Select Committee on Public Accounts Minutes of Evidence


Examination of Witnesses (Questions 20-39)

OFFICE OF GAS AND ELECTRICITY MARKETS

MONDAY 8 MAY 2006

  Q20  Helen Goodman: When is the next pricing review?

  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 ever?

  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 £4 million.

  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 case—and I know many of you have run businesses and many of you have been in the financial sector as well—gearing 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 it not?

  Mr Gray: That would assume that we made no progress in this first review in identifying additional savings.

  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 million.

  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 outcomes.

  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 of that?

  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.


 
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