Ofgem's leniency in Transco price curbs has Lattice shares soaring

The energy regulator Callum McCarthy backed down yesterday from a clash with the gas pipeline operator Transco by unveiling more lenient price curbs than the City had feared.

The new controls, which will take effect in April next year, will reduce the average domestic gas bill by about £15 a year, compared with a reduction of up to £50 had the regulator taken a tougher approach.

Mr McCarthy, the chief executive of Ofgem, also warned that gas bills could end up rising, not falling, if the Health and Safety Executive (HSE) orders Transco to replace all of its old cast-iron mains – a programme that could cost up to £2bn.

Shares in Transco's parent company, Lattice, soared 8.8 per cent to 154p on the news that Mr McCarthy had decided against slashing the regulatory asset value of Transco by up to £2bn – a move that could have wiped £140m a year off its profits. But Transco cautioned that the new price curbs were still a "long way apart" from what it thinks is achievable and refused to rule out an appeal to the Competition Commission.

Gas transmission charges account for 35-40 per cent of final bills. The new five-year controls proposed by Ofgem will reduce those charges by 14 per cent, meaning a reduction in the typical household gas bill from £331 to £316 a year.

Transco will also be required to meet guaranteed standards of service covering areas such as interruptions to supply or face penalties of up to £40m a year and reduce operating expenditure by 3.5 per cent a year.

Mr McCarthy is also proposing to limit its return on capital to 6.1 per cent compared with the 7 per cent Transco wanted. He rejected suggestions that he had caved in to pressure from Transco, maintaining that the approach he had taken would give the company the regulatory certainty to fund its five-year £3.6bn capital expenditure programme.

"Overall, this is a package which protects the consumer and ensures that Transco can finance itself provided it operates efficiently," Mr McCarthy said.

Chris Bolt, Transco's director of regulation, said he was "relieved rather than pleased" that Ofgem had decided not to cut the regulatory value of Transco. However, he said Transco would resist the proposed reduction in its return on capital and operating expenditure.

"The efficiency targets Ofgem is talking about are unprecedented in terms of what other utilities are expected to achieve and in our view a cost of capital of 6.1 per cent does not enable us to raise the sort of capital that we will need."

Transco estimates that its operating expenditure over the next five years will be £6.4bn but the regulator is only proposing to allow it £5.3bn. Mr McCarthy has also sliced £500m off Transco's capital expenditure forecast.

Ofgem is proposing to allow Transco to spend £1.7bn on mains replacement. But this figure could be considerably higher depending on the size of the programme the HSE requires when it announces its decision next month. Transco will be allowed to pass through any increase to consumers.

Transco will also be given financial incentives to invest more in the national transmission system so that it can cope with increased demand and maintain security of supply. If there is a big increase in the amount of gas brought in from Norway through the St Fergus terminal in Scotland, then Transco may need to spend an extra £1bn on new pipelines connecting to the rest of the country.

Outlook, page 21