Hard times for the electricity man

Professor Stephen Littlechild, the electricity regulator, has had an uncomfortable year. Soaring electricity company profits, takeover frenzy, fat rewards for directors and confusion in the stock market have all at one time or another been blamed on defects in the regulatory system he oversees.

But Professor Littlechild, probably the most pilloried regulator of our time, rejects the blame. He regrets that his new five-year price controls on regional electricity companies - the recs - have got muddled up in a controversy that has its roots in decisions taken years ago.

Worse still, the row makes it likely that a Labour government will tear up the system and start again. But Professor Littlechild says this would be "throwing the baby out with the bathwater".

"People see high profits, proposals for dividend increases and repayments to shareholders and assume the present price proposals are wrong," says Professor Littlechild. He is prepared to discuss modifications, but becomes strongly defensive when root-and-branch reforms are suggested.

Professor Littlechild gives four reasons why the recs have become so unexpectedly wealthy, and makes clear that none of them were his responsibility. This comes perilously close to blaming politicians, a dangerous argument for a regulator, though when this is pointed out, Professor Littlechild says: "I am not blaming the Government".

The first of the causes, the original post-privatisation price controls, Professor Littlchild did not set himself; neither did he have anything to do with the government's decision to give the National Grid Company to the recs - unaware at the time of how valuable an asset it would prove to be.

Equally, the vital decision taken in 1990 on how much debt the recs should be left with at privatisation was a government one. "Advisers to the Government were very, very cautious -they thought the recs needed a small amount of debt to be on the safe side," says Professor Littlechild.

Caution was certainly the order of the day, but it is now clear it was overdone and the recs are robust enough to borrow heavily and give cash back to shareholders. This change in financial structure - more debt and less equity - allows big dividend increases.

"If you move to that sort of structure you borrow more and pay more to shareholders," says Professor Littlechild. That is exactly what has been happening.

This month Manweb announced a pounds 600m give-away to shareholders in its defence against a bid from Scottish Power, and Swalec, the South Wales company, promised pounds 315m to shareholders.

It was Northern Electric's decision to fend off a bid from Trafalgar House with a huge payout to shareholders accompanied by heavy borrowing that first showed the companies' hidden wealth. As a direct result, Professor Littlechild was forced this year into revising price controls he had announced only in August 1994.

But he takes the argument a step further. Why did it take so long for the City and the Government, as well as himself, to appreciate that the recs were much richer than they looked? His answer is that the ban on takeovers which lasted until this year was a mistake.

He says "If that possibility of takeover had existed earlier, instead of being deferred for five years, it would have been necessary for the Government and its advisers to think very much more carefully about the implications for the capital structure of the companies and about the cost reductions that could be made by a bidder."

Future privatisations, he suggests - there is one to go in electricity, the nuclear sale - should not include takeover bans or government golden shares.

That leads to what he considers is another wrong conclusion. Share prices rose after the revised price controls were announced this year, leading to claims that they were again too lax. "People mixed the rise in price, which you always get in a bid, with the effect of the price controls, which is false," says Professor Littlechild.

Why had he not spotted all this a year ago, before his first attempt to set new price controls? "At that stage we could not know what effect the takeovers would have," says Professor Littlechild. He thinks it would have been unreasonable to cut prices charged to consumers just to compensate for the possibility of a change in capital structure.

The furore over electricity seems certain to lead to a reform of regulation and probably a windfall profits tax if a Labour government gets into power. Tory backbenchers are demanding a windfall profits tax to steal Labour's clothes. But Professor Littlechild warns against over-reaction, saying the controversy arose in only a small part of the regulatory patch - what he describes, in his precise academic language, as a "subset of controls of a sub-set of companies of one particular industry", by which he means the power cabling networks of the recs.

He and three other regulators - Ian Byatt for water, Clare Spottiswoode for gas and Don Cruickshank for telecoms - are united in their belief that the basic system works, though they disagree about how far the tinkering should go.

Mrs Spottiswoode is investigating a limited form of the Labour Party proposal for profit sharing between customers and shareholders, rather than the present system which sets price controls linked to the retail price index.

Professor Littlechild says "Clare [Spottiswoode] has not yet set a series of price controls and she wants to look at all the possibilities, new suggestions as well as old ones." Despite his scepticism, he plans to look into the idea of some form of profit sharing in his forthcoming review of the National Grid.

He says "We would all be willing to accept changes in the formula if it led to customers benefiting earlier and increased the perception that customers are getting benefits."

Professor Littlechild can also see the advantage of a panel or a full or part time board to back the regulator and share his burden, which could bring "less of a cult of personality". That might, of course, mean less personal abuse of the regulator for unpopular decisions. Professor Littlechild says this is an idea worth exploring.

Mrs Spottiswoode is strongly opposed to another suggestion, for US style public hearings to open up the setting of price controls to public scrutiny. Professor Littlechild is in favour if it makes comment more informed. His preference, though, would be simply to publish an interim document for public comment during the period in which price controls are being reviewed, setting out the companies' cases in far more detail than is done at present.

And he is even prepared to look at shortening future price control periods from five to three years and setting out ranges within which the controls can be varied if circumstances change.

By the time any Labour government sets out to reform electricity regulation, Hanson, British Gas, PowerGen, National Power and a host of other companies may be competing to supply power to domestic customers against the local electricity companies, and the spate of takeovers now under way will also have completely reorganised the industry.

Against this background, the biggest challenge Professor Littlechild now faces is overseeing the introduction of competition in supply of electricity to 22m domestic customers from1998. The recs, now a local monopoly for domestic consumers, will be obliged to offer competing suppliers the use of their cable networks (which they already do for business customers.)

The regulator will still have to ensure the price charged for the use of the wires is not excessive, but he will also have to oversee the new market in electricity to prevent abuses of competitive position. "I have to consider whether there should be some maximum price to protect customers in areas of high market power" says Professor Littlechild.

But he is enthusiastic about the 1998 plan, which is designed to allow market forces to exert more control over prices and take some of the load off the regulator's shoulders.

"This is going to bring enormous power to domestic customers," says Professor Littlechild. But he acknowledges that the new regime is going to be a "tough job at the beginning. We are talking about a massive amount of change and a massive amount of effort over the next three years to ensure it all works."

Peter Rodgers