Written evidence submitted by Wales & West Utilities (NTC0016)

This document is submitted as evidence to the Energy and Climate Change Committee by Wales & West Utilities Ltd (WWU). WWU was established in 2005 following the acquisition from National Grid of the Wales and South West England gas networks. We are one of eight gas networks operating across the UK. We provide the gas emergency service and transport gas to 2.5m homes and businesses across our operating region. Our responses focus solely on matters relating to gas distribution.
 

1. Executive Summary             
                

1.1.        Since our inception in 2005, we have fully recognised our position as a monopoly service provider and sought from the outset to deliver excellence in five key areas of delivery - customer service, safety, reliability, cost efficiency and investment. Our clear strategy and continuous drive for excellence in these key areas has delivered significant benefits for consumers since 2005;             
 

1.1.1.       Customer service. We have consistently been a leading customer service provider in our sector since 2005, continually being top of the independent tables for customer satisfaction amongst the eight gas networks.              
 

1.1.2.       Safety.  We have consistently outperformed the 1 & 2 hour emergency response standards every year since inception. This is achieved through meticulous planning, and in particular, ensuring the robustness of our winter preparedness plans.  We respond to 100,000 emergency calls each year - with 85% of these being gas leaks on the consumers’ own gas equipment rather than on our network.             
 

1.1.3.       Reliability. Our clear focus on planned maintenance and strategic investment ensures that consumers in the WWU region can only expect to experience a gas supply interruption on average once in forty years.             
 

1.1.4.       Cost Efficiency. Using Ofgem’s independent cost efficiency rankings we are recognised as one of the best performing businesses across the last regulatory price control period 2008-13. We also outperformed the regulatory allowances for that period, meaning customers benefit from that outperformance going forward.             
 

1.1.5.       Investment.  We have invested £780m in our network since 2008 - more than £150m a year.  This investment has been critical to the safety and reliability of our network as 80% of homes use gas as their primary source of heating. This investment has delivered the following benefits over the period;                
 

•               The replacement of more than 2,000 kilometres of deteriorating iron gas mains that present a risk to the public
•               Completion of 60,000 new consumer connections to our network – of which 10% are for ‘fuel poor’ customers
•               An increasingly robust distribution network with the capacity to transport all required gas to power stations, homes and businesses with minimal disruption
•               Significant contribution to the local; and national economy, as we spend over £100m per annum with our contractors and external service providers
• Employment for almost 2,000 people in the local economy – providing highly skilled jobs both currently and into the foreseeable future.

1.2.        Our network charges are £144[1] per annum - representing around 18% of a typical domestic gas bill.  We believe this represents excellent value for delivering a safe and reliable service to consumers. We will invest an additional £1bn of investment through to 2021 to maintain the safety and reliability of our network - whilst keeping our charges broadly flat in real terms over this period.             

1.3.        We are an essential service provider and will continue to play a key; and cost efficient role in a balanced energy mix for the foreseeable future.  Investment in the gas distribution networks will also ensure we can deliver our carbon reduction targets and energy security efficiently to consumers.             

1.4.        The remainder of this response addresses the specific questions within the call for evidence. 
 

2. Responses to detailed questions:             
    

2.1.        What factors determine network costs? What contribution do these factors currently make towards a typical household energy bill and how might this change over time?             

2.1.1.       Our Annual charge is currently £144[2] per domestic consumer, which is around 18% of a typical domestic gas bill.              
 

2.1.2.       Our costs are determined by the key services and Outputs we deliver; and the requirement to achieve specific regulatory standards which are defined within our Licence.

2.1.3.       Our charges are not linked to gas volumes distributed, and we do not influence the amount of gas that passes through our network.             
 

2.1.4.       WWU’s charges are likely to remain broadly flat in real terms until 2021. There is an annual sharing mechanism that ensures any cost outperformance is shared with consumers through the gas shippers’ bills. For consumers to receive these benefits it is necessary for gas retailers to pass on these savings in consumer bills.             
 

2.1.5.       A wide range of stakeholders are involved in defining the Outputs we are required to deliver. Our stakeholder engagement process has full regard to the cost impact of delivering the required service standards. We actively seek public consent for the level of services we deliver and the associated costs. As a result, we achieve an appropriate balance between delivery of Outputs and affordability. This is supported by the stakeholder feedback we have received.              

