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	England and Wales Court of Appeal (Civil Division) Decisions
You are here: BAILII >> Databases >> England and Wales Court of Appeal (Civil Division) Decisions >> Scottish Power Plc, R (on the application of) v The Director General Of Electricity Supply [1997] EWCA Civ 911 (03 February 1997) URL: http://www.bailii.org/ew/cases/EWCA/Civ/1997/911.html Cite as: [1997] CLY 4949, [1997] EWCA Civ 911

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IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
CROWN OFFICE LIST
(Mr. Justice Ognall)

		Royal Courts of Justice Strand, London WC2
		3rd February 1997

SIR RALPH GIBSON:

This is the judgment of the Court.

1. Scottish Power Plc ("S.P.") appeal against the dismissal of their application for judicial review on 31st July l996 by Ognall J. S.P. seeks orders to quash a decision of the Director General of Electricity Supply set out in a letter of 14th September l995, and for other relief. The case concerns licence conditions for supply price controls on the supply of electricity in Scotland by S.P. The decision of the Director was to the effect that he would not propose modifications in the conditions of the licence granted to S.P. under The Electricity Act l989 ("The Act"); and that the Director would not give effect, with reference to the licence of S.P, to modifications proposed by the Monopolies and Mergers Commission ("M.M.C") in a report of 29th May l995, upon a reference under the Act concerning the licence of Scottish Hydro-Electric Plc ("H.E.").
2. S.P. is a Scottish company. The customers of S.P. and of H.E. are in Scotland. The Act, of course, applies to Scotland. When it asked why the case is proceeding in the High Court of England and Wales, the Court was told that, since the office of the Director is in Birmingham, S.P. commenced proceedings in England. The Director, who is represented by the Treasury Solicitor, has taken no point with reference to the conduct of the proceedings in the High Court of England and Wales.
3. The Act brought about the privatisation of the greater part of the supply of electricity in Great Britain. Part of the legislative structure deals with the fixing of price controls in licences to generate, transmit, distribute and supply electricity. For an understanding of the contentions in law put forward for the Director and for S.P. it is necessary to set out in brief summary the structure of the Act, the role and statutory duties and powers of the Director and of the M.M.C, the position and rights of S.P. and H.E. as licence holders under the Act and the organisation of the electricity supply industry both in Scotland and in England and Wales.

The Legislation and the Industry

4. In Scotland both the two electricity companies, H.E. in the North and S.P. in the South, under their licences carry on the activities of generation, transmission, distribution and supply of electricity. In England and Wales, generation is carried on by separate generating companies, National Power Plc, PowerGen Plc and Nuclear Electric Plc; transmission is the work of National Grid Plc; and distribution and supply are done by twelve regional electricity companies, REC's, the successors to the former Area Electricity Boards. The Scottish companies are said to be "vertically integrated", in that they carry on all activities, but each activity is "a separate business" as defined in their licences. Cross subsidy between these separate businesses is prohibited save for the special provision in the case of H.E, which is known as "Hydro Benefit". This permits the subsidising of the costs of transmission and distribution in the licensed area of H.E, which costs are exceptionally high, from the earnings of electricity produced more cheaply from hydro electric generation.
5. 1 The statutory objectives of the Act are set out in Section 3. It is the duty of the Secretary of State and of the Director to exercise their functions under the Act "in the manner which [they] consider best calculated" to achieve the objectives. By Section 12(7) the M.M.C. in discharging its functions under the Act is also required to have regard to those objectives. The first duties or objectives are stated in Section 3(1) as (a) to secure that all reasonable demands for electricity are satisfied; (b) to secure that licence holders are able to finance the carrying on of the activities which they are authorised by their licences to carry on; and (c).....to promote competition in the generation and supply of electricity.

6. 2 Section 3(3) sets out further duties or objectives which are expressly subject to those set out in Section 3(1). It is sufficient to state the following: The protection of interests of consumers of electricity supplied by persons authorised by licences in respect of the prices charged and the other terms of supply; the continuity of supply; and the quality of the electricity supply services provided.

7. 3 Licences authorising the generation, transmission and supply of electricity may be granted under Section 6 of the Act either by the Secretary of State or by the Director; and they may include conditions as provided by Section 7.

8. 4 The conditions of a licence may be modified by the Director either under Section 11(1) of the Act, with the consent of the holder of the licence, or under Section 14(1) for the purpose of remedying or preventing effects adverse to the public interest as specified in a report by the M.M.C.

9. 5 A reference to the M.M.C. may be made by the Director under Section 12(1) to require the M.M.C to investigate and report on the questions whether any matters which relate to the generation, transmission or supply of electricity in pursuance of a licence and are specified in the reference, operate or may be expected to operate against the public interest; and, if so, whether the effects adverse to the public interest which those matters have or may be expected to have, could be remedied or prevented by modifications of the conditions of the licence.

