1 INTRODUCTION

1.1 In its Green Paper on Utility Regulation, "A Fair Deal for Consumers", published on 25 March, the Government invited the utility regulators to carry out and publish a joint study of the regulatory issues associated with multi-utilities, looking to likely developments over the next decade. They asked that, before undertaking the work, the Regulators should consult interested parties on the scope of the study and the particular issues it should address. The Regulators are invited to report by the end of May. The Government will then consider the adequacy of the Regulators' current powers to address these issues, and any need to strengthen them by legislation.

1.2 The text of the relevant section of the Green Paper is at Annex A.

2 BACKGROUND

2.1 There are now a significant number of companies which offer more than one utility service to customers. In some cases, a company in one utility sector has taken over a company in another. Examples are the take-overs of NORWEB by North West Water (to create United Utilities), of SWALEC by Welsh Water (to create Hyder), and of Southern Water by ScottishPower. In other cases, a company in one utility sector has set up a business in another utility sector. For example, most of the Public Electricity Suppliers (PESs) are now also active in gas supply, and Centrica intends to sell electricity in addition to gas when the electricity market for smaller customers opens for competition. Some PESs also have telecommunications licences, and some water companies have gas licences.

2.2 Companies have said that involvement in more than one utility sector enables them to operate more efficiently and reduce their costs. They have also said that the possession of a customer base in one utility service may present opportunities for companies to sell other utility services (and perhaps other non-utility services also) to the same customers.

3 POSSIBLE CONCERNS

3.1 Where mergers have been proposed between water and electricity companies, the water and electricity regulators have jointly sought views on the implications of the merger, before submitting advice to the Director General of Fair Trading on whether or not the merger should be referred. Among the concerns about multi-utilities which have been raised in these consultation exercises, or in other contexts, have been the following:

Access to Information

• whether Regulators will have the necessary access to information about the multi-utility, including both information about licensed utility companies within the multi-utility group, as well as information about non-licensed associate companies providing services to the licensed utilities;

• issues relating to the allocation of costs between different utility activities, including for the purposes of regulatory accounts and for revising price controls;
• how costs and benefits arising from the creation of the multi-utility should be assessed and treated in setting new price controls;
• the potential for cross-subsidy between one utility service and another, and between monopoly and competitive activities. These include issues relating to the allocation of capital and operating costs, and the potential for cross-subsidy where technological developments have opened up possibilities for multiple use of networks (for example, the use of electricity distribution systems for telecommunications);

• whether Regulators will continue to have adequate powers to enforce the conditions in the licences of utility licensees, for example, where the holding company of a multi-utility is not itself a licensee, or where the multi-utility sets up a new, unlicensed subsidiary to provide significant services to and on behalf of the licensees;
• whether the Board of the company holding the utility licence will be subject to pressure to act other than in accordance with the best interests of the licensee and of its customers;
• whether it is possible to put in place adequate ring-fencing of the financial resources of each utility licensee so as to prevent their possible misuse for other purposes to the disadvantage of customers;

• whether multi-utilities may be able to exploit market power in one utility sector (including linking the sale of different utility services) to the disadvantage of competitors and customers;
• whether multi-utilities may misuse customer information, or employ inappropriate selling tactics;
• how sector specific customer representation arrangements might be adapted to secure effective representation of customer interests;
• whether operations of multi-utilities are effectively transparent.

• issues of consistent treatment between different Regulators (for example, with respect to costs, or the valuation of assets; or the regulation of markets in which competition is emerging).

4 HOW REGULATORS HAVE RESPONDED

4.1 Regulators have already considered and responded to many of these issues, for example, in the context of take-overs, and of the development of competition in gas and electricity. They have, for example, modified licences following take-overs so as to secure access to information, and to ring-fence the assets of licensed businesses. The MMC have considered some of these licence modifications in the inquiry into the proposed take-over of the Energy Group by PacifiCorp. Regulators have also considered appropriate cost allocation rules for multi-utilities, and further measures to enforce better separation of businesses.

4.2 The situation however is continuing to evolve. For example, Hyder (the parent company of Welsh Water and SWALEC) has announced a restructuring which involves the merger of significant operational activities of the water and electricity licensees. The water and electricity regulators are examining jointly the implications of the restructuring.

