Official Report 215KB pdf
I welcome everybody to today's meeting and remind them to switch off mobile phones and pagers—or put them into flight mode—so as to avoid any disruption to our sound system.
Gentlemen, you will be aware of the background to my questions, and you will have read the evidence that we received in Melrose—in particular, the evidence from a private developer. The criticism of Scottish Power was, to say the least, trenchant; but Scottish and Southern Energy has a similar policy to that of Scottish Power, so the issue could be described as Scotland-wide.
Both our licence and the regulator require us to publish the methodology of how we collect charges. We ask for money up front because, if we did not, we would have to recover the costs of financing any work. We are a low-risk business, so we think it better that the customer should raise the finances and then pay us. On the question of when we require the money, that depends on the job. Some jobs might take two years to come to fruition, in which case there could be phased payments. Payment is not always entirely up front, but it is required before we incur any expense.
The practice is used not only by Scottish Power and Scottish and Southern Energy, but by all regulated and licensed distributors in the United Kingdom.
For most goods and services that people purchase, very seldom would costs be paid up front, with a wait of several weeks or months before anything was delivered. If people buy goods and services, they normally receive at least part of the goods or services before paying a deposit or anything towards the cost. However, you require the whole cost up front and, as I say, you sometimes require payment many weeks before the customer receives the service. Is that justifiable?
It is because of the way in which we are set up as a regulated industry. We cannot refuse to make an offer for making a connection. We do not have that commercial freedom. If a customer comes to us and asks for a connection, we are duty bound to give him that connection, but we are also duty bound to recover our costs. Our policy is the most efficient and economical way of doing that.
I am sure that it is, but the customer does not really have a choice. Is that not the point? At the end of the day, this issue stems from your monopoly. I appreciate that there can be some movement on the margins, and that some services can be provided by others, but I suspect that very few people take up that option. People do not have a choice. They have to pay you up front because, if they do not, they do not get the service. Is that not quite exploitative?
You raise valid points. There has been competition since 1995, and it has ever-increasing scope. Originally, we were in a monopoly, but that is being eroded over time. The amount of competition is increasing. Ofgem looks into that regularly, and every year it publishes its findings on competition in the market. The latest report is on its website.
The most effective connections competition market in the UK has developed in SP's distribution area in the south of Scotland over the past five years. About 70 per cent of connections are delivered through competition connections in the south of Scotland.
Can you be a bit more specific about that? If, for example, individual home builders are required to pay £10,000 up front in February or March for an installation that they are told will not happen until October, how much money do you make from that? It is clear that you make some money. How much of that money would you have to spend before October? Such a case happened in my constituency—as other members have said, we are all experiencing this. The people had to pay £10,000 in February or March for work that will not be of any benefit to them until October. They were required to pay every single penny. How much money do you make from that and how much of it is pre-committed by you?
I could not say what proportion of money would be pre-committed for that particular job, because each job varies depending on the circumstances.
Who gets the interest on the money?
We function in a five-year price control window. At the end of the regulatory period, Ofgem would socialise net profits that we made from connections activity or from allowed revenues, so the whole customer base would ultimately pay less.
So the interest that you get on that £10,000 does not go back to the people who paid you the money.
It depends on the circumstances of the job and the contracts that are placed. As Max Lalli said, there are phased payments for larger jobs. When a job will be delivered over a number of years, if there are major plant items that might have delivery periods of 18 months or 12 months, we would phase payments from the customers to match the commercial exposure from the distribution company, but those would typically be much larger jobs.
I had not picked up from our briefing this business about regulated connections being a not-for-profit activity. You talked about competition. Is it correct that in some areas those connections could be done by other organisations?
Yes. Across the whole of the United Kingdom there is a vibrant independent connection provider market. Independent connection providers do new connections activities and diversionary activities, which we—or a licensed distribution company—subsequently adopt. In the past four years, there has been the introduction of licensed distribution companies operating out of area, so SSE, for example, has a number of significant networks across our area in the south of Scotland. A number of small independent network operators also install, own and operate networks. Those parties are not subject to the same regulatory constraints as us.
But those companies are all doing that for a profit—they are not charities.
Yes.
You say that competition has been very successful, so why are your potential customers going to those other companies? Is it because they are cheaper or is it because they do the job more quickly?