10. 6 Section 13 contains provisions with reference to reports by the M.M.C on modification references. Such a report is to be made to the Director. There are provisions for consultation.

11. 7 The duties of the Director upon publication of a report from the M.M.C are set out in Section 14. In brief, the Director is required to make such modifications of the conditions of the licence as appear to him requisite for the purpose of remedying or preventing any effects adverse to the public interest specified in the report. Again, there are provisions for publication and consultation.

    The Nature and History of the Dispute

12. 1 S.P's licence under the Act, which is a combined licence authorising generation, transmission, distribution and supply, was granted by the Secretary of State in March l990. On the same date a similar licence was granted to H.E. The licences contained the supply price controls of both companies and a central element of those controls was the Great Britain Yardstick ("G.B.Y"). These controls regulate the price which may be charged by the supply businesses of the two companies to their franchise customers, i.e. those with a maximum demand of under 100 kW.

13. 2 A principle of price control is that it is generally necessary only where there is no competitive market or where competition is not sufficient to protect consumers. The vertically integrated businesses of S.P. and H.E require a greater degree of price control than is necessary in England and Wales where the generation activity is largely separated from transmission, distribution and supply, and is a relatively competitive activity in which prices are set by market forces through the pool.

14. 3 In England and Wales, and in Scotland, increasing competition has been and will be introduced in the supply of electricity. Since privatisation, consumers in excess of 1Mw, such as large industrial firms, have been able to choose their suppliers; since 1st April l994 consumers in excess of 100kW have also been able to choose their suppliers; and the intention is that from 1st April l998 all consumers will have the same freedom of choice.

15. 4 There have been similar stepped changes in the composition of the market subject to price control. The licences of the two Scottish companies at first had two supply price controls: the main control applied to all consumers below 10Mw. S.P's controlled market was reduced to include only the under 100kW market from 1st April l995. Customers in the price controlled part of the market are called regulated customers: they are 99% of all customers and consume about 60% of all electricity supplied.

16. 5 The supply price control mechanism in the licence of S.P. is now contained in the modified paragraph 2 of Schedule 6 in the licence. The modification took effect on 1st April l995 in circumstances described below. S.P. is required in setting its supply charges to regulated customers to ensure that in any financial year the average charge shall not exceed the maximum average charge per kilowatt hour calculated in accordance with the stated formula, namely: M = T + U + A + S + F - K. M is the maximum price; T is the allowed transmission cost per unit; U is the distribution cost per unit; S is the supply component; F is the Scottish Fossil Fuel levy; and K is a correction factor for under or over recovery in the preceding year. It is component A which underlies the dispute in this case: it is the generation component and it accounts for over 60% of the final price. It controls the amount which may be charged to regulated customers in respect of electricity purchased by the supply business of S.P. from the generation business of S.P. or from some other supplier. This component is set by reference to a formula composed partly of the indexed purchase price, or "I.P.", and partly by a term based upon the average price paid by the R.E.C's in England and Wales for purchasing electricity to supply their customers. This is the G.B.Y term mentioned above.

17. 6 Between l994 and l998, for the definition of the generation component, there is a phased transition from I.P. to the market based G.B.Y. G.B.Y. fixes a percentage of the allowed purchase cost, namely 10% in l994-l995; 25% in l995-96; 50% in l996-97; 75% in l997-98 and 100% in l998-l999. The basis of the dispute in this case is that, until the Director modified the definition of the generation component in the licence of H.E. on 31st March l995, the licence of both Scottish companies contained a definition of G.B.Y. fixed by reference to the price paid by the R.E.C's in England and Wales to supply their total market. It was the contention of both companies that, since the supply price controls applied only to the franchise market (under 100 kW) the G.B.Y. term should be modified so that the definition of it would refer to the price paid by the R.E.C's for electricity to supply their franchise market only and not their total market. The ground of the contention was that, for supply to the franchise market, the cost of electricity purchased is higher than for supply to other customers because of the more "peaky" demand profile in the franchise market. The reason why G.B.Y refers to the price of electricity paid by the R.E.C's in England and Wales is to fix a price determined in a competitive market; and, therefore, the price referred to should be that price paid for the more expensive electricity purchased for supplying the franchise market, and not that price fixed in the total market which includes electricity purchased more cheaply for the larger consumers.

