RECs penalties blamed on new spending

PFour regional electricity companies are to suffer extra penalties as a result of the power price review announced yesterday.

The hardest-hit include Northern Electric, the expected target of a renewed bid from Trafalgar House, and Yorkshire Electricity, widely rumoured to be likely to be on the receiving end of predators' attentions.

Along with East Midlands and Seeboard, they have been penalised with an extra two percentage points of distribution price reductions next year, taking their total to13 per cent. But the share prices of all four nevertheless closed well ahead.

In the case of East Midlands, Yorkshire and Seeboard, some or all of the penalty was incurred because the companies cut their capital spending significantly below the amounts they had promised during last year's electricity price review.

Professor Stephen Littlechild also points out that Northern's capital spending projection in its defence document against the previous Trafalgar bid was below the level he had assumed last year. He said the extra penalty was the result of new cost assumptions for the company.

In contrast to these penalties, Eastern Group and Southern Electric have been let off with a 1 per cent easing to 10 per cent in next year's price cuts, part of a readjustment of the burden of the regime between companies.

Henry Casley, chief executive of Southern, nevertheless called the review "as tough if not tougher than we were expecting." He said Professor Littlechild had taken another pounds 130m out of his company over four years in addition to the pounds 280m last year, making pounds 410m over a five-year period.

And Mr Casley warned that to avoid making shareholders pay for it all, the electricity companies would launch a new efficiency drive that would include cost-cutting measures.

Mr Casley said: "We have been historically aiming for dividend growth of 5 per cent real. This is certainly going to make my life a lot tougher. Giving more money back to customers is potentially at the shareholders' expense unless you do something about it."

John Devaney, chief executive of Eastern Electricity, said that the proposals at first sight represented a significant tightening of the controls. However, Mr Devaney welcomed the reduction in the "remarkable disparity of prices between various companies across the country."

Analysts went into a huddle with their computers to assess the results, and their initial reactions were mixed, with a majority suggesting that the new regime was slightly less harsh for the companies than expected.

Phillip Green of Lehman Brothers said Professor Littlechild had not changed "the relativity of the companies" substantially, although there were some winners and losers.

Professor Littlechild said that to claw back profits from the previous price control period would be a breach of faith with investors, though some had argued in favour because of high profits over the past five years.

He reaffirmed his view that there should be a special payment to customers when the National Grid Company, owned by the RECs, is floated.

Referring to Labour plans to change the present price control system and introduce profit sharing, Professor Littlechild agreed it would be "worth exploring the possibility of improvements, if this could be done without impairing incentives to efficiency or widening the scope for manipulation by the companies."

Professor Littlechild justified his decision to change the numbers on two grounds.

Citing the recent Monopolies and Mergers Commission report on Scottish Hydro, he said he had decided to exclude redundancy costs from the base costs on which price controls were calculated.

This meant a reduction in allowances for restructuring costs for the companies and he proposed to reflect this by increasing the X value for all the RECs from 2 to 3. The X value is the amount price changes have to be kept below inflation.

The second adjustment also cited the MMC report, on a technical issue of whether to make adjustments for the RECs' asset valuations as a result of changes in the cost of capital since flotation.

Professor Littlechild said his new proposals dealt fully with concerns that his proposals last August were too lenient. "They ensure that customers as well as shareholders have done extremely well, and that an acceptable balance between them has been secured."