It is because they are more readily able to innovate, I believe. They offer multi-utility services—they do gas and electricity at the same time, and they install telecoms infrastructure and suchlike. They are not subject to the same time constraints or financial constraints as we are.
I am not sure why you should be subject to time constraints. Substantial numbers of customers seem to be going to those other companies, which are making a profit. We have heard that some customers feel that they have to go to you, and they hand you over a huge sum of money up front. Then, sometime in the dim and distant future, they actually get what they have paid for—yet you say that you are not making a profit out of that. Perhaps the other companies are doing something that you should be doing.
The independent distribution network operators that drive the development of the market are regulated differently. They make more profit, or greater margins, from owning the networks than we would, and they are able to subsidise connections. Primarily, that is what drives the IDN market. Developers get cheaper connections from independent network owners than they would get from the incumbent licence distribution companies.
Ofgem allows other companies to undercut you, whereas you have to fix the price at a certain level by regulation. Is that what you are saying?
Our prices are supposed to be cost reflective. We are restricted through the regulatory regime from offering subsidies for connections related to future income streams, whereas the IDNOs are not. The market is skewed to encourage competition in connection to develop.
But that competition does not seem to have had the effect of speeding things up yet, or of making you change your policy of asking for all the money up front. The regulator does not insist that you ask for the money up front, does it?
The regulator gives us operating cost allowances, based on historical costs and the costs that we face now, which, ultimately, are paid by all customers who are connected to our network, including the 2 million customers in the south of Scotland. If we changed our operating policy to increase the level of commercial risk that we carry, that could ultimately reflect through into the regulatory settlement that Ofgem gave us. The rest of the customer base would carry the cost.
The people who make up the customer base might feel that they are carrying considerable costs at the moment.
Indeed—they are carrying all the costs at the moment, are they not?
The map that is contained in the SPICe briefing marks the south of Scotland with "ScottishPower EnergyNetworks". I do not have the sense from your evidence that it is possible to have a connection made with no involvement whatever of Scottish Power. Is it possible to have a connection set up in your area without any involvement from your organisation?
No. For smaller connections, we would provide the ultimate point of connection to the independent company, or we would adopt the network from independent connection providers. Some major connections could be connected directly to the transmission system, in which case the transmission companies would be involved, rather than the distribution companies.
In that sense, you remain a regional monopoly, ultimately. You have the final say over exactly when a connection occurs, and you influence the timing. Whatever work is done by small companies, you make the final connection, and you have the ultimate influence over what happens.
Our written evidence refers to the timescales that apply under our licence for responding to quotations. We would deliver a connection to an independent connection provider or an independent distribution company to energise the first element of that connection, but the energisation and the connections into the houses would be done by the independent connection provider or the independent distribution company. That would be entirely within their control.
The regulator reviews annually what all the IDNOs do with regard to what we call non-contestable quotations, which are given out to facilitate another party giving the contestable bid. The regulator monitors how we perform in that regard, and the information is published annually.
John Scott may want to pick up on that point.
Before he does, I welcome to the public gallery a member of Parliament from the Parliament of Victoria in Australia, who happens to be called Heidi Victoria. I hope that she will find our work interesting.
I add my welcome to that of the convener.
All distribution companies are in the early stages of negotiation with Ofgem on price control from 2010 to 2015. We are lobbying Ofgem to level the playing field for competition on connections. On the issue of profit, we think that it is unreasonable that any company should be required to carry out activity for no return.
Is the fact that you do not make a profit on the work the reason that it does not appear to be addressed as a matter of urgency? At our recent meeting, a representative of Tweed Homes stated:
I do not believe that to be the case. Our connections business has a strong focus on customer service and delivering what its customers require. You mentioned timescales. A number of the constraints—road opening notices, way leaves and the land rights that we need to install our cables—are not apparent to developers and customers. Before we can energise cables, we need to have the appropriate title to land or access rights to ensure supplies once cables have been energised. At any site, there are a number of significant inherent delays that cannot be avoided.
There appears to be a general problem. We have been given one specific piece of evidence on the issue, but it is supported by anecdotal evidence. There is a communication problem, at the very least, if developers and individuals do not understand the difficulties that you face and assume that the work is not done because you cannot be bothered to turn up, have too much else on or are not addressing yourself to it because you do not make a profit from it. Developers and individuals say that you turn up only months later, when it suits you, but you say that you work as fast as you can; you cannot both be right. The committee must establish where the truth lies. Can you help us?