18. 7 As noted above in paragraph 5, the formula, for fixing the supply price control, contained, among other components, component U, the distribution cost per unit. At the time of privatisation, the fixed distribution costs of both Scottish companies were set under the licences at the same figure. As with the transmission cost, component T, the permitted distribution costs are separately controlled and the whole cost is passed through to the formula by which the maximum supply price is fixed. The maximum or overall price under the formula is an aggregate of the individual prices for the component activities. The control on distribution costs is fixed by reference to the Retail Price Index ("R.P.I") by stating that the costs may be increased by a proportion of the percentage increase in R.P.I. Thus the control in the licence of S.P. from l990 was R.P.I. - 0.5%. That meant that if the increase in R.P.I. for a particular year was 3% the distribution charge might be increased only by 2.5%. The similar control in the licence of H.E from l990 was slightly less rigorous, namely R.P.I. - 0.3%.

19. 8 In November l993 the Director conducted a review of the price controls in the licences of S.P. and H.E. Both companies submitted that, for the reasons stated above, the G.B.Y term should be modified so as to refer to the price paid by R.E.C's to supply their franchise market. In September l994 the Director announced his proposals for revised price controls for S.P. and H.E. The proposals retained the total market definition of G.B.Y; and proposed for S.P a distribution price control tightened from R.P.I - 0.5% to R.P.I. - 2%; and for H.E. a distribution price control also tightened from R.P.I. -0.3% to R.P.I. - 1%.

20. 9 S.P. agreed to the proposed amendments to its licence under Section 11 of the Act. In so doing S.P. recorded its contention that the total market definition of G.B.Y. was biased and should not set a precedent for future regulatory reviews. It "reluctantly" accepted the proposals in order, as it said, to avoid precipitating a reference to the M.M.C; Bundle A, page 247; letter dated 28th October l994. The proposals, it was said, failed to strike an appropriate balance between the interests of customers and those of the shareholders of the company. The agreed amendments became effective on 1st April l995.

21. 10 H.E. did not agree to the Director's proposals. On 15th November l994 the Director referred the price controls in H.E's licence to the M.M.C under Section 12(1) of the Act. The Director could also have referred to the M.M.C the price controls in S.P's licence. He was not asked to do so by S.P. If he had been asked he was not obliged to agree. If he had done so the M.M.C would have determined the question of the definition of G.B.Y for both Scottish companies. The Director did announce that he would consider the implications of the M.M.C report on H.E. for the controls in S.P.'s licence.

22. 11 The report of the M.M.C was presented in May l995 and was published on 15th June l995. The group of six responsible for the report consisted of Mr G.D.W. Odgers, the Chairman, three other members of the Commission and two selected under Section 12(9). The Report with appendices extends to 250 pages. S.P. made submissions to the M.M.C - see paragraph 11.23 to 11.31.

23. 12. The conclusion of the M.M.C on the G.B.Y issue was that the definition of G.B.Y in H.E's licence should be modified, as both Scottish companies contended that it should be modified, so as to refer to the price paid by the R.E.C for the purchase of electricity for their franchise market and not for their total market: see paragraphs 2.76 to 2.78 and 2.81: Bundle A, pages 85-86. The report says at paragraph 2.78:

    "H.E. proposed that G.B.Y should be based on the costs the R.E.C's incur in purchasing electricity for their under 100 kW customers, because the price controls would apply only to H.E's under 100 kW market. Otherwise, prices in H.E's area would be based on the total R.E.C. market where average prices are lower because of the less "peaky" demand profile in the over 100 kW market. In our view it would be unfair to H.E. if the two markets did not match. The whole object of G.B.Y. is to link maximum purchase costs in Scotland (where generation is largely carried out in house) to the market based price prevailing in England and Wales. It would be illogical to base Scottish prices on the prices in a different market in England and Wales. We therefore consider that G.B.Y should be based on R.E.C purchase costs for the under 100kW market rather than the total market. Although this would mean that prices do not diminish as rapidly during the transmission period, there should still be significant reductions in the general component."

24. 13 The M.M.C made an adverse public interest finding on the continuation of the "total market" definition of G.B.Y in H.E's licensed conditions. The Commission said at paragraph 2.81:

    "We conclude that the continuation without modification...(of the definition of G.B.Y)...will, when competition is introduced into the under 100 kW market, lead to H.E having its prices held below the level which would prevail in a free market, with the result that competition will be deterred, with consequential loss for consumers in terms of quality of service. Accordingly, we conclude that such continuation may be expected to operate against the public interest.

25. 14 The M.M.C. rejected the contention of the Director that, upon the basis that the G.B.Y should be thus changed, no change need be made until l998. The Commission said at paragraph 2.76:

    ".........first we discuss a more general argument by the Director against making any adjustment to G.B.Y which will give H.E a greater revenue during the period up to l998. The Director plans to review the supply price control again prior to the opening of 100 kW market to competition in April l998. He therefore expects the price control which follows our review to last only for the three years from l995/96 to l997/98. During this period, in the Director's view, the generation component of the price control formula is generous to H.E because only part of it.....will be based on G.B.Y, with the remainder still based on the higher I.P. term. Thus ensuring the three year period prices will be above a market based level.

