Transcript NGN Cost Workshop Presentation Slides

Presentation to GDPCR Cost Workshop
Alex Wiseman
Regulation Director
19th April 2007
Agenda
 Introduction to NGN
 Environment for the 5 Year Reset
 Opex Forecasts
 Comparative Efficiency
 Summary
Introduction to NGN
Innovative Business Model

NGN has implemented a unique business model based on the principles of Strategic
Asset Management, under which the roles of asset ownership/asset management
and asset services are unbundled

NGN remains accountable for all asset management including licence and safety
case obligations

Competitive procurement process used to select service provider. United Utilities
selected on basis of market experience and success in similar utility contracts

UUOL is a special purpose vehicle working exclusively for NGN. Neither CKI nor NGN
has any interests in UUOL or its parent

On 1 June 2005, NGN entered into an Asset Services Agreement (ASA) with UUOL to
contract out the provision of a wide range of services including
 Operation and maintenance of the DN
 Delivery of Capex and Repex programmes
NGN Business vision

To be benchmarked by Ofgem and HSE in the top two comparable
utilities in:
 Customer service
 Efficiency
 Health and Safety
NGN supports the benchmark approach
Business environment
for 5 Year Reset
Business Environment – leading to cost pressures

Legislative changes – such as waste, environment (including landfill tax),
pensions, noise at work regulations and working at height regulations

Regulatory Changes – notably offtake and interruption reforms
- although decision now made, still uncertainty on incentive
mechanism and precise implementation mechanism

Real increases in EPC costs – EPC rates forecast to increase by RPI+4% pa driven
by predicted shortages of engineers and manpower as a result of large UK
infrastructure programmes

Real increases in salary costs – Direct labour costs forecast to increase at RPI +2%
pa. Shortages of experienced gas personnel due to an aging workforce resulting in
investment in apprentice schemes. Also increase in staff levels and training (eg. 2
years training for network control and 3 years for safety)
Cost Pressures

Real increases in Material costs – General increase in material costs of RPI+2%
pa from rising commodity prices in particular oil and oil based goods

Real increase in Energy Costs – Energy costs doubled during 2005/06. Forward
curves continue to show significant volatility in market prices

Security - An increasing focus on security of assets due to potential terrorist
threats on gas networks

Service improvements – Improvements that NGN is planning to make in its
quality of service and safety to achieve the frontier.
Changing Nature of RPI
Annual price changes in the goods and service sectors, 1993 to 2005
15
10
5
0
1994
-5
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Goods
Services
-10
 Supermarkets and suppliers of goods produced overseas are
seeing inflation below RPI
 Service sector firms employing a UK based workforce are seeing
inflation above RPI
Opex Forecasts
NGN Performance in Current Review Period
NGN Performance vs Regulatory Allowances
Controllable Opex (less Pensions & Shrinkage)
.
Controllable Opex Less Pensions & Shrinkage - 2005/6 Prices
90
85
80
Actual/Forecast
75
Allow ance
70
65
60
2002/3
2003/4
2004/5
2005/6
2006/7
Despite upward cost pressures NGN has delivered significant efficiencies in
the current review period
NGN Performance in Current Review Period
GDN Controllable Opex
(less Pension & Shrinkage)
120
Controllable Opex
(Indexed to 100 2004/5) .
115
110
105
100
NGN
95
90
2004/5
Source Data:
2005/6
2006/7
2004/5 Ofgem Second Consultation Document
2005/6 & 2006/7 Ofgem Third Consultation Document

