Pipes & Wires

THE JOURNAL OF COOL ENERGY & UTILITIES STUFF

Issue 116 – November 2012

 

From the editor’s desk…

 

Welcome to Pipes & Wires #116. This month we look at a few regulatory decisions in New Zealand and England, and then consider some energy security and policy interactions in England and Germany. We conclude this issue with a look at the future of electricity network regulation in Australia and how the Solar Cities.

 

General stuff

 

What have I been doing lately ?

 

A couple of interesting projects I’ve been involved with lately that might be of interest to others include...

 

·       Performing customer surveys for a couple of EDB’s, to determine customers’ views and preferences for a range of matters including price-quality trade-offs.

 

·       Compiling asset management plans in preparation for disclosure by 31st March 2013.

 

·       Assisting several EDB’s with their AMMAT assessments for disclosure by 31st March 2013.

 

·       Analysing supply reliability against peer EDB’s

 

·       Analysing EDB’s operating and capital costs against peer EDB’s.

 

·       Initial discussions about how to approach a CPP.

 

·       Taking the kids on a road-trip from San Francisco to Washington DC and New York.

 

CPEng status

 

I’m pleased to announce that I am now a Chartered Professional Engineer (CPEng), and am available to undertake work for which the Commerce Commission requires an Independent Engineer.

 

Re-vamped website   

 

My website has been substantially re-vamped, with some up-dated content to better reflect my experience and emerging industry issues. Please pick here and take a browse around.

 

Guide to NZ electricity laws

 

I’ve compiled a “wall chart” setting out the relationship between various past and present electricity Acts, Regulations, Codes etc in sort of a chronological progression. To request your free copy, pick here.

 

New Zealand

 

NZ – setting the WACC for gas distribution

 

Introduction

 

Setting the weighted average cost of capital (WACC) is an essential part of controlling the revenue or prices for an infrastructure business. This article examines the Commerce Commission’s recent WACC decision that will apply to Powerco’s gas distribution business for the 2013 Information Disclosure year.

 

Key components of the WACC

 

The key components of the WACC that will apply are....

 

Parameter

Value

5 Year risk free rate

2.97%

5 Year debt premium

2.45%

Equity beta

0.79

Tax adjusted market risk premium

7.0%

Average corporate tax rate

28%

Average investor tax rate

28%

5 Year debt issuance costs

0.35%

Leverage

44%

Standard error of debt premium

0.0015

Standard error of WACC

0.012

5 Year cost of debt

5.77%

5 Year cost of equity

7.67%

 

Final WACC

 

The final 5 Year WACC’s that will apply for the 2013 are....

 

WACC

Mid-point

Range

Lower bound

Upper bound

Vanilla

6.83%

6.02%

7.64%

Post-tax

6.12%

5.31%

6.93%

 

NZ – the gas Default Price Path (DPP) Draft Decision

 

Introduction

 

The Commerce Commission recently announced the Draft DPP’s that it intends to apply inter alia to Vector and Powerco’s gas distribution businesses when the Gas Authorisations expire on 1st July 2012. This article examines the key features of the Draft DPP and the industry’s response.

 

Background

 

The gas distribution businesses belonging to Vector and Powerco were subject to the 2003 Gas Pipeline Enquiry, and as a result were placed under control by the Commerce (Control of Natural Gas Services) Order 2005. On 31st October 2008 that Control was extended by the Gas Authorisations, which will expire on 1st July 2012.

 

Part 4 of the Commerce Act 1986 requires the Commission to set the Initial DPP’s for certain suppliers of gas pipeline services. Those DPP’s must embody the following elements....

 

·       The prices or revenue that can be charged at the start of the DPP.

 

·       The annual rate of change in prices or revenue that are allowed to occur in subsequent years of the DPP.

 

·       The quality standards that must be met.

 

Key features of the draft DPP

 

The key features of the draft DPP are as follows....

 

Parameter

Vector

Powerco

Allowable revenue for first 15 months.

$88m

$61m

Average adjustment to current revenue required to earn allowable revenue for first 15 months.

-16%

+5%

Estimated excess revenue for first 15 months if revenues were not adjusted as proposed by the Draft DPP.

$48.4m

-$8.7m

Allowable rate of change for Draft DPP period.

