From the editor’s
desk…
Welcome
to Pipes & Wires #102. Once again our thoughts and prayers are with our
clients and friends in Christchurch after yet more earthquakes.
This
issue covers a wide range of issues, including the rapidly unfolding regulatory
framework for electricity lines and gas pipelines in New Zealand, the rapidly
shifting nuclear policy in Germany, and a broad overview of mergers and
industry reshuffling in North America.
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Asset
strategy
NZ
– public safety management systems
Just a reminder that the requirement for
all electricity businesses (of more than 10MW capacity) to have their PSMS in
place and externally audited is only 9 months away. For help with compiling
your PSMS, or to have a pre-audit review undertaken, phone Phil on (07)
854-6541 or pick
here.
UK
– redesigning the pylons
Introduction
The overall shape of high voltage pylons
has changed little since the 1920’s. This article examines a competition being
held by National Grid to identify
new shapes for pylons in the face of a lot of new build to connect wind farms
and the new nuclear stations.
Background
Pylon design has changed little from the
utilitarian design of the mid-1920’s. Those who got the chance to watch the 1st
episode of “The Secret Life Of The National Grid” (before it was removed from
You Tube) may have noticed the UK’s concern about the harsh, brutal appearance
of pylons in countries that were considered to have a higher degree of state
intervention (which apparently conservative Prime Minister Stanley Baldwin was
keen to avoid). To this end, the Central
Electricity Board engaged the famed architect Sir Reginald Blomfield
to design something less intrusive, and less representative of state intrusion
and power. Over the next 85 years some 88,000 pylons were built.
The
competition
A competition is being run by the Royal
Institute of British Architects on behalf the Department of Energy and Climate
Change and National Grid to identify designs that will, in the words of Energy
Secretary Chris Huhne “accommodate infrastructure into our natural and
urban landscapes”. The competition closes on the 12th July and the
entries will be displayed at the London Design Festival in September. Pipes
& Wires will revisit this issue around that time to see what the entrants
have come up with.
US
– joining forces for regional grid development
Introduction
The need to “invest” in electricity
transmission grids seems to become ever more pressing, despite the apparent
easing of the high demand growth experienced a few years ago. This article
briefly examines a joint venture between 2 giant US utilities to coordinate
grid investment, but firstly we set out a few thoughts on grid CapEx.
A
few thoughts on grid CapEx
Transmission grids are under 3 dimensions
of spend “pressure” (and there are similar parallels for gas transmission
pipelines as well):
·
Renewal
CapEx - the need to renew or replace existing lines simply because their
condition has declined to the point where Renewal CapEx is cheaper and more
reliable than continued OpEx (and if anyone wants to talk about this,
especially in the Australian and New
Zealand regulatory context, please
pick here).
·
Growth
CapEx - the need to increase the capacity of existing lines due to demand
growth or re-determined security of supply requirements.
·
Extension
CapEx - The need to build new lines in completely new areas to import
electricity from new generation sites (typically remotely sited wind farms).
For a more detailed explanation of these
terms, pick here.
The
joint venture
A non-binding MOU has been signed between American Electric Power (AEP) and the Tennessee Valley Authority (TVA) to
collaboratively identify mutually beneficial EHV transmission opportunities
along the boundary of the PJM and TVA grids.
It would seem that a key benefit of a joint approach would be avoiding
duplication, and therefore enhancing allocative efficiency (obviously a key
goal of regulators).
In addition to this MOU, AEP in conjunction
with Duke Energy has
entered into a separate MOU with the TVA to build 55 miles of 765kV line
between Rockport Power Station, Indiana and Paradise Power Station in Kentucky.
It will be interesting to see how the FERC
and the various state regulators treat these joint approaches, so Pipes &
Wires will check back in a couple of months.
NZ
– progress on the NIGUP
Work on the NIGUP (known to many of
us the 400kV) seems to be proceeding well. Those that like looking at power
lines might have noticed a few towers without wires (which is a pretty
interesting sight) but along Highway 1 at Karapiro are several monopoles
without conductors which look so cool against a grey sky. For those in the
South Island, they look very similar to the 220kV monopoles near Carisbrook on
the Three Mile Hill – South Dunedin line.
