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| NTL PRICE CONTROL FOR THE PERIOD 1997-2002 - Interim Statement | |
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INTRODUCTION 1 The consultative document of the 24 January 1996 set out Oftel's proposed approach to the control of prices for the provision of broadcast transmission services to the Channel 3 companies, Channel 4 and S4C (NTL's 'regulated business'). 2 This statement sets out the Director General's views on the price control for the next period from 1 January 1997 to 31 December 2002. 3 The consultative document discussed a number of issues and sought views and evidence on a number of questions. The major issues concerned:
- the treatment of the cash held by NTL at the time of purchase; - the proportion of the acquisition cost (purchase price) accounted for by the regulated business; - whether the acquisition cost price represented the true value of the business at the time or whether there was an implied discount; - whether the asset base at acquisition should be uprated for inflation between 1991 and 1996; - how the value of the regulatory asset base should be adjusted to reflect capital expenditure and depreciation in the previous price control period (1991 -1996 inclusive) and in the next price control period; - the appropriateness of the proposed capital expenditure programme for the period.
- the prospects for improvements in productivity and the scope for reductions in real unit labour costs (productivity improvements less increases in real wages); - the shares of common costs to be borne by the regulated and non-regulated business. The conclusions and proposals on these issues are outlined below. (For the sake of brevity this document does not rehearse the arguments on these issues contained in the consultative document). THE REGULATORY ASSET BASE4 The Director General has considered the representations made on these issues and has endorsed the position taken in the consultative document that:
TREATMENT OF CAPITAL EXPENDITURE AND DEPRECIATION5 The Director General has taken the view that it is reasonable to take account of capital expenditure and depreciation since 1991 in assessing the rate base for the next price control period. Since the original price control was set on an HCA basis, capital expenditure has been added at its historic cost and depreciation subtracted on a historic costs basis. 6 Similar account needs to be taken of the proposed capital expenditure and future depreciation. PROJECTED CAPITAL EXPENDITURE7 The consultative document noted that NTL had submitted supporting evidence on the programmes to be undertaken to explain why their proposals are efficient and appropriate to the regulated business. A further check was carried out to ensure that the cumulative planned capital expenditure dose not significantly exceed the cumulative CCA OCM depreciation charge over the price control period. 8 In response to representations by the television companies Oftel has provided them with further information on the proposed expenditure and sought their views on its reasonableness. The companies have in particular questioned the justification for expenditure by NTL on the replacement of certain of its tall (200m+) masts. The masts concerned are at risk from failures in the welding due to metal fatigue. NTL have developed methods for detecting incipient cracks to enable large steel clamps to be bolted to bypass the weak point. However this is not possible at every point and there is a risk of failure and collapse. 9 The Director General's view is that this expenditure should be allowed. However, he has taken the view that a greater proportion of the cost should be allocated to NTL's non-regulated business than had originally been proposed to take account, among other things, of the use of these masts by Channel 5. 10 The companies have also expressed deep reservations about NTL's proposed expenditure on the replacement of its four regional customer service centres (CSCs) with a national centre. There are two separate issues here. 11 The first of these concerns whether the expenditure on these projects would result in the companies paying higher charges than they otherwise would have done. The Director General's proposals for the price control incorporate assumed significant efficiency improvements as a result of these projects. The efficiency improvements will yield savings greater than the cost of the capital involved - customers will therefore, in fact, pay less as a result of this expenditure. In view of the savings accruing to the regulated business Oftel has not altered the allocation of the cost of this work between the regulated and non-regulated businesses. 12 The second issue concerns quality of service where NTL's customers have sought reassurance that the quality of service offered to them will remain acceptable. Their contracts with NTL provide for consultation with them on such changes. NTL have made it clear throughout that the introduction of these changes would only take place after consultation with the television companies. However, Oftel asked them to meet with the companies as a matter of urgency to answer their concerns on these issues before any final decision is made on the level of the price control. COST OF CAPITAL13 The consultative document set out the problems involved in assessing the beta for NTL. The Director General has endorsed the conclusion of the document that, in the absence of better information, the beta should be in the range of 0.7 to 0.8. While the Director General has not accepted the view that the beta for NTL's regulated business should be the same as for the regulated water and gas utilities, he has taken the view that it should be at the low end of the the range given in the consultative document. 