Select Committee on Trade and Industry Appendices to the Minutes of Evidence


Further Supplementary memorandum by Lattice

  Thank you for your letter of 13 December regarding the concerns expressed to the Trade and Industry Select Committee that speculative international investments by the Lattice Group might imperil its financial integrity and in turn jeopardise the ability of the Group's principal subsidiary, Transco, to fulfil its functions as the principal provider of Britain's gas transportation infrastructure. You invite our observations on this matter.

  I can readily confirm that in the case of the Lattice Group and Transco there are secure regulatory safeguards in place which will ensure Transco's continuing financial integrity and ensure delivery of safety, reliability and customer service standards required by law and by the regulator.

  Transco's licence contains special conditions, known as "the ring-fence conditions" which were introduced in December 1999. Essentially, these special conditions ensure that Transco has sufficient management and financial resources to carry out its business, and that its parent company is unable to take any action which would jeopardise Transco's current and future financial integrity. Full details are provided in the attachment.

  The Lattice Group is engaged in providing and managing network infrastructure and related services, mainly in the field of gas. There are compelling commercial reasons for the Lattice Group to be prudent in developing its other businesses and managing the associated risks. It is a capital-intensive asset-based business which, in the interests of its shareholders, must achieve a high degree of capital efficiency. This entails relatively high gearing with debt and the prudent, rigorous management of risk throughout the Group. The credit ratings of both the Lattice Group and its principal subsidiary, Transco, are a prime factor in the financial performance of the Group. It follows that the Group's strategy is pre-disposed against speculative overseas investment.

  I trust that this provides the information and assurance which you are seeking.

4 January 2002


  Transco's Licence, which allows it to operate as a gas transporter in Great Britain is subject to a number of ring-fence conditions, separating it from other activities of the Lattice Group.

  Without the written consent of the Gas and Electricity Markets Authority (the Authority) neither Transco, nor its subsidiaries, may carry on any activities other than those permitted by the Licence. These activities are Transportation of gas and LNG Storage, Metering and Meter Reading in Great Britain. The Licence also permits Transco to carry on "de minimis" businesses to encourage innovation, but in aggregate these can only amount to 2½ per cent of Transco's turnover or capital.

  Under the Licence, Transco is obliged to act at all times in a manner best calculated to ensure that it has sufficient management and financial resources and financial facilities to enable it to carry on the transportation business and to comply with its statutory and Licence obligations. Each year Transco's Board has to certify to the Authority whether it has a reasonable expectation that these facilities and resources will be available to Transco to carry on its obligations for the next 12 months. The certificate has to be accompanied with a statement of the main factors which the Directors of Transco have taken into account in giving the certificate. If Transco becomes aware of any circumstances that causes it no longer to have the expectation expressed in the most recent certificate, it has to inform the Authority immediately. Furthermore, the directors of Transco cannot declare any dividend (nor shall Transco make any other form of distribution to Lattice) unless it has first issued a certificate to the Authority that it is in compliance in all material respects with the obligations imposed by the ring fence, and that the making of the distribution will not cause Transco to be in material breach of these obligations in the future.

  Other aspects of the ring fence are that Transco must use reasonable endeavours to ensure that, as an issuer of corporate debt, it maintains an investment grade issuer credit rating and it is not permitted to guarantee the obligations of a third party (whether or not Lattice). Without the consent of the Authority, Transco is only permitted to borrow for its permitted activities and on an arms' length basis/normal commercial terms. In addition, Transco is only able to enter into transactions with other members of the Lattice Group in certain limited circumstances (essentially on an arms' length basis/normal commercial terms); there must be no cross subsidy between Transco and other members of the Lattice Group and, in conducting the transportation business, Transco must not confer any unfair commercial advantage on an affiliate.

  Transco is, of course, also subject to a number of other onerous obligations under the Gas Act and the Licence, including safety obligations and obligations to connect premises and convey gas. Transco has a price control, which is reviewed every five years by the Authority, which is intended to ensure that Transco can meet all its obligations and finance its activities. Its delivery of safety, reliability and customer service standards is monitored by Ofgem and by the Health and Safety Executive.

  Transco is also protected from actions by other members of the Lattice Group because, under the Licence, Lattice is obliged to give—and has given—a legally enforceable undertaking in the form specified by the Authority that the members of the Lattice Group will refrain from any action which would be likely to cause Transco to breach any of its obligations under the Gas Act or the Licence. If Lattice breach this undertaking, Transco has to comply with any directions from the Authority to enforce it.

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