decision on esb pes’s price control 2011-12 · decision on esb pes’s supply price control...

Decision on ESB PES’s Price Control 2011-12

DOCUMENT TYPE:

Decision Paper

REFERENCE:

CER 10/182

DATE PUBLISHED:

13th October 2010

RESPONSES TO:

[email protected]

The Commission for Energy Regulation,

The Exchange, Belgard Square North, Tallaght, Dublin 24. www.cer.ie

CER – Information Page Abstract: Following on from the consultation paper1 on ESB PES's Price Control 2011-2012, this document sets out the CER’s final decision on ESB PES’s allowed revenue for 2011-12. The document outlines the issues raised in the original consultation paper and those raised in the consultation responses. It also sets out the CER’s decision on the form of price control to be implemented along with the level of allowed revenue to be passed through in regulated tariffs. The CER has decided to allow PES costs of €87.81m for 2011 and €83.78m for 2012. Further to this a total of €94.67m of allowed revenue for the 12-month period from 1st October 2010 to 30th September 2011.

Target Audience: This paper is for the attention of members of the public, the energy industry, customers and all interested parties. Related Documents:

• Consultation on ESB PES's Price Control 2011-2012 – CER/10/130 • Decision on ESB PES Revenue Regulation Framework - CER10067 • Direction to ESB PES on Allowable Costs 2006 – 2010 - CER05164 • ESB PES Allowable costs for the period 1st October 2009 - 30th

September 2010 - CER09152 For further information on this decision paper, please contact Fergus O’Toole ([email protected]) at the CER 1 Consultation on ESB PES's Price Control 2011-2012 – CER10130

Decision on ESB PES’s Supply Price Control 2011-2012 CER/10/182 – 13 Oct 2010

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Executive Summary This paper sets out the CER decision on PES’s internal supply costs for the 2011-12 period. The paper sets out how the CER reviewed these costs and what reasonable and efficient costs have been allowed to be passed on to domestic customers through the regulated tariffs. The consultation paper preceding this decision outlined that PES had submitted to the CER internal supply costs of €115.93 million for 2011 and €111.09 million for 2012 (in 2010 monies) which covers the supply costs for both domestic and business customers. These compare to CER-approved supply costs of €159.8 million for 2010 and €160.32 million for 2009 (in 2009 monies). Since the PES’ business customer segment will become deregulated upon 1st October 2010, the CER has reviewed the proposed allocation of costs to regulated and unregulated customer segments set out in the consultation paper. The CER found the approach to be reasonable and is satisfied that there is not any cross subsidization from domestic to business customers. Therefore the allocation of the total PES supply costs to its deregulated and regulated customer segments has been approved. Based on a detailed review and analysis of the PES submission, the CER finds the majority of the applied for supply costs to be reasonable, efficient and necessary for the fulfilment of the role of Public Electricity Supplier and compliance with the associated licence conditions. The CER has made the decision not to allow all elements of the PES proposal as it is not clear that they represent reasonable, efficient and necessary levels of cost. The CER has made every effort to ensure that, in the difficult economic circumstances, efficiencies are being made and passed along to consumers. Specifically, the CER has decided to reduce the allowed level of cost in the following areas:

• Capital expenditures associated with IT investments expected to be made by ESB Customer Supply as part of its transition to a deregulated supply company which impacts the level of depreciation allowed over the period; (Reduction of; €0.44 million)

• Payroll. The CER has reduced baseline payroll costs by 5% with a further 2.5% per annum, in line with ESRI forecast nominal wage decreases and in line with expected productivity gains. (Reduction of; €3.21 million)

• Sales and advertising costs. The CER has disallowed an increase in sales and advertising cost which has been applied for and to allow costs at pre-2010 levels. (Reduction of; €1.11 million)

• Bad debts. In order to incentivise PES to reduce the level of bad debt the CER is allowing PES to recover bad debts at 1% of forecast turnover and not the 1.6% applied for. (Reduction of; €7.38 million)

• ESB Corporate Centre, SLAs & Inter Business Unit Costs. The CER has decided that an incentive should be incorporated into the allowance based on a productivity increase of 2.5% per annum. (Reduction €2.04million)


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Once these cost elements are excluded, the CER has made the final decision to allow internal supply costs of €87.81 million in 2011 and €83.78 million in 2012. PES’s allowed revenue for 2010 has been previously approved2, but adjusting the allowed revenue for margin and for the separation of regulated and deregulated costs the CER has decided to allow a total of €28.81 million to be included in the 2010/11 MAR. As in prior controls, the CER has approved these for a base year (2010) and thereafter will link changes in allowed costs to inflation. The CER will use the HICP as the inflation index for the 2011-12 period as this should be less volatile and stable business revenues will benefit both the final customer and the PES business. Further, in prior controls PES has been allowed to track “uncertain costs” (i.e., costs outside the control of PES such as the CER levy or SEM-related investments) and has been allowed to recover these at levels deemed reasonable and efficient by the CER. For this price control, the CER will not allow uncertain costs for the 2011 allowed revenue. For 2012, the CER will consider any submission made by PES in advance of setting the 2012 allowed revenue, for costs arising outside of its control. The incentive payments and penalties associated with the performance at the National Customer Contact Centre (NCCC) will be continued for the 2011-12 period.. However the total reward or penalty will be allocated between regulated and deregulated customers in a manner consistent with other cost areas, ensuring that costs relating to deregulated customers are not attributed to the regulated customer base. The consultation paper outlined that PES had projected a considerable accumulated K-factor to 30th September 2010. In previous reviews, revenue under or over recoveries were allowed for in the regulated supply costs through a correction or K-factor. Revenue surpluses were refunded to customers and revenue shortfalls recovered through tariffs. However as the market becomes increasingly competitive, the allocation of K-factors becomes more complex, potentially having negative consequences for consumers and impacting on competition. Recognising this, the CER issued a decision in 2008 which stated that K-factors should not be included in tariffs where they have a negative impact on competition3. In 2009 the CER also consulted on the future application of K-factors in regulated tariffs4. Further to that consultation the CER has largely eliminated the mechanism from the regulatory framework that will be applied to PES during 2011/12, moving to an ex-post review of revenue that requires in year adjustments to avoid the accumulation of K-factors. Much of the accumulated K-factor projected by PES has accrued due to a general reduction

2 ESB PES Allowable costs for the period 1st October 2009 - 30th September 2010 CER09152 3 Treatment of K-factors in Retail Tariffs-Letter to ESB CS – CER08049 4 Information Note - Review of K Factors and Supply Margins and Tariff Structures - CER09203


