The shock announcement of new price controls on British Gas's pipeline business, TransCo Interanational, are far more severe than had been expected and could jeopardise both the company's planned demerger next year and the introduction of full competition in the domestic gas market from 1998.
The new price formula will reduce TransCo's revenues by pounds 650m-pounds 850m next year - more than its profits in the last two years and bigger than British Gas's total dividend payment last year.
British Gas shares plunged 27p to 201p - their biggest one-day fall apart from during the stock market crash in 1987 - as investors panicked about its ability to continue paying dividends under the new formula.
The new controls, due to take effect next April and run for five years, will cut prices TransCo charges to gas shippers by 20-28 per cent in the first year and then keep prices to RPI-5 in each of the following years.
Ms Spottiswoode, director general of gas supply, said the curbs would mean pounds 30 off average domestic gas bills next year and a reduction of pounds 40- pounds 50 by the end of the five-year period. Industrial and commercial companies could make savings ranging from pounds 600 a year for small firms to pounds 40,000 a year for a company with an annual gas bill of pounds 500,000.
However, British Gas chairman Richard Giordano, questioned whether any of the price reductions would feed through to end customers and suggested that they more likely to widen the profit margins of independent suppliers competing with British Gas when the domestic market is opened to full competition in 1998.
The regulator said the proposals "represent a fair balance between the interests of cosnumers and the interests of shareholders", adding that the targets were challenging but achievable.
But British Gas said the proposals represented "the seizure of shareholders' income on an unprecedented scale" and could undermine confidence in the entire regulatory system while putting at risk the safety, reliability and efficiency of TransCo's transportation system. The gulf between the two sides makes an MMC referral look inevitable. Philip Rogerson, British Gas's deputy chairman, said it was now "highly probable" that it would reject Ofgas's proposals, trigggering an automatic inquiry by the MMC at the end of July. He denied, however, that this would compromise the planned demerger of TransCo and British Gas Energy into separate quoted companies next March. Ofgas said TransCo had scope to achieve 4 per cent productivity gains a year to compensate for the lower revenues it will be allowed.
The new formula also cuts the amount of depreciation British Gas can charge a year and the return shareholders are able to earn by lowering the value of TransCo's assets from their present pounds 18bn to pounds 9bn-pounds 11bn.
British Gas said it did not accept Ofgas's proposals nor the basis on which they were calculated and took a swipe at both Ms Spottiswoode and Ofgas's consultants, accouncants Coopers and Lybrand and consulting engineers WS Atkins, for their lack of understanding of business.
There is a mechanism in the formula to correct for underspending or overspending on capital expenditure - an area where Ofgas says TransCo has been over-estimating forecasts by 30 per cent. But Ofgas has rejected propoals put forward by British Gas for profit sharing of any excess gains it might make between TransCo and the 40 shippers who use its pipeline network.
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