From the
editor’s desk…
Welcome
to Pipes & Wires #106. After watching the Holden’s
completely demolish the Ford’s at Bathurst and seeing the All Blacks make
it into the semi-finals for the Rugby World Cup, its back to the wonderful
world of energy and utilities. Geographical coverage for this month
predominates in the United States, albeit across a wide range of issues, from
regulation of electric car recharging to merger concessions.
Apart
from that, we also examine 2 very critical aspects of the evolving electricity
distribution regulatory framework in New Zealand. In amongst that we also
examine some industry reshuffling and strategic realignment in Europe and take
a look at possible designs for new pylons in the UK.
Energy policy
US
– smart meter Bill gets rejected in Illinois
Introduction
The benefit-cost ratio of smart meter
roll-outs appears to be about 3:1 (based on a couple of studies I’ve looked at
recently – but also noting that some of those studies have had their accuracy
challenged), so it’s hard to understand why regulators baulk at allowing
utilities to recover those costs from customers. This article examines the recent
rejection of Senate
Bill 1652 in the US state of Illinois that would’ve allowed Commonwealth Edison (ComEd) to
do exactly that.
Previous
smart meter issues
Pipes & Wires has previously examined
the following smart meter issues...
·
In
the state of Maryland, Baltimore
Gas & Electric’s (BG&E) proposed to install 2,100,000 smart meters
at a cost of $835m with estimated savings of $2.6b over 15 years. Despite being
broadly supported by policy makers, this plan was rejected by the Maryland Public Service
Commission (PSC) on the basis that the benefits to customers were “largely indirect, highly contingent and a long way off” (Pipes &
Wires #94).
·
In
the state of California, Pacific Gas &
Electric (PG&E) experienced wide-spread public outrage after smart
meters were proclaimed as likely to reduce consumers’ electric bills.
Unfortunately the smart meter roll-out occurred just prior to the
air-conditioning season when the kWh consumption increased,
leading to higher electric bills (Pipes &
Wires #94).
Not surprisingly, the benefits of smart
meters have been lost amidst the wailing and gnashing of teeth.
Recent
events in Illinois
Citing an independent study by Black & Veatch based on a pilot program,
ComEd indicated that a full roll-out of smart meters to its 3,100,000 customers
in northern Illinois could save those customers $2.8b over the 20 year life of
the meters. Despite these claimed benefits, Governor Pat Quinn recently
rejected Senate Bill 1652 despite both chambers of the General Assembly passing
the Bill. Quinn claimed that the Bill would result in “excessive financial
burden on consumers, sweetheart deals, and no guarantee of improved service”. A
cursory reading of the Bill, however, indicates that the recovery of any
infrastructure investment will be through the rate-setting process, and subject
to the approval of the Illinois Commerce
Commission. Hence it is unclear how Quinn has formed the view that smart
meters will be just a meal ticket to inflate tariffs.
Undoubtedly these issues will continue to
emerge, and Pipes & Wires will provide analysis and comment when they do.
US
– California deregulates car recharging points
Introduction
We in the industry fully understand the
need for electric cars to be recharged during off-peak periods, in contrast to
the wider public (and unfortunately some policy makers) who
just don’t seem to get it. This article takes a more detailed look at whether
the deregulation of electric car recharging points in the US state of
California last year will address this important energy policy issue.
From
the consumer’s perspective
Promoters of electric cars have long
realised that conveniently located recharging points will be the single biggest
issue with electric cars. As a small aside, a vivid example screened recently
on Top
Gear with Jeremy and James test driving the Nissan Leaf and Peugeot Ion
through the small English town of Lincoln, for which the nearest recharging
point was about 45km away (and in all fairness, it appears they may have set
off with the batteries only half-full). However, convenient location of
recharging points is likely to be only half of the issue – the other half will
be the importance of off-peak charging to avoid both investment in additional
grid and generation capacity, and the use of fossil-fired peaking plants.
