Watching the watchdogs

Are the privatised utilities being properly regulated? Paul Gosling on the researchers who are determined to see that they are

This month's announcement by Ofgas, the gas regulator, of a harsh new price regime for TransCo, the pipeline division of British Gas, again puts the spotlight on how privatised utilities are governed. The long- running dispute between Ofgas and British Gas is now likely to go to the Monopolies and Mergers Commission to resolve.

Regulation of the utilities will stay in centre stage during the general election campaign, with the Labour Party accusing the Government of not being hard enough on the utilities. Labour wants a one-off windfall tax on utilities' excess profits, and a strengthening of the regulatory system. The Conservatives, though, believe the current regime has delivered improved services at lower cost, bringing benefits that will be extended as new competitors enter the market, driving prices down further.

Whether we have the best possible regulatory system is the core question being asked by the Centre for the study of the Regulated Industries (CRI), the five-year-old research division of the Chartered Institute of Public Finance and Accountancy (Cipfa).

The CRI receives funding from some of the utilities, but this does not jeopardise its independence, says Peter Boulding, its financial analyst. "We don't let it compromise us. We maintain our independent line," Mr Boulding says. "That doesn't mean we take a rash line to bash them. We find having support from the industries gives us better information and lets us bounce ideas off them."

The utilities gain by having an expert overview of regulation generically, compared with the industry-specific approach from the companies and the regulators. The CRI can keep the utilities informed of changes in approach by each regulator, what effect the changes have and whether they are inspired by an industry-specific factor or if they might be copied by other regulators.

Not that the CRI is primarily concerned with servicing the utilities; it is also funded by Ofwat, the water regulator. The CRI aims to develop a new political consensus on how regulation can work best, and how regulators can be made more publicly accountable.

"We would agree to tighter regulation but not so tight that it destroys incentives," says Peter Vass, founder and research director of the CRI and a senior lecturer in the management school at Bath University. He opposes Labour's proposal for a windfall tax which, he argues, "could be held to be contrary to the principles of incentive regulation because it would be retrospective. What confidence would anyone have in the future that profits would not be clawed back?"

The CRI's most important contribution to the regulation debate was made earlier this month when it published proposals to replace the existing system of price controls. Regulators currently approve price changes annually on the basis of RPI - X (the rate of inflation minus a percentage in recognition of improved efficiency in the industry). In recent years, this has led to price reductions not just in real terms but in cash terms.

While the CRI's researchers - Philip Burns and Ralph Turvey, and Tom Weyman-Jones of Loughborough University - confirmed that RPI - X had delivered consistent price reductions, they also found the system was unhelpfully inflexible. It does not allow companies to plan ahead, and might even plunge them into unexpected losses if the regulator is very severe. Instead, the report recommends reverting to the system of regulation that predated the nationalisation of the utilities.

From 1875 to 1939, the utilities were subject to sliding-scale price controls which determined that profits beyond a pre-set limit were to be distributed jointly between shareholders and consumers. This way, an incentive to improvement was retained, consumers felt the benefit of cost- cutting and the utilities were able to plan their businesses properly.

Even this system, though, would have its disadvantages, introducing an added level of bureaucracy into the system through belated rebates, which may prove difficult to administer where customers have moved home.

Other work being undertaken by the CRI is looking at the valuation of assets, and whether regulators should permit depreciation on the pre-privatisation book values or only on the written-down values - a debate at the heart of the dispute between British Gas and Ofgas.

The CRI hopes to establish itself as a voice that can be trusted amid a welter of vested interests, with even the regulators publicly distrusted and accused of wilting under pressure from one interest group or another.

A future role might move beyond being a pressure point on government and regulators in Britain alone. As privatisation of the utilities spreads across Europe and the rest of the world, there is a growing international focus on our regulatory system, asking whether it is suitable for adoption elsewhere.

The CRI has been doing research for the World Bank, assessing regulatory systems in several countries, and is talking with the European Commission on the future of competitions policy and regulation. This remains a politically contentious area, with strong resistance in France to the enforced sale of the still state-owned utilities, whereas in Germany, there is support for greater liberalisation.

Peter Vass says the CRI has inadvertently benefited from good timing. "I could not have anticipated the political crisis over regulation," he admits. "I don't believe the crisis is over regulation per se. It is partly due to a failure in communication by government, by industry and by the regulators. Perhaps high profits are the quid pro quo for low prices. But that is a quite sophisticated message to get across."