Gas conflict builds up for the final explosion: British Gas is set against break-up as the MMC considers the regulator's plan to reshape the industry. Russell Hotten reports

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ONE OF corporate UK's most extraordinary, acrimonious and prolonged wars - British Gas's epic fight with Sir James McKinnon, head of the industry regulator Ofgas - is about to reach its denouement. The Monopolies and Mergers Commission will shortly decide whether to accept Ofgas proposals for a radical break-up of British Gas into 17 separately quoted and competing companies, or to leave one of the Government's most successful privatisations largely untouched.

According to Sir James, the break-up would bring huge benefits for both domestic and industrial consumers. It would mean cheaper bills and better quality of service.

According to British Gas, a break-up would just increase costs. The effect for the vast majority of gas consumers would be higher prices and worse service. It is ideology gone mad, the company says.

Furthermore, if ministers accepted the proposals, it would mean reneging on the terms under which British Gas was sold to the British public. To ask shareholders to swap their valuable stakes in British Gas for shares in 17 largely worthless successors would amount to a con, the company and its City supporters insist.

Privately, executives go further. Sir James, they say, is motivated by a deep personal hatred of the company he regulates. They say he wants to end his reign in a grand gesture of destruction.

British Gas has found an unlikely ally in its campaign to ward off its old enemy - the Gas Consumers Council. Figures published later this month will show that both complaints against the company and disconnections of domestic supplies are down significantly.

Most consumer surveys also rate British Gas as one of the best companies in Britain for quality of service. Why try and fix something that clearly works well, ask the utility's supporters.

The arguments are finely balanced, complex and contentious - so much so that the MMC has been forced to ask for a three-month extension to complete its report. Conspiracy theorists say the invisible hand of the Government played a part in the delay, with ministers not wanting to sour the sale of the remaining tranche of British Telecom. Others say it is because the MMC is split and needs more time to deliberate.

Whatever the reason, the hostile - sometimes personal - dispute between British Gas and Sir James, the self- styled consumer champion, will simmer on. Ofgas has been a thorn in the side of the company ever since it was privatised in 1986. Nothing, however, could have prepared the utility for the shock of Sir James's public announcement that he wanted it broken up completely. Little more than two years ago, he appeared to concede that a break-up would amount to a breach of the terms and conditions of the privatisation and therefore create a legal and political minefield. Nobody had any reason to believe he had changed his mind.

The MMC was asked last year to undertake a full review of British Gas's operation. Ofgas's submission was followed by an avalanche of criticism from consumer groups and the City, as well as the company, which called the proposals a 'smash and grab raid'. Shell, the world's largest independent gas market operator, also entered the argument, saying that liberalisation of the sector endangered gas supplies to domestic users. Shell has a vested interest in maintaining the status quo, because it suits its book to supply just one company. Nevertheless, its argument will carry weight.

Peter Spring, of Henderson Crosthwaite, the stockbroker, said: 'No economically credible case has been made for breaking up BG, an outcome irreconcilable with its privatisation'.

Ofgas sees its proposals as another step in a campaign to bring in lower prices and more consumer choice. Since privatisation, gas prices have dropped 19 per cent in real terms, though this has as much to do with the knock-on effects of collapsing oil prices as anything else. But Sir James can certainly take credit for pushing through a tough 'RPI minus 5' pricing formula, which restricts price rises to 5 percentage points below inflation for the next five years. When inflation falls below 5 per cent, prices also come down.

Pressure from Ofgas has also helped slash the rate of disconnections, and opened up the gas market for independent suppliers to serve business users. British Gas, with about 75 per cent of the industrial supply market, has agreed to cut this to 40 per cent by 1995, though Ofgas says it is still unclear how it intends to achieve this.

So when Sir James retires later this year, he should have been able to look back on a job well done. But now he has staked all on his radical break- up plan. His reputation will stand or fall with the success of his proposals.

According to Sir James, British Gas is not just a single monopoly but three rolled into one. It is the largest buyer of gas and biggest owner of North Sea gas fields; it controls pipelines and storage facilities, and supplies 98 per cent of gas consumers.

To address the problem, Ofgas believes the utility's gas transport arm (pipeline network) should first be separated from the trading arm. Independent gas suppliers have to rent transport from British Gas, and when approaching potential customers, they must get a quote from it. A spokesman for Alliance Gas, an independent supplier, said: 'It means that British Gas knows confidential information about pricing and who we are approaching.' British Gas says Chinese walls divide its trading and transport operations, but critics say these are not enough.