NGN has reduced costs since sale

There is reduced scope for future efficiency savings
Major Forecast Assumptions - Opex
 Contractor costs increase by RPI + 2% against a forecast of RPI + 4%
 Direct Labour costs increase by RPI + 2%
 Material Costs increase by RPI + 2%
 All xoserve costs treated as opex in BPQ consistent with current
treatment
 Shrinkage gas costs based on forward prices in September 06, modest
demand increases and a reduction in the shrinkage factor in line with
leakage reduction
 Pension costs based on latest actuarial valuation
Major Forecast Assumptions - Opex
 98.5% of controlled escapes will be attended within 2 hours on a 24/7
basis across the entire NGN area
 External escapes anticipated to reduce by 2% year on year throughout
the period but partly offset by increase in internal escapes
 Continuation of TMS and UMS metering contracts which act as “fill in”
work for emergency workforce (This is now looking very doubtful)
 NGN exits SOMSA NSA in 2009
Efficiency Initiatives
Since Purchase
 £1.9m spent on rationalisation and reducing workforce
 Business model has substantially reduced central overheads
 Initiatives on decommissioning expensive vehicles, procurement,
recycling
 Partnership approach to contractors
Planned Initiatives




New IR framework
Changing working practices
Vehicle efficiency initiatives
Improved back office processes
Opex Forecast
Despite significant upward pressure on input costs NGN is forecasting to
deliver efficiencies to hold costs stable in real terms over the plan
period.
Capex Forecast
Major Forecast Assumptions - Capex
 Contractor, direct labour and material cost increases as per opex
 Investment based on existing legislation, policy and procedures
 NTS storage available to NGN at zero cost throughout plan period
 Network storage deficit position throughout plan period
 Capacity designed to meet 1:20 demand criteria in line with 2006 LTDS
 Existing numbers of network sensitive loads (ie no programme to actively
reinforce the network to remove such loads)

Connections and diversion workload consistent with historic levels – no
significant changes to connections market
 PAS 55 principles applied
Capex Forecast
 Two major LTS projects required in 2011/12 and 2012/13
 IT investment required in early years to replace GTMS and to refresh IS
systems
Repex Forecast
Major Forecast Assumptions - Repex
 Labour, material and contractor cost increases in line with opex
 Iron mains replacement workload based on existing agreement with HSE –
528km per annum abandoned
 Selection of pipes for replacement driven by existing HSE risk model
 Service volumes based on historic patterns
 TMA costs excluded
Repex - Forecast
 Major project in 2009 /10 to replace the Catton to Weatherall LTS pipeline
due to its deteriorating condition
Comparative Analysis
Results of Ofgem Consultants’ bottom up Analysis
PB Power – Direct Opex:
 NGN at the efficiency frontier for 4 out of 5 cost categories
LECG – Support Services Opex:
 NGN not identified as being at the frontier in Support Services, but NGN ahead of
the median
 Allocation issues between support services and direct costs suggests that the
benchmarking may not be consistent eg SGN most efficient for support service
and least efficient for direct costs
 Hence top down benchmarking may be appropriate
PB Power report on Capex and Repex:
 NGN at the efficiency frontier for total net repex
 Capex projects less suitable to comparative analysis but proposed reduction in
forecasts lower than for other IDNs
EE
Relative efficiency

Models should pass ‘real world’ test. For example, not clear that %
non- domestic customers is a direct cost driver and it is ‘explained’
by customer numbers and volume

Objectively, main cost driver is network length (eg driving repairs
and maintenance, emergency costs)

Substantive correlation between network length, customer
numbers and volume

Different networks will favour different drivers but given small
number of data points, a composite variable seems appropriate

One solution would be network length, customer numbers and
volume in ratio 50:25:25 in line with DNO review
Summary
Summary

NGN has a clear focus on efficiency and continuous improvement led by its
corporate vision and implemented via its business model.

Resulted in ongoing improvements in efficiency since purchase in June
2005 in an environment of increasing cost pressures.

NGN business plan continuing to contain costs despite exposure to
significant above inflation increases

NGN incurred the lowest capital expenditure overspend in 2002-2007
period and is the only GDN to forecast 2006/7 costs below 2004/5 costs.

This achievement reflected in Ofgem Consultants’ analysis that places NGN
at or close to the efficiency frontier.

Top down benchmarking using a composite variable the most appropriate
approach to set regulatory allowances to maintain the strength of
incentives for efficiency and hence lead to customer benefits.