Mergers
& acquisitions
US
– Fortis enters the regulated US market
Introduction
Mergers consolidating the US electricity
distribution industry have been a common theme of the last few issues of Pipes
& Wires. This article examining Fortis’ acquisition of the Central Vermont Public Service Corp (CVPSC) sort
of follows that theme, albeit with a few differences.
Who
are the deal partners ?
The deal partners are:
·
Fortis
is Canada’s largest investor-owned distribution utility, with 2,300,000
regulated electric and gas customers in Canada and the Caribbean as well as
hydro in Canada, the Caribbean and the US. One of their objectives is to
achieve a return on capital commensurate with that of a well-run North American
utility.
·
The
CVPSC is a publicly listed utility supplying 159,000 customers throughout the
US state of Vermont, and also owns a 41% stake in Vermont Transco LLC (which
owns and operates Vermont’s high-voltage grid).
The
proposed deal
Fortis will acquire CVPSC for $470m in cash
and the assumption of $230m in debt. The cash offer of $35.10 per share
represents a premium of about 44% above CVPSC’s closing price on the NYSE,
which is significantly higher than the premiums paid in other recent deals.
Like most other deals, this is subject to approval by the Vermont Public Service Board
and the FERC.
Fortis has indicated that the key reasons
for acquiring CVPSC include the acquisition being accretive to EPS within 1
year, and a cost-of-service regulatory regime that is stable, has minimum lags,
and allows pass through of key inputs such as fuel, transmission charges and
energy purchases.
Pulling
together some wider thoughts
Some of the reasons for recent mergers in
the US have included:
·
The
need to extract operating efficiencies in the face of increasing costs.
·
The
need to better utilise generation and transmission by capturing geographical
diversity.
·
The
need to capture higher retail margins in an era of languishing wholesale prices
(the AES – DPL acquisition).
·
The
need to migrate capital from distribution to transmission where higher returns
are allowed (refer to Pipes
& Wires #97 where National Grid
sold its 2 regulated New Hampshire businesses to a Canadian utility).
Being a portfolio investor, Fortis motivations
may be somewhat different than the other mergers that have been examined, with
the allowable return being a likely significant driver.
Canada
– investing in the US
Introduction
Pipes
& Wires #97 noted that Algonquin Power & Utilities Corp’s
acquisition of National Grid’s Granite
State Electric and EnergyNorth businesses might represent another emerging
wave of investment. Fortis’
acquisition of the Central Vermont Public
Service Corporation could represent another chunk of that wave, which is
what this article examines.
What constitutes an investment wave ?
It’s
hard to define, but I guess an investment wave could be defined as a
“reasonable number of separate investments from the same jurisdiction to the
same jurisdiction for similar reasons over a reasonably distinct period of
time”. I think it would be pushing it to infer that 2 deals worth less than $1b
constitutes a wave, but it may represent the start of a wave.
Summary of the 2 deals so far
The 2 deals so far can be summarised as:
|
Deal |
Consideration |
|
Algonquin
acquisition of Granite State and EnergyNorth. |
$285m
cash. |
|
Fortis
acquisition of Central Vermont. |
$470m
cash, $230m debt assumption. |
This could be the beginning of something,
especially if individual US states begin allowing higher returns to discourage
capital migrating to FERC-regulated transmission grids.
US
– approving the Duke – Progress merger
Introduction
Pipes
& Wires #100 examined Duke
Energy’s pursuit of Progress
Energy, and noted that the approval of both the North
Carolina Utilities Commission and the South
Carolina Public Service Commission is required (as well as the approval of
several other regulators such as the DoJ
and the FERC). This article examines Duke’s
attempt to circumvent the SCPSC’s approval requirement by merging only Duke and
Progress’ holding companies but not the operating subsidiaries.
