OFT Respond on Manx Gas Queries

NEWS FROM THE CELTIC LEAGUE

 

Celtic League has received a detailed response which I include below from the Isle of Man Office of Fair Trading on the Manx Gas issue.

Mr Ball acknowledges concerns and says:

“I do note your genuine concern about the risk that vulnerable members of society will be scared to turn on essential heating in cold weather. Indeed, the OFT shares that concern. The problem is that the cause of that fear is not a price increase for gas, because there simply is no overall increase, but rather the noise around the issue, where people are projecting that there is a gas price increase because they are ill-informed or for political gain.”

The letter was also accompanied by a copy of the Gas agreement entered into by OFT/Treasury/DED and Manx Gas together with illustrating savings in the winter months (these are not reproduced due to size constraints).

I’m publishing the letter in full. The Celtic League has set out our view in previous postings in detail – and we stand by those.

We leave you (particularly any gas consumers) to be reassured or otherwise by the letter.

“27th October 2015

Dear Mr Moffatt,

Manx Gas Ltd. – Tariff Restructuring

Thank you for your letters of 22nd and 23rd October in the above matter addressed to the Chief Minister and copied to my Chairman, David Quirk MHK. The Chief Minister has asked the Office of Fair Trading to respond thereto.

At the outset I would wish to make it clear that whilst the Government can rightly take pride in the performance of the economy, there is also recognition that there are those in society who are struggling. One of the three key priorities of the current administration is to “Protect the Vulnerable” and the Council of Ministers and all Departments and Statutory Boards have this high on their agendas. As you will see from later in this letter, this priority has actually informed the approach which the OFT has taken in relation to the tariff restructuring by Manx Gas Ltd.

Whilst there has been much misinformation and scaremongering in the media and elsewhere, it is important to recognise that the tariff restructuring is revenue neutral for Manx Gas Ltd. and does not constitute an overall price increase for consumers. The OFT scrutinised the changes prior to the announcement and confirmed this to be accurate. The OFT also confirmed the validity of the Manx Gas Ltd. analysis, that whilst there would be some “winners” and “losers”, for the vast majority of individual customers, provided that the customer is in the correct band, the maximum annual loss or gain is under £25 including VAT.  What customers will see under the new system are slightly lower gas bills in the winter months and slightly higher gas bills in the summer months.

I note your comment that “Isle of Man Newspapers calculated that 7000 customers would suffer detriment”.  It is my understanding that the figures quoted were in fact supplied to the newspaper by Manx Gas Ltd. and were the same figures which had, prior to the announcement of the new tariff, been validated by the OFT.

The Regulatory Agreement for gas supply was negotiated with the approval of the Council of Ministers by the OFT and the Treasury. I attach a copy of the Agreement which has been publically available from the OFT website at the following weblink since it was signed:

https://www.gov.im/lib/docs/oft/gasregulationagreementfinalwebsi.pdf

You will note that there are three signatories to the Agreement from the Government, the OFT, the Treasury and the Department of Economic Development.  You express the view that the profit which Manx Gas Ltd. is allowed to make under the Agreement is “outrageous”.  Government agencies entered into the Agreement to protect consumers from the potential effects of the monopoly enjoyed by Manx Gas Ltd. in gas supply. The Agreement provides that the annual profit of Manx Gas is fixed at 9.99% of the value of the capital assets utilised in the gas supply business. This method of fixing profits, often referred to as Return on Capital Employed or ROCE, is a methodology often used by regulators in capital intensive businesses such as the energy industry.

In order to understand the profitability which is fixed under the Regulatory Agreement, you need to go back almost a decade. In 2007 the Council of Ministers made a reference under section 19A of Fair Trading Act 1996 to the OFT in respect of gas prices charged over a 12 month period up to 31st January 2007. Whilst the resulting investigation was undertaken by the OFT, it relied extensively on the use of an external specialist consultant. The report of that investigation is published on the OFT website.

The investigation started from the premise that, provided it was established that Manx Gas Ltd. was operating reasonably efficiently, if it was charging excessive prices it would be making excessive profits; thus profits would be used as a proxy measure for prices. In order to establish whether profits were excessive, it was first necessary to establish what level of profit was reasonable. This report provided a number of key findings:-

  • It concluded that Return on Capital Employed (ROCE) was the appropriate way of assessing profit within capital intensive industries;
  • It defined the acceptable range of profitability for Manx Gas Ltd. based on Return on Capital Employed ;
  • It confirmed that Manx Gas Ltd. was for the reference period within that range; and
  • It provided the methodology to revalue the acceptable level of profitability on an ongoing basis, based on economic parameters.

Following the publication of the report, Manx Gas Ltd. decided of its own volition to ensure that its profitability remained within that acceptable range and to provide to the OFT, on a commercially confidential basis, evidence which would confirm adherence.

When the OFT and the Treasury were mandated to seek to negotiate a light touch regulatory agreement we were very keen to agree a fixed level of profit rather than a range as identified in the above report.  The starting point for the negotiations was a revaluation of the original formula using 2014 economic parameters. The eventual Regulatory Agreement fixes Manx Gas Ltd profits at 9.99% ROCE which is below the mid-point of the revalued acceptable range and below the average level achieved by Manx Gas Ltd. over the intervening period. This is a good deal for consumers but also gives Manx Gas Ltd. what has been independently assessed as a fair return on its investment. In the pre January 2015 system, Manx Gas Ltd. could simply keep any ‘excessive profits’ generated. However with the Regulatory Agreement in place, the balance has to be returned to the consumer in the form of future rebates.