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in overall electricity demand, but a significant proportion is attributable to PES losses due to increased customer switching. As a regulated supplier, PES is allowed to recover its reasonably incurred costs. Regulatory controls are intended to provide the correct package of incentives to drive efficiencies in the regulated company, to reflect how an efficient supplier would behave in a competitive market, to the benefit of consumers. The CER is mindful that the application of the carryover from the current price control does not create unintended consequences, such as electricity prices being artificially raised above an efficient level, due to a fall in demand or increased competition. The CER considers that this would constitute a perverse economic logic, and notes that all businesses have had to react to this difficult economic climate, cutting costs to address reductions in consumer demand. The application of the accumulated K-factors to a diminished regulated customer base would present a disproportionate burden on consumers at this time. Therefore the CER has decided not to allow any K-factors to be included in the 2010/11 regulated tariffs. The CER does however recognise that a proportion of the costs may have been legitimately incurred in the context of the prevailing regulatory framework. Bearing this in mind the CER will give further consideration to potential recovery mechanisms to ensure that ESBCS is not unduly disadvantaged in an increasingly competitive market. In its Decision on ESB PES Revenue Regulation Framework, the CER determined that a supply margin of 1.3% continues to be appropriate for 2011 and 2012. As in prior controls, this supply margin will be considered part of PES’ “allowed revenue” and will be calculated based on outturn costs on an ex post basis. At the conclusion of the 12 month MAR review period, the CER will perform a detailed ex post review of PES’ tariff revenues and the MAR formula. The margin for the 2010/11 period will be included as part of this consultation. Insofar as PES remains regulated for the 2011/12 tariff period, the CER will also perform a detailed ex post review of PES’ tariff revenues and the MAR formula for that period and a review of the margin will be incorporated into this. Finally, taking 75% of the of the 2011 allowed revenue and the appropriate allocation of the portion of the 2010 allowed revenue applicable to domestic customers the CER has decided that a total of €94.67 million be included in regulated tariffs over the 2010/11 MAR period.


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Table of Contents Executive Summary .............................................................................................. 3 1.0 Introduction ..................................................................................................... 8

1.1 The Commission for Energy Regulation ...................................................... 8 1.2 Purpose of this paper ................................................................................... 8 1.3 Background Information ............................................................................... 8 1.4 Comments Received ................................................................................. 10 1.5 Structure of this paper ............................................................................... 10

2.0 Regulatory Background ................................................................................ 11 2.1 Introduction ................................................................................................ 11 2.2PES Supply Price Control 2006 - 2010 ....................................................... 12 2.3 Elements of Revenue Regulation Framework for 2011-2012 .................... 12 2.4 PES Allowed Revenue Review for the 2011-12 Period ............................. 13

3.0 CER Decision on Form of Price Control ........................................................ 14 3.1 Introduction ................................................................................................ 14 3.2 Ex ante Approval of Supply Costs ............................................................. 14 3.3 Formula for Adjusting Supply Costs from Year to Year ............................. 14 3.4 Inflation ...................................................................................................... 15 3.5 Incentive Mechanisms ............................................................................... 15

3.5.1 Continuation of Incentive Mechanisms ................................................ 16 3.6 Uncertain Costs ......................................................................................... 17 3.7 Margin ........................................................................................................ 17 3.8 Treatment of 2010 Allowed Revenue ......................................................... 18 3. 9 Treatment of Accrued K-factor .................................................................. 18 3.10 Underlying Assumptions .......................................................................... 19

4.0 CER Decision on Allowed Operational Expenditure ...................................... 21 4.1 Allowed OPEX ........................................................................................... 21 4.2 Review of OPEX ........................................................................................ 22 4.3 Payroll ........................................................................................................ 22 4.4 Contractors ................................................................................................ 24 4.5 Materials for Goods and Service ................................................................ 24 4.6 Transport & Communications .................................................................... 25 4.7 Establishment ............................................................................................ 25 4.8 Computer ................................................................................................... 25 4.9 Selling & Advertising .................................................................................. 25 4.10 Professional Fees .................................................................................... 26 4.11 Depreciation ............................................................................................ 26 4.12 Bad Debts ................................................................................................ 27 4.13 ESB Corporate Centre, Service Agreements & Inter Business Unit Costs ........................................................................................................................ 27 4.14 Uncertain Costs ....................................................................................... 29

5.0 Consultation Responses ............................................................................... 30 5.1 Consultation Issues ................................................................................... 30

6.0 Conclusions .................................................................................................. 35 6.1 Summary of Allowed Revenue 2011 & 2012 ............................................. 35


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6.2 Summary of Allowed Revenue for 2010/11 MAR ....................................... 35


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1.0 Introduction

1.1 The Commission for Energy Regulation The Commission for Energy Regulation (‘the CER’) is the independent body responsible for overseeing the regulation of Ireland's electricity and gas sectors. The CER was initially established and granted regulatory powers over the electricity market under the Electricity Regulation Act, 1999. The enactment of the Gas (Interim) (Regulation) Act, 2002 expanded the CER’s jurisdiction to include regulation of the natural gas market, while the Energy (Miscellaneous Provisions) Act 2006 granted the CER powers to regulate electrical contractors with respect to safety, to regulate to natural gas undertakings involved in the transmission, distribution, storage, supply and shipping of gas and to regulate natural gas installers with respect to safety. The Electricity Regulation Amendment (SEM) Act 2007 outlined the CER’s functions in relation to the Single Electricity Market (SEM) for the island of Ireland. This market is regulated by the CER and the Northern Ireland Authority for Utility Regulation (NIAUR). The CER is working to ensure that consumers benefit from regulation and the introduction of competition in the energy sector. S.I. No. 60 of 2005, European Communities (Internal Market in Electricity) Regulations, 2005 outlined the functions of the CER.

1.2 Purpose of this paper The purpose of this paper is to inform the public and the CER’s stakeholders with regard to the form of price control to be implemented along with the level of allowable revenue for ESB Customer Supply (ESBCS), the Public Electricity Supplier (PES) for the period 2011-2012.

1.3 Background Information The CER imposes separate revenue controls on each of ESB’s regulated businesses, namely, Transmission Asset Owner (‘TAO’), Distribution System Operator (‘DSO’) and PES. In addition, the CER regulates the revenue recovered by EirGrid, the independent state-owned body licenced by the CER to act as the Transmission System Operator (‘TSO’). The first 5-year price control imposed on the ESB PES business unit commenced in 2001 and concluded at the end of December 2005. Early in 2005, the CER undertook to develop a revenue control to apply to the supply businesses for the


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next 5-year period, from 2006 to 2010. This involved a thorough analysis of PES’s submission on costs of supplying electricity to customers over this period. Following a consultation period and thorough analysis of the data, the CER’s published its final decision on ‘allowable’ costs and form of revenue control to apply for the business over this 5 year period5. The form of revenue control determines the nature of control placed on the business (e.g., a cap on revenues recovered from customers or a cap on prices charged to customers). It also sets out an efficient level of revenues (made up of allowed operating costs, depreciation charges on capital expenditure (derived from the allowable CAPEX) and an allowable margin) that can be recovered by the business from its customers in a particular operating period. For the second 5-year control period, from 2006 to 2010, the CER decided to allow the PES business a total of €585.8m in allowable costs (in 2004 values). Last year the CER conducted the final review6 under the 2006-2010 revenue control period. During this process the CER examined the appropriateness of using the 2006-2010 regulatory formula given the fall in overall market demand and the impact of increased competition in the domestic market. In April 2010, the CER published its decision on the deregulation of the Irish retail electricity market. The ‘Roadmap7’, set out the competitive milestones for when specific market segments would be deregulated, ceasing the obligations of a price control, with regulated tariffs, on PES. The detailed competition review, published in parallel, concluded that all business markets would be deregulated from 1st October 2010 and that the CER would continue to monitor competition to determine when the threshold for deregulation in the domestic market has been met. In parallel to the Roadmap consultation process, the CER published a decision paper8 setting out the CER’s decision with respect to the regulatory arrangements that will apply from 1st October 2010 for the regulated domestic market. Recognising the increased level of competition in the Irish retail electricity market, changing market dynamics, and the progressive transition to a fully deregulated market, this paper set out the form of price control to apply and defined a Maximum Allowable Revenue (MAR) to be calculated on an ex post basis. The CER is committed to retaining appropriate regulatory controls to support competition and protect domestic consumers. Tariffs will continue to be set on a cost reflective basis, in a transparent framework with continued regulatory oversight.