    2.77 Although we agree that the supply price control should be looked at primarily in relation to the three year period, it is likely that some price control will continue to be needed after l998 until competition in the 100 kW market has become established and been shown to be effective. Since, therefore, the G.B.Y. linked formula is likely to continue beyond l998 into a period when the I.P. term has dropped out of the calculation, we regard it as important that G.B.Y is defined in a way that will satisfactorily reflect market prices at that time. Otherwise competition will be distorted because one competitor will effectively have its prices held below the level that would prevail in a free market. In this situation the price controls would not promote competition and would therefore be expected to operate against the public interest."

26. 15 The M.M.C acknowledged that the change in the definition of G.B.Y. would have the effect of increasing the permitted charge to franchise customers and of so increasing the revenue of the supply business of H.E. Reductions in the generation component, however, would still give rise to reductions in the final price to franchise customers; see paragraph 2.139. The Director later calculated that the change in G.B.Y would increase the revenue to H.E's supply business by about £18m per annum over that which would have been received if the total market definition had been retained: Bundle A, page 307.

27. 16 As to H.E's distribution price controls, which govern the price charged by H.E's distribution business, they were considered by M.M.C separately from the supply price controls which contained the G.B.Y term. As stated above, the modified distribution price control of S.P. at the time of the M.M.C report was R.P.I - 2%. The unmodified price control for H.E. was R.P.I. - 0.3%. The M.M.C concluded that H.E's distribution price controls should be set so as to match those of S.P. as modified, namely R.P.I. - 2%. The M.M.C. concluded that it would be more appropriate to continue the policy of using S.P's charges as the yardstick against which to set H.E's charges: see paragraph 2.57. That meant a tightening of the control from R.P.I - 0.3% in the unmodified licence, and from R.P.I - 1% as proposed by the Director, to R.P.I. - 2% as proposed by the Director for S.P. and agreed to by S.P. The Director later calculated that that part of the M.M.C decision had the effect of reducing the revenue of H.E's distribution business by about £17m: Bundle A: p.307.

28. 17 The decision of the Director with reference to S.P. was sent by letter of 14th September l995. The relevant parts of the letter read as follows:

    "You have argued that the M.M.C. report on H.E. has implications for S.P. that should be reflected in changes to its price controls....You have focused particularly on one point: that if the M.M.C's recommendations on G.B.Y are applied to H.E they should be applied equally to S.P. You have argued that not to do so would be inconsistent and illogical.

    On the last point I agree that, other things being equal, there is advantage in treating similar cases consistently. But this is only one of several considerations that I need to take into account. In deciding whether to propose a licence modification I need to be guided by my statutory duties. In the present case, the most relevant ones are the duty to promote competition and the duty to protect customers with respect to price. I therefore need to look at the whole picture, not just at one aspect.

    The M.M.C would have been aware that implementation of its recommendations would have led to a difference in definitions of G.B.Y between the H.E and the S.P. licences. I note that the M.M.C did not comment on this in their report as a possible disadvantage. Nor did the M.M.C make any reference, as they could have done, to the advantage of making a similar change in S.P.'s licence.

    As to the implications for competition, I note the M.M.C's argument that if G.B.Y was based on an inappropriate yardstick before l998, then prices might be held artificially low in Scotland after l998, with subsequent detrimental effects on competition. In implementing the M.M.C's suggested licence changes for H.E, I should not be held to agree with every detail of the M.M.C's argument. I have stated my intention to review the supply of price control for all public electricity suppliers before l998 with a view to making appropriate changes to take effect from l998 onwards....

    As to the implications for customers, I note that implementation of the M.M.C's recommendations on G.B.Y would lead to higher prices for H.E's customers than would otherwise obtain, but that this would be broadly offset over the next five years, by recommended reductions in charges in other aspects of the price controls. You argued that there would be no such corresponding reduction in charges to S.P's customers if the M.M.C's approach were applied to your company. I calculate that, in broad terms, the effect of changing G.B.Y alone would be that S.P. customers would pay of the order of £25m more over the next three years than they otherwise would do. (That figure has been recalculated at £40m).

    In forming their conclusions on H.E, the M.M.C were able to look both at the detail of each recommendation taken separately and at the overall picture. In recommending a change in G.B.Y they would have been aware that their other recommended changes had a broadly off-setting effect on H.E's customers. Since S.P. accepted the proposed price control, we do not know how the M.M.C would have concluded if S.P's price controls had been referred to it. In my view, the arguments based on consistency of treatment and on promotion of competition are not sufficiently strong to justify licence modifications to the price control that S.P. has already accepted, for these would lead to the detriment of higher prices to S.P's customers than would otherwise obtain.......I have concluded that, in all the circumstances, it would not be appropriate at this stage to propose further changes to S.P.'s price controls."