You said that the issue had been raised by one person. I do not know how many others have mentioned it to you, but we do not regard it as a general problem. The licence under which we operate prescribes that time is of the essence, so we cannot just fail to turn up. We must respond to requests. The customer must specify in his request when he wants work to be done. In our quotation, we must acknowledge that or make a counter-proposal. The customer may ask us to come the next day, but that is not realistic—we may not be able to do the work for three or 12 weeks. However, we must respond to the customer on that basis; in the quotation that we provide, time is of the essence. The customer has the right to go to Ofgem to seek a determination if he finds that we have not been fulfilling our contractual obligations. We are under the cosh of the regulator, and the fact that the market is competitive means that we compete with other people to win business and keep it to ourselves.
So neither of you is aware of any complaints about the delivery of the systems that you install. You work on the basis that everyone is happy with what you are doing.
You cannot always please everyone, but we do not recognise such complaints as a familiar theme.
Could that be to do with the fact that, to a large extent—certainly as far as the final connection is concerned—you are monopoly providers, and people might take the view that if they were to challenge you, you might just take a little longer and put their application to the bottom of the pile again? I dare say that you would challenge that.
We would. As I said, the regulator monitors us and we have to publish our performance on such matters. Ultimately, if we do not perform, we will lose the business because the competition is out there.
As regards the complaint by Tweed Homes, I asked my colleagues in our connections business to investigate whether there was a history of complaints and an on-going customer service issue that needed to be addressed. We have one record of Tweed Homes expressing a concern in the past year or so, which related to physical delivery of connections on a site. There were delays, which we had communications with Tweed Homes about, and the fault lay with a number of parties. On one occasion, the site was not ready when our staff turned up to install equipment.
I want to clarify the point that you made about not being able to make a profit on new connections. I think that you indicated that if you were to make a profit accidentally, so to speak, you could not keep it. Is that the case? You can make a profit, but you cannot keep it—you must put it towards subsidising your social obligations. Am I correct in understanding that that is what you said?
Yes. That is how the allowed revenue mechanism works. At the end of each five-year price control period, Ofgem makes regulatory adjustments to our asset base for various activities. One such activity is the making of any connections margin.
So you can make a profit, but over time it is taken out of the system and applied to other things.
Yes. We would seek only to recover our costs on each job and would price it accordingly.
So the price that you quote will, as far as you can gather, cover just the cost of that job, thereby eliminating any profit element.
Yes.
If that is the case—I do not doubt that it is—what is the case for charging anyone anything up front? The way in which the costs work means that you end up not making a profit. If an individual or a small company did not have to fork out £10,000—or £6,000, or whatever it might be—up front, the removal of that burden would help their cash flow and assist them in various other ways. Would that not be a fair proposition?
The regulatory mechanism works in a one-sided way. If we made a loss, a regulatory adjustment would not be made to our asset value. Any net profit is taken away, but any net loss is not compensated for.
So taking the cash up front and using the interest that you can gain on it until you complete your expenditure is part of the way in which you balance the equation without generating a profit. Is that correct?
I am sorry—could you repeat that?
If you keep my £10,000 in your bank account for six months, you will make some money on it. Is that money factored into the quotation to ensure that you do not make a profit? Would you use that cash to reduce any losses?
I do not know precisely how it is factored in. As Max Lalli said, it also deals with rising costs in the period. We have seen unprecedented input cost rises over the past five years. We would not go back to the customer and say that we were increasing their quotation because the price of copper had increased significantly.
House building is a rather curious thing. When I built a house four years ago I was subject to this regime, so I understand how painful the process can be. I am not seeking retribution in my questions to you.
That is one of the fundamental issues. We are not like the other providers. Historically, we had a monopoly, so we have to provide the connection. The people to whom you referred are in the business to make a profit. We are there because we have an obligation as providers.
So, the obligation on you forces the customer to pay up front. Is that what you are saying?
No. We are saying that the way in which we are regulated means that we are a low-risk business in that sense—we are not there for that purpose. The presumption has been that we get the money way up front and, therefore, live off the interest. However, that is fundamentally not the case. We have to publish our methodology and make things cost reflective. The customer always has the redress of Ofgem to look at our prices. They can go to the regulator, which determines cases in which people think that excessive charges have been made. We are always under the regulatory burden to defend our charges and to demonstrate that they are cost reflective.