5 2006-2010 ESB Price Control Review PES Report – CER05164 6 ESB PES Allowable costs for the period 1st October 2009 - 30th September 2010 - CER09152 7 Roadmap to Deregulation - CER10058 8 Decision on ESB PES Revenue Regulation Framework - CER10067


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On the 13th August the CER published a consultation paper outlining PES's submission for allowed revenue for the period 2011-12. It also sets out the CER’s proposals for the form of price control to be implemented along with the level of allowed revenue to be passed through in regulated tariffs. Interested Parties were invited to comment on the proposals presented in the paper by close of business on 10th September 2010.

1.4 Comments Received

The CER received three responses to the consultation paper (CER10130). Submissions were received from the following organisations: • Airtricity • Bord Gáis Energy • ESB Customer Supply The CER has published each of the responses received alongside this decision paper. The issues raised in these responses are addressed in Section 5.

1.5 Structure of this paper

• Section 1 Provides an introduction to the decision.

• Section 2 Outlines the background for the regulatory review.

• Section 3 Sets out the CER’s decision on the form of the price control and the approach taken to certain underlying factors.

• Section 4 Examines PES’s historical and forward looking OPEX and shows the CERs decision for each cost.

• Section 5 Sets out some of the key points raised in the consultation and provides the CERs view on each.

• Section 6 Sets out the CER’s final decision on PESs allowed revenue for 2011-2012 and the allowed revenue to be included in the 2010/11 MAR.


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2.0 Regulatory Background

2.1 Introduction The CER has stated that its goal is to have in place fully competitive and deregulated markets in all segments of the electricity retail market. This is supported by policy coming from the EU, which purports that effective competition is likely to be superior to regulation and thus where markets are effectively competitive the replacement of end user retail tariff regulation is a desirable outcome. The CER considers that a fully competitive retail market can bring real benefits to consumers in terms of the choice and quality of the offers available from suppliers, improved value-added services and potentially lower prices. However the CER intends to keep regulation in place for market segments that do not meet the criteria for deregulation as set out in the CERs roadmap for the deregulation of the market. The CER retains regulatory control over those markets that are not deemed to be competitive for the following three reasons: 1. Consumer Protection

To prevent a dominant undertaking (or collectively dominant undertakings) from extracting economic (monopoly) rents through excessive pricing.

2. Encouraging efficiency

In the absence of meaningful competition, regulation can provide the right incentives for rewarding success and penalising failure. Thereby encouraging regulated entities to act efficiently and in the best interest of final customers.

3. Promotion of Competition Proper regulation prevents exclusionary prices that discourage efficient entry by setting retail prices too low in the short term. Through regulation the right market dynamics and price indicators can be put in place in order to encourage new, efficient market entrants.

Where market segments are not deemed to be fully competitive the CER must maintain some form of regulation in order to ensure that consumer protection, efficiency and the promotion of competition. In addressing how this should be done the CER has considered a number of options as to the form of price control to adopt, taking into account the shortcomings of the previous price control, changing market dynamics and the recommendations coming from the 2009 review of K-factors and supply margins.


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2.2PES Supply Price Control 2006 - 2010 The current regulatory control follows on from the prior control for the PES, covering 2006-2010. In 2005 the CER determined the allowed revenues for the 2006-2010 price control. The price control formula is in its final year and concludes on the 31st of December 20109. The 2009 decision on PES allowed costs and revenues for the current tariff period10 concludes on 30th September 2010.

2.3 Elements of Revenue Regulation Framework for 2011-2012 There are two key elements that have been considered in implementing changes to the regulatory framework, which will serve as the interim arrangements until such time as the market is deregulated in full;

(i) Regulatory Formula

(ii) Internal Supply Costs Review.

In May 2010 the CER published a decision paper11 setting out the Revenue Regulation Framework, including the Regulatory Formula. This paper set out the CER’s decision with respect to the regulatory arrangements that will apply from 1st October 2010 for the regulated domestic market. The CER’s decision changes the form of price control to apply and defines a MAR to be calculated on an ex post basis

The form of revenue control determines the nature of control placed on the business (e.g., a cap on revenues recovered from customers or a cap on prices charged to customers). It also sets out an efficient level of revenues (made up of allowed operating costs, depreciation charges on capital expenditure derived from the allowable CAPEX, and an allowable margin) that can be recovered by the business from its customers in a particular operating period (usually a calendar year). The revenue control can also incorporate incentives for the regulated entity to improve both productive efficiency and customer service performance levels.

This paper sets out what reasonable and efficient supply costs will be passed on to domestic customers through the regulated tariffs in the 2011-12 period.

9 Allowed revenue was originally calculated on a calendar year basis and then adjusted when the SEM tariff year was aligned with Northern Ireland from 1st October – 30th September. 10 ESB PES Allowable costs for the period 1st October 2009 - 30th September 2010 - CER09152. 11 Decision on ESB PES’s Revenue Regulation Framework – CER10067


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2.4 PES Allowed Revenue Review for the 2011-12 Period The CER considered a number of options when considering the form of price control to apply during 2011-2012. One option that was considered was to maintain the status quo. This would have involved maintaining the existing regulatory formula, and reflecting falling demand and diminishing customer numbers in the Kt-1 and Kt-2 K-factor adjustments. The shortcomings of the existing regulatory formula were analysed in detail in CER/10/067. In that Decision, the CER rejects the status quo because it does not sufficiently advance the price control process to take account of changing market conditions. CER/10/067 outlines a new revenue regulation framework, which relies on a maximum allowable revenue fixed on an ex-post basis. This new framework promotes competition and brings the system of regulation closer to that of a deregulated market, minimising the impact of the K-factor.


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3.0 CER Decision on Form of Price Control

3.1 Introduction As specified in CER/10/067, for the 2010/11 tariff period,12 the CER will apply a form of regulatory control to PES based on an ex post determination of maximum allowable revenue (MAR). The formula below illustrates the cost components involved in calculating the MAR, which includes the supply costs addressed in this paper.

MAR (Domestic Customer Category) = Wholesale Generation Costs + Network Charges + Supply Costs + Allowed Margin + PSO Costs

In the prior control period, the CER defined “Allowed Revenue” to include operating expenditure (OPEX), depreciation charges on capital expenditure (derived from the allowable CAPEX) as well as the allowed margin. Allowed revenue also included a customer service incentive payment or penalty linked to the performance of the National Customer Contact Centre. In the 2011-2012 control period, the cost elements that had previously been grouped into “Allowed Revenue” (i.e., supply costs and allowed margin) will be addressed individually through the MAR formula, as further explained in this section.