5 SCOPE OF THE REVIEW

5.1 In the review which the Government has asked them to undertake by the end of May, the Regulators envisage examining the present extent of multi-utility activity and possible future development. They will want to consider what action has been taken to meet the concerns mentioned in this paper, and other concerns which may be drawn to their attention. It will not be possible to resolve all issues relating to multi-utilities by the end of May, and the Regulators envisage that it will be necessary to keep many of them under ongoing review. By the end of May, however, they will aim to advise the Government as to the adequacy of their powers in relation to multi-utilities, so that any legislative changes can be made at the same time as those needed to implement the Green Paper, and to set out the principles which should underlay the effective regulation of multi-utilities to secure the best interests of customers.

6 COMMENTS INVITED

6.1 The Regulators would welcome comments on the issues which they should address in carrying out the study which the Government has requested. Comments should be sent to:

Mr Mike Saunders
Office of Water Services
City Centre Tower
7 Hill Street
BIRMINGHAM
B5 4UA

Tel: 0121 625 1334
Fax: 0121 625 1359

to arrive by 1 May 1998.

It would be helpful if responses could be copied to the other regulatory offices involved:

Mr Nick Fincham
Office of Gas Supply
Stockley House
130 Wilton Road
LONDON
SW1V 1LQ

Tel: 0171 932 1652
Fax: 0171 932 1600

Mr Paul Campbell
Office of Telecommunications
50 Ludgate Hill
LONDON
EC4M 7JJ

Tel: 0171 634 8890
Fax: 0171 634 8893

Miss Jackie Sellers
Office of Electricity Regulation
Regulation & Business Affairs 2
13^th Floor, Hagley House
Hagley Road
Edgbaston
BIRMINGHAM
B16 8QG

Fax: 0121 456 6244
Fax: 0121 456 6361

Mr Charles Coulthard
Office for the Regulation of
Electricity and Gas
Brook Mount Buildings
42 Fountain Street
Belfast
NORTHERN IRELAND
BT1 5AA

Tel: 01232 311575
Fax: 01232 311740

6.2 The Regulators wish to make public the responses they receive, by placing them in their Libraries. Please indicate clearly on your response if you do not wish it to be made public.

Annex A

Effective Regulation of Multi-Utilities

7.37 Multi-utility companies providing a number of different utilities services and subject to regulation by more than one utility regulator, are starting to emerge. Multi-utilities can develop through mergers, acquisitions, or the expansion of existing utility providers into new areas of business. The trend will be for consumers to buy utility services from large integrated companies, rather than from companies providing a single service. This has the potential to produce benefits in the form of economies of scale and convenience. However, multi-utilities also provide regulatory challenges. Joint activities by a multi-utility group can make it more difficult for regulators to maintain an effective regulatory grip over the specific utility services for which they exercise responsibility. There is the potential, for example, for multi-utility groups to apportion costs within the group so that captive customers of monopoly suppliers are effectively paying for the group's activities in other competitive utility markets.

7.38 Regulators need adequate powers and procedures to regulate multi-utilities effectively. They need to be able to distinguish clearly between the different activities of a multi-utility, and the relevant financial transactions within the multi-utility group. The proposals for ensuring close co-operation and consultation between regulators identified in paragraphs 7.31 – 7.37 should help the regulators to develop effective means for regulating multi-utilities. But this is an issue requiring early collective consideration by the regulators. There may be merit, for example, in the regulators agreeing a consistent approach to ring-fencing their particular regulated businesses. There might also be benefits in identifying a common methodology for monitoring group transfer pricing where transactions cross the ring-fenced boundaries.

7.39 Regulators will also need to consider the regulatory implications of technological developments. New technology, for example is likely to improve the capacity of monopoly networks to carry more than one utility service. Technology will also affect metering and billing procedures following, for example, the introduction of dual fuel meters and multiple function smart cards. Meter ownership patterns may change. Issues concerning the use of customer data for cross-marketing of utility services will arise. The consumer councils for each utility sector will also need to take parallel steps to develop effective working arrangements so that they are able to represent the consumer interest effectively in a multi-utility environment.

Proposal 7.9: The Government invites the utility regulators to carry out and publish a joint study of the regulatory issues associated with multi-utilities, looking to likely developments over the next decade. Before undertaking the work, the regulators should consult interested parties on the scope of the study and particular issues it should address. The regulators are invited to report to Ministers by the end of May. The Government will then consider the adequacy of the regulators' current powers to address these issues, and any need to strengthen them by legislation.