Dear Regulatory Director
Revaluation of assets for the 2009 price review
We last required companies to carry out a full revaluation of their assets for the 1999 price review. At the time of the 2004 review we accepted that a ten-year period between revaluations was appropriate because we:
- did not expect the replacement cost of assets to vary significantly over a five-year period; and
- wished to understand more fully companies current cost depreciation positions without first having to understand any effects of an asset revaluation.
For the 2009 price review, we therefore require each company to carry out a full revaluation of its asset stock. The revaluation exercise must be carried out on a modern equivalent asset (MEA) basis and consider both the gross value of the assets and the net (ie depreciated) position. You must explain the basis of the revaluation and set out the results from it in your draft business plan in August 2008. We will set out in detail the information that we require you to provide in our consultation on our information requirements for the price review later this year.
In the past we have highlighted that the size of the adjustments to MEA values at previous reviews did not give us confidence in the robustness of companies’ valuations. We will therefore ask you, in your business plan, to reconcile the movements in both the gross and net MEA value from the value reported at 31 March 2008 in the 2008 June return and explain clearly the reasons for the movements.
The MEA revaluations form only one aspect of the work which companies undertake in relation to their capital stock as part of business planning. For example, each company must:
- carry out an assessment of service risk as part of the common framework for capital maintenance planning;
- carry out a full assessment of the condition and performance of its asset stock;
- provide projections of the capital maintenance expenditure it considers it requires over the longer term;
- provide unit costs for cost base comparison to inform our capital efficiency assumptions.
In considering the robustness of companies’ MEA revaluations we want to understand how each company has drawn together these different strands. In your business plan we will therefore ask you to explain and demonstrate:
- how you have taken into account the links between your MEA revaluation exercise;
- your condition, performance and service risk assessments;
- your capital expenditure projections; and
- your unit cost assessments.
One of the most important aspects of the MEA revaluation for the price review is the impact on companies’ CCD projections. An important part of our challenge to those projections will be in understanding the impact of the MEA revaluation exercise on the projected depreciation charge. We will look particularly at the key drivers (either through changes to the gross asset valuation or impact on remaining asset lives) of any changes in CCD from the charges companies are currently making in their regulatory accounts. You must therefore clearly explain and support any stepped changes in CCD in your business plan.
As at previous price reviews, given our concerns about the robustness of past revaluations, we will continue to apply a range of challenges to companies’ CCD projections including retaining a check on the overall level of depreciation by comparing CCD with actual and projected maintenance expenditure.
Director of Regulatory Finance and Competition