Transco warns price cuts will leave £3bn shortfall

Transco, the gas pipeline operator, warned yesterday that it would suffer a £3bn shortfall if the draft price proposals unveiled last month by the energy regulator, Ofgem, were implemented as they stood.

The company, which is owned by Lattice, also claimed it would have difficulty maintaining its single-A credit rating even if it were able to resolve its differences with Ofgem over how much operating expenditure the regulator will allow.

Transco went on to say that the efficiency targets proposed by Callum McCarthy, the chief executive of Ofgem, would require it to reduce its controllable costs by as much as 14 per cent next year. This could lead to around 1,000 job losses. The regulator's proposals, published in June, would result in a 14 per cent cut in Transco's revenues from next April, reducing the average household gas bill by around £15 a year.

In its first detailed response, Transco said "significant" changes would be needed to make the proposals workable. It said the proposals for capital and operating expenditure would lead to a shortfall of £3bn against the £12bn it needed to fund the five-year programme set out in its strategic business plan.

Ofgem has accepted that its final proposals, due to be published in September, may have to be modified depending on the size of the mains replacement programme required by the Health and Safety Executive. This could total some £2.5bn against the £1.7bn allowed by Ofgem.

Transco said its future cost of capital had to recognise the £5bn investment and renewal programme it was facing over the next five years. The regulator has proposed 6.1 per cent but Transco says it needs a cost of capital of at least 7 per cent.

"Ofgem's final proposals must ultimately be judged not simply in relation to the benchmarks for the cost of capital but in particular on the extent to which they yield financial projections, which are bankable and meet the expectations of investors and lenders," it said.

"Even if the big difference over operating expenditure is resolved, Transco would have difficulty maintaining a mid-single-A credit rating ­ a rating which allows Transco to raise finance at the lowest cost to consumers ­ given a cost of capital of 6 per cent."

Chris Bolt, Transco's director of regulation, said: "There need to be significant changes to these proposals before September to make them acceptable." He said discussions had already begun with Ofgem and would continue through the summer.

Transco had hoped the HSE would announce its mains replacement requirements this month but the timing may now slip into August. Depending on the size of the programme, gas bills could end up rising rather than falling from next April. Ofgem has agreed that Transco can pass through any additional costs to consumers. Transportation charges, despite having fallen by 16 per cent since 1994, still account for 35-40 per cent of domestic bills.