2.1.6.       Our direct costs are specifically related to maintaining the network in a safe and reliable manner - and to deliver the gas emergency service. In addition to our direct costs, there are additional “non-controllable” costs that are charged through the gas distribution bill on an annual basis. For the period to 2021, the analysis below shows the 4 broad factors that determine the total annual network costs;             
 

•               Investment in the network; 51%
•               Provision of the gas emergency service; 4%
•               Maintaining our assets;  24%
•               Non controllable costs such as Business Rates, taxation, payments to the Transmission System and purchase of gas losses;  21%             
   

Below is a brief overview of these factors.              
 

2.1.7.       We operate over 35,000 km of gas pipelines across one sixth of the GB land mass and take gas from the National Transmission system at 17 Offtake points. On a winter’s day we transport up to 4 times more energy than electricity networks. We must ensure we provide a network of sufficient robustness and capacity to transport gas from the National Transmission system to where users need it.                            
 

2.1.8.       The WWU region has around half of the oldest small diameter local transmission pipelines in Great Britain and a significant proportion of the pipe infrastructure is deteriorating Iron Mains. We are replacing over 360km of deteriorating iron pipe per annum with plastic pipe. We are 12 years into a replacement programme agreed with the HSE, and will complete the programme by 2032. The pace of the replacement programme has been set by the HSE to provide an appropriate balance between safety and affordability.               
 

2.1.9.       We have the requirement to respond to gas emergency calls within one hour, where the leak is uncontrolled; 97% of the time. WWU has always met this key requirement.  We receive more than 100,000 calls a year across our very large area, with over 85% related to household appliances. As would be expected, the number of calls peak during winter months.

2.1.10.   From the 100,000 calls we receive, around 15,000 relate to faults on our assets. We repair these faults where it is more economical compared to renewal. In addition to the underground pipeline assets, we maintain and repair a significant amount of above ground assets.             
 

2.1.11.   There are some costs that we “pass through” the gas distribution charge each year[3] that we have little control over.  On an annual basis, these include;             
 

•               Business rates[4] on our assets, taxation and Ofgem Licence Fee; £38m
   
•               We pay the National Transmission System for capacity availability; £23m.             
•         Lost gas (“shrinkage”) that is lost during transportation; £10m.             
  
  These three elements cost around £71m a year, and represent about £28 of the average annual domestic gas bill.              

2.2.        What impact does the Government’s low carbon ambitions (e.g. smart meter roll out, developing the offshore grid and interconnectors etc) have on network costs?              
 

2.2.1.       Except for the rollout of gas smart meters, we see little direct upward cost impact of the Government’s low carbon ambitions on our network costs.                           

2.2.2.       We are fully engaged within the future energy debates as gas has a vital role to play in a balanced and low carbon energy mix that the UK requires for the future. Around 80% of households currently use gas as their primary heat source. We are taking a number of steps to help ensure that the low carbon ambition has regard to the need for security of energy supply and affordability, as well as responding to consumer preferences and the potential impact on them.  The following are some brief insights into the work we are doing to support a sustainable energy mix strategy:             
 

•               We have provided DECC with two key reports that highlight the value of retaining gas in the energy mix. Gas has a vital role in helping achieve the UK’s low carbon ambitions - and in doing so could save over £2,000 per households in the UK[5]              .
   
•               We are working to facilitate renewable gas connections to our grid, which will improve security of supply and lower our carbon footprint. In 2013 WWU completed the first non-subsidised biogas network connection.             
   
•               We are actively exploring a number of innovative opportunities with third party experts for other potential renewable and sustainable sources of energy, for example hydrogen.              
   

2.2.3.       The introduction of Smart Gas Meters will likely increase the number of operational call outs during the rollout phase. The impact is very difficult to assess precisely at present, but we are fully engaged with all participants in industry workgroups to deliver the roll-out requirements efficiently. We have conducted a study to highlight the potential impact and shared this through the ‘Industry Smart’ forums.  We do not anticipate a material impact on network management or network costs after the smart meter rollout.             