Deregulating
recharging points
Some regulators have been quick to
recognise that roll-out of conveniently located recharging points would require
a high degree of certainty of investment recovery, and pleasingly enough,
should also recognise the capabilities of the electric grid. In a ruling
back in 2010, the California Public Utilities
Commission concluded that...
·
The
California legislature did not intend the Commission to regulate suppliers of
recharging points as “public utilities” ie. that
operators of recharging stations are prima
facie free to set their charges as they see fit.
·
The
Commission’s authority to set rates (tariffs) including demand response rates for
the public utilities supplying the recharging points will be used to align
recharging practices with the needs of the grid.
·
Public
utilities will be able to pass those demand response rates on to the recharging
operator as a legitimate cost of business.
·
The
Commission has the authority to set the terms upon which an electric utility
supplies a recharging operator.
·
The
sale of electricity by an investor-owned utility to a recharging operator is
considered to be a retail sale, not a wholesale sale or “sale for resale”
(which would invoke the Federal Energy
Regulatory Commission’s jurisdiction).
On the whole, this seems to be a fairly
balanced outcome. Hopefully the intended effect of discouraging off-peak
recharging will materialise.
Asset
strategy
UK
– redesigning the pylons
Introduction
Pipes &
Wires #102 examined the competition to design new pylons for the UK’s
national grid. This article re-caps the competition and examines the 6 short-listed
entries.
The
competition
The competition is being run by the Royal Institute of British Architects
on behalf of the Department of Energy and
Climate Change and National
Grid to identify new designs to replace the 88,000 pylons built in Britain
since the mid-1920’s. In the words of Energy
Secretary Chris Huhne, the new pylons will “accommodate infrastructure into
our natural and urban landscapes”.
The
short-listed entries
The 6 short-listed entries were from the
following parties...
·
Entry
#12 – Ian Ritchie Architects (Silhouette).
·
Entry
#33 – Bystrup Engineering, Architecture & Design (T-Pylon).
·
Entry
#82 – Gustafson Porter (Flower
Tower).
·
Entry
#113 – AL_A & Arup (Plexus).
·
Entry
#197 - Knight Architects (Y).
·
Entry
#205 – Newtown Studio (Lattice).
Interestingly enough, 4 of the 6
short-listed entries are based around a monopole configuration, which if
nothing else should provide for ease of operation and maintenance. Pipes &
Wires will follow this up once a winner emerges.
Industry
reshuffling
Poland
– Vattenfall sells Polish assets
Introduction
Vattenfall seems to keep just
below the line of sight in the wider European energy industry, certainly a lot
less than its more visible competitors E.On, RWE, and EDF. None-the-less,
Vattenfall has accumulated a sizeable portfolio of electricity, gas and heat
businesses outside of its native Sweden. This article examines the sale of 2 of
Vattenfall’s Polish businesses, and then examines some possible wider drivers
of asset sales
The
asset sales
The assets that Vattenfall will sell are...
·
Vattenfall Heat
Poland SA, which will be sold to gas utility PGNiG SA for an enterprise
value of €880m.
·
Vattenfall’s Silesian electricity company Gornoslaski Zaklad
Electroenergetyczny (GZE), which will be sold to Tauron SA for an enterprise value
of €838m.
The sales are expected to be concluded at
the end of 2011 subject to competition authority approval, and will be for cash.
Why
would Vattenfall exit the Polish market ?
Vattenfall has publicly stated the
following reasons for existing Poland....
·
To
enable a stronger focus on the core markets of Sweden, Germany and the
Netherlands.
·
To
migrate its’ capital into the renewable sector.
A further aspect of Vattenfall’s strategy
is to reduce its CO2 exposure, so selling off thermal generation plant
makes obvious sense.
Possible
wider drivers for asset sales
Asset sales by the European giants are now
regular occurrences (after many years of growth by acquisition). So what could
some of the wider drivers of strategy and changes to strategy be? Possibilities include....
·
Over-arching
policy such as the EU’s Third Package, forcing utilities to choose between
lines and energy eg. the 4 major German
utilities seem to be migrating their capital away from grids and into
energy.