The
key issue
Duke and Progress plan to firstly merge
only the holding companies, and then several years along the track merge the
operating companies (that will release most if not all of the merger
synergies). Duke believes that South Carolina law gives the SCPSC jurisdiction
only over the merger of operating companies, not of corporate owners.
The
regulator’s responses
The SCPSC is understandably arguing that it
should be able to rule on the deal as it affects electric and gas customers in
South Carolina, whilst the NCUC has allowed
the South
Carolina Office Of Regulatory Staff to participate in hearings in North
Carolina as a party of record.
Given the flurry of merger activity, this
approach could well prove very valuable to the industry, so Pipes & Wires
will watch this one closely. Thanks to Spiegel
& McDiarmid LLP in Washington, DC for their assistance with this
article.
Energy
policy
Germany
– phasing out the phase out of the phase out
Introduction
The 3 months or so since the Japanese
earthquake have precipitated a significant shift in the way Germany views
nuclear power. This article revisits the policy shifts and then examines the
latest policy and its implications.
The
policy shifts to date
German nuclear energy policy has taken the
following shifts:
·
Back in 2000 the German coalition
government announced its intention to phase out nuclear power. This intention
was subsequently enacted as the Nuclear Exit Law and has already seen plants at
Stade, Obrigheim
and Krummel closed down in November 2003, May 2005 and June 2007 respectively. The
30 year old plus stations at Biblis, Neckarwestheim
and Brunsbüttel
were scheduled for closure in 2010, which would have removed about 5,540MW of
Germany’s 120,000MW of installed capacity.
·
In 2005 a new federal government was
elected in which Chancellor
Angela Merkel announced an intention to re-negotiate the required closures.
However her party’s coalition agreement with the Social
Democrat Party (SPD) saw the closure policy being retained for the time
being.
·
In early 2008 Merkel and her party
shifted to an open opposition of the nuclear phase-out and rejected a
compromise by the SPD to postpone further shutdowns in return for a ban on new
nuclear plants. Media comment suggested that the SPD were on the way out in the
build up to the 2009 election as public opinion shifted toward “phasing out the
phase out” (but appeared to stop short of approving new nuclear stations).
·
After
the 2009 election little time was lost in reaffirming the
coalition government’s taste for nuclear energy, with a formal statement
emerging from the CDU that Germany needed nuclear energy as a bridge until
renewable are able to fill the gap.
·
The radiation leaks from Fukushima
prompted vigorous protests from the anti-nuclear brigade, but also prompted something
of a quick policy U-turn by Merkel who announced that last year’s life
extension decision of 17 plants has been suspended for 3 months, and that
shutdown of the 7 oldest reactors will proceed.
The
latest pronouncements
Key aspects of the Merkel government’s
latest policy are:
·
Closure
of all nuclear plants by 2022.
·
Reduce
electricity consumption by 10% by 2020.
·
Increase
the contribution of renewables to 35% by 2020.
·
Possibly
scrapping a tax on fuel rods (worth about €2b per year to the government) in
return for the utility industry supporting an early phase-out.
Some commentators have described Merkel’s
plans as being more green than the Greens, whilst the heavy industrial sector
is reiterating its concerns about security of supply and the already-high
prices and the union representing nuclear plant operators is warning that
“thousands of jobs will be lost”.
The
likely implications
Nuclear represents about 23% of Germany’s
annual 595,000 GWh of (gross) generation. Given the pressure to also reduce
coal-fired generation (aside from the simple issue of plant aging and
retirement) and the heightened tensions around gas supply from Russia, close to
80% of Germany’s electricity generation could be considered insecure or of
limited life. So if Germany can achieve
the desired 10% reduction in consumption and 35% renewables, they might just
squeak home (that is if they continue with the current levels of coal and
gas-fired generation).
Regulatory
decisions
NZ
– the next gas distribution price reset
Introduction
The current regulatory framework for gas
pipeline businesses requires the Commerce
Commission to set an initial default price-quality path (Initial DPP) as
soon as practicable after 1st July 2010. This article examines the Discussion
Paper that was released in April (and has since been extensively consulted
upon).