29. 18 On 15th September l995 the Director announced his conclusion upon the M.M.C Report of May l995 on H.E: his statement included the following: (Page 138)

    "I have....considered the M.M.C's public interest findings and their recommendations for licence modifications. I have concluded that the Commission's recommendations form an appropriate basis for revised price controls for H.E................................................................

    I expect to publish detailed licence modifications next week."

    The modifications were duly published under Section 14(3) of the Act on 22nd September l995. They were back dated to take effect in relation to the year from 1st April l995 and included both the change in the definition of G.B.Y and the change in the distribution price control. The reasons for those modifications were stated to be the reasons set out in the M.M.C Report.

30. 19 By letter of 9th October l995 the Director responded to a letter of protest from S.P. and added:

    "In considering recommendations for H.E. the Commission was comparing its own recommendations to H.E's price control conditions as they existed prior to my review. The effect of its recommendations was broadly neutral as compared both with those existing licence conditions and my own proposals. The position in S.P.'s case is rather different. You accepted the proposals I made in September last year and your licence was modified to give effect to those proposals from 1st April this year. In assessing the effect on prices to your own customers, however, the comparison I made was with the licence as modified and not with the licence conditions as they existed prior to my review. As you acknowledge in your letter, modifying your licence now in order to change the definition of G.B.Y would result in prices to S.P's customers higher than could be expected from the present price control conditions."

31. The Proceedings.
32. 1 S.P. applied for leave to apply for judicial review on 11th December l995. Leave was granted on 20th February l996. S.P. claimed that the decision of the Director not to propose modifications to the licence of S.P. as made to that of H.E should be quashed on the grounds that it was irrational and unfair; and that the Director should be required to propose the same modifications in the licence of S.P; or that the matter be remitted to the Director to reconsider it and to reach a decision in accordance with the findings of the Court.

33. 2 The application came before Ognall J. on 25th and 26th July l996. By his judgment of 31st July l996 he dismissed the application. After examination of the submissions made for the parties he identified the two essential issues as follows: "First, and primarily, whether the distinction drawn between H.E. and S.P. and the differing formulae adapted for G.B.Y is founded upon an irrational basis, and therefore unlawful and, secondly, what I have described as "the l998 point". " The l998 point is concerned with the question whether, on the true construction of the M.M.C Report, the M.M.C was finding that the G.B.Y definition, if unaltered, would have adverse effects to the public interest in the years between l995 and l998 or only as from l998. The Judge reached the conclusion that the Director was entitled to take account of the impact of the reduced distribution revenues on H.E's supply prices when deciding whether to modify their G.B.Y. He could find no irrationality in the Director's approach to G.B.Y, or his rejection of S.P.'s case, on the basis of his overall approach to the revenues of one when compared to those of the other and their impact during l995/l998 on consumer prices.

    As to the l998 point, it was, in the view of the Judge, at best peripheral. The relevant passages in the Report, which he identified, suggested to him that the M.M.C were intending to refer to the immediately ensuing years of l995/l998 in their review and reasoning, but that they were only doing so with a view to facilitating a smooth transition into the post April l998 position when competition will bite. In other words, they were saying that without such change in G.B.Y, so far as H.E was concerned pre l998, this could have a potential for adversely affecting competition from April l998 onwards. He therefore did not criticise the Director for interpreting the conclusion of the M.M.C on G.B.Y as not immediately binding on him under Section 14(1) of the Act.

34. 1 In this Court, the parties have, in substance, repeated their contentions. It has not been disputed that the effect of implementing the M.M.C conclusion on the G.B.Y issue is similar for both companies. The generation component of the supply price as modified continues to deliver falling prices in real terms for consumers but the price payable will fall less than if the total market definition of G.B.Y remained.

35. 2 Further, it has not been disputed that, if the Director had no rational or valid basis for treating the two Scottish companies differently on the G.B.Y point, his decision should be quashed.

36. 3 For S.P. Mr Grabiner Q.C., contended that four separate reasons given by the Director for treating the company differently on the G.B.Y issue are defective; and, further, that the Director's refusal to apply the M.M.C definition of G.B.Y in the case of S.P. is contrary to the policy and objects of the Act because it fails to give effect to the adverse public interest finding made by the M.M.C in respect of the total market definition. The four separate defective reasons were in summary described as follows.

37. 4 Consumer Prices:

    It was the Director's explanation that the effect on H.E's customers of implementing the M.M.C conclusion on the G.B.Y issue would be "broadly offset" by the M.M.C's recommended reduction in the distribution price controls but that there would be no corresponding reduction in the case of S.P. In fact the M.M.C's decision was to align H.E's distribution prices with those of S.P.: (see Paragraphs 1.6(e), 2.55 to 2.58 and 2.103). Since the distribution prices for H.E's customers were set by M.M.C to match those of S.P. they cannot provide a good reason for treating the two companies differently on the G.B.Y issue.

