A new pricing framework for Openreach

Statement published 22|05|09

Summary

Introduction

1.1 In May 2008, we published a consultation document, "A New Pricing Framework for Openreach" (the "First Consultation"). This set out our intention to review certain aspects of the regulatory regime, including the prices of the regulated access network services; certain other access and backhaul services are covered by the separate Leased Line Charge Control review. The scope of this review included the prices for WLR, MPF and SMPF rentals (the "Core Rental Services") and related services.

1.2 In December 2008, we published a range of proposals for modified price controls (the "Second Consultation"). The Second Consultation set out the key assumptions and parameters we proposed would be taken into account in reaching our final conclusions on any new price controls. In particular, we invited views on the methodology and assumptions used in arriving at these proposals. Informed by responses received during this consultation, we are now setting prices for MPF and SMPF. This Statement sets out these prices and the bases for the underlying calculations including our impact assessment.

1.3 In response to the Second Consultation, the European Commission recommended that we delay implementation of new WLR prices until the outcome of the ongoing Wholesale Narrowband Market Review is known. In light of this recommendation, we have not determined new prices for WLR at this stage.

1.4 If, as we propose in the Wholesale Narrowband Market Review Consultation, we find that there is still a need for WLR price controls, we would expect to set new prices later this year. We will shortly be publishing a consultation document setting out our proposals for these prices. To a significant extent, these will draw upon the analysis summarised in this Statement.

1.5 As well as the Core Rental Services, Openreach provides a range of other services, related to the provision of the MPF and SMPF rental services. These are currently subject to price control and/or cost orientation obligations. In the Second Consultation, we proposed that these services should be subject to price controls applied to appropriately defined baskets. This Statement sets out our determination of the appropriate design of these baskets and the related controls.

The Second Consultation

1.6 In December 2008, we set out proposed ranges for the new controls. They comprised two elements: the proposed price ceilings for 2009/10 and the proposed indexation of the ceiling for the MPF and SMPF services in 2010/11.

1.7 We explained that the final combination of 2009/10 charge and subsequent indexation in 2010/11 would be determined such that – if an equivalent annual indexation were to apply until 2012/13 - it would deliver a price that equals our final assessment of the projected efficient fully allocated cost of each service in the final year. For the purposes of illustration, we calculated the proposed indexation ranges for 2010/11 indexation assuming that these would start from the mid-point of the respective range for the proposed 2009/10 charges. The illustrative indexation ranges were estimated such that – if applied to this mid-point starting charge – they would allow prices to approach fully allocated costs by 2012/13.

1.8 On this basis we proposed the following combination of 2009/10 charges and subsequent indexation in 2010/11.

Table 1.1: Proposals from Second Consultation

Service	Current price cap	Proposed price from 1 April 2009	Proposed indexation on 1 April 2010
MPF rental	£81.69	£85.00 to £91.00	RPI + 0.0% to RPI + 5.0%
SMPF rental	£15.60	£15.60 to £16.20	RPI - 2.5% to RPI + 1.5%
WLR residential rental	£100.68	£100.68 to £104.40	See paragraph 1.10
WLR business rental	£110.00	£106.00 to £110.00	See paragraph 1.10

 

1.9 We proposed that the LLU charge controls would apply for a period of two years. The period would ensure charges were appropriate for the period leading up to the completion of the next Wholesale Local Access Review at which time the future requirement for LLU and related charge controls would be determined. We confirmed the appropriateness of a modification of the LLU controls in the absence of the recent Market Review through a determination that the market had not experienced a material change since the last Market Review.

1.10 We also explained that the ongoing Wholesale Narrowband Market Review would consider whether the WLR remedy was still necessary in the longer term. On this basis, we did not propose price changes beyond 2009/10.

1.11 Our proposals were set out in ranges. We set out how we would finalise the controls based on a number of factors discussed in the consultation.

1.12 We also explained that there were significant uncertainties surrounding the short term macro-economic outlook and capital markets continued to exhibit unusual levels of volatility. We explained that setting new price controls in this context is challenging and we recognised the possibility that certain eventualities (such as general price deflation) may present unforeseen challenges that might necessitate review of the controls that we may set following the consultation.

Recent developments

1.13 We received 14 responses to the Second Consultation. These are listed in Annex 11. We have published non-confidential responses on our website . As set out in this Statement, responses included comments on the following:

• The appropriate approach to setting prices, including the appropriateness of fully allocated costs as the basis for setting charges;
• The underlying assumptions to be used in our cost modelling, including the need to take account of recent economic developments;
• The implications of the proposed price changes, including the impact of price changes on consumers;
• The appropriate notice period ahead of any price changes; and
• The level of transparency provided by the December Consultation.