The
regulatory framework
The broad regulatory framework is set out
in Part
4 of the Commerce Act 1986, and in particular the following subparts are
directly relevant to gas pipeline businesses:
·
Subpart
3 – Input Methodologies.
·
Subpart
4 – Information Disclosure regulation.
·
Subpart
6 – Default and Customised Price-Quality Path regulation.
·
Subpart
10 – Gas Pipeline Services.
Key
work to date
A major work stream to date has been
compiling the Input Methodologies pursuant to Subpart 3, which was completed in
December 20101. The Discussion Paper sets out the Commission’s thinking on
aspects of the DPP that are not prescribed in the Input Methodologies such as
setting appropriate price paths, rates of change, quality standards, regulatory
control periods and compliance assessment periods.
Commission’s
current views on key parameters
The Commission’s current views include inter alia:
·
Gas
transmission and distribution should be treated differently.
·
A
weighted average price cap is considered the most suitable form of control for
gas distribution and for Vector’s gas transmission, whilst a total revenue cap
is considered the most appropriate for Maui Developments.
·
The
compliance mechanism is likely to be an allowable notional revenue approach.
·
The
option of a Customised Price Path is considered a sufficient approach for
accommodating the future investment needs of a gas transmission business.
·
An
X-factor of 0 is considered appropriate for the Initial DPP.
·
The
key quality standard to be incorporated into the Initial DPP is safety, and it
is expected that other quality parameters will be scrutinised through the
Information Disclosure process and may be used to include quality measures in
future DPP’s.
·
The
preferred regulatory period will be for 4 years and 3 months, starting on 2nd
July 2012.
Next
steps
The Commission expects the following next
steps:
·
The
possibility of an updated Discussion Paper in late August, with consultation
through to late October 2011.
·
Draft
decisions paper and draft determination in early December, with consultation
through to late January 2012.
·
Final
reasons paper and final determination in late February (pending confirmation of
the Initial DPP starting on 2nd July 2012).
Pipes & Wires will make further comment
as the discussion papers and decisions emerge.
Aus
– revised AGP access arrangement
Introduction
Pipes
& Wires #101 discussed the Australian
Energy Regulator’s (AER) recent draft
decision to not accept NT Gas’
proposed access arrangement for the Amadeus Gas Pipeline (AGP)
for the regulatory period from 1st July 2011 to 30th June
2016. This short article examines NT Gas’ revised access arrangement
The
revised access arrangement
The following table compares the AER’s
draft decision with NT Gas’ proposed access arrangement (and will be completed
as the revised arrangement and final decision come to hand):
|
Component |
Proposed access arrangement |
Draft decision |
Revised access arrangement |
Final decision |
|
Total revenue requirement |
$169.8m |
$129.7m |
$170.2m |
|
|
Reference tariff |
$0.7596/GJ |
$0.5778/GJ |
$0.7605/GJ |
|
|
Nominal risk free
rate |
5.48% |
5.53% |
5.54% |
|
|
Inflation forecast |
2.50%/yr |
2.57%/yr |
2.57% |
|
|
Real risk free
rate |
2.66% |
2.89% |
Not stated |
|
|
Cost of debt |
10.94% |
9.32% |
10.14% |
|
|
Debt risk premium |
5.46% |
3.79% |
4.60% |
|
|
Cost of equity |
11.98% |
10.335% |
12.04% |
|
|
Equity beta |
1.00 |
0.80 |
1.0 |
|
|
Market risk
premium |
6.50% |
6.00% |
6.50% |
|
|
Gearing |
60% |
60% |
60% |
|
|
Nominal vanilla WACC |
11.36% |
9.72% |
10.90% |
|
|
Opening capital base |
$112.4m |
$97.0m |
$102.7m |
|
|
CapEx |
$14.4m |
$13.9m |
$17.5m |
|
|
OpEx |
$73.0m |
$58.6m |
$71.9m |
|
Pipes & Wires will make further comment
as the final decision emerges.