38. 5 Revenues:

    It was said for the Director that he regarded the effect on H.E's distribution prices as a relevant consideration which justified the application of the M.M.C definition of G.B.Y to H.E and not to S.P.: Bundle A, Pages 290 and 307: because he calculated that the estimated £18m benefit to H.E's supply revenues from the new G.B.Y definition was offset by the estimated £17m reduced revenue from the M.M.C decision on H.E's distribution price controls. In fact, said Mr Grabiner, the reasoning and conclusion of the M.M.C on H.E's distribution price control are entirely independent of their reasoning and conclusion on the proper definition of G.B.Y for H.E's supply price controls. Further, the reduced revenue fixed for H.E's distribution business was found to be sufficient to meet the need of that business as calculated by the M.M.C: paragraphs 2.59 and 2.60 and thus provides no reason for treating S.P. differently on the G.B.Y issue. Lastly, this "revenues" consideration is irrelevant because of the prohibition of cross subsidy between the distribution and the supply businesses.

39. 6 The effect of the M.M.C's adverse public interest finding: the l998 point:

    The Judge, it was said, was wrong to hold that the Director was not to be criticised for interpreting the M.M.C's conclusion on G.B.Y as not immediately binding on him in the years l995 to l998. On the proper construction of the Report the adverse public interest finding was seen by the M.M.C as requiring immediate change. Even if that be wrong, the Director cannot on this ground justify implementing the change at once for H.E. and refusing to implement the change for S.P.

40. 7 The Agreement of S.P. to the Section 11 modification of its licence:

    The fact of the agreement was advanced as a further reason by the Director in his letter of 9th October l995. The agreement has, in fact, no force at all in this argument. To correct in the licence of S.P. that which the Director corrects in the licence of H.E does not produce any impermissible "windfall" but merely secures to S.P. what the Director, on the findings of the M.M.C, should have allowed to S.P. in the first place.

41. 8 For the Director, a respondent's notice was served in this Court. In our judgment, the first ground there set out does not matter. The second ground asserts that the consent by S.P. to the modification proposed by the Director was a matter relevant to his decision of September l995 because it was a reasonable inference from that consent that S.P. considered that the proposals would secure adequate finance for the company over the period to which they were to relate.

42. 9 Mr Barnes, Q.C. in substance, contended that the learned Judge was right for the reasons which he gave. His detailed submissions included the following. As to the right of the Director to "take account of the overall picture", including the distribution component, Mr Barnes argued that the M.M.C were able to look, and did look, at the overall picture, namely the G.B.Y definition and the calculation of the distribution component, and that it is contrary to common sense and to law to say that the Director should not do the same.

43. 10 As to "cross subsidy", Mr Barnes submitted, firstly, that there is no express provision in the Act which requires the Director to consider each element of the business of the licencee in isolation and to disregard the overall picture; secondly, that the contention for S.P. is inconsistent with the express statutory duty of the Director in Section 3(3)(i) "to protect the consumers of electricity in respect of the prices charged and other terms of supply"; and, thirdly, that there is no evidence that any cross subsidy would have been required if the modification of G.B.Y and the licence of S.P. were not made; fourthly, the contention of S.P. runs contrary to the nature of the pricing system contained in the licence. The overall price under the formula is an aggregate of the individual prices for the component activities. What matters to the millions of consumers of S.P. is the ultimate price derived from the formula. If there is a reduction in one component, and an increase in another, it will not concern the consumer if the two balance each other out. For that reason the Director is entitled to take an overall view.

44. 11 As to the alignment of distribution prices between H.E and S.P., Mr Barnes pointed to the fact that the M.M.C considered the details of the distribution charge controls for H.E but could not do the same for S.P. The crux of the matter is, said Mr Barnes, that it is not possible to know what the M.M.C would have concluded for S.P. as regards the distribution component. They might have recommended a change adverse to S.P. as compared to the agreed modification.

45. 12 As to the l998 issue, upon its true construction the report of the M.M.C did not conclude that the present method of calculation of G.B.Y operated against the public interest as regards H.E from l995. The Director had in fact no obligation said Mr Barnes, under the Act even as regards H.E to modify the G.B.Y calculation provision before l998.

46. 13 As to the matter of acceptance of the proposals of the Director by S.P., Mr Barnes submitted that it is of "minor import". It was never regarded by the Director as decisive.

47. 14 As to the terms of any order which this Court might make, it was submitted by Mr Barnes that difficulty would be caused if any order should take effect before 1st April l997. Mr Grabiner, with reference to the effective date of any order, informed the Court that S.P. would be content if any amendment that were introduced were to take effect from 1st April l997.

