Background information
The UK Gas Distribution business of National
Grid Transco is operated by Transco and
comprises almost all of Britain’s gas distribution
system. The gas distribution system consists of
approximately 170,000 miles of distribution
pipelines and is the largest gas distribution
system in Europe. Gas is transported on behalf
of approximately 70 active gas shippers from
the National Transmission System through the
eight regional distribution networks to around
21 million consumers.
As well as gas transportation, Transco is
responsible for the safety, development and
maintenance of the transportation system and
operates the national gas emergency service.
Regulation
On 1 April 2002, the activities of Transco’s
distribution business became subject to a
separate five-year price control formula
(‘distribution price control formula’). With effect
from 1 April 2004, this single price control
formula was disaggregated into eight separate
price control formulae (‘networks price control
formulae’) to cover the activities of the eight
regional distribution networks.
The new networks price control formulae take
the same form as the distribution price control
formula, with a maximum allowed revenue
assigned to each network. Each formula retains
the 65% fixed, 35% variable revenue associated
with transportation volume changes, a mains
replacement incentive mechanism and the pass-through
of prescribed rates and gas transporter
licence fees.
Each network has been allocated a regulatory
value associated with its distribution assets,
using an estimate of Transco’s distribution
business regulatory value as at 1 April 2002.
The allocation was done in a manner to minimise
unnecessary regional differentials in transportation
charges. The networks price control formulae
also incorporate the same cost of capital
assumptions at a real pre-tax rate of 6.25%.
To set the new networks price control formulae
it was also necessary to allocate allowances for
operating costs, capital expenditure,
replacement expenditure, regulatory
depreciation and transportation volumes.
Projected replacement expenditure continues
to be divided 50:50 between regulatory capital
and regulatory operating expenditure, thereby
ensuring that the cost of the iron mains
replacement programme does not fall wholly
on today’s customers but is shared with future
customers. The regulatory treatment of
replacement expenditure contrasts with the
accounting treatment where all such costs are
expensed (see critical accounting policies –
replacement expenditure).
Each network is subject to its own mains
replacement incentive mechanism and retains
33% of any outperformance against Ofgem’s
annual cost targets as additional profit, or
alternatively, bears 50% of any overspend
if it underperforms.
In 2003/04, operating under the distribution
price control formula Transco made an
estimated £10 million of additional profit from
this mechanism.
Financial performance
UK Gas Distribution turnover for the year
ended 31 March 2004 was £2,245 million,
compared with £2,089 million in 2002/03 and
£2,013 million in 2001/02.
Principal factors behind the £156 million increase
in turnover comparing 2003/04 to 2002/03 were:
- an increase in revenue recovered under
the distribution price control formula of
£84 million, primarily because of a 5% price
increase implemented in October 2003 which
added £79 million, combined with an
increase in underlying volumes which added
£21 million, but offset by an £11 million
reduction because of relatively mild weather;
and
- a £72 million increase in other, relatively low
margin income, primarily because of
increased work for the Group’s other
businesses, such as increased workload
undertaken by Transco’s emergency service
on behalf of the Group’s regulated and
non-regulated metering businesses.
Principal factors behind the £76 million increase
in turnover comparing 2002/03 to 2001/02
were an increase in revenue recovered under the
distribution price control formula of £33 million,
of which £23 million was due to an increase in
underlying volumes, while £10 million was the
result of relatively cold weather. In addition, there
was an increase of £43 million in other income
primarily because of increased work for the
Group’s other businesses.
UK Gas Distribution adjusted operating profit for
the year ended 31 March 2004 was £729 million,
compared with £554 million in 2002/03 and
£548 million in 2001/02.
UK Gas Distribution operating profit for the year
ended 31 March 2004 was £640 million,
compared with £443 million in 2002/03 and
£504 million in 2001/02.
Exceptional charges which explain the difference
between adjusted operating profit and operating
profit are discussed in the context of all
exceptional items of the Group under Exceptional items - 2003/04
and Exceptional items - 2002/03.
The £175 million increase in adjusted operating
profit comparing 2003/04 to 2002/03 was
mainly a result of an £84 million increase in
formula income, a £103 million reduction in
controllable operating costs and a £17 million
reduction in replacement expenditure. This was
offset by a net increase in depreciation and
amortisation of capital contributions of
£11 million and a £23 million charge for UK
Gas Distribution’s share of the Lattice
pensions deficit.
Principal factors behind the £6 million increase
in adjusted operating profit comparing 2002/03
to 2001/02 were an increase in revenue
recovered under the distribution price control
formula of £33 million, combined with a
£26 million reduction in controllable operating
costs, offset by increased depreciation of
£9 million and an increase in replacement
expenditure of £37 million (see critical accounting
policies – replacement expenditure).
UK Gas Distribution’s replacement expenditure
(repex) for the year ended 31 March 2004 was
£388 million, compared with £405 million in
2002/03 and £368 million in 2001/02.
The £37 million increase in repex in 2002/03
compared with 2001/02 was due to the
completion of the Medium Pressure Ductile Iron
replacement programme in 2002/03. The
£17 million reduction comparing 2003/04 to
2002/03 was associated with the start of the
iron mains replacement programme with
2003/04 representing the lowest year of
expenditure planned until 2007.