·
Relative
attractiveness (or lack of) of differing regulatory regimes eg. FERC-regulated transmission assets in the US
have a higher allowable return than state-regulated distribution assets.
·
Relative
values of foreign currencies eg. the recent weakening
of the US$ has made acquisitions in the US attractive.
·
A
desire to keep ahead of the “carbon curve” as various climate change
initiatives erode the profitability of mature coal-fired plants that were once
the low-cost mainstay of many utilities.
US
– exiting the non-regulated businesses
Introduction
A fairly clear picture of Europe’s major
electric utilities migrating their capital away from
lines and towards energy is emerging. This article examines US utility PNM Resources’ migration of capital in
the opposite direction.
A
bit about PNM Resources
PNM Resources is the holding company of inter alia the Public Service Company of New Mexico, the Texas – New Mexico Power Company, First Choice Power and Optim Energy. These subsidiaries supply
line services and energy to 875,000 customers in parts of New Mexico and Texas,
and also own 2,600MW of generation. Annual revenues are about $1.7b.
Details
of the capital migration
PNM recently announced that it would do the
following...
·
Sell
its energy supply business First Choice Power to Centrica plc subsidiary Direct Energy for $270m
cash plus adjustments for working capital.
·
Reduce
its equity stake in generator Optim Energy to 1% by allowing co-owner ECJV
Holdings to increase its equity stake.
PNM’s
strategy
PNM have publicly stated their intention to
focus on the regulated wires businesses, which are subject to the jurisdiction
of the New Mexico Public Regulation
Committee and the Public Utility
Commission of Texas respectively. Most of us will have a strong
appreciation that PNM will be now be able to sharpen its focus to that of an
asset management company.
PNM has indicated that it will use the sale
proceeds to recapitalise by repurchasing debt and equity, and has indicated
that its 2011 consolidated earnings should be about 20% up on previous years
due to a range of factors including a reduced impact of Optim on the balance
sheet.
The
wider picture
For a start, we need to be clear that 1
deal doesn’t set a trend (unlike Europe, where many deals seem to be pointing
in a similar direction). A number of factors are worth considering....
·
Migration
towards a regulated wires business enables a sharper focus on asset management,
cost optimisation and managing the regulatory regimes.
·
Migration
towards unregulated energy businesses requires significant scale and a starting
point of experience in deregulated energy markets, and involves managing
completely different risks.
·
If
everybody heads toward energy, someone still has to own the wires businesses.
Regulatory
decisions
NZ
– determining the WACC for electricity CPP’s
Introduction
Most of us have a thorough understanding of
the importance of the weighted average cost of capital (WACC) and the primary
role that WACC plays in regulatory decisions. This article examines the Commerce Commission’s recent
Decision #732 which sets out the Commission’s determination for the 75th
percentile estimate of WACC to be used for electricity Customised Price Path
proposals.
Background
Electricity distribution businesses (EDB’s)
that do not meet the customer
ownership criteria are subject to a 5 year Default Price Path (DPP). Those
EDB’s that believe they cannot meet the revenue or supply reliability
constraints of a DPP have the option of applying to the Commission for a
Customised Price Path (CPP). Clause 5.3.28 of the Commission’s
Decision #710 of December 2011 requires the Commission to determine a 75th
percentile vanilla WACC estimate according to a specified methodology.
What
exactly is the 75th percentile WACC ?
First some probability theory ... for a Gaussian (normal)
distribution, we know that the probability of an event being within 1
standard deviation (σ) either side of the mean (μ) is about 0.682. To
extend this thinking a bit, the probability of an event being less than the
mean plus 1 standard deviation is about 0.841. A bit of mucking round reveals
that the probability of an event being less than the mean plus 0.674 standard
deviations (μ + 0.674σ) is 0.75, or the 75th percentile.
Why
the 75th percentile ?
The simple answer (at least in theory) is
that adopting the 75th percentile provides a margin of error in
favor of the regulated business over and above what the adoption of the 50th
percentile or mid-point WACC would. This margin of error is to compensate for
the limited accuracy of WACC calculations.
