From the
editor’s desk…
Welcome
to Pipes & Wires #129. This issue examines a few regulatory processes and decisions
in New Zealand and the UK. We also examine what appears to be a slowing
enthusiasm for renewable energy in Germany, and the on-going politics of retail
contestability in Tasmania.
I’d
also take the opportunity to wish you and yours a very Merry Christmas and all
the best for a Happy New Year.
Matters for attention
Amendments to NZS 7901 (Safety
Management Systems)
A
draft document for Amendment #1 to NZS 7901 is open for public comment until 21st
February 2014. For help with this issue, pick here or call Phil on (07) 854-6541.
Initial observations on EDB’s disclosed
forecasts
The
Commerce Commission recently released its initial observations on EDB’s disclosed forecasts (refer to full article below).
Following a workshop in Wellington last week, the Commission will receive
written comments until 23rd December 2013.
Distribution pricing methodologies
The
Electricity Authority has released the results of its distribution pricing review. For help with this report or
developing your initial thoughts, pick here or call Phil on (07) 854-6541.
New Zealand
NZ – initial observations of Electricity
Distribution Business’ forecasts
Introduction
The Commerce Commission recently released its Initial Observations on the forecast information that was disclosed by the 29 EDB’s back in March
2013. This article summarises the Commission’s observations.
Summary of the Commission’s observations
The following table summarises the Commission’s observations…
|
Aspect |
Description |
Observations
and comments |
|
CapEx |
Percentage real increase of 2014-18 CapEx with respect to 2010-13
CapEx. |
· Significant variations observed, ranging from
+142% to -55%, with 22 EDB’s forecasting a + change. Of those 22 EDB’s, 15
are forecasting an average increase of more than 20% per year. · “Asset replacement and renewal” is generally
the category which is forecast to increase the most. · Average CapEx is forecast to be about 16%
higher for 2014-19 than for 2008-13. |
|
OpEx |
Percentage real increase of 2014-18 OpEx with respect to 2010-13
OpEx. |
· Less variations observed, ranging from +33% to
-63%, but also with 22 EDB’s forecasting a + change. Of those 22 EDB’s, 15
are forecasting an average increase of more than 10% each year. · “System operations and network support” is the
category for which the highest increases have been forecast. · Average OpEx is forecast to be about 9% higher
for 2014-18 than for 2010-13. |
|
Top-down OpEx modeling |
Commission’s initial observations on top-down models for OpEx. |
· Use of Commission’s previously compiled model
to observe whether the spend drivers underpinning the model help explain each
EDB’s forecast, using a simple escalator based on network scale, operating
efficiency and changes to input prices. · Recognition of costs that are outside EDB’s
control. · Possibility of using an average of several
historical years as the starting point for the top-down model, as opposed to
using 1 year. |
|
Top-down CapEx modeling |
Commission’s initial observations on top-down models for CapEx. |
· Recognises that it may be necessary to build
separate models for each CapEx category. · Also recognises that forecasting CapEx from
previous CapEx is problematic, and notes that a hybrid (still not a true
bottom-up) approach is likely to give a better result. |
|
Input prices |
Real and nominal increases to OpEx and CapEx input prices. |
· The NZIER forecast price increases are greater
than those forecast by EDB’s. · Across all EDB’s, expectations of OpEx changes
range from -0.9% to +3.5%. · Across all EDB’s, expectations of CapEx changes
range from -4.2% to +3.5%. |
Comments on the Commission’s modeling
The Commission has also compiled a model to forecast expected costs.
It is pleasing that the Commission has noted that variations between its model
and EDB’s own forecasts may arise for a number of reasons (including relative
efficiencies and extrapolation of historical trends), including specific
details described in the Asset Management Plan. It does merit reiterating that
an EDB is a very complex business and trying to represent and compare EDB’s
with a simple suite of high-level measures needs to be treated as indicative
only.
What is of concern is the emphasis placed on top-down models which
obviously have a strong inherent bias to past performance that may bear no
resemblance to future performance. Consideration of bottom-up models rather
than attempts to refine top-down models is urged.
NZ – High Court rules on Input Methodology
appeals
Introduction
Several regulated infrastructure suppliers and two infrastructure
users appealed aspects of the Commerce Commission’s December 2010 Input Methodologies Determination (Decision #710). The High Court ruling on Wellington International Airport Ltd & Others
v Commerce Commission of December 2013 forms the basis of this article.
Background
As part of its work of compiling the regulatory framework for
regulated infrastructure, the Commission compiled Input Methodologies (IM’s) that
describe how various parameters are to be calculated or treated, with the
purpose of providing greater certainty to infrastructure investors. Three IM’s
covering electricity distribution, gas distribution and gas transmission were
released by the Commission in December 2010.
Basis of the appeals
The appeals included…
· The cost of capital IM.
· The asset valuation IM.
· The tax IM.
· The cost allocation IM for Information Disclosure
and for the Default and Customised Price Paths (DPP and CPP).
· Certain process IM’s including reconsideration of
DPP’s.
· The Commission’s decision not to compile an IM
for the starting price adjustments.
Summary of Court ruling
The High Court’s broadly dismissed all the appeals with two
exceptions…
· That part of the airport asset valuation IM
appeal that relates to the date for the initial market value alternative use
(MVAU) valuation of airport land assets, and
· That part of Vector’s regulatory rules and
process IM appeal relating to the reconsideration of DPP’s.
It is obviously difficult to summarise a 661 page High Court ruling
(which involved examining over 40,000 pages of documents and 39 days of
hearings), so readers are invited to download the ruling from the link above.
NZ – final decision for Orion’s CPP
Introduction
The
Commerce Commission released its final decision on Orion’s Customised
Price Path (CPP) application in late November 2013. This article examines the
key features of that decision, and compares those features with those of the
application and the draft decision.
Legal framework
The
regulatory framework for electricity distribution companies is set out in Part 4 of the Commerce Act 1986, with Subpart 6 dealing specifically with CPP’s. A
non-exempt electricity distribution company (subject to a Default Price Path)
can apply for a CPP if it believes that it cannot adequately fund its
activities under the DPP.
Key features of the final decision
Key
features of the CPP application, draft decision and final decision include...
|
Parameter |
Application |
Draft
decision |
Final
decision |
|
CapEx |
$397m |
$269m |
$252m |
|
Price
increase on 1st April 2014 |
CPI + 15% |
CPI + 9.2% |
CPI + 8.4% |
|
Price
increases on 1st April 2015, 2016, 2017 and 2018 |
CPI + 1.2% |
CPI |
CPI + 1% |
|
Typical
domestic bill increase |
$8.50 per month. |
$5.20 per month. |
$4.80 per month. |
|
Total
revenue |
$896.4m |
$826.8m |
$837.4m |
A
few of the Commission’s more salient remarks from the final decision include…
· There is concern that Orion has proposed
to do too much too soon. The Commission expressed the view that some of this
expenditure would either lead to excessive service levels, or was inefficient.
· The extent and timing of the proposed
expenditure around contingent investments has not been adequately justified.