14 Oftel's approach to assessing the equity-risk premium, and the pre and post-tax cost of capital is consistent with that adopted for BT. 15 The Director General has also endorsed the conclusion made in the consultative document that it is not necessary to make any revision to the rate base to allow for the change in the estimate of the cost of capital. THE REGULATORY COST BASE16 In view of the growth of the non-regulated business since 1991 and the potential for further growth implied by International CableTel's purchase of NTL, the issue of the attribution of common costs has been very important to the review of the price control. 17 The method favoured by the consultative document was to identify the costs which can be attributed specifically to each type of activity in order to reduce to a minimum the set of common and joint costs. Oftel has taken account of the projected growth in the unregulated business by reallocating the common and joint costs between the regulated and non-regulated businesses so that the shares of common costs allocated to the two businesses reflect the relative sizes and levels of activity. It has been assumed that the total pool of common costs should decline by 1% per annum in real terms. In view of the fact that the regulated business is largely stable the Director General has taken the view that it is reasonable to assume that any increase in the real level of common costs should be attributable to the non-regulated business. 18 The consultative document also set out Oftel's proposed approach to assessing the impact on the calculation of common costs of the sale of NTL's Advanced Products Division (APD). The Director General has endorsed the approach taken in the consultative document that the regulated business should not bear any share of the common costs previously attributed to the APD. CHANNEL 5 AND TELETEXT19 Channel 5 and Teletext both make use of the assets of the regulated business. An appropriate contribution to these has been assessed and included in the calculations. PRODUCTIVITY20 The consultative document set out two sets of assumptions on productivity. The first from NTL, was that productivity would rise by 1.5% per annum while real wages rose at 1% - giving a reduction of real unit labour costs of 0.5% per annum. The second, proposed by Oftel assumed a 4% per annum improvement in productivity together with a 1% increase in real wages. 21 NTL have put forward a number of detailed arguments as to why the productivity gains in the last price control were "one-off" gains, and that the assumption of productivity improvements of some 4% per annum is not realistic. 22 It is recognised that, the scope for productivity improvements is constrained by the fact that:
23 The Director General accepts to some degree the force of these arguments nevertheless he takes the view that the scope for productivity improvements is substantially greater than is assumed by NTL's projections. ENERGY COSTS24 The television companies have drawn Oftel's attention to the potential savings in energy consumption resulting from the replacement of thermionic transmitters with solid-state. They also argue that NTL as a large user of electricity has the potential to make considerable savings from the liberalisation of the electricity supply market in 1998. In view of these points the assumed reduction in the real cost of electricity has been increased. THE SCOPE OF THE PRICE CONTROL25 The consultative document proposed that the costs related to certain components of terrestrial television - namely the transmitter control circuits and inter-transmitter SHF links for C3, C4 and S4C. 26 BT in response to the consultative document argued, citing the fact that the BBC had contracted with Energis for similar facilities, that these services should not be price capped because there is effective competition. We accept that there is the possibility for NTL to contract with other suppliers however independent entry by competitors to BT and NTL appears unlikely so NTL's customers have not effective choice of supplier. The effect of bringing these services within the scope of the price control is to give NTL an incentive to seek savings which it would not have if it were simply able to pass the costs on to the end customer - which it might seek to do by contracting with alternative suppliers. THE STARTING LEVEL FOR PRICES IN THE NEW PRICE CONTROL PERIOD AND VALUE OF 'X'27 One of the two scenarios set out in the price control document included a step discount. The Director General believes that in view of the exceptionally high levels of returns earned by NTL in it regulated transmission business a step discount would, in this case, be appropriate. 28 The step discount suggested in the consultative document took as its starting point the price negotiated between NTL and the ITV Association - in effect a second step discount had been added to that already offered by NTL. After further consideration Oftel has concluded that the calculation of the new PO should be independent of the negotiations between NTL and the companies. Oftel has therefore taken the 1996 price as its starting pointin calculating the step. 29 The P0 for NTL's regulated transmission business and the value of 'X' will be dependent on the outcome of the discussions on the single customer centre, but, on the basis of the current plans and subject to final calculations, are expected to be £53.4m and to fall between 4 and 4.3%. The General's conclusions will be value will be announced in the final statement. THE APPORTIONMENT OF CHARGES BETWEEN C3 AND CHANNEL 4 AND S4C30 In the previous price control period the relative shares of the total revenues of the regulated transmission business were respectively C3: 52; Channel 4: 40.8; and S4C 7.2. The apportionment of charges appears to be out of line with the respective shares of costs: the service offered to C3 and Channel 4/S4C are essentially the same - the differences would justify only a small difference in price. A degree of reapportionment appears necessary. 31 After consideration the Director General has accepted the need for reapportionment of charges. However, in response to Channel 4's representations Oftel is to consider further the scope and timing of the reapportionment. OTHER ISSUES32 There were a number of other issues raised in the consultative document. These included:
UNBUNDLING OF THE REGULATED TRANSMISSION SERVICE33 The consultative document outlined, and sought views on, proposals to require NTL to 'unbundle' its services - ie to offer a menu of prices and services - by type of service and area. It became clear during the course of the consultation that such ground rules would need to apply equally to the BBC's service when it is sold. This raises in turn the broader issues of the potential for competition in broadcast transmission services. In view of this wider dimension it will be necessary to consider this issue further with a view to publication of proposals before the BBC's network is offered for sale. 34 A number of respondents to the consultative document raised concerns about the implications of geographical unbundling. Presently the ITV companies are bound by the terms of the Broadcasting (Channel 3 Transmission and Shared Distribution of Costs) Order 1991 which requires them to contract for broadcasting transmission services with a single person and to share the costs. At present NTL charges a single price and the ITV companies share costs on the basis of advertising revenue. The order is due to expire at the end of this year although the Secretary of State for National Heritage may renew it for a further period. 35 The Director General recognises and accepts the importance which the Government attaches to a maintaining a national independent television network. It is clear that any move toward charging on a geographical basis related to actual costs will require careful consideration and the transition will require careful management. At the same time the Director General recognises that the television companies have a legitimate expectation of information about the relative costs of transmission in different ITV regions. The Director General also takes the view that those who might be about to purchase ITV companies in the higher-cost areas should be in possession of the available information about the true transmission costs. More generally, he has taken the view elsewhere that where cross-subsidy is necessary to achieve socially-valued objectives, it should be fully transparent. 36 In the light of these considerations Oftel will, after discussion with the Department of National Heritage and the Independent Television Commission, make available data on transmission costs by ITV franchise as a first step toward charging on a geographical basis. PRIVATISATION OF THE BBC37 The consultative document indicated that should NTL purchase the BBC transmission network it would be necessary to review this price control both to ensure that prices charged to the customers of the combined regulated business were on a consistent basis and that the customers were able to benefit from the economies of scale and scope resulting from the formation of the combined group. This remains the Director General's view. 38 At the same time NTL have sought assurances that, in the event of their not being successful, the successful bidder would be subject to the same rules on unbundling as they were. Were there to be an asymmetry in obligations they would stand to lose business without being able to compete for new broadcasting transmission business to replace it. Oftel has confirmed that whatever approach to unbundling it decides to propose will apply equally to both companies. COSTS AND REVENUES FOR DIGITAL TERRESTRIAL TRANSMISSION39 The consultative document stated that Oftel did not intend to allow overhead costs attributable to the development of digital terrestrial television to be included in the common costs shared by the regulated business. The Director General has endorsed this view. 40 The Director General has also taken the view that, on the basis of the evidence before him, it would not be his intention to reopen the price cap - a possibility suggested by the consultative document - to take into account the development of digital terrestrial transmission. This is without prejudice to the next periodic review of the price control (in 2002) where it would be open to the Director General to conclude that the prices of digital terrestrial transmission services should be price regulated. If these circumstances were to arise appropriate account would need to be taken of the NTL's investment in these services in assessing the new rate base. (This is without prejudice to the Director's power to determine the basis for setting access charges for the use of NTL's sites). 41 Oftel's approach in this area would however be guided by the same principles as it follows elsewhere: it would seek to promote competition, and the conditions for competition, and only intervene where competition - or the threat of competition - was not an effective constraint on firms' pricing behaviour.
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