3.2 Ex ante Approval of Supply Costs This decision paper sets out the CER’s allowance for Internal Supply Costs for 2011 and 2012. As in prior controls, the supply costs will be approved in advance of the tariff period. The ex ante approval of OPEX charges and allowable CAPEX allows PES to benefit from “regulatory lag” and encourages PES to pursue efficiency-enhancing measures.

3.3 Formula for Adjusting Supply Costs from Year to Year In previous price reviews the CER had developed a control formula in order to capture the year on year adjustments and K-factors. However due to the shorter time period for the 2011-12 price control and the removal of the K-factor adjustment, a specific price control formula of this nature is no longer required.

12 The revenue control will also apply to the 2011/12 period if the domestic sector is not deregulated before then.


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In prior controls, the formula allowed PES to accrue K-factors. PES was allowed to refund revenue surpluses to customers and to recover revenue shortfalls. The CER has largely eliminated this mechanism from the regulatory framework that will be applied to PES during 2011 and 2012 through its decision on ESB PES’s Revenue Regulation Framework. The decision set a +/-3% band around the ex post MAR where over-recoveries within the 3% band are retained by PES, but any excess beyond 3% are applied as a reduction to the following years MAR. Any under-recoveries within the 3% band are applied as an increase to the following years MAR, but any shortfalls beyond 3% are lost to the PES. This decision paper sets the allowed supply costs for 2011 and 2012 and in any subsequent reviews there will be an adjustment for inflation and the inclusion of any necessary uncertain costs. The CER will consult on all subsequent annual revenue reviews.

3.4 Inflation The approach taken by the CER in approving the allowed supply costs for the period 2006 – 2010 was to set allowed costs for a base year and thereafter to link changes in allowed costs to inflation. This approach is to be continued and the, the CER is of the view that using a consumer focused inflation index is preferable and that the HICP is the most appropriate index to use. The HICP should be less volatile and stable business revenues will benefit both the final customer and the PES business. Therefore, the CER will use the HICP as the inflation index for the 2011-12 period. This will be applied for all future revenue reviews within the period.

3.5 Incentive Mechanisms During the last revenue control PES was incentivised to improve the quality of the service provided to customers that utilised its National Customer Contact Centre (NCCC). The four specific measurements related to:

• Speed of Telephone Response; • Call Abandonment Rate; • Mystery Caller survey results; and, • Customer Call-Back survey results.

The incentive mechanism captures the value of any penalties or payments in respect of PES’s level of customer service against specific targets set out in two separate incentive mechanisms applied to the ESB Call Centre and PES


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Customer Charter13. The Customer Charter incentive mechanism has been operational since 1st June 2008 while the Call Centre mechanism, was implemented in 2006. PES actively responded to the performance improvement incentives within the mechanism and significantly improved on the metrics listed above. Recognising the importance of suppliers providing a high quality of customer service, the CER is of the view that the incentive mechanisms put in place in order reward or penalise PES for its performance in this regard should be continued. The reward or penalty allowed in 2011 is based on the performance of PES’s NCCC in 2009 and as a percentage of the allowed revenue in that year. Analysis of 2009 PES accounts, as highlighted in Section 5.3, shows that 90% of operational costs in 2009 can be attributed to the domestic side of the business with the remaining 10% of costs being incurred by the business market side. Therefore the CER has decided to allow 90% of the maximum reward or penalty to be included in regulated tariffs from 1st October 2010. This maintains a consistent approach and ensures that costs relating to deregulated customers are not attributed to regulated customers. Percentage targets are set for each of the following categories; speed of telephone response, abandonment rate, mystery shopper calls and a call back survey. In 2009 PES scored above the targets in each of the categories. As a result, PES earned the maximum reward payment of €431,275 for call centre performance in 2009. Thus, reducing this to the 90% level, the value of this incentive term for 2011 is set at €388,148.

3.5.1 Continuation of Incentive Mechanisms The incentive mechanism resulted in an improvement in the PES’s performance over the past number of years and as a result the CER will continue to apply the mechanism in much the same manner. The performance targets are to be kept at the levels outlined in the consultation document, with the exception of the target for Speed of Telephone Response, which will be kept at the 2009 level of 80% to facilitate the transition to a First Call Resolution environment. The only other change, as was outlined in the consultation paper is in the application of the maximum reward and penalty. In previous years the allowed margin has been included in the allowed revenue figure, but from 2010 onwards the CER will calculate rewards/penalties on the allowed revenue, excluding margin. The CER will continue to assess PES’s performance with regard to incentive mechanisms, based on the same year end method as the previous price control

13 For further detail on each of these mechanisms please see the Commission’s Decision paper CER/06/107.


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and include the reward or penalty in subsequent MARs. Table 3.5.1 sets out the targets and forecast maximum penalty and rewards over the next few years.

Year 2009 2010 2011 2012Weights Targets

Speed of Tel Response 30% 80% 80% 83% 83%Abandonment Rate 30% 5% 5% 5% 5%Mystery Caller 20% 80% 80% 80% 80%Callback Survey 20% 80% 80% 80% 80%

Allowed Revenue 155,259,000€ 115,248,600€ €87,644,000 €83,783,000 Max. Penalty 1.00% 1,552,590€ 1,152,486€ 876,440€ 837,830€ Max. Reward 0.25% 388,148€ 288,122€ 219,110€ 209,458€

Table 3.5.1 – Forecast Maximum Incentive Mechanism Rewards/Penalties

3.6 Uncertain Costs In recent years the allowed revenue formula has incorporated an ‘Uncertain Costs’ term. This term captures PES uncertain costs, as approved by the CER, relating to costs arising primarily outside of the PES’s control. For example, changes to the CER levy or changes in CER policy that affect (both positively and negatively) PES costs. There are no uncertain costs allowed for the 2011 period and while the CER does not envisage that there should be any uncertain costs in 2012, it will consider submissions from PES in advance of setting the 2011/12 tariffs, for costs arising outside of their control and if they are deemed reasonable they may be included in the final allowed revenue for 2012.

3.7 Margin For the purpose of calculating the 2010/11 MAR the margin is set at 1.3% and will be calculated based on outturn costs on an ex post basis. Outturn costs are calculated from outturn demand, outturn SMPs, capacity costs, network charges, and SEM charges. For the purpose of calculating the 2010/11 regulated tariffs on an ex ante basis the margin has been calculated using forecasts. At the conclusion of the 12 month MAR review period, the CER will conduct a detailed ex post review and consultation on PES tariff revenues and the MAR formula. The margin for the 2010/11 period will be included as part of this consultation.


