lesson learned and a useful part of the process.
However, the delay was important in November 2003 because we had
received such strong representations from various parties to the
sale to take more time, to analyse the cost-benefit analysis,
that we actually effectively put a block on the sale we put in
a three/four-month review and the board then looked at that analysis
in April. I think that was the right thing to do and indeed whilst
I am very keen to pick up some of the criticisms of us in this
Reportas mentioned, paragraph 2.17 about perhaps over-engineering
iton the other hand in paragraph 2.11 the NAO very kindly
say that we consulted very well. I should not want there in any
way to be a suggestion that we did not sound out all the parties
through this process. We sought to do that. In fact, David told
me last week, when we went back to have a look, we actually did
13 consultations in this process, which is a lot.
Q4 Chairman: The Report tells us
that Ofgem concluded that the potential benefits to customers
from the sales were most likely to be £325 million. Does
that indicate to the Committee therefore that there was a huge
level of inefficiency in this industry?
Mr Buchanan: The benefit that
the electricity industry had had since 1990 was that it was broken
up. Basically in England and Wales you had 12 companies and through
the price reviews of 1995 and 1999 the regulator effectively took
50% of the income away from the companies they put in cuts of
what are called "P-noughts"one-off price cuts
of 50% combined over 1995 and 1999. You did not have that in the
gas industry and in fact the gas industry was treated as a job
lot. The regional companies and the national transmission company,
Transco, were effectively given one price control in 2002. A year
later that was broken down into the constituent eight regional
companies. Effectively, in gas you got the eight regional companies
in 2003, whereas in electricity you had the 12 England and Wales
regional companies in 1990. Therefore from 1990 onwards in electricity
you had the benefits of comparative regulation. You can clearly
see that in figure 12 on page 22 because the electricity industry
delivered 7.7% annual cost saving 1992 to 2003 was the timescale
used in that analysis.
Q5 Chairman: So the reason you did
not identify this £325 million before was because, in your
words, it was viewed as a job lot. Is that right?
Mr Buchanan: We believe comparative
analysis is a substantial benefit to getting more for the consumer
and we estimated in this Report that 95% of the benefits will
come from comparative analysis.
Q6 Chairman: It tells us in the Report
"The predicted benefits are subject to uncertainty".
I am sure that is right and it may be an understatement. "The
benefits are forecast over a long time frame, whereas the costs
of restructuring are already being incurred by the industry. It
is possible, therefore, that the disposals could lead to higher
costs before the predicted efficiency savings are passed on to
customers. The difficulties faced by Ofgem in securing customer
benefits include: the inherent uncertainty of achieving benefits
over a period as long as 15 years". So the obvious question
to you is: before we get any of this benefit to the public, are
we just paying for restructuring?
Mr Buchanan: The good news is
that we have a track record and comparative analysis works over
a track record. If I hark back to the answer to your previous
question, we have basically seen that track record work from 1993
to 2005 for the electricity companies and what we are saying for
the gas companies is that the gun is effectively going to go in
2008 and going to run forward.
Q7 Chairman: So in that sense this
Report is wrong and the customer will not have to wait 15 years
for any benefit.
Mr Buchanan: What the Report has
clearly identified is that that 2013 price review is the real
crunch price review, because it is at that point that we have
captured five years of data, five years of benchmarking and yardstick
and comparison between the companies and that is why we estimate
that 80% of the benefit comes after 2013, which is exactly what
happened in 1995, five years after the electricity companies had
been running under comparative analysis. I am going to hand over
to David for the detail.
Mr Gray: There is an important
point which is that the costs concerned are those that were being
imposed on the other participants in the industry. We took a very
firm view early on that, to the extent that there were costs of
restructuring that would be felt by National Grid and by the buyers,
they should pay those costs and those costs should not in any
way be passed through to customers. That was very clear. Our assessment
of the costs was based on the question of what sort of systems
users of the transportation system would have to invest in, in
order to work with the new set-up. It was about £25 million
in up front costs and then about £7 million per annum and
that gives you, in present value terms, the £100 million
we talked about. We took the view that that impact, the £25
million up front, was small enough that it should not put us off
allowing the sale, given the substantial nature of the benefits
that we saw coming later.