NZ
– electricity distribution starting price adjustments
Introduction
Non-exempt
electricity distribution businesses have been subject to a default
price-quality path (DPP) since April 2010. The regulatory framework provides
for the Commerce Commission to reset
that DPP if the recently developed Input Methodologies would have resulted in a
materially different DPP had they applied in April 2010. This article examines
the Commission’s Starting
Price Adjustment (SPA) paper that was released back in April 2011 (and has
since been consulted on).
The
regulatory framework
The operative component of the regulatory
framework is s54K(3)
of the Commerce Act 1986 which states “If an input methodology is published after
1 April 2010 and if, had that methodology applied at the time the default
price-quality paths were reset as required by subsection (1), it would
have resulted in a materially different path being set, then the Commission may
reset the default price-quality paths in accordance with section 53P and may apply claw-back,
despite section 53ZB(1)”.
Key
issues in the SPA paper
The principle issue addressed in the SPA
paper is the Commission’s proposal to reset starting prices for the 2010 – 2015
regulatory period based on the current and projected profitability of distribution
businesses. A few of the key issues set out in the SPA paper include:
·
The
Commission’s proposal to set starting prices so that businesses may be expected
to earn at least a normal rate of return over the regulatory period given
assumed industry-wide trends.
·
In
the event that the industry-wide assumptions do not provide adequate returns,
the Commission considers that the option of applying for a Customised Price
Path provides an adequate remedy.
·
The
Commission notes that the Commerce Act provides it (the Commission) with
discretionary powers to apply claw-back at the time of resetting the DPP
starting prices.
This is obviously a significant issue for
the distribution businesses, so Pipes & Wires will comment as the
Commission’s thoughts emerge.
NZ
– exempting the Sidewinder Pipeline
Introduction
Schedule
6 of the Commerce Act 1986 lists the pipelines that are exempt from the
requirements of Part
4 of the Commerce Act 1986. This article examines the Commerce Commission’s Proposed Recommendation
to the Minister of Energy that TAG
Oil’s Sidewinder Pipeline be added to that Schedule ie. exempted from the
requirements of Part 4.
The
Sidewinder Pipeline
Sidewinder is a dedicated 200mm nominal
diameter gas transmission pipeline that will stretch about 3.35km from TAG
Oil’s Sidewinder field in the Taranaki Basin to an interconnection point on Vector’s
high pressure transmission pipeline.
Legal
aspects to recommending exemption
Sidewinder’s current regulatory status (the
default) is that it is automatically subject to the Information Disclosure
requirements and Price-Quality regulation under Part 4. However s55A(6)
of the Act provides for the Minister to recommend exemption (ie. addition to
Schedule 6) if inter alia the owner
of the pipeline does not have a substantial degree of market power.
Key
aspects of the Proposed Recommendation
In making its recommendation to the
Minister, the Commission has considered the following lines of thought:
·
TAG
Oil will only be transporting its own gas through Sidewinder therefore third
party access is not an issue, so TAG will only be providing pipeline services
to itself.
·
The
open access of both the Vector and Maui pipelines in Taranaki provides a single
market with highly transparent prices. TAG’s expected maximum injection into
that market is expected to be about 9% of the lowest ever recorded market
volume, hence TAG would be unlikely to be able to exert any market power.
The Commission will be consulting on its
recommendation around the time this issue is published, so Pipes & Wires
will check back in a few months.
A bit of light reading…
Wanted – old electricity history books
If
anyone has an old copy of the following books (or any similar books) they no
longer want I’d be happy to give them a good home…
·
White Diamonds North.
·
Northwards March The Pylons.
·
Two Per Mile.
·
Live Lines (the old ESAA journal)
Conferences & training courses
The following
conferences and training courses are planned...
·
Infrastructure:
Investment & Regulation – Sydney, 21st October, 2010.
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Disclaimer
These articles
are of a general nature and are not intended as specific legal, consulting or
investment advice, and are correct at the time of writing. In particular Pipes
& Wires may make forward looking or speculative statements, projections or
estimates of such matters as industry structural changes, merger outcomes or
regulatory determinations.
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Consultants Ltd accepts no liability for action or inaction based on the
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