UK Gas Distribution’s controllable costs in
2003/04 were £103 million lower than 2002/03
and 7% lower than the 2003/04 allowance
agreed with Ofgem as part of the five-year
distribution price control formula agreed in April
2002. The reduction was a direct result of the
implementation of restructuring plans announced
in September 2002, coupled with continued
investment in technology and the centralisation
of activities, and aided by synergies from the
merger of National Grid and Lattice.
Operating performance
Gas throughput was 706 TWh in 2003/04,
compared with 708 TWh in 2002/03 and
697 TWh in 2001/02. If the weather had
corresponded to seasonal normal temperatures,
it is estimated that gas throughput would have
been 732 TWh in 2003/04, compared with
730 TWh in 2002/03 and 727 TWh in 2001/02.
While there has been underlying growth of 1.9%
in demand from small users (2002/03 2.0%
demand growth), 2003/04 saw a 3.5% reduction
in underlying demand from business and other
large users (2002/03 1.6% reduction), which can
be attributed to higher gas prices, power stations
being off-line and recession in a number of
manufacturing sectors.
Standards of service
Over the past few months we have been working
with Ofgem and the wider industry to implement
plans to improve the standards of service
provided by Transco in relation to its connections
activities. While Ofgem has recognised that the
performance of the connections service provided
by Transco has improved, in May 2004 it
confirmed a financial penalty of £1 million in
relation to earlier performance problems.
The problems we have had with our connections
operations have adversely impacted our overall
standards of service performance and as a result
there is some room for improvement. Despite this
we have once again exceeded our safety-related
standards of service targets with more than 98%
of ‘uncontrolled’ gas escapes (where the gas leak
cannot be controlled by turning the gas supply off
at the meter) attended within one hour, and more
than 99% of ‘controlled’ gas escapes (where the
gas leak can be controlled at the meter) attended
within two hours.
Safety
Using DuPont Safety Resources, we have been
working to improve our overall safety, health
and environmental performance through the
implementation of best practice in UK Gas
Distribution. Over the last 12 months, we have
demonstrated a continued improvement with a
22% reduction in employee Lost Time Injuries
(LTIs). By working closely with our supply chain
partners to share best practice, we have also
made significant steps in improving their
performance resulting in a 43% reduction in their
LTIs. We have initiated new training, which we
believe will educate and change behaviours to
drive improved safety performance further
towards our goal of zero injuries.
Investment in the network
Capital expenditure in the reinforcement and
extension of Transco’s gas distribution network
was £293 million in 2003/04, compared with
£380 million in 2002/03 and £455 million in
2001/02. The reductions in capital expenditure
comparing 2003/04 to 2002/03 and 2002/03 to
2001/02 were principally due to the fact that
investment in the high pressure pipelines in the
distribution networks incorporates a number of
large projects and is dependent on forecasts of
future demand. The profile of expenditure over
time is stepped with the commencement and
completion of projects to expand the network.
As a result of the level of project activity,
expenditure in 2001/02 was particularly high due
to a number of large projects being undertaken.
It fell by £75 million in 2002/03 and then by a
further £87 million in 2003/04 with the
completion of these projects.
During the year ended 31 March 2004, Transco
made over 100,000 new connections to its
network. The total number of new connections
to Britain’s network, taking into account other
connections made by third parties, is estimated
to be in excess of 200,000.
Network sales
Plans for the possible sale of up to four of
Transco’s eight distribution networks, announced
in May 2003, have progressed steadily over the
past year. A large number of indicative bids for
the five networks potentially identified for sale
(Scotland, Wales and West, North of England,
North West and South of England) were received
and discussions have continued with a number
of parties. It is expected that the results of the
sales process will be announced this summer
with any sales due for completion in early 2005.
National Grid Transco has been discussing its
plans with Ofgem and the wider industry
through industry workstreams. In April 2004,
Ofgem gave approval for the next phase of
work to consider the implications of the
proposed network sales on the basis that it
is in consumers’ interests. Completion of this
phase of work is expected by the end of July
and Ofgem’s final consent to specific sales is
expected in the second half of 2004.
The HSE has been kept appraised of all
developments and will need to approve new
safety cases and any changes proposed by
National Grid Transco before the sales can
complete. The 0800 111 999 national gas
emergency service number will remain the same
and will continue to be managed by National
Grid Transco. The emergency engineers who
are currently dispatched to attend public
reported gas escapes and gas emergencies
within each network will be included as part of
any network sale.
Although we may sell up to four networks,
if this maximises value, we remain committed to
a substantial gas distribution business in Britain
and we will continue to be the largest operator of
gas distribution assets in the country.
The ‘Way Ahead’ for our retained distribution networks
We have begun our ‘Way Ahead’ restructuring
programme in the networks that we will retain.
This involves a move to a more centralised
structure that will enable us to place increased
emphasis on safety and efficiency, the
deployment of best practice across the
organisation, and facilitate our aim to be the
best in the world at balancing cost, performance
and risk. Any network that is currently part of the
sale process, but is not subsequently sold, will
be incorporated into the Way Ahead programme
later this year.
This should enable us to deliver major reductions
in controllable operating expenditure.
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