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3.8 Treatment of 2010 Allowed Revenue In the CER’s decision paper on ESB PES Allowable Costs for 2009-201014 the allowed revenue for 2010 was set at €159.77m. Of this total figure, 75% has been included in the 2009/10 PES regulated tariffs. The remaining 25% or €39.94m would normally be included in the 2010/11 regulated tariffs. However, following the deregulation of the business markets, the regulated tariffs for 2010/11 will cover domestic customers only. Therefore the inclusion of the full €39.94m would be inappropriate. In order to bring the 2010 supply costs in line with the methodology being adapted under the new regulatory formula the supply margin must be removed from last year’s total figure of €159.77m. The supply margin included in that total figure (including inflation) was €25.76m. 75% of this supply margin is being recovered during the current tariff period, and it is necessary to remove the remaining 25% from the €39.94m which leaves €33.50m. Analysis of PES accounts, as highlighted in Section 5.3 of the consultation paper, shows that 86% of operational costs can be attributed to the domestic side of the business with the remaining 14% of costs being incurred by the business market side. Therefore the CER has decided to include 86% of the €33.50m in the 2010/11 regulated tariffs. This results in a total of €28.81m being included in the 2010/11 MAR.

3. 9 Treatment of Accrued K-factor

The consultation paper outlined that PES had projected an accumulated K-factor to 30th September 2010 of €173.8m. This figure included €81.15m outlined in the allowed revenue review for 2009/1015 as well as additional K-factors accumulated over the subsequent 12 months. As set out in the consultation paper the allocation of K-factors becomes ever more complex in an increasingly competitive market, potentially having negative consequences for consumers and impacting on competition. Recognising this, the CER issued a decision in 2008 which stated that K-factors should not be included in tariffs where they have a negative impact on competition16. In 2009 the CER also consulted on the future application of K-factors in regulated tariffs17. Further to that consultation the CER has largely eliminated the mechanism from the regulatory framework that will be applied to PES during 2011/12, moving to an ex-post review of revenue that requires in year adjustments to avoid the accumulation of K-factors. In deliberating over the 14 ESB PES Allowable costs for the period 1st October 2009 - 30th September 2010 CER09152 15 ESB PES Allowable costs for the period 1st October 2009 - 30th September 2010 - CER09152 16 Treatment of K-factors in Retail Tariffs-Letter to ESB CS – CER08049 17 Information Note - Review of K Factors and Supply Margins and Tariff Structures - CER09203


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appropriate approach for the recovery of all or part of the projected €173.8m, the CER must take into consideration the market structure, as well as what is in the best interests of both customers and suppliers. There have been a number of significant changes to the Irish electricity market over the past 18 months. Aside from the general reduction in overall electricity demand, the growth of competition, has resulted in large numbers of customers switching from PES to independent suppliers, this is particularly evident in the domestic market where independent suppliers had acquired a 25%18 share of domestic customer numbers by the end of Q1 2010. In April 2010, the CER published the Roadmap paper19 which set out the criteria for retail market deregulation, and the decision that all business markets would be deregulated from 1st October 2010. Therefore from the 1st October 2010 only PES domestic customers will have regulated tariffs. As a regulated supplier, PES is allowed to recover its reasonably incurred costs. Regulatory controls are intended to provide the correct package of incentives to drive efficiencies in the regulated company, to reflect how an efficient supplier would behave in a competitive market, to the benefit of consumers. The CER is mindful that the application of the carryover from the current price control does not create unintended consequences, such as electricity prices being artificially raised above an efficient level, due to a fall in demand or increased competition. The CER considers that this would constitute a perverse economic logic, and notes that all businesses have had to react to this difficult economic climate, cutting costs to address reductions in consumer demand. The application of the accumulated K-factors to a diminished regulated customer base would present a disproportionate burden on consumers at this time. Therefore the CER has decided not to allow any K-factors to be included in the 2010/11 regulated tariffs. The CER does however recognise that a proportion of the costs may have been legitimately incurred in the context of the prevailing regulatory framework. Therefore the CER will give further consideration to potential recovery mechanisms to ensure that ESBCS is not unduly disadvantaged in an increasingly competitive market.

3.10 Underlying Assumptions

Below are the underlying assumptions included in the calculation of PES allowed supply costs for the 2011-12 period. 18 Competition Review Q2 2010 CER10116 19 Roadmap to Deregulation CER10058


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3.10.1 Customer Numbers Table 3.10.1 below shows the actual figures for numbers of customers served by PES as well as the volume of regulated Units Supplied in each year. In addition the table shows the forecast figures for the 2010-2012 period. This provides a breakdown of customer numbers into the regulated domestic customer numbers and the unregulated business customer numbers.

Actual ForecastDomestic (Regulated) 2006 2007 2008 2009 2010 2011 2012

Number of Customers 1,767,901 1,877,733 1,946,706 1,776,641 1,434,662 1,211,568 1,069,742

Units Supplied (GWh) 8,322 8,663 9,027 7,815 6,232 4,876 4,061 Table 3.10.1 – PES Customer Numbers & Energy Supplied

PES estimated that both the number of customers and use per customer will decline through 2012. Table 3.10.1 above shows that by 2012 the total number of customers served by PES will fall by approximately 40% (relative to 2009) and the volume of energy supplied by PES will fall by nearly 50% (relative to 2009).

The CER does not find the projected customer losses to be unreasonable and the customer numbers detailed in Table 3.10.1 have been adopted for the calculation of PES’s allowed revenue. 3.10.2 Regulated/Unregulated Costs Separation NERA reviewed the proposed allocation of costs to regulated and unregulated customer segments. Following their review, NERA did not identify any evidence in the proposed cost allocation to suggest that there is any cross subsidization from domestic to business customers.


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4.0 CER Decision on Allowed Operational Expenditure This section examines the PES’s historical and forecast operational expenditure (OPEX).

4.1 Allowed OPEX This section sets out domestic customers allowed OPEX. This is set out in Table 4.1 below and each category of OPEX is subsequently addressed.

OPEX Cost Category Allowed OPEX

2011 2012 Total€,000 €,000 €,000

Payroll €20,403 €19,907 €40,309

Contractors €9,479 €8,414 €17,893

Material & goods & Services €292 €294 €586

Transport & Communications €6,933 €6,153 €13,086

Establishment €230 €232 €462

Computer €276 €278 €554

Insurance €1 €1 €2

Selling & Advertising €4,800 €4,800 €9,600

Professional Fees €3,116 €3,142 €6,258

Depreciation €8,747 €8,615 €17,362

Bad Debts €6,571 €5,797 €12,367

Other €2 €0 €2

Total Operating costs €60,849 €57,633 €118,482

Inter BU costs

Shared Services €4,809 €4,727 €9,536

ITS €10,243 €10,070 €20,313

Telecoms €1,000 €983 €1,983

Networks €4,505 €4,335 €8,840

Networks ‐ token meters €3,008 €3,079 €6,087

Misc. Others €523 €514 €1,037

Corporate centre €2,484 €2,442 €4,926

Total Inter BU costs €26,573 €26,151 €52,723

Total Supply Costs €87,422 €83,783 €171,205 Table 4.1 Domestic Customers OPEX for 2011-12 period.


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4.2 Review of OPEX The objective in setting an allowed OPEX was to ensure that efficiency improvements continue to be made, to the benefit of customers. The approach taken ensures that the allowed operating expenditures meet this objective Setting allowed OPEX for the 2011-12 price control period involved a number of steps.

1) An analysis was first undertaken to evaluate PES’s performance over the previous review period to determine whether or not (a) expected efficiencies in OPEX were achieved and (b) any efficiency improvements in the controllable OPEX were achieved. This analysis also sought to identify where any over/under spend had occurred. In addition, any accounting or financial issues were identified, with a view to avoiding any difficulties that these might present at the next review.