The
Commission’s determination
The Commission’s 75th percentile
WACC determination has been compiled from the following parameters....
|
Parameter |
3 year CPP |
4 year CPP |
5 year CPP |
|
Risk-free rate |
3.62% |
3.87% |
4.04% |
|
Debt premium |
1.64% |
1.80% |
1.90% |
|
Debt issuance costs |
0.58% |
0.44% |
0.35% |
|
Equity beta |
0.61 |
0.61 |
0.61 |
|
Tax-adjusted market risk premium |
7.0% |
7.0% |
7.0% |
|
Average corporate tax rate |
28% |
28% |
28% |
|
Average investor tax rate |
28% |
28% |
28% |
|
Leverage |
44% |
44% |
44% |
|
Standard error of debt premium |
0.0015 |
0.0015 |
0.0015 |
|
Standard error of WACC |
0.011 |
0.011 |
0.011 |
|
Pre-tax cost of debt |
5.84% |
6.11% |
6.29% |
|
Cost of equity |
6.88% |
7.06% |
7.18% |
|
Mid-point vanilla WACC |
6.42% |
6.64% |
6.79% |
|
75th
percentile vanilla WACC |
7.14% |
7.36% |
7.50% |
NZ
– suspending the proposed mid-term DPP reset
Introduction
Pipes
& Wires #104 examined the draft
decision on resetting the default price paths (DPP) that the Commerce Commission proposed to apply to
non-exempt electricity distribution businesses (EDB’s) on 1st April
2012 for the remaining 3 years of the 2010 – 2015 Default Price Path (DPP).
This article summarises the key elements of a recent High
Court judgment in favor of Vector
that has prompted the Commission to suspend that mid-term reset.
Basis
of Vector’s judicial review application
The 3 principal components of Vector’s case
are (extracted from Justice
Denis Clifford’s summary) as follows...
·
Parliament
clearly intended Part 4 of the Commerce Act 1986 to provide greater certainty
of infrastructure investment, with Input Methodologies being a principal means
of achieving that greater certainty. The Commission’s failure to specify a more
comprehensive range of Input Methodologies was inconsistent with Parliament’s
clear intention.
·
The
specific provisions of Part 4 at s52R, s52S and s52T taken together require the
Commission to determine and publish, under s52U(1), an Input Methodology
applying to the DPP Reset (starting price adjustment) or key elements thereof.
·
The
failure of the Commission to specify an Input Methodology limited the scope of
Vector’s rights of appeal to questions of law under s91 of the Commerce Act
1986, rather than the broader scope of appeal available under s52Z if an Input
Methodology had been specified.
The
Commission’s response
The Commission’s response is based largely
on what it considers to be a correct interpretation of Part 4, viz...
·
That
the Commission’s 2 step process of setting the Input Methodologies first, and
then making s52P determinations, was clearly mandated by Part 4.
·
The
Commission is expressly authorised to reset starting prices by s54K(3). Once that (midterm) reset is completed, investment
certainty would be provided. Moreover, an EDB that was not satisfied with the
(midterm) reset could apply for a Customised Price Path (CPP).
High
Court’s judgment
The High Court’s broad judgment was that
the Commission had misinterpreted Part 4 to the extent inter alia that it had not determined a starting price adjustment
Input Methodology. Relief included the compilation of a stand-alone starting
price adjustment Input Methodology.
Suspending
the proposed mid-term reset
As a result of the High Court’s judgment,
the Commission has announced that the proposed mid-term DPP reset will be
suspended.
Mergers
& acquisitions
US
– Central Vermont and Green Mountain file merger plan
Introduction
Pipes &
Wires #102 and #103
examined competing bids for the Central Vermont
Public Service Corp (CVPSC) from 2 Canadian utilities, Fortis and Gaz Metro Limited
Partnership. This article notes the official filing of a merger approval
request by CVPSC and Green
Mountain Power (GMP) with the Vermont Public Service Board,
and the approval of CVPSC’s shareholders.
