Gas Distribution Price Control Review

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Gas Distribution Price Control Review

• Summary of Initial Proposals
• Gas Customer Forum
• 9 July 2007

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Presentation content

• Introduction
• Context
• Initial proposals
• Financial issues
• Key policy proposals
• Outstanding issues
• Next steps

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Introduction (1)

• The price control that has applied to the Gas
  Distribution Networks (GDNs) since 1 April 2002
  expired on 31 March 2007.
• We extended the price control for one year from 1
  April 2007 to 31 March 2008. This was completed
  in December 2006 and addressed a number of big
  issues from previous period.
• The Gas Distribution Price Control Review (GDPCR)
  will reset the price control, which specifies the
  maximum revenue that a network can recover from
  its customers from 1 April 2008 to 31 March 2013.

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Introduction (2)

• This presentation discusses our initial proposals
  document which was published in May 2007.
• The document set out our view on
• appropriate operating, capital and replacement
  expenditure allowances for the period 2008-13
  and
• a range of incentives and outputs that together
  with the allowances protect customers interests.

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Context

• GDPCR is first distribution price control review
  since the sale by National Grid Gas plc (NGG) of
  4 of its 8 GDNs to 3 new owners on 1 June 2005.
• Benefits to consumers identified from sale
  generated mainly from comparing relative GDN
  performance.
• The benefits from this comparative competition
  will be build up over time and passed back to
  consumers at future reviews (majority expected
  post 2013).

Scotia Gas Networks
Northern Gas Networks
Wales West Utilities
Scotia Gas Networks
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Initial proposals Key themes

• Despite short period in independent ownership
  benefits to customers through comparative
  competition (mainly reductions in operating
  expenditure)
• Increased allowances for investment and for
  replacement of old iron gas mains
• Obligations to offer good quality customer
  service to be strengthened
• Initiatives on sustainable development, such as
  network extensions and incentives on GDNs to
  reduce gas shrinkage

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Initial proposals Overall impact

• Impact of proposals on revenue negligible
  operating cost reductions broadly offset by
  increasing cost of mains replacement programme
• Allowances by GDN (m, 2005-06 prices)

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Headline cost allowances
Note - Large reductions against forecasts -
Data based on average GDN, some significant
outliers - Actuals vs allowances
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Cost allowances

• Operating expenditure
• Propose a reduction in operating expenditure of
  3.3 per cent a year from forecast actual levels
  for 2006-07
• Capital expenditure
• Increased allowances mainly driven by lumpy LTS
  investment
• Replacement expenditure (mandated by HSE)
• Required to fund cast iron mains replacement
  volume
• Unit costs gap

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Initial proposals opex allowances (1)

• To assess opex, we have focussed on benchmarking
  at individual activity level and used top-down
  analysis as a sense check.
• We have proposed benchmarking at an upper
  quartile level.
• We have taken into account regional labour rates
  in our benchmarking.
• Other regional price costs will be considered as
  part of the updated proposals work.
• We have taken account of real price effects
• We have proposed an on-going efficiency target of
  2.5 p.a.

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Initial proposals opex allowances (2)
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Initial proposals capex and repex allowances

• To assess capex and repex, we have adopted a
  similar approach to opex
• The scope for benchmarking capex is more limited
  resulting in extensive use of recommendations
  made by technical consultants.
• In some cases, there are large differences
  between us and the GDNs on their capex and repex
  requirements.
• We are proposing an Information Quality Incentive
  designed to bridge this gap.

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Initial proposals capex allowances (pre-IQI)
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Initial proposals repex allowances (pre-IQI)
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Financial issues

• Cost of capital
• TPCR most recent reference point
• Modelling assumption for initial proposals
• Cost of debt continuing to fall on a trailing
  average basis adjusted by 20b.p.
• Cost of equity will be informed by our
  comparative risk analysis to be carried out
  between now and updated proposals - unchanged at
  mid-point of total equity returns
• Gearing 62.5 - consistent with previous review
  for now
• This provides a point estimate WACC of 4.84
  (post-tax 4.2)
• Assessing financeability
• Ratios arising from our notional assumptions
  consistent with a comfortable investment grade
  credit rating for majority of GDNs
• Will be considered further at updated and final
  proposals to establish whether any adjustments
  are required.

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Outputs and Quality of Service (1)

• We are proposing a number of changes to the
  outputs and quality of service arrangements for
  GDNs to
• simplify the arrangements
• improve protection for consumers
• improve the accuracy and reliability of the data
  recorded and reported by GDNs
• enhance comparative competition between the GDNs
  and
• enable us to better monitor how performance is
  improving both over time and between different
  GDNs.
• We have undertaken a programme of consumer
  research to inform these changes and to comply
  with our statutory duty.

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Outputs and Quality of Service (2)

• Removal of the Overall Standards of Performance
• Propose to revoke the Overall Standards and
  migrate these obligations to licence conditions
  or guaranteed standards.
• Improved ability to take appropriate enforcement
  action
• Consistent with DPCR4.
• Changes to the Guaranteed Standards
• Complaint handling and the timing and quality of
  reinstatement works were identified in the
  consumer research as areas where GDNs
  performance could be improved.
• Improved protection for consumers connected to
  IGTs smaller non-domestic consumers regarding
  supply restoration.

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Outputs and Quality of Service (3)

• Other changes to the arrangements
• Introducing targets for the accuracy and
  completeness of GDNs interruptions data
• Expanding the existing quarterly consumer
  satisfaction survey to include GDNs performance
  in connections, emergencies and providing
  information during unplanned interruptions
• Introducing a reporting regime to strengthen
  incentives on GDNs to maintain accurate pipeline
  records and
• Developing a balanced score card to better
  compare GDNs performance across a number of key
  areas.

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Incentives (1)

• Information Quality Incentive
• Proposing to implement an information quality
  incentive (IQI) similar to DPCR4
• GDNs rewarded for forecasting their capital and
  replacement expenditure close to our consultants
  view (conversely penalty if long way from our
  view). Also rewarded for forecasting accurately.
• Intention to close gap between GDN forecasts
  and our proposed allowances
• Re-bids due this summer (13 July)

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Incentives (2)
Comparison of post IQI allowances to forecasts
2008-13 (m, 2005-06 prices)
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Sustainable development

• Sustainable development
• Extending the network to fuel poor communities
• Reducing levels of gas shrinkage
• Responding to concerns about CO poisoning
• Proposals
• Discretionary reward scheme (4m pa)
• Change to structure of charges for fuel poor
  communities
• Roll forward shrinkage incentive but consider
  whether it should be strengthened for cost of
  carbon

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Outstanding issues

• These are initial proposals there are still a
  number of areas to be considered further
  including
• Resubmission by GDNs of actual 2006-07 data plus
  resubmission of forecast expenditure this summer
• Some cost issues still to be concluded, e.g.
  regional factors
• Detailed analysis for cost of capital and further
  assessment of financeability to be undertaken
• Number of policy areas still need to be
  concluded, e.g. opex rolling incentive
• This may mean that changes for our September
  updated proposals could be more substantive

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Next steps
We propose to introduce a cost reporting
framework to apply from 2008-09 onwards similar
to electricity distribution and transmission.
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Key policy proposals

• Proposed IQI matrix