2) The historical OPEX analysis and trends found were used as background to the assessment of the forward-looking OPEX. The forward-looking OPEX, as proposed by PES, was benchmarked against comparable companies, and checked for consistency with the trend over the first control period.

3) The recent market developments were taken into consideration, including the deregulation of the business market and the requirements this places on the separation of costs between the regulated and unregulated business areas.

As part of the evaluation of future efficiency levels, the OPEX costs were also split between controllable and non-controllable costs. In addition, the implication of the capital expenditure programme was taken into account in the evaluation of required future OPEX. These inputs, along with a bottom-up review of the forecast OPEX submitted by PES, guided the CER’s views on the allowed level of OPEX for the 2006 to 2010 control period.

4.3 Payroll PES’s historic data shows that payroll costs increased over the 2006-2010 period. Wages/Salaries specifically, and "personnel"-type expenses generally have gone up and most noticeably towards the end of the price control period. There have also been variances in the number of employees which decreased in 2008, but increased in 2009.


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Total customer service centre costs have gone up a little faster than overall payroll, increasing by 33% (€4 million) since 2007. Most of that is driven by higher costs per customer service staff member. PES attribute the recent increase in employees (both FTE and contracted) to the following factors:

1) An increase in workloads at the call centre 2) A recent review of the PES business and business processes

In payroll costs, we also see multiple extraordinary charges associated with the cost of the ESB defined benefit pension plan. These are largely borne by ESB, and not by customers, with the exception of a €1.52m contribution towards the pension deficit as outlined in a CER decision paper published in October 200620. However PES projected that payroll costs will fall by €3.8 million, or 11%, from 2009 through 2012. This reflects a workforce reduction of 66 FTEs over the same time period partly driven by PES’s plan to close 10 customer service centres as a result of its lower market share. There has been a rapid change in the retail market and PES volumes of customers over the past 18 months. While the CER would expect PES staff numbers to fall over time to reflect this change, it is reasonable to expect some rigidity in staffing levels and there is not an expectation that staff levels would fall as quickly as loads. Therefore it is the CERs view that the staffing numbers submitted by PES for the 2011-12 period are reasonable. In addition the CER has examined the average payroll cost per employee to ensure that it is reasonable. Table 4.3 below shows the average payroll cost per employee from 2009 to 2012 as per the PES submission. The average cost per employee has increased by 2% over the period. The CER has made decisions in previous revenue reviews as to the level of any wage increases up to 2010. However PES submitted payroll costs increase by 1% in 2011 and 2.4% in 2012.

2009 2010 2011 2012Outturn Forecast Forecast Forecast

€ 65,498 € 64,697 € 65,254 € 66,841

PES Average payroll cost per employee

Table 4.3 – PES Average Payroll Cost Per Employee 2009-12

Note: Payroll figures are presented in 2010€ Both the private and public sectors have had to meet the challenges presented by the current recession. One response has been to cut payroll cost; wages have been cut in both the public and private sectors of the Irish economy. While 20 Electricity Allowed Revenue and Tariff Final Determination 2007 - Overview of the Decision Papers CER06207


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definitive statistics are not available at this time, a recent ESRI document expects a nominal wage decrease in the region of 6% over the 2009 to 2011 period21 and this is highlighted once again in their Spring 2010 quarterly economic commentary which shows wage growth of -2%, -3% and -1% in 2009, 2010 and 2011 respectively. Therefore the CER has decided not to allow the full payroll costs submitted by PES, but to reduce the payroll costs by 5%. The ESRI Medium Term Review 200822 forecasts that the average growth in productivity of the Irish economy to be 2.5% per annum over the period 2011 to 2015. The PES’s activities are supported by significant levels of IT investment and the introduction of competition should provide incentive to drive efficiency gains. The CERs expects that PES would achieve these levels of productivity and are therefore incorporate this into the allowed payroll costs. Table 4.3.1 below shows the payroll costs allowed for 2011 and 2012.

Year Allowed Payroll Costs €,000

2011 20,403€ 2012 19,907€ Total 40,309€

Table 4.3.1 – Allowance for Payroll Costs 2011 & 2012

4.4 Contractors The PES submission showed that contractor costs rose 20% between 2006 and 2009, but are forecast to fall below their 2006 level by 2012. PES attributed the rise in contractor costs to increased need for third-party debt collection contractors and increased outsourcing of call centre costs. Given the rise in bad debt costs and call length and volume, the CER view this increase as reasonable. The forecast drop in contractor costs of 24% between 2010 and 2012 is in line with the drop in customer numbers over the same period. The CER has decided to allow the full €17.89m cost of contractors for 2011 and 2012.

4.5 Materials for Goods and Service PES’ costs for materials for goods and service averaged €0.46m between 2006 and 2009, with little discernable trend. The PES submission included an expected drop to €0.31m in 2010, with costs remaining at the same level in 2011 and 2012. The CER has decided to allow the full costs submitted by PES.

21 The ESRI document ‘Recovery Scenarios for Ireland’. 22 ESRI Document - Medium-Term Review: 2008-2015


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4.6 Transport & Communications The cost of transport and communications has risen gradually between 2006 and 2010. Due to lower customer numbers, the PES submission included an expected fall of 23% by 2012. This fall is in line with the reduction in customer numbers and the CER has decided to allow the full costs submitted by PES.

4.7 Establishment The PES submission showed that premises costs are forecast to increase to €0.25m per annum for both 2011 and 2012. This figure is slightly above the 2006 to 2009 average of €0.2m, but at the same level as the 2010 budget. A premises cost that remains constant in real terms is reasonable, given the fixed nature of this expense. The CER has decided to allow these costs.

4.8 Computer PES expects computer costs to remain close to 2009 levels of €0.29m. The average over the 2006 to 2009 period was €0.27m. The CER does not expect large reductions in computer costs during a short (i.e., two-year) control period. The CER has therefore decided to allow the forecast level of cost, as proposed by PES.

4.9 Selling & Advertising Selling and advertising costs increased by an average rate of 8% over the 2006- 2010 control period, although they remained below the level allowed by the CER in CER/05/164. However there was a significant increase in overall selling and advertisings costs between 2009 and 2010, which raised the question of whether the increase is related to ESBCS’ preparation to enter the deregulated market.

The PES submission included higher selling and advertising costs in 2011-2012 and the main types of expenditure included in the non-energy efficiency sales and advertising budget relate to customer care and communications including:

- Explaining and communicating information on tariffs, price changes, understanding your bill and industry changes.

- Bill inserts (customer advise highlighting Customer Charter and vulnerable customer code of practice, payment terms and methods, safety awareness)

- Promotion of lower cost to serve payment methods - Customer Research


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- Compliance with the Official Languages act - Bill redesign - Customer support ,including

o Support for Know Your Neighbour Week o Support for Positive Ageing week o Saint Vincent de Paul support

- Community support and sponsorships for the GAA All Ireland minor championship, Hockey, U21 Irish Rugby and Feis Ceol.