Q8 Chairman: How can you be sure
that these gas companies will pass on the benefits of cost savings
to the consumer?
Mr Buchanan: This is how the five-year
price regulatory cycle works. Effectively, the companies compete
aggressively amongst each other, we collate that information,
we see what we can capture for the consumer and it is at the price
review that we shall capture that benefit for the consumer. We
are committed to doing that. Sir John Bourn clearly said in his
comment about us that it is well done so far, but we have to get
everything now, and we fully understand that.
Q9 Chairman: What if I said to you
in summary that, after reading this Report, it is clear that there
are so many uncertainties in all this that it is by no means certain
that you will be able to pass on any benefits to the hard-pressed
gas consumer, in other words us, as opposed to the people running
Mr Buchanan: One of the certainties
of the energy regulatory regime has been that a track record has
now been delivered since 1990 of stable, consistent, tough regulation
and I would hope that that would give confidence to those looking
Q10 Chairman: You would hope?
Mr Buchanan: I would hope.
Q11 Chairman: How much has all this
Mr Buchanan: I cannot give you
an absolute certainty, but what I can say is that the track record
we have and the commitment we have to do the best for the consumer
and why everybody comes to work at Ofgem is for our fundamental
section three responsibility that we shall seek to get the best
Q12 Chairman: Why can you not say
"we guarantee"? Why do you use the words "we hope"?
Mr Buchanan: Largely because,
looking forward over a period of 15 years, there may be situations
that we could not foresee at the moment. Laws may be passed, changes
may occur in the way businesses operate and we would have to take
that into consideration.
Q13 Chairman: How much has this restructuring
Mr Buchanan: In terms of...?
Q14 Chairman: How much has it cost
to the companies for instance?
Mr Gray: I do not have an estimate
of what the cost was for the companies concerned because we made
it entirely clear that they had to pay that, so it comes from
their own shareholders' pockets essentially. The costs for other
companies in the industry were that £100 million I referred
to, and our own costs were the £2.5 million figure that the
NAO reported in the Report.
Q15 Helen Goodman: I wonder whether
I could ask you to turn to page 22 and figure 13. This is the
one that shows the scope for cost reductions in the gas distribution
sector. I was rather concerned to read that you were assuming
a £325 million cost saving. Is my understanding correct that
you have captured that already in the existing regulatory structure?
Mr Buchanan: No, that is not right.
This is what we believe can be captured.
Q16 Helen Goodman: Right. But the
NAO are saying that in fact another £830 million could be
Mr Buchanan: Correct.
Q17 Helen Goodman: Do you dispute
the NAO figure, or do you accept it?
Mr Buchanan: When we look at the
NAO figure, the best words for us to use are that it "appears
to be a reasonable assumption for the NAO to make". In the
light of figure 12 just above it perhaps you can see where the
NAO was drawing its information from, but the figure that we focused
on in our consultants' review and in our review was the £325
million. I am not disputing the NAO's figure it looks reasonable
but we are not committing to that figure.
Q18 Helen Goodman: It is just that
normally the numbers in the NAO Report have been agreed with the
department or whoever it is, so I would have expected you to have
Mr Buchanan: It may be my use
of the word "reasonable". I am sorry if I am causing
Q19 Helen Goodman: My concern is
of course that if, when you come to the next price review, you
work on the assumption that the savings achievable are £325
million and you ignore this £830 million, gas consumers are
going to be paying over the odds. Do you think there is that risk?
Mr Buchanan: I would hope very
much that the evidence from what we have seen in the electricity
sector, as evidenced in figure 12, will be the kind of performance
that we shall see unleashed in the gas sector. I fundamentally
believe that comparative analysis will ensure that the companies
look for their cost saving of 77%, which is the amount that they
can go for of their cost base and which is controllable by them.
I would hope to see cost savings coming from how they address
their working practices, how they address their IT, the transport
fleet et cetera. I would be hoping and confident that we could