CPI-0%

 

Errata – the original version of PW116 distributed by email had incorrectly stated the figures in red above as Vector +5% and Powerco -16%. This version is corrected as above.

 

The industry’s views

 

Vector levelled the following 2 criticisms at the Draft DPP...

 

·       A reliance on asset valuations that are nearly 10 years old.

 

·       That the investment signals appear inconsistent with the Minister of Energy’s stated importance of gas infrastructure.

 

Next steps

 

The Commission will receive submissions on the Draft DPP until 7th December 2012. Pipes & Wires will comment further as the DPP is finalised.

 

NZ – updating the grid’s Maximum Allowable Revenues

 

Introduction

 

The NZ electricity transmission grid owner, Transpower, is subject to an Individual Price Quality Path (IPP) that Pipes & Wires has previously examined. This article examines the recently announced updates to the Maximum Allowable Revenues (MAR’s)

 

Background

 

The Commission’s previous work has included considering what sort of regulatory instrument Transpower should be subject to, recommending to the Minister that Transpower should be subject to an Individual Price-Quality regulation (as described in s53ZC of the Act), and setting out the Maximum Allowable Revenues (MAR) and quality targets. These are examined in Pipes & Wires #90, #97, #98 and #105.

 

Key features of the initial IPP

 

Key features of the IPP that will cover the regulatory control period (RCP1) from 1st April 2011 to 31st March 2015 include...

 

·       A maximum allowable revenue (MAR) of $644m for the 1st April 2011 – 31st March 2012 year (referred to as the transition year).

 

·       A requirement for Transpower to submit forecast MAR’s for the remaining 3 years by 21st October 2011.

 

·       A requirement for the Commerce Commission to determine forecast MAR’s for the remaining 3 years by 30th November 2011, based on the information submitted by Transpower.

 

·       A requirement for Transpower to certify each year that it has complied with the forecast MAR.

 

·        Quality targets for the year ending 30th June 2012 of...

 

 

 

 

 

·       A requirement for Transpower to determine quality targets for the years ending 30th June 2013, 2014 and 2015 by 30th November 2011.

 

·       A requirement to annual disclose the MAR, CapEx, Opex and Economic Value Added (EVA).

 

The recent amendments

 

The recent amendments to Transpower’s MAR are based inter alia on the following amendments to Pass-Through Costs...

 

 

YE 31st March 2014

YE 31st March 2015

Initially proposed 22nd December 2010.

$906.4m

$958.9m

Amended as of 31st October 2012.

$874.3m

$959.7m

 

UK and Europe

 

UK – the declining reserve capacity margin

 

Introduction

 

The looming generation capacity gap in the UK has been the subject of much public debate, and indeed various policy overhauls and market reforms to “incentivise” new generation. This article examines a recent report from UK energy regulator OFGEM predicting that the UK’s reserve capacity margin could fall from the comfortable current 14% to a scary base case of 4% by 2015/16.

 

Key drivers of the declining capacity

 

The report notes several key drivers of the declining reserve capacity margin...

 

·       Closure of some 12,000MW of older coal-fired and oil-fired stations under the EU’s Large Combustion Plant Directive, which limited such plants to 20,000 hours of operation between 1st January 2008 and 31st December 2015. Some of these plants have been retired earlier under the LCPD’s “opt out” arrangement.

 

·       Changes to the generation mix, which would appear to be a cryptic way of saying that wind and solar are unreliable due to their intermittent nature.

 

·       Possible similar reductions in reserve capacity margins in the countries that the UK imports electricity from.

 

I’d also add reduced security of gas supply from Europe as a further strategic issue, as this limits the usefulness of any gas-fired generation that could be built quickly.

 

Possible answers to restoring the reserve capacity margin

 

There are really only 2 possible answers ... either build more firm capacity, or reduce demand. Putting aside the occasional drop in demand, the long-term scenario is increasing demand due to heat pumps, plasma TV’s, more lap-tops and other power-hungry gizmo’s.

 

So that really does leave building more nuclear, coal-fired or gas-fired plants as the only answer. Recent announcements would suggest that many if not all of the UK’s proposed new nuclear stations are now non-starters due to a wide range of issues, leaving only fossil-fired stations as the real option.