PES has submitted for a total of €5.33m in 2011 and €5.38m in 2012. The CER was not satisfied that the increase between 2009 and 2010 of 32% is justified and therefore has made the decision not to allow the full cost of selling and advertisings submitted by PES. Instead the CER has decided that PES are to be allowed recover €4.8 million in each year.

4.10 Professional Fees The outturn level of spending for professional fees in the prior control period ranges from €3.0m in 2006 to €3.9m in 2009. PES undertook a thorough review of its business processes, which led to the increase in 2009. For 2011-2012, PES projects professional fees will fall to an annual level of €3.3m. The CER views a reduction from 2009 levels to be appropriate, particularly since the business process review was a one-off expenditure and therefore has decided allow the full costs submitted by PES.

4.11 Depreciation The PES submission showed depreciation costs increasing every year between 2006 and 2009 (a total of 43%), but falling by half between 2009 and 2010. PES attributed the increased depreciation to SEM-related capital expenditures and a new billing system. The fact that the depreciation term on these items is short explains the abrupt drop off in 2010. In keeping with this explanation, the forecast is for depreciation to be markedly lower than prior years going forward. Depreciation will not be eliminated entirely, however. The PES submission included several capital projects planned for the period 2010 through to 2012, which they forecast create depreciation charges totalling €17.8m in the 2011-12 period.

PES has provided a rationale for these new capital programmes, which are IT related. The CER has sought evidence that the capital programs are ones that would have been implemented regardless of the imminent deregulation of the business customer segments. NERA identified one set of activities that were clearly undertaken to prepare for deregulation, which was the IVR Improvements Project. The CER has decided not to allow recovery of the costs of this project


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from regulated customers. The final decision is to allow a total of €17.4m to be recovered for depreciation over the 2011-12 period.

4.12 Bad Debts In their submission, PES showed bad debts rising sharply in 2008 (20%) and 2009 (115%) as the economy worsened. PES attributed increased bad debts to economic hardship, lower credit quality customers remaining with the PES tariff, and increased customer switching leading to stranded unpaid accounts. Following the sharp rise in 2009 and 2010, PES projected that bad debts would recede gradually from a total of €15m for domestic customers in 2010 down to €10.5m and €9.3m in 2011 and 2012 respectively. This assumes improvements to the overall economic climate.

The CER recognises the deterioration in the economic climate over the past number of years and the increase in bad debts this is likely to cause. The latest ESRI forecast contained in spring 201023 quarterly commentary shows both GNP and GDP returning to positive, growth figures in 2011 of 2.75% and 2.5% respectively. Therefore the CER is of the view that PES should see a reduction in the levels of bad debt. PES’s submission includes bad debt levels of 1.6% of turnover in 2011 and 2012. Whilst the CER is aware of the economic situation that prompted the increase in bad debts, the 1.6% level included in the submission is significantly above the average level over the past five years. In order to incentivise PES to reduce the level of bad debt the CER is allowing PES recover bad debts at 1% of forecast turnover. This reduces the bad debt allowance to €6.57m and €5.8m for 2011 and 2012 respectively.

4.13 ESB Corporate Centre, Service Agreements & Inter Business Unit Costs

A portion of PES’s costs derives from work completed by other parts of the ESB Group for PES. During the 2006-2010 period, this category of cost represented PES’ largest expenditure (when the PSO is included, and second largest expenditure with the PSO excluded). These costs generally reflect the following activities:

1) Allocation of the ESB Corporate Centre costs to PES. The corporate centre is presumed to provide value for each business division and each receives an allocation of the costs.

23 ESRI Quarterly Economic Commentary, Spring 2010


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2) Service Level Agreements. These are services (primarily IT, but also HR, facilities, accounting, procurement) provided by ESB to PES under explicit contracts.

3) Other inter-business unit costs. This includes field services provided by networks, and other services not covered by the service level agreements.

The movement in PSO – particularly the large drop in the PSO from 2006 to 2007 – masks the true movements in ESB-related expenditures over the control period. When PSO is excluded, we see that ESB-related costs were relatively stable during the control period, with a slight net trend downward, driven by a consistent trend down in payments for other business services. There was, however, an increase in shared services costs of 13% from 2006 to 2009, and a subsequent decrease of 10% in 2010. PES attributes these changes to SEM-related activities. Figure 4.13 below illustrates the trend for inter-business unit costs from 2006-2012.

Figure 4.13 – PES Inter-Business Unit Costs 2006-2012

The PES submission showed that ESB-related expenditures are anticipated to remain fairly flat, at between €30 and €31 million per year. These numbers are consistent with the expenditures in 2010, the end of the prior control period. Prior to 2010, they had been significantly higher.


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The level of ESB-related expenditures proposed by PES was lower than prior approved levels for these costs. The CER recognises that most of these costs will remain after the deregulation of the business market segment takes place and that PES still has licence obligations related to SOLR etc. Therefore the CER is satisfied that the level of inter business costs included in the PES submission is reasonable, however the CER‘s view is that, in line with the ESRI Medium Term Review discussed in Section 4.3, the same increases in productivity that can be achieved in payroll should be seen in the work undertaken by other parts of the ESB group. The CER has therefore decided that a productivity increase of 2.5% per annum be incorporated into the allowance. The allowance for ESB Corporate Centre, Service Agreements & Inter Business Unit Costs is therefore set at €26.6m and €26.2m for 2011 and 2012 respectively.

4.14 Uncertain Costs As discussed in Section 3.6, there are no uncertain costs included for 2011, but the CER will consider any submissions made by PES for the 2012 review.


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5.0 Consultation Responses The CER received a total of three written submissions during the consultation period. The responses are published in full on the CER website. This section highlights some of the key points which were raised and provides the CERs view on each of the issues, which include:-

• Costs Allocation • Treatment of over/under recovery following deregulation • Application of HICP over 2006-2010 control period • Introduction of variable element to price control • Incentive Mechanisms • Bad Debts • ESB Corporate Centre, Service Agreements & Inter BU Costs • Depreciation • K-Factor • Cost to Serve

5.1 Consultation Issues 5.1.1 Costs Allocation Respondents’ Comments One respondent requested a clear and detailed breakdown of how all of these supply costs are individually allocated across the different customer/tariff categories. CER View In the original consultation paper, section 5.3 provided a detailed breakdown of how supply costs are to be allocated between regulated and unregulated customers. The CER and NERA did not identify any evidence in the proposed cost allocation to suggest that there is any cross subsidization from domestic to business customers. Supply costs are then allocated between the different domestic tariffs on a cost to serve basis, as in previous years. 5.1.2 Treatment of over/under recovery following deregulation Respondents’ Comments One respondent asked for the CER to provide details of how any accrued over/under recovery will be treated once PES’s market share has reduced far enough to trigger deregulation.


