Gas bills to fall as reglator takes axe to Transco

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The energy regulator Callum McCarthy is to slash up to £2bn from the value of the gas pipeline operator Transco in a move that will mean lower household bills but also a huge cut in the company's profits.

Mr McCarthy, the chief executive of Ofgem, has also decided to clamp down on the return Transco is allowed to earn on its assets by reducing its cost of capital to about 6 per cent.

The regulator's proposals, to be published in 11 days, could cut up to £140m from the profits of Transco's parent company Lattice and force it to appeal to the Competition Commission.

Gas transmission costs make up 35-40 per cent of the average domestic bill, so a further reduction in the amount Transco can charge shippers could have a significant impact on households.

The new price controls, which take effect in April, will initially set a national transportation charge, but Ofgem intends to move to regional pricing in two to three years. This could mean lower bills for households in Scotland and the east of England, which are close to where the UK's gas is landed, but higher bills in areas such as Cornwall and Devon, which are farthest away.

Ofgem is expected to argue that by reducing the asset value of Transco from £12.6bn to about £10.6bn, it is merely bringing the company into line with other regulated utilities such as National Grid and the regional electricity companies.

The reduction in the regulatory asset base is designed to reflect the discount at which British Gas was sold to investors when it was privatised in 1986 ­ the so-called "focused" approach to valuing the company. At privatisation, no value was ascribed to the British Gas portfolio of exploration and production interests. These are now owned by BG Group, which has a market capitalisation of £10bn.

The new five-year price control formula to be announced by Ofgem will for the first time also contain a mechanism for penalising Transco for poor performance. Transco could lose up to £80m of its annual revenues if it fails to meet targets on capacity availability and interruptions to supply.

However, Ofgem is expected to take a more flexible stance on Transco's capital spending programme. The company is concerned that it might need to invest an extra £1bn in its transmission network if there is a big increase in the amount of gas brought onshore through the St Fergus terminal in Scotland. To help Transco cover the risk, Ofgem is encouraging shippers to sign 10-year deals.

Transco will also be allowed to raise charges if the Health and Safety Executive forces it to speed up the programme of mains replacement. This could increase Transco's spending by about £2.5bn over the five-year period.