But the regulatory regime does not require you to ask for all the money up front.
It is to do with the way in which the framework is set up. As Jim McOmish said, in doing our five-year price control reviews, when we make our case for our business costs, we do it on the assumption that we will get the money up front; we are not financing that—
But it is not the regulatory regime that requires you to do that. There is no regulation that says that you must ask for the money up front. There is nothing to prevent you from asking for 50 per cent now and 50 per cent on completion, is there?
Except that we would then have to finance that. Therefore, we would have to recover it in the costs at the end.
But surely you are financing only the bit of work that is immediately coming. You said that you phase larger jobs. Presumably you could phase all jobs, so that an individual who has to pay £10,000—which might not be a lot of money to an energy company, but is a lot to the individual—could pay £1,000 to cover the initial work, after which subsequent payments could also be phased. You have not done 100 per cent of the work, so you do not have 100 per cent outlays. You are covering more than your outlays. Why cannot you phase for all jobs, regardless of their size?
It is primarily to do with administrative efficiency.
I want to take a slightly different tack. On incentives in the system, you say that what you are doing is not for profit, but if you make a profit, there is the handy side benefit of socialising such profits across your customers. In the current environment, in which energy costs have been spiralling, anything that allows you to defray cost charges to customers across the board is attractive. Chipping back the additional surplus to the individual concerned, whether in a £10,000 small project or on a larger scale, just does not have the same attractiveness. I can see perverse incentives for you to estimate a charge that is not just cost reflective but errs on the high side, because there is no downside to that.
The downside would be that competition is there, so the customer can go out into the marketplace and get another quotation for that work.
You said that the competitive market is undercutting you in time and costs, so what are a few thousand pounds here or there on any given project?
Our duty is to have prices that are cost reflective. We are in the business to provide connections and that is what we want to do. We do not want to lose out to competition, because our obligation is to provide connections and we must have a de minimis workforce to provide connections. We are keen to provide as many connections as we can, as best we can.
What happens if you take £10,000 up front but the cost of the job turns out to be £8,000? Perhaps you never bother to cost the job in retrospect.
For certain jobs our methodology is to produce fixed quotations—that is partly the customer's choice. The costs might go over or under, but that is not always reconciled at the end of the process.
You are competing against companies that have to make a profit. You told us that those companies can outbid you and get the job, even though you are not making a profit. Does that suggest that your estimates are often rather higher than they should be?
No, because we are covering the whole area, which includes rural and urban areas. I do not know where the competitors are operating, but they might be localised and have lower overheads—
Fair enough. Perhaps a competitor operates in a small area, but that suggests that your estimates are overly high in that small area at least, because someone can outbid you even though they are making a profit.
I repeat that our methodology for coming up with quotations is published; the principles of that are approved by Ofgem; and we must abide by those principles. It might well be that the cost of connection in rural areas is higher, only because the area is remote from the network into which we are connected, but that is the cost-reflective nature of the business.
I accept that your methodology is published, but, with respect, that does not make it good methodology. If you, who are not supposed to make a profit, can be outcompeted in some areas by companies that are making a profit, your charges must be too high in those areas, because otherwise the companies that make a profit could not outcompete you.
The methodology is not only published but approved by the regulator.
People are already paying large sums of money and energy costs are going up, but you are asking to make a profit on connections, on top of the other profits that you make. Energy companies are not losing money just now.
One must be careful. In talking to us today you are talking to the distribution business. We are not associated with the retail or supply side of the business. There are different, ring-fenced, regulated businesses.
You mentioned the competition that has come into the market since Ofgem's intervention a number of years ago. What percentage of your previous business has been lost to the competition? If the information is not readily available, could you supply it to the committee?
Ofgem publishes that information every year. I scoured Ofgem's website, and the data for 2007-08 are not on the website, but the data for 2006-07 are there. Ofgem is due to publish the more recent information. It publishes information yearly on all the IDNOs and shows what is supplied by independent connection providers.
In my written submission I included information about the connections market in our area. That reflects physical connections that have been delivered, which relate to contracts that in some cases were placed two years previously. The actual connections that have been won by independent distribution companies represent about 50 per cent of the market in our area.
As ever, you are invited to put on paper additional thoughts if you want to clarify points or raise matters that we did not ask about. Equally, we will follow up with you anything on which we want further information. I thank you both for coming, particularly at such short notice. You are free to leave or to stay now.