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CER View The CER published its decision paper on the ESB PES's Revenue Regulation Framework in May of this year in which it was set out that quarterly reviews would be undertaken to ensure that PES tariffs remain cost reflective. In addition, if at any time through the year, revenue forecasts move outside a 3% band then PES must notify the CER and adjust tariffs to bring revenues back in line with the forecast MAR. Therefore tariffs will remain cost reflective within the 3% band and this will be continuously monitored right up until deregulation takes place. When the criteria for deregulation of the domestic market has been reached and deregulation takes place, then any over or under recovery at the time of deregulation will be absorbed by PES. However, the 3% band will effectively limit the size of any over or under recovery that PES will absorb. 5.1.3 Application of HICP over 2006-2010 control period Respondents’ Comments One respondent requested that the CER provide details of how the allowed revenues for ESB PES, ESB Networks and EirGrid would have differed had HICP been used instead of CPI as the measure of inflation over the past five year control period. CER View The CER has published annual consultation and decision papers for all three entities over the 2006-2010 control period. Using these papers it is possible for any interested stakeholder to calculate how the allowed revenues for these three entities would have differed if HICP had been applied. 5.1.4 Introduction of variable element to price control Respondents’ Comments Given the uncertainty over the levels of switching and PES customer numbers for the next two years, one respondent proposed the inclusion of an adjustment for variable costs in the regulatory formula. CER View As set out in the consultation paper the removal of the K-factor adjustment removes one of the primary reasons for adjusting supply costs from year to year. In addition the paper set out that in any subsequent reviews there will be an adjustment for inflation and the inclusion of any necessary uncertain costs.


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The control period is short relative to previous five year periods. However, as in previous price controls the ex ante approval of OPEX charges and allowable CAPEX allows PES to benefit from “regulatory lag” and encourages PES to pursue efficiency-enhancing measures. 5.1.5 Incentive Mechanisms Respondents’ Comments In their response, PES requested that the target for the Speed of Telephone Response targets should remain at 80% for 2010 in order to facilitate the NCCC’s transition to a First Call Resolution environment. CER View The CER accepts that there is a need to allow additional time for the transition to the First Call Resolution methodology, which will bring about improved customer service. Therefore the CER has revised the 2010 target for Speed of Telephone Response to 80%. 5.1.6 – Bad Debts Respondents’ Comments A couple of responses questioned the CER’s proposal to allow bad debt levels based on 1% of sales, as opposed to the PES submission which allowed for a 1.6% level. It was requested that the CER review the proposed reduction. CER View As set out in the consultation document he CER recognises the deterioration in the economic climate and the increase in bad debts this is likely to cause. However, given the ESRI’s forecast of a return to positive economic growth in 2011 and the previous price control capped bad debts at 0.5% of turnover, the CER is of the view that a 1% level should be sufficient and will incentivise PES to reduce the level of bad debt. 5.1.7 ESB Corporate Centre, Service Agreements & Inter BU Costs Respondents’ Comments One respondent requested the CER review it decision to reduce the ESB Corporate Centre, Service Agreements & Inter Business Unit Costs, included in the PES submission by 2.5%. It was argued that many of the costs based on market rates for these services and that the proposed reductions are effectively a reduction to below market rates.


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CER View The CER expects that ESB business should be able to introduce the productivity gains in line with the average growth in productivity of the Irish economy forecast in the ESRI review. Therefore the CER is incorporating the 2.5% per annum productivity gain into the PES price control for 2011-12. 5.1.8 Depreciation Respondents’ Comments One respondent requested that the CER review the proposed decision not to allow recovery of the costs of the Interactive Voice Response (IVR) enhancements. The rationale is that the CER over-estimated the cost of the project and also that the IVR project is necessary and reasonable. CER View CER relied upon the forecast budget provided by PES for the capital costs of the IVR project. The PES budget foresees that an upgrade will be required to IVR in 2011 with an expected budget cost of €1m. In light of these capital costs, the adjustment for IVR depreciation proposed by the CER in the Consultation paper remains appropriate. 5.1.9 K-Factor Respondents’ Comments One respondent found that the exclusion of the accumulated K-Factors negatively impacts on competition and may actually undermine competing suppliers. In addition, while certain aspects of the K-Factors may not be viewed as efficient costs it was stated that other elements, which in the respondents view relate to uncontrollable costs such as increased capacity charges and energy procurement and as such represent real costs in supplying electricity to customers. Bearing these factors in mind it was requested that the CER review its proposal with regard to K-Factors and to delineate those associated costs that were reasonably incurred in the provision of services to customers. CER View With regards to the 2010/11 regulated tariffs, the CER has decided not to include any of the accumulated K-Factors. However, as set out in the consultation paper, the CER recognises that a proportion of the costs in the accumulated K-Factors may have been legitimately incurred in the context of the prevailing regulatory framework, The CER will give further consideration to potential recovery


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mechanisms to ensure that neither ESBCS nor independent suppliers are unduly disadvantaged in an increasingly competitive market. 5.1.10 Cost to Serve Respondents’ Comments One respondent stated that the expected decrease in the cost to serve over the two year period appeared to be very high and requested that the CER provide more detail on any strategy devised to reduce the cost to serve. CER View The respondent was incorrect in concluding that PES’ per-customer cost to serve is expected to decrease. As noted in the consultation paper, the per-customer cost to serve is projected to increase over the 2011-2012 period, as PES’ fixed costs are spread over fewer customers


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6.0 Conclusions

6.1 Summary of Allowed Revenue 2011 & 2012 The CER has set out its decision on the approach to setting out the PES allowed revenue for the 2011-12 period as well as the total revenues. Table 6.1 below shows the breakdown of the total €171.6m figure, for allowed revenues in 2011-12, that PES are to recover through the regulated tariffs.

Proposed PES Allowed Revenue 2011 2012 Total€,000 €,000 €,000

Opex Cost Category

Payroll €20,403 €19,907 €40,309Contractors €9,479 €8,414 €17,893Material & goods & Services €292 €294 €586Transport & Communications €6,933 €6,153 €13,086Establishment €230 €232 €462Computer €276 €278 €554Selling & Advertising €4,800 €4,800 €9,600Professional Fees €3,116 €3,142 €6,258Depreciation €8,747 €8,615 €17,362Bad Debts €6,571 €5,797 €12,367Inter BU Costs €26,573 €26,151 €52,723Other €3 €1 €4Total Operating costs €87,422 €83,783 €171,205

Additional Costs

Uncertain Costs ‐€ ‐€ €0Incentive Mechanism 388€ ‐€ €388Total Allowed Revenue €87,810 €83,783 €171,593

Table 6.1 Summary of Allowed Revenue for 2011-12 period

6.2 Summary of Allowed Revenue for 2010/11 MAR Given that the 12-month MAR period straddles two different calendar years, that is, the last 3 months of 2010 and the first 9 months of 2011, the cost allowance for the PES business (to be reflected in the PES retail tariffs) corresponds exactly to the same 12-month period. Thus the final allowed revenue to be included in the 2010/11 MAR period must take account of 75% of the 2011 allowed revenue


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and the appropriate allocation of the portion of the 2010 allowed revenue applicable to domestic customers – as set out in Section 3.8. The CER has decided that a total of €94.67m be included in regulated tariffs over the 2010/11 MAR period. The calculation of this figure is shown in Table 6.2 below.

Table 6.2 – Allowed Revenue to be included in 2010/11 tariffs

Finally, the CER has decided not to include any K-factors in the 2010/11 regulated tariffs. Recognising that a proportion of the costs may have been legitimately incurred in the context of the prevailing regulatory framework, the CER will give further consideration to potential recovery mechanisms to ensure that ESBCS is not unduly disadvantaged in an increasingly competitive market.