 

2.3.        Does Ofgem provide the right incentives to network companies to ensure they keep their costs as low as possible?             
 

2.3.1.       Yes. The regulatory regime balances investment and service delivery with cost to gas customers. Our revenues are dependent on us delivering agreed Outputs and Licence Obligations. Failure to deliver would result in revenue reductions as well other possible sanctions such as fines. We outline below some of the key incentives included in our tough and challenging framework;             
 

•               Our cost and workload allowances are traditionally reduced by the regulator at Price Control resets in recognition of previous efficiency developments - and are always benchmarked in detail. In addition, cost allowances include year on year challenges to encourage a continuous drive for increased efficiency.             
   
•               For every £1 of ‘controllable cost’ overspent during the price control period, network operators fund around 63p. Conversely, if we outperform the cost allowances we retain 63p of the benefit. Therefore, there is a very strong and symmetrical cost incentive.             
   
•               Networks bear all reasonable operational and management risk. There are very few ‘re-opener mechanisms’ during price control periods and therefore we are expected to absorb a level of additional cost from changes that inevitably occur and must be dealt with.             
   

2.3.2.       In addition, the UK regulatory framework has historically been recognised as an exemplar of utility regulation across the world. This is enhanced by the increasing role of a wide range of stakeholders, and the delivery of investments and services cost-efficiently.

2.4.        How does Ofgem identify and regulate profits for network companies within a regulatory settlement period? What scope is there to adjust profit gains over regulatory periods? Are the current levels of transparency sufficient?             
 

2.4.1.       Our regulatory Licence limits the activities we can undertake and also contains challenging obligations and targets. The cost of equity is fixed for the period of the regulatory review. As a standalone gas distribution network  there are only two ways in which we can increase profitability;

•               Deliver the required Outputs at a lower cost than that allowed, and;
•               Outperform the key additional targets to deliver the incentives contained within the RIIO framework. 

Therefore, increased profits for network operators during a price control period are clearly linked to effective and efficient delivery of services to bill payers.

2.4.2.       It is important to note that the incentive regime is symmetrical and if we overspend allowances, or fall short of the additional incentives, returns to shareholders will be reduced.

2.4.3.       Prior to each regulatory period, our business plan is discussed extensively with our stakeholders and the agreed final proposals are published by Ofgem. Each year during the price control period we report in detail our costs, revenues and Outputs. This ensures that our performance is highly transparent.              

 

2.5.        How can UK network costs be benchmarked against utility sectors or networks in other countries? Would this increase confidence in UK network costs?                
 

2.5.1.       We strive for excellence and transparency to ensure we are doing the right things for our customers at the best price. Benchmarking, including cross sector comparisons is extensively used in setting network cost allowances.                
 

2.5.2.       We are open to more comparative benchmarking with other utilities and those in other countries. Additional cross sector and internal comparisons could increase confidence in UK network costs. However, we must ensure comparisons are robust and meaningful. Some issues that would need to be reflected in order to compare networks internationally are;             
 

•               The GB gas network is older and more integrated than those of most other countries             
•               The GB system is a model whereby networks and retail operations are licensed separately and ownership is not provided by governments. Some other countries have combined retail and networks within government ownership             
• In some countries it is difficult to identify government subsidies in order to see equivalent service line costs.             
   

2.6.        To what extent does the way network companies charge energy supply companies impact on consumer energy prices? Is there scope to improve this relationship in order to reduce prices for consumers? How would this be done?                           
 

2.6.1.       We are obliged to ensure our charges are cost reflective. The majority of our costs do not vary with throughput, and about 95% of our costs are linked to providing capacity and maintenance of the network. Consequently, our charges reflect this structure. We continually keep the charging methodology under review and consult on changes, whether they are proposed by us or suppliers.             

2.6.2.       In 2007/2008 the feedback from suppliers was that they were concerned with significant charging volatility and unpredictability within network charges. Following consultation we were able to implement a more stable charging regime. This has been well received and has significantly improved the stability and predictability of charges             

2.6.3.       We continue to work with all suppliers to improve transparency and longer term visibility of charges. These are key factors that would assist suppliers to remove any risk premiums they include in their charges to reflect uncertainty.             


