Ofgas have today published the Monopolies and Mergers Commission's (MMC) Report on the regulation of prices for BG Transco's gas transportation and storage services for the period April 1997 to March 2002. This follows the reference made by Ofgas in October 1996 after British Gas rejected Ofgas' proposals for a new price control.

The effect of the MMC's proposals, including the adjustment to take account of the under-recovery of revenue in 1996/97, will be to reduce Transco's revenue by 5 per cent in 1997/98, compared with 1996/7, and a further 7 per cent in 1998/99, followed by increases of 1-2 per cent in each of the subsequent 3 years.

The MMC have estimated that the implied average reduction per therm in gas transportation charges for Transco's customers - the gas shipping companies - will be 21 per cent (before adjustment for the under-recovery of revenues from the current period) in the first year (Po) followed by average annual reductions for the next four years of RPI-2 per cent.

Commenting on the MMC's findings and recommendations and BG's willingness to settle on the basis of them, David Varney said:

"The MMC Report has provided the opportunity to end a prolonged period of regulatory instability and uncertainty. To this end, we have already begun to work with Ofgas in rapidly translating the MMC's recommendations into new licence terms, with agreement reached on a number of points.

"Last October, after careful consideration, we rejected Ofgas' proposals. We did so because we believed that the resources provided would have been insufficient to maintain a safe, reliable and efficient gas infrastructure while providing a fair return to shareholders. Also we were concerned at the lack of incentives provided by the regulatory framework, and the opportunities for Ofgas to intervene extensively in Transco's operations.

"We particularly welcome the MMC's clear endorsement of an RPI-X incentive-based regulatory framework which gives us the freedom of action to benefit our shareholders and customers through the quality of Transco's performance.

"This is a tough settlement, but provided we continue to improve our efficiency, one which we believe will enable us to manage and finance our business effectively. The MMC's recommendations provide more resources and a better regulatory framework, enabling us to strive for two goals - providing high standards of service for Transco's customers, and meeting the expectations of our shareholders.

"Early settlement of the licence terms will enable Transco to concentrate on improving the business and meeting the demands which it faces as a prime enabler of the fully competitive gas supply market in Great Britain."

A disappointing feature of the Report was the reversal of the MMC's previous policy on asset valuation, with the adoption of a regulatory asset base (RAB) of £11.6 billion compared with the true replacement cost of £17 billion in Transco's books. As a result of this fundamental change, BG plc intends to write down the value of the Company's assets in Transco by some £5 billion so as to align the balance sheet in the statutory accounts more closely with the regulatory balance sheet.

However, the MMC have addressed BG's concerns over the potential for uncertainty in moving from replacement cost valuation to a RAB. The MMC's clearly stated intention is that their recommended method of valuation should establish once and for all the accounting basis on which shareholders are rewarded. This secures past and future investment in Transco. Attachment 1 provides further details.

The MMC also acknowledged BG's concerns over Ofgas' operating cost proposals, allowing an additional £445 million over the price control period.

Dividend

The dividend policy for BG plc set out in the Demerger Circular to shareholders was that the international activities would be self-financing and that Transco's current cost profit, after servicing its regulatory capital and taxation, would be fully dedicated to the payment of dividends.

It is intended that both the statutory consolidated accounts for BG plc and Transco's regulatory accounts will cease to be prepared on a full CCA basis. The depreciation charge will therefore be lower than under full current cost accounting leading to an increase in reported profits not reflected in higher underlying cash flow. Therefore, the expression of dividend policy will be revised in the light of this change at the time of the next dividend declaration in mid-September. The international activities will continue to be self-financing.

Management Appointments

In conjunction with the MMC settlement, BG announced two key management appointments. Phil Nolan has been appointed Managing Director of Transco with immediate effect; and Howard Higgins will take responsibility for separating and independently managing the Storage business as soon as practicable. This development continues the organisational changes already being made within Transco and is consistent with the MMC's recommendation of the separate price regulation of storage.

Both the Managing Director of Transco and the Managing Director Designate of the new Storage business will report directly to David Varney, Chief Executive of BG plc, who will remain the Executive Director responsible for Transco, and later Storage.