 

The troubling thing...

 

The troubling thing is that many industry stakeholders (myself included) have repeatedly cried for many years that current policies would lead to such electricity shortages. These cries were ignored, dismissed as alarmist or rejected as inconsistent with a low-carbon future.

 

It would appear that on-going market reforms and policy overhauls have not incentivised new generation as it was suggested that they would. Moreover 3 to 4 years is too short to build serious amounts of firm capacity to reverse the declining reserve capacity margin. So the medium-term looks a bit cold and dark for the UK, a coldness and darkness that will require some strong policy and leadership to fix.

 

Germany – what future hath coal ?

 

Introduction

 

Pipes & Wires #75, #90 and #101 examined the likely role of coal-fired generation in the US under the rather pithy heading “what future hath coal ?” and concluded that coal had a very uncertain future (after the 2012 election result it appears, however, that coal has a very certain future). In Germany, however, it appears the future for coal is very bright. This article notes the opening of the first of 20 something (reports differ) large coal-fired stations to off-set the closure of the nuclear stations.

 

Key strategic issues

 

Key strategic energy issues facing Germany include...

 

·       A policy directive to close all nuclear plants by 2022.

 

·       Uncertain gas supplies from Russia.

 

These 2 issues cast a shadow over close to 80% of Germany’s generation capacity.

 

The new coal station

 

RWE’s 2 new 1,100 MW lignite-fired units at Neurath are capable of following the intermittent supply from wind and solar. The 2 units have an efficiency of about 43%, and complement the 5 original units.

 

Likely future role of coal

 

It appears that Neurath is the first of 20 something (reports suggest between 22 and 25) new coal or lignite-fired stations Germany intends to build to both off-set the closure of the nuclear stations and to buffer wind and solar. So it would appear that coal indeed does have a bright future in Germany.

 

UK – defining the regulatory information requirements

 

Introduction

 

The UK energy regulator OFGEM is developing a regulatory framework known as RIIO that it hopes will encourage investment and innovation in energy networks. Pipes & Wires has recently examined the Initial Proposals for both electricity and gas transmission (RIIO-T1) and gas distribution (RIIO-GD1). This article examines OFGEM’s recently released draft Regulatory Instructions and Guidance paper setting out the broad structure and content of the information that OFGEM proposes to gather during the RIIO period.

 

A regulator’s requirement for information

 

Most of understand that for a regulator to fulfill its statutory duties of compiling price controls and then monitoring compliance and comparing efficiencies, it will require a wide range of detailed information that generally always has to be collected from the regulated suppliers.

 

What are OFGEM proposing ?

 

Primarily OFGEM are proposing a set of Excel templates for recording the data, calculating the revenue elements and providing data commentaries (this would seem very similar to the various Information Disclosure templates required in New Zealand). OFGEM has also proposed the following principles to guide the data gathering process...

 

·       That the data should directly contribute to the RIG objectives of being necessary to administer license conditions and Final Proposals, and informing expected annual cost and performance reports.

 

·       That the data gathered should be proportionate ie. the data requirements do not exceed what OFGEM reasonably needs to achieve the RIG objectives. OFGEM proposes 4 classifications for such data ranging from “critically important” (ie. couldn’t fulfill its obligations without that data) to “not important”.

 

·       That data reporting requirements should align with or draw from existing reporting formats so that new formats do not have to be compiled.

 

 Next steps

 

OFGEM will receive submissions on the draft RIG paper until 14th December 2012.

 

Australia

 

Aus – rethinking electricity network regulation

 

Introduction

 

Australia’s Productivity Commission (PC) has been enquiring into aspects of national electricity regulation in Australia to provide some context for future analysis. This article examines the findings of the PC’s recent Draft Report.

 

Key issues considered

 

The PC has been considering inter alia the following 2 issues...

 

·       The role of benchmarking as a distinct alternative to the bottom up approach.

 

·       That any such benchmarking must compare “apples with apples”, and that issues such topography, customer density and temperature extremes must be correctly accounted for. Indeed, the issues paper correctly recognises that incorrect classification of an outlier as “inefficient” can lead to economically inefficient investments.

 

Key findings of the draft report

 

The key findings of the PC’s draft report include....