In its submission to the MMC, Ofgas also proposed that British Gas be split into 12 regional gas companies, with separate exploration, production and purchasing businesses. Storage and pipelines would also be spun off into independent companies.

Greater competition would not only reduce the need for a regulator but reduce prices, said Sir James. 'It is only by giving all customers the right to choose that value for money can be assured. Real choice can only be provided through effective competition. Therefore, competition must be introduced wherever possible.'

British Gas's competitors agree. Alliance Gas, a joint venture between British Petroleum and Norway's Statoil, said domestic users could save 10 per cent on their gas bills, about pounds 50 a year. 'The new independents are much leaner and more cost-effective than British Gas,' said a spokesman. 'The rules say that if you spend pounds 1,200 a year on gas bills, you can switch suppliers. Households have done this and seen their bills drop.'

But even Alliance thinks a complete break-up would go too far. 'No independent supplier wants to see British Gas destroyed as a gas purchaser,' said the spokesman.

BRITISH Gas says region al companies would still be local monopolies for small buyers, so any competitive gains would be in doubt. And break-up would lead to higher costs, a 15 per cent hike in prices and less value for shareholders. Services to rural communities would not be guaranteed, and its world- class research and development would be undermined.

According to British Gas, prices would rise because a break-up would end the policy of charging each customer the same price, whether they live near the North Sea fields or far away. In effect, British Gas now charges east coast customers higher margins to subsidise those in the west. The utility has told the MMC 66 per cent of 18 million customers will pay more, many facing a doubling of bills.

Independent suppliers say this problem is easily resolved. 'Regulators ensure that the transport division charges the same price throughout the country - just like the postal service,' said Alliance.

British Gas says the cost of breaking up the industry - pounds 3bn over 10 years, it claims - would be passed on to consumers. This is disputed by Ofgas: 'We believe much of what is needed to introduce these changes is in place.'

The company says regional companies would lose economies of scale available only to a national operator. New storage and pipelines would have to be built, at up to pounds 1bn, and the administrative expense of running 17 companies could add another pounds 500m.

'The economies of scale that come from an integrated network and bulk purchasing power would be lost,' said one gas executive. 'It's all extra cost that will burden the consumers and shareholders.'

Such views have found an ally in the Gas Consumers Council, whose director, Ian Powe, said: 'If you are going to make a radical and irreversible change then you must first demonstrate that change will bring benefit to the consumer. The risks inherent in these proposals are high.'

The council is not necessarily against the sale of the pipelines. But it thinks the case has yet to be proved.

The GCC's annual report, out in a week's time, says: 'The council believes that, although British Gas has plenty of scope to improve its service to the public, no case has yet been made for breaking the company up along lines favoured by Ofgas.'

Many consumers are also shareholders, and the value of their stock has consistently outperformed the market. Mr Spring at Henderson Crosthwaite said: 'There are some analysts who when they hear the words 'break-up' think it means added value. But there is no value to shareholders in these proposals.' About 1.4 million people own shares in British Gas with a capital value of less than pounds 1,500. 'Is it seriously proposed that they get shareholdings in 17 new companies averaging in worth about pounds 90?' he asked.

'Ofgas's proposals would reduce shareholder value as the agenda is to put pipeline and storage on an artificially low rate of return and lower the market share of the remaining marketing businesses. Users of small amounts of gas, those without central heating, could face much higher unit charges.' He said Ofgas was 'putting the interests of third-party marketers before consumers and shareholders, justified only by the assertion that competition can solve everything'.

As a compromise, British Gas has proposed an alternative to the MMC. This is to split into wholly owned subsidiaries covering industry, domestic sales and pipelines. Two separate purchasing arms, one each for the industrial and domestic markets, would buy gas from the North Sea. The company thinks this would make buying gas easier for independent suppliers.

For Ofgas, such a plan doesn't go nearly far enough. 'The result would be the board of directors sitting on Chinese walls. The directors would still make the corporate decisions for the whole company. It is simply not feasible,' said Ofgas.

No wonder the MMC has postponed a decision. The gap between the two sides is as wide as ever, and any decision will provoke an outcry.

(Photographs, graph and chart omitted)