 

2.7.        To what extent are different consumer groups (e.g. domestic and non-domestic) charged different network rates? Is the current charging regime fair to all consumers?             
 

2.7.1.       As stated above, our charges are cost reflective, largely driven by fixed costs and a common methodology is applied across the consumer groups. We do not vary charges dependent on location across our region - the same charges are applied to domestic and non-domestic consumers whether they are rural or urban.              

2.7.2.       We believe the current charging regime is fair and transparent. The industry forums we hold include representatives from domestic and non-domestic customer groups. WWU also holds one-to-one sessions with trade representatives such as ICOSS (non- domestic trade body) and the Energy Retail Association. We have excellent relationships with these industry representatives and develop proposals with all parties.

2.7.3.       Our charging methodology is published and fully transparent, and we have held a number of briefing sessions for suppliers.              
 

2.7.4.       Charging is reviewed annually by ourselves and we also monitor the proportion of charges between the groups and any year on year changes. Our charges must be cost reflective, and we are able to confirm that the proportion of network charges for each group has remained stable over the past seven years - 80% to domestic and 20% to non- domestic.             
 

2.8.        In the absence of competition, does Ofgem provide sufficient incentives to network companies to maintain, invest and innovate in their networks?              
 

2.8.1.       The level of investment, coupled with the continuous cost efficiency challenges within a stable regulatory regime, has delivered significant benefits to consumers. The networks are key infrastructure assets that support heat and energy for homes and business.              
 

2.8.2.       Over the next two decades significant investment is required in our network assets to maintain them and also ensure they are fit for purpose into the future. Therefore the additional innovation funds that are now in place for 3rd parties to work with us are a welcome addition to the regulatory framework.              
 

2.8.3.       A key enabler to investment is a fair rate of return. The continual reduction in base returns is becoming a concern with a danger that the significant investments required are not delivered.             
 

2.8.4.       The incentive package for gas distribution, coupled with the new innovation opportunities, provides an appropriate framework to secure the significant investments required. Further reductions to returns will put future investment at risk. As we stated earlier, we will be investing over £1bn over the next eight years - without increasing the cost to consumers in real terms.

2.9.        How do losses and leakages in the networks influence network costs and are these reflected in consumer prices? Could Ofgem do more to ensure network companies keep losses and leakages to a minimum?             
 

2.9.1.         A proportion of gas is lost as it flows through the distribution network, and this is included in our charges to shippers. The loss is a very small percentage of throughput volumes - at less than 0.7%. This represents around £10m a year and equates to circa £4 on an average domestic annual bill.
 

2.9.2.         WWU has reduced leakage significantly over the last 5 year regulatory price control period by some 18%. Had we not substantially reduced leakage, consumers would have had to pay an additional £5m over that period.             
 

2.9.3.       There are already strong incentives for reducing gas distribution leakage and we face   tough challenges in the period to 2021.  The impact on consumer bills is relatively low – however we are continually seeking ways to keep this to a minimum.

2.10.    How should the balance be determined between investing in a more reliable network and the impact of this on consumer bills?             
 

2.10.1.   We are ultimately accountable to the people and businesses that pay to use our network and services. We consider it is right and proper that they play a role in determining an appropriate balance between investment and bills.             

2.10.2.   To develop our business plan we consulted with a wide range of stakeholders. They provided guidance to us on what they wanted, and at what price. In broad terms they wanted us to maintain current performance levels with regard to asset health, emergency standards and network reliability - whilst minimising increases in bills.  Our role is to ensure that we work within the parameters set but also ensure we do not burden future consumers by cutting necessary investment now.             
 

2.10.3.   As the gas network is a regional monopoly, we fully recognise there is a clear role for an independent economic regulator which is able to independently benchmark cost allowances, and set Output targets utilizing their own specific consumer challenge panels.             
 

2.10.4.   In summary, our view is that the existing regulatory regime, coupled with incentives for a continuous drive for efficiency, service and long term sustainability, is delivering the right balance between investment and bills. We will continue to provide open and transparent information on our performance and take on board relevant stakeholder input to inform our strategic planning, investment levels and the resultant impact on bills.

April 2014