 

·       Electricity prices have risen by more than 50% in real terms over the last 5 years, with transmission and distribution costs being the main contributors.

 

·       The over-arching regulatory objective of the long-term interests of consumers has been lost.

 

·       Resolving interconnection issues between state transmission grids would need to be part of a wider reform package to deliver real benefits.

 

·       About 25% of a retail electric bill is required to supply about 40 hours of critical peak demand each year. Something like $11b of capacity is only used for about 100 hours per year.

 

·       Some consumers are being forced to pay for more reliability than they want.

 

·       State-owned electric companies have conflicting objectives, and also appear less efficient than privatised companies.

 

·       The AER needs more resourcing, expertise, accountability and accountability.

 

·       The existing incentive regulation encourages regulated electric companies to build too much.

 

·       Many inefficiencies that might be blamed on the electric companies are simply responses to regulatory incentives and structures that impede efficiency.

 

Next steps

 

At the time of writing, the Productivity Commission is receiving submissions on the Draft Report until 23rd November 2012 with a view to delivering its Final Report on 9th April 2013. Pipes & Wires will examine that Final Report when it emerges, and compare the findings to those of the Draft Report.

 

Aus – the Solar Cities report

 

Introduction

 

Solar energy is undoubtedly a great thing - as I write this about 20kW of free energy is pouring down on the deck outside my study. Sadly, capturing that energy, converting it to electricity, and then integrating that electricity into conventional grid connected electricity seems to be mired in commercial and strategic issues. This article examines the Australian Government’s Solar Cities program to see how those issues are being managed.

 

The Solar Cities program

 

The Solar Cities program is aimed at trialing new sustainable models for electricity supply and use in 7 separate grid connected cities – Adelaide, Alice Springs, Blacktown, Central Victoria, Moreland, Perth and Townsville. These models include

 

·       Energy efficiency measures.

 

·       Using solar technologies.

 

·       Cost reflective pricing trials.

 

·       Community education.

 

The results so far

 

The Solar Cities  - Catalyst For Change – Community Engagement Paper sets out a the conclusions and observations to date. A few of these include...

 

·       Over 50% of households were aware of the Solar Cities program (Adelaide).

 

·       723 solar hot water systems have been installed (Alice Springs).

 

·       310kW of solar electricity generation has been installed (Blacktown).

 

·       521 solar electricity systems have been purchased (Central Victoria).

 

·       79,000 residents are reached by a newspaper column on sustainability (Moreland).

 

·       Reductions of 12% in electricity consumption and 11% in peak electricity demand, along with an 8 year deferral of a 3rd undersea electricity cable to Magnetic Island (Townsville).

 

What might we make of this ?

 

There are certainly some exciting demand and energy consumption reduction initiatives occurring that are to be encouraged. From where I look at all this, the following policy adjustments would be a useful step forward...

 

·       There will need to be a stronger recognition by policy makers that most of the electricity supply chain has high fixed costs that are independent of energy (kWh) throughput. As energy throughput decreases, revenues based on energy throughput will decline, so a shift towards fixed charges based on capacity will be needed to ensure that the electricity supply chain is sustainably funded.

 

·       Care will need to be taken around the timing of peak demand reductions, especially if heavy air conditioning still occurs. This could make asset utilisation even more peaky.

 

·       The need to fully disclose the costs of connecting embedded generation if we are to be true to the objective of cost reflective pricing.

 

·       Ensuring that consumers are fully informed of the reliability trade-offs that come with weather-dependent embedded generation, and that they willingly accept the possibilities of supply interruptions if local networks have a reduced capacity.

 

Pipes & Wires will check back on the Solar Cities in a year or so to see what progress has been made.

 

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).

 

·       The Engineering History Of Electric Supply In New Zealand.

 

Conferences & training courses

 

The following conferences and training courses are planned...

 

·       Infrastructure, Investment & Regulation Conference – Sydney, 30th – 31st May 2013.

 

House-keeping stuff

 

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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. These articles also summarise lengthy documents, and it is important that readers refer to those documents in forming opinions or taking action.

 

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, or from any republishing by a third-party whether authorised or not, nor from any comments posted on Linked In, Face Book or similar by other parties.