Having explained how the profitability for Manx Gas Ltd. was determined; and why it is a good deal for consumers, I will return to the subject of the changes to the tariff structure itself. The OFT is a formal consultee in relation to any change in the proposed tariffs for gas, something which is enshrined in the Regulatory Agreement. I can confirm that the OFT were consulted on the current proposals and made substantial comment; which resulted in changes to the proposals. In particular the OFT were concerned about the potential impact of the new tariff on the vulnerable members of society and this ultimately influenced the new tariff structure:-

  • The biggest potential impact of any change was on low volume users, which is likely to include many of the more vulnerable members of society. The OFT influenced the decision by Manx Gas Ltd. to leave tariffs unaltered for customers for low volume central heating customers using under 5,000 kWh per annum. Cooking and gas fire tariffs are also unchanged.
  • The OFT was concerned that, whilst inevitably there would be “winners” and “losers” from the change, the scale of the gains and losses needed to be small; especially for vulnerable customers. The OFT influenced the number of bands in the eventual proposal. Whilst the 9 band structure adds to the complexity; its primary purpose is to ensure that losses and gains are limited.

Whilst I have made it clear that the changes to the gas tariff structure announced by Manx Gas Ltd. are revenue neutral for the company; that does beg the question as to why they have decided to make the changes. The answer to that question is in the Regulatory Agreement itself. One of the challenges during the negotiation process for the Agreement was to ensure that it would be possible for OFT, with support from Treasury accountants, to monitor the setting of tariffs by Manx Gas Ltd and thereby be able to comment constructively on tariff proposals. In the past Manx Gas Ltd. had developed a tariff for central heating customers under which the standing charge was recovering between 15% and 20% of the cost of the fixed network. This meant that Manx Gas Ltd. needed to include within the price of gas, recovery of the balance of the correct share of the fixed network costs. Whilst the number of standing charges collected in a year is relatively predictable, the volume (kWh) of gas sold in a year is extremely variable, as gas consumption is highly weather dependant. It is easy to see that attempting to recover a large part the fixed network costs in this way is likely to lead to under or over recovery (depending how warm or cold it is). This makes it difficult to set prices to achieve a definite profit level. Under the Regulatory Agreement, Manx Gas Ltd. is required to do exactly that; and the OFT needs to understand how they are doing so. The new tariff structure is intended to rebalance the split between standing charge and gas price. As I explained, the changes announced are demonstrably revenue neutral for Manx Gas. The fall in the gas price in the new tariffs is a result of removing the share of recovery of the fixed network costs from the price.

I note your comments about the handling of customer and public relations by Manx Gas Ltd. It is not the role of the Government to manage the public relations of a private company and I note that you have copied your letter to their Managing Director. I will leave Mr Nicholls to respond to that criticism himself.

I do note your genuine concern about the risk that vulnerable members of society will be scared to turn on essential heating in cold weather. Indeed, the OFT shares that concern. The problem is that the cause of that fear is not a price increase for gas, because there simply is no overall increase, but rather the noise around the issue, where people are projecting that there is a gas price increase because they are ill-informed or for political gain. I know that the OFT will be looking to work with Manx Gas Ltd. before the new tariffs come into force, to reinforce the message that there is no price increase and that winter bills will fall and summer bills increase as a result of the new tariff.

You raise the issue of the impact of a cold weather on bills. As the unit price of gas under the new tariff is lower than under the old tariff the impact would be that if usage rises customers would generally be better off than they would have been. This is contrary to what has been alleged by some; but it is the reality. I attach charts prepared by Manx Gas Ltd which demonstrate the extent to which customers would benefit. In fact the only loser if there is a long cold winter is Manx Gas Ltd

In your second letter (23rd October) you raise the issue of the potential introduction of competition into the gas market. As the current legislation stands there is nothing to prevent a new entrant into the market. Any new entrant would, however, need to set up its own separate infrastructure and the OFT believes that this is highly unlikely. If Government was desirous of introducing competition it would need to introduce legislation which would allow a competitor to have regulated access to the existing distribution network. Whilst this might, at first sight, appear to be an interesting idea; it is important to look at it in the context of overall efficiency. Looking back at the earlier investigations into gas supply it is clear that one of the key reasons why gas prices in the Island are more expensive is the lack of economy of scale; and there is a very real risk that opening the market to competition would simply make Manx Gas Ltd less efficient with an inefficient competitor; and an outcome that prices would rise rather than fall.  The current position is that Manx Gas Ltd. has the minimum infrastructure necessary to meet current demand but could in fact massively increase output at only a marginally increased cost. The OFT view is therefore that accepting the monopoly, and regulating it, is the most cost effective solution for the Island

Finally, I would just wish to reiterate that, under the Regulatory Agreement, whilst Manx Gas Ltd. is free to run its business as it sees fit, its profits are fixed. If they make too much profit it goes back to their customers.

I hope that this response is helpful.

Yours sincerely,

Mike Ball

Chief Officer

Copy to:          Hon AR Bell, MHK, Chief Minister

Mr D Davies, Cabinet Office

Tony Nicholls, Manx Gas Ltd.

OFT Board”

The Celtic League is grateful to Mr Ball and the staff at OFT for providing the detailed information on how OFT interprets the current position.

BERNARD MOFFATT

Issued by: The Celtic News

29/10/15

THE CELTIC LEAGUE INFORMATION SERVICE.

The Celtic League established in 1961 has branches in the six Celtic Countries. It promotes cooperation between the countries and campaigns on a range of political, cultural and environmental matters. It highlights human rights abuse, military activity and socio-economic issues

https://celticleague.net

 

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