    Conclusion

48. For the reasons which follow, we allow this appeal and set aside the decision of the Director not to propose modifications to the licence conditions of S.P. which would give effect to the conclusion of the M.M.C on the appropriate definition of G.B.Y in the licensed conditions of H.E. We will not order the Director to propose any specific modification. We will remit the matter to him for him to examine it and to reach a decision in accordance with the findings of this Court, including consideration of whether to make a further reference to M.M.C.
49. The Director attached importance to the fact that S.P. agreed to the modifications in their licence as proposed by the Director. It is not contended that such agreement gives rise to any conclusive answer in law to the claims now made by S.P. It is said that the agreement provided evidence that the directors of S.P. considered that the revenue which S.P. would receive under the modified licence would be sufficient for the running of their combined businesses for a period of time. That, we think, is true; but it seems to us to be of no significant force. S.P. does not dispute, and it could not, that it regarded what it would get under the modified licence terms as being probably as good as it could get although it believed that it was entitled to more under the statutory provisions. It is common ground that there was no way by which S.P. could foretell what view the M.M.C would take of the issue about the definition of G.B.Y or anything else. There were no relevant prior decisions. On such a matter, as can be seen from the submissions made to the M.M.C, there can be no single true answer. All that can be done is to look at the decision of that authority which, as Parliament has provided, is, to the extent set out in the Act, to prevail. The Director could have referred the licence conditions of both companies to the M.M.C but did not do so. He announced that he would consider the implications of the M.M.C report for S.P. When he came to carry out that consideration, having decided to implement forthwith the modifications proposed by the M.M.C for H.E, the fact that S.P. had agreed to his proposed modifications seems to us to have been of no significant force because the view of the directors of S.P. as to what would be a sufficient income for a period of time for the supply business of S.P. is not of any assistance in deciding what the proper definition of G.B.Y should be, in the licence of S.P., for the purpose of achieving what that term was intended to achieve, namely to relate the supply price control to a comparable competitive market in England and Wales.
50. The decisive issue is whether, as the Judge put it, the distinction drawn between H.E and S.P. in the differing formulae adopted for G.B.Y is founded upon an irrational basis. It does not matter, in our judgment, whether upon the report of the M.M.C the Director was obliged forthwith to modify the definition of G.B.Y and H.E's licence or whether he could choose to postpone any modification until l998. The Director did modify the definition in H.E's licence with effect from 1st April l995 in accordance with the recommendations of M.M.C. Having decided to do so, he considered S.P. and decided that he would not propose any modifications to the definition of G.B.Y in their licence for the reasons set out in his letter of 14th September l995.
51. Those reasons provide, in our judgment, no valid basis for the decision. The Director referred to his statutory duties to promote competition and to protect customers with reference to prices which required him to look "at the whole picture not just one aspect". The supply price formula in the licence in which appear U, the distribution cost, and A, the generation component, is, as was submitted for the Director, an aggregate of individual prices for the component activities. When the Director considered what those separate components should be in his proposals to S.P. and H.E, it was his duty to have regard to protection of the customers with reference to prices and to the need to secure for the two companies sufficient revenues for the proper conduct of their several businesses. The Director does not suggest that he did not perform that duty. A price would not be fixed greater than was shown to be necessary. The same duties lay upon the M.M.C and it is not suggested that in proposing to fix the generation component by reference to the amended G.B.Y definition, or in proposing the modified distribution cost for H.E, M.M.C did not have proper regard to the same duties. It is possible to imagine circumstances in which the separate consideration and proper fixing of the individual prices for the component activities might reveal an apparently necessary increase in cost which the Director or M.M.C might regard as too great to be imposed upon consumers at a particular date. The M.M.C said nothing of such a perceived difficulty, no doubt because, in this case, even if the amended definition of G.B.Y were applied to S.P. the results would not be an increase in price to consumers but a smaller reduction in price.
52. As to "looking at the whole picture", it seems to us that the Director, in deciding what to do with reference to the amended definition of G.B.Y in the case of S.P., was indeed entitled, and required, to look at the whole picture and not simply to pass on that amended definition to S.P's licence. The Director had considered and dealt with the whole picture in proposing the modifications which S.P. had accepted. He was engaged, as he had announced, upon considering the implications of the M.M.C report on H.E for the controls in S.P's licence. If there were any aspect of those accepted proposals which would be affected by the insertion of the amended definition of GBY in S.P's licence, he was, in our judgment, bound to consider whether some further accompanying modification was required for the proper performance of his statutory duties. He has not suggested the need for any such accompanying modification. There would simply be an increase in the generation component by the amount and for the reasons stated by M.M.C.
53. The invocation by the Director of the right to "look at the whole picture", was to justify refusing to pass to S.P. the increase in the generation component because of the fact, that in the case of H.E, there had been imposed a "broad offset over the next 5 years by recommended reductions in charges in other aspects", i.e. the distribution charge. Mr Barnes asserted that the crux of the matter is that it is not possible to know what the M.M.C would have concluded for S.P. as regards the distribution component and that the M.M.C might have recommended a change adverse to S.P. as compared with the agreed modification of the S.P. licence. We can see no force whatever in this contention. The Director was as well, or better, placed than anyone in this country to decide whether, if S.P's licence had been before the M.M.C, it was likely that the M.M.C would, having regard to their reasoning and decision with reference to H.E, have proposed a distribution component more adverse to S.P. than that proposed by the Director himself and accepted by S.P. More importantly, however, the Director was as well placed to make this decision for himself as he was to make the decision set out in his proposals to S.P. which S.P. accepted. He knew why he had proposed the distribution component of R.P.I - 2% to S.P. and R.P.I - 1% to H.E. We can think of no reason why he could not, while proposing to modify the generation component in S.P's licence by inserting the amended definition of G.B.Y, make such proposal, if any, for amending S.P's distribution price component as seemed to him to be required or justified by the reasoning and decision of the M.M.C with reference to the distribution price controls in H.E's licence. No such preventing reason has been put forward by the Director or on his behalf. If he had put forward such a proposal, S.P. would have been able to accept it or, if grounds for doing so appeared, to challenge it. In the alternative the Director could have referred the matter to the M.M.C. The simple refusal to propose the modification of the definition of G.B.Y in the licence of S.P, to which on the grounds of fairness S.P. was entitled, cannot be justified, in our judgment, by the reasons advanced.
54. In our judgment, the additional grounds of attack upon the Director's decision do not matter. We will state briefly our view of these issues. As to the cross subsidy provision, we are not persuaded that it could afford to S.P. an effective and separate ground for quashing the decision of the Director. If, as we would hold it is not, it were a valid reason for the Director's decision that the Director did not know what the M.M.C would have done with reference to the distribution price controls in S.P's licence, if that licence had been before the M.M.C, the fact that S.P. would have been left with an unaltered generation factor in the supply price formula and thus reduced revenue in their generation business, has not been shown to have required resort by S.P. to any forbidden cross subsidy. The position is, we think, no more than that S.P. has been receiving, and will continue to receive until the definition is changed, by way of revenue to its generation business, less than it should have been receiving under the definition of G.B.Y proposed by M.M.C and applied by the Director to H.E.
55. As to the l998 point, again, in our judgment, it affords no separate ground of application. We agree with the learned Judge that the M.M.C Report on this matter could have been more clearly drafted. We do not regard it as entirely clear that the M.M.C found that adverse effects would be worked against the public interest unless the change in the definition of G.B.Y was made forthwith, although there are parts of the language in the report which support Mr Grabiner's submission. The M.M.C appears to have thought that the necessary change would not occur unless made at once: see paragraph 2.77. We agree with the learned Judge who said: J.41:

"The passages in the Report which I have...identified,....suggest to me that the M.M.C were intending to refer to the immediately ensuing years of l995-l998 in their review and reasoning, but that they were only doing so with the view to facilitating a smooth transition into the post April l998 position when competition will bite. In other words, they were saying that without some change in G.B.Y, so far as H.E was concerned, pre l998, then this could have a potential for adversely affecting competition from April l998 onwards".

The Director has stated his intention to undertake a further review of the matter before competition begins.

56. As to the form of the order which this Court should make, we will not order that the Director propose a modification of the S.P. licence so as to amend the G.B.Y definition in line with that now in the H.E licence. The Court should not, in our judgment, make such an order unless it is clear that at the time of making the invalid decision, there was only one decision which the Director, in the proper performance of his duties, and on the material before him, could reasonably make. As explained above, although in our judgment the Director has advanced no valid reason for refusing to apply the modified G.B.Y definition to S.P's licence, it was his duty to consider whether, in applying that modified definition his duties required him to propose some other necessary accompanying modification to S.P's licence or to refer S.P.'s licence to the M.M.C. It is our understanding that Mr Grabiner's concession, to the effect that the modification to the G.B.Y definition should have effect from 1st April l997 was intended to have effect for any modification proposed by the Director in consequence of the making of any order by this Court. We will wish to hear Counsel as to the form of the Order.

Order: appeal allowed and orders of Ognall J made on 31.7.96 set aside; order of certiorari made to quash the decision contained in the Director's letter dated 14.9.95; liberty to apply to the Court of Appeal for further directions; the respondent to pay to the appellant its costs here and below, to include the application for leave and the hearing before the High Court, to be taxed on the standard basis if not agreed; leave to appeal to the House of Lords refused.