Northern Ireland Electricity Plc: A report on a reference under Article 15 of the Electricity (Northern Ireland) Order 1992

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Summary

On 18 September 1996 the Director General of Electricity Supply for Northern Ireland (the DG) made a reference to us under the Electric-ity (Northern Ireland) Order 1992 (the Electricity Order) concern-ing two sets of price controls in the licence of Northern Ireland Electricity plc (NIE). The terms of reference are set out in Appendix 1.1.

The structure of the electricity supply industry in Northern Ireland is different from that in Great Britain. The generating sector is almost all in the hands of three private sector companies to which the power stations were sold in 1992. NIE, which was privatized in June 1993, has a statutory monopoly of transmission and distribution (T&D) in Northern Ireland and is the Public Electricity Supplier (PES) for the province. It also has a Power Procurement Business (PPB) which has a statutory monopoly in both the purchasing of wholesale electricity from generators and its sale to suppliers. NIE's Supply Business is in principle open to competition and three companies have been granted second-tier supply licences but their share of the market to date is well under 1 per cent.

During 1995 and 1996 the DG carried out a review of the price controls on NIE's three main regulated businesses-the PPB, the T&D Business and the Supply Business-and published proposals for revised controls to apply from 1 April 1997. NIE accepted the pro-posals for the PPB but rejected those for T&D and Supply. Consequently the DG referred these matters to us. Our terms of reference require us to report on whether the continuation without modification of the provisions in Schedule 4 to NIE's licence, which restrict NIE's T&D charges, and the provisions in Schedule 6 which restrict its Supply charges, in either case operates or may be expected to operate against the public interest; and if so, whether the effects adverse to the public interest could be remedied or prevented by modifications to the licence.

In considering the appropriate level of price controls on the T&D Business we have adopted the following:

(a) a cost of capital of 7 per cent;

(b) a value of £370 million for the asset base of the business at privatization, at 1993/94 prices; after allowing for new investment since then, for depreciation and for inflation, that led us to a value of £475 million at 1996/97 prices for the asset base as at the begin-ning of the forthcoming regulatory period;

(c) a level of £310 million (at 1996/97 prices), after deducting customer contributions, for capital expenditure over the next five years; and

(d) an amount of £328 million (at 1996/97 prices) for operating expen-diture over that period.

For the purpose of our calculations we have also made a downward adjustment because of the extent and nature of the capital underspend in the period since privatization.

On the basis of these assessments we consider that the price control for the next five years should be set to give NIE total revenues from its T&D Business with a net present value (NPV) of £575 million at 1996/97 prices. We also propose that the term in the price formula concerning electricity losses, which is intended to give NIE an incentive to reduce the rate of losses, should be reduced from 10.5 to 10 per cent in line with the DG's proposals.

Continuation without modification of the present price controls would lead to revenues far higher than the amount referred to in paragraph 1.5. We therefore concluded that continu-ation of the existing provisions of Schedule 4 may be expected to operate against the public interest and that the adverse effects which we identified could be prevented by modifications to those provisions. Specifically, we propose that revenues allowed by the price control formula should be reduced by 25 per cent in 1997/98, compared with the level allowed in 1996/97, and should fall by 2 per cent in real terms in each of the four subsequent years of the period.

The Supply Business requires relatively little capital expenditure and the key element affecting its need for finance is operating expenditure. In reviewing the price controls on the business we adopted:

(a) an amount of £90 million (at 1996/97 prices) for operating expenditure over the next five years;

(b) an amount of £0.6 million a year for energy efficiency activities, as proposed by the DG; and

(c) a return of 0.5 per cent on total turnover as a suitable level of profit. Turnover is very high in relation to the costs of the Supply Business because it includes the pass-through of electricity and T&D costs. A rate of 0.5 per cent on turnover would give the business about £11.5 million in profit, at 1996/97 prices, over the five years.

On this basis we consider that the price control for the next five years should be set to give NIE total revenues for its Supply Business of £105 million at 1996/97 prices.

Continuation without modificat-ion of the present price controls would lead to revenues well above this level. We therefore concluded that the continuation of the existing provisions of Schedule 6 may be expected to operate against the public interest and that the adverse effects which we identified could be prevented by modifications to those provisions. We propose modifications which would entail a reduction of 42 per cent in the revenues allowed under the formula in 1997/98, compared with 1996/97, and a real reduction of 2 per cent a year in the following four years.

We estimate that the effect of our proposals will be to reduce domestic electricity prices in Northern Ireland by about 14 per cent in real terms between 1996/97 and 1997/98. The first-year reduction for large industrial customers will be smaller, about 5 per cent, because generation costs account for a much higher proportion of the final price to them than for domestic customers. These estimates do not take account of changes in the generation component of electricity prices, or the deployment of the sum which the Government is providing to reduce prices in Northern Ireland, neither of which is affected by our inquiry. The reductions are a little lower than those which would have resulted from implementation of the DG's proposals, but greater than those implied by NIE's counter-proposals. The amounts which we have adopted for capital and operating expenditure will provide a basis for NIE to achieve, in a number of respects, a better quality of service than would have been likely under the DG's proposals.

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