The
proposed merger
The merged entity will have about 256,000
electric customers across Vermont, and will provide opportunities for about
$144m of cost savings over 10 years as well as investment in renewables.
Considering the way US regulators are treating other merger approvals, it would
seem that the allocation of those cost savings between shareholders and customers
is likely to be a significant issue.
Shareholder
approval received
Approval of CVPSC’s shareholders was
obtained in late September 2011.
Outstanding
regulatory approvals
Following the Federal Trade Commission’s
(FTC) approval in late September 2011, the following primary regulatory
approvals are still to be obtained...
·
Federal
Energy Regulatory Commission.
·
Vermont
Public Service Board.
Pipes & Wires will comment as these
approvals are granted.
US
– extracting concessions from the Duke – Progress merger
Introduction
Pipes & Wires has been following the
proposed merger of Duke Power and Progress Energy to form the largest
electric utility in the US. This article examines the Federal Energy Regulatory Commission’s (FERC)
request for options to offset the diminished competition in the states of North
Carolina and South Carolina if the merger was to proceed to completion.
Background
to the deal
Duke
offered Progress’ shareholders 2.6125 Duke shares for
each Progress share, as well as Duke assuming $12.2b of Progress’ debt. If
successful, the merged companies would have about 56,000MW of generation and
supply about 7,100,000 electric customers in North Carolina, South Carolina,
Indiana, Kentucky, Ohio and Florida (Pipes
& Wires #100, #102
and #105).
On a note more closely aligned to this
specific article, Duke and Progress have offered the following accord to the North
Carolina Utilities Commission and the South Carolina Public Service
Commission...
·
Customers
in North Carolina and South Carolina will benefit from cost reductions totaling
at least $650m over the first 5 years of the merged company.
·
Ensuring
that North South Carolina customers are fully insulated from the costs of a new
nuclear station in Florida and a new coal-fired station in Indiana.
Both regulators have broadly accepted these
undertakings.
Diminished
competition in the Carolina’s
Diminished competition resulting from
mergers is obviously a major concern to regulators, and one that Pipes &
Wires has closely examined on several previous occasions. In this instance, the
FERC is concerned that competition in the Carolina’s wholesale electricity
market would be diminished, and suggested that the following possible
concessions could be considered...
·
Sale
of generation plant to unrelated parties.
·
Placing
control of transmission lines with a Regional Transmission Operator (RTO).
·
Building
new transmission lines.
Not only could any of these possible
concessions prevent Duke and Progress’ consolidating market power, they could
potentially diminish their market power with respect to existing levels.
Understandably, equity analysts are nervous about this whole issue.
The
proposed concession
In response to the FERC’s proposed options,
Duke and Progress have offered an alternative concession to the FERC in which
the price of electricity sold into the Carolina’s market would be limited to cost
plus 10% for a period of 8 years. Competitors would be free to enter the
Carolina’s market at any time.
This proposed concession has already
attracted criticism from merger critics, so it will be interesting to see what
the FERC’s response is.
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, 2011.
·
Fundamentals
of the NZ electricity industry – Wellington, 26th – 27th
October, 2011.
·
Fundamentals
of the NZ electricity industry – Auckland, 9th – 10th
November, 2011.
·
Fundamentals
of the NZ electricity industry – Wellington, 8th – 9th
May, 2012.
·
Fundamentals
of the NZ electricity industry – Auckland, 22nd – 23rd
May, 2012
Accredited supplier status
Utility
Consultants is pleased to announce that it is now an Asia-Pacific Utilities Group (APUG) accredited
supplier (registration number 88899493).
Opt out from Pipes & Wires
Pick
this link
to opt out from Pipes & Wires. Please ensure that you send from the email
address we send Pipes & Wires to.
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.
Utility
Consultants Ltd accepts no liability for action or inaction based on the
contents of Pipes & Wires including any loss, damage or exposure to
offensive material from linking to any websites contained herein.