1.14 The responses included comments from the European Commission as part of the community-wide consultation which ran in parallel with the national consultation. As noted above, this included a recommendation that we delay implementation of new WLR prices until we have concluded the ongoing Wholesale Narrowband Market Review is known. The Commission also invited us to re-notify our final decision setting the regulated wholesale prices and price caps for LLU. We have decided not to take up this recommendation for reasons set out later in this statement (see Section 2).

1.15 This Statement sets out how we have taken these responses into account in making our final decisions on prices.

1.16 The economic uncertainty observed in December still prevails. General price deflation (as measured by the retail price index) now looks likely in the short term and commodity prices have fallen. Stakeholders, including BT and Sky have made public announcements regarding their intentions regarding their future use of MPF and we now have better visibility of Openreach’s financial projections and operating plans for in 2008/09 and 2009/10. We have taken account of this new information in setting the new price controls. As explained in this Statement, the impact of these developments has been to reduce our estimates of the likely cost of providing the services in 2009/10.

New prices

1.17 Informed by the responses to our consultations, we have set new price controls for the MPF and SMPF rental services. As proposed, these controls comprise two elements: price ceilings for 2009/10 and indexation of the ceiling for the services in 2010/11. We do not consider it is appropriate to set charges beyond two years as this would extend the controls beyond the expected review of the requirement for LLU within the Wholesale Local Access Review.

1.18 As proposed in the Second Consultation, we have determined a combination of 2009/10 charge and subsequent indexation in 2010/11 such that – if an equivalent annual indexation were to apply until 2012/13 - it would deliver a price that equals our assessment of the projected efficient fully allocated cost of each service in the final year.

1.19 Historically, linking prices to RPI has provided protection for all parties against unexpected movements in inflation. To provide this protection the RPI data needs to provide a relevant measure of the cost pressures facing the supplier during the period in which the price control is to apply. However, it must also provide a workable approach. In practical terms, this means it must be based on historical published data. For the purposes of the indexation in 2009/10, the RPI data will be for October 2009.

1.20 As explained in this Statement, we note that the October 2009 RPI is unlikely to provide a reliable indicator of the inflationary pressure facing Openreach for the relevant period. Specifically, the October RPI data is likely to show a much lower level of reported inflation than we consider should be used in setting the 2010/11 control due to the impact of changes in VAT and mortgage interest rates on the reported RPI. The values of the Xs set out below have therefore been adjusted to allow for this bias. The effect of this adjustment has been to increase the values of the Xs in 2010/11 by approximately 4%.

Table 1.2: New controls on MPF and SMPF

	Current price	Price in 2009/10	Indexation in 2010/11
MPF	£81.69	£86.40	RPI +5.5%
SMPF	£15.60	£15.60	RPI +1.0%

 

1.21 BT is free to implement these charges 28 days from 22 May 2009.

1.22 Until the conclusion of the Wholesale Narrowband Market Review and the related review of the WLR charge control, the prices for residential and business WLR rental services will remain at their current levels, of £100.68 and £110.00 respectively.

1.23 The price controls to be applied to the baskets of other services are described in detail in Section 6 and summarised in Table 1.3. These are described in two parts: the allowable indexation in 2009/10 and the indexation on 1 April 2010. Only the indexation for 2010 is linked to RPI. The baskets also include some one-off adjustments to MPF new provide, MPF and SMPF connection charges.

Table 1.3: New controls on Ancillary Services

Service	Indexation in 2009/10	Indexation on 1 April 2010
MPF ancillary services	3.0%	RPI +4.5%
SMPF ancillary services	3.0%	RPI +4.5%
Co-mingling services	3.0%	RPI +4.5%

 

1.24 New prices on these services can be implemented under existing regulatory rules on notification, that is, 90 days after BT gives notification of any proposed changes.

Ongoing review

1.25 We explained in December that, in light of the ongoing economic uncertainty, we recognise the possibility that certain eventualities may present unforeseen challenges that necessitate review of the controls that we may set following the consultation. As proposed in December, we will closely monitor the effectiveness of our new controls, and intervene if such circumstances require. However, we recognise that such intervention is not without risk and potentially introduces an additional level of uncertainty. Such intervention will be at our discretion and will not be based on any automatic trigger mechanism.

1.26 Also as explained in this statement, our cost calculations exclude Openreach’s share of annual payments made by BT to address the funding shortfall in its pension scheme. While this approach is consistent with our historic treatment of pension deficits and surpluses, we consider that this issue is of increasing importance to the companies we regulate. Accordingly, we propose to undertake a separate review of our treatment of pension costs which will inform our future approach.