Examination of Witnesses (Questions 20-39)|
MONDAY 8 MAY
Q20 Helen Goodman: When is the next
Mr Buchanan: We decided to extend
the price review and we are currently into 2008 then we shall
start the five-year rolling programme out to 2023.
Q21 Helen Goodman: So that fact obviously
brings two questions. First of all, at the point at which the
restructuring was taken the efficiency savings should have kicked
in, so why did you extend the pricing review and why did you not
re-jig it to incorporate this higher figure?
Mr Buchanan: Perhaps I might deal
with why we opted for the one-year rollover. Essentially three
reasons: one, we wanted more time to collate information so that
we can do as good a review as we possibly can in 2008. Two, we
wanted the new management teams, the innovation and the drive
that they will bring into the process, to have a bit more time
before that price review to get hold of the companies and then
work them through. Those are the two key issues. The lesser issue
is work prioritisation. David and his team are running three major
price reviews this year and therefore in terms of handling that
workload it is the weakest of the three arguments. We felt that
as a package, going for the new five-year review starting in 2008
made a lot of sense.
Mr Gray: The most important task
for that review is to set up a framework which will allow us to
measure what advantages new management can bring to the industry,
so that we can make sure we capture the benefits arising from
that in future price control reviews. We wanted to do it as soon
as we could in order to set that clock starting, but we needed
the benefit of at least one or two years of base data after the
sale in order to set a starting point that we could measure from
for the next review.
Q22 Helen Goodman: I can understand
that. Is there any way in which you will be able in 2008 to capture
the efficiency savings that we have in this intermediate period
for the subsequent period or are they lost to the customer for
Mr Gray: To the extent that we
can identify any efficiency savings before 2008, we shall certainly
try to capture them in that review. As I said, the evidence will
come through mainly in the longer term when we get a five-year
period of seeing what these companies can do and then in the first
review after that, I would expect us to be able to make major
advances in passing through those savings to customers. That is
essentially how it has worked in the other sectors. You see what
the industry can do, you give them the biggest incentives you
can to make them compete with each other to demonstrate best practice
and then you impose that best practice on the other companies.
That is what we shall do in gas.
Q23 Helen Goodman: I just want to
ask you a question about the operation of Ofgem as well and the
fact that you were under-staffed and you had to employ consultants
and you ended up spending five or ten times as much as you anticipated
spending. Obviously this is rather unsatisfactory. Could I ask
you whether you think you are properly staffed now?
Mr Buchanan: I welcome recommendation
19j in the Report, which highlights that we always need to keep
our eye on our contractors and the amount we spend on contracting.
You have picked out a sentence within the Report which is a thoroughly
reasonable thing to do. Equally reasonable to do, to give that
balance, would be to pick out paragraphs 2.5, 2.13, 2.11 where
what the team did in terms of good working practices and good
planning and good consultation is all commended and it is all
down to David and Sonia Brown, his lead director on the deal.
In terms of being satisfactory, what I should like to give you
some confidence over at Ofgem is that we take financial management
extremely seriously and in the last three years we have driven
our overall consultants' budget down from £8 million to £6
million, which will be released in a couple of weeks' time. We
also operate under an RPI minus X price regime ourselves. It is
tougher than Gershon and Lyons have set for the rest of Whitehall
and we have beaten that handsomely this year and will return £2.8
million to the licence payer this year without, I believe, in
any way putting the work that we do at risk and that includes
those consultants' costs. Unfortunately, in terms of the way that
the budget worked in October 2003, we have basically put a large
lump of money in the contingency rather than put it firmly directed
to DN sales. Therefore, although the trend of consultancy is clearly
falling at Ofgem by £2 million over the last three years,
you are right to point out that we had not clearly identified
where the consultants' budget was going. I welcome the comment,
because I can use it internally to say "Look at consultants.
The NAO and the PAC are watching us".
Q24 Helen Goodman: We have a general
concern because departments come to us continuously with large
consultancy budgets and one is bound to ask oneself the question
and I am going to ask you. Are we, in general, not staffing up
the Civil Service enough and not having the level of skills internally
that we ought to have and consequently paying more for people
from the private sector? You tell me you saved £2 million,
but I could say to you that perhaps if you staffed up Ofgem a
bit more, with three more economists or something, you might save
Mr Buchanan: Yes. It is a very
good question and is a topic of much discussion. At the moment
we believe we can do our job and we believe we can do it well
for the consumer and it is a point which you validly make, which
is that if you want to hire unique expertise . . . This was a
unique deal, effectively a corporate finance deal. David was one
of the lead investment bankers in the city for 20 years and it
was a deal made in a way for David to run. If we had not been
fortunate enough to have David at Ofgem, one could well argue
that we would have had to go out and pay a very large sum of money
to hire somebody to help us to get that kind of information so
that we could run this deal and be part of this deal. The point
you make is a very interesting point. For us in this specific
caseand I know many of you have run businesses and many
of you have been in the financial sector as wellgearing
up with expensive employees, only to find that once the deal was
done, we probably would not have another deal like this for many,
many years, would make it very difficult to justify hiring people.
The question which we could maybe take further outside this forum
is: am I worried about attracting staff into Ofgem? I have to
tell you that two of our major competitor organisations, Ofcom
and the FSA, pay substantially higher at the senior management
level than we do because we are very much within the Whitehall
pay structure and they are not.
Q25 Chairman: Why is that?
Mr Buchanan: That I believe is
more historic than anything else. I believe Ofcom and the FSA
have negotiated their financial, legal structure differently from
us. Certainly if we are out trying to find senior manager levels
and we are competing with those kinds of organisations, then it
is difficult for us, there is no question about that. We welcome
your interest in it.
Mr Gray: Your initial question
was quite specific and it was "Are we properly staffed now?".
The answer is that we are properly staffed, although it is always
a struggle at the margin and we are always losing people and having
to recruit more. We are properly staffed for our normal business.
The point about this project though was that it was a big one-off
which came along and was going to require a peak of activity over
a period of about a year. It is not sensible for us to have a
team waiting around in case a project like that comes along. That
is the area where we should use consultants. In general, I am
thoroughly signed up to the idea that we should recruit our own
talent and have it in-house for the day-to-day business, but for
the one-off projects we should go outside and we did in this case.
Q26 Greg Clark: "Hope"
seems to be the key word from the evidence so far. If one were
to do a word search, it would appear more than any other word.
Mr Buchanan: Yes.
Q27 Greg Clark: It is good that you
are positive. According to your website, your first priority is
to protect customers. Correct?
Mr Buchanan: Indeed.
Q28 Greg Clark: Just looking at some
of the figures, on page 22 paragraph 3.10 the central value of
the costs for consumers is £100 million, is it not?
Mr Buchanan: Yes.
Q29 Greg Clark: But according to
footnote 27 it could be as high as £118 million. Correct?
Just turning a couple of pages on to page 24 figure 16, if the
benefits occur in the second and third price controls, then the
actual present value of those benefits is only £55 million.
That is correct, is it not?
Mr Buchanan: Yes, that is what
it is saying in figure 16.
Q30 Greg Clark: So it is possible,
on these forecasts in the Report, that the net effect on the consumer
could be benefits of £55 million, costs of £118 million,
in other words a loss of £63 million. That is correct, is
Mr Gray: That would assume that
we made no progress in this first review in identifying additional
Q31 Greg Clark: No, no, I am purely
looking at different scenarios which are presented here in terms
of when the savings could come out and what the costs might be.
There are scenarios which are clear enough to be in the Report
in which there could be a pretty substantial loss, £63 million,
to the consumer. That is a correct statement of fact, is it not?
Mr Gray: That was not a scenario
that we analysed in our cost-benefit assessment.
Q32 Greg Clark: Why not?
Mr Gray: We looked at a whole
range of scenarios as to when we should be able to get the benefits
and how big they would be at the various stages over the next
three price controls. We came to the view that there was a probability
distribution curve in which we were really very confident that
the actual value of benefits would be higher than the central
estimate of costs of £100 million and very confident also
that they would be higher than the top-end range of £118
Q33 Greg Clark: Let us come on to
that. The NAO thought fit to point out, helpfully, that if the
benefits do occur not in the first phase but in the second and
third price controls, the value of the benefits would only be
£55 million. I am interested in this probability distribution.
You did assign different probabilities to each of these potential
Mr Gray: We looked at a range
of possibilities and we looked at what we thought was
Q34 Greg Clark: Did you assign probabilities
to each of these outcomes? I mentioned one outcome which would
be a substantial loss to the consumer. What was the probability
Mr Gray: We did not think it was
a likely outcome that there would be no benefits to consumers
in the first review.
Q35 Greg Clark: I am sure your judgment
is very wise, but it would be interesting to know what percentage
of probability you attached to that.
Mr Gray: We did not go to putting
specific percentage probabilities on different distributions.
Q36 Greg Clark: So despite the fact
that your remit is to protect the consumer, in the Report there
was clearly a possibility that the consumer could actually lose
and you did not assess the likelihood of that.
Mr Gray: We assessed the likelihood
of all sorts of scenarios in which the consumer might lose.
Q37 Greg Clark: I am interested to
know what assessment you made of how likely that was.
Mr Gray: It was not likely that
there would be no benefits.
Q38 Greg Clark: But you did not assess
it as a probability.
Mr Gray: We did not go through
an exercise of putting specific probabilities on different outcomes
for the timing of savings
Q39 Greg Clark: Is that not a bit
reckless, when your prime responsibility is a bit like the medical
Hippocratic oath, which refers to "do no harm"? That
applies to you does it not, for consumers? You must first do no
harm to consumers, yet there is a possibility here that you are
going to do harm to consumers and you did not assess the probability.
Mr Buchanan: What was very useful
for us was that a range of Reports was done and, as you can imagine,
they were very much made available to us. I can remember two in
particular where external consultants were used by shippers and
those who were not keen to see this deal go through who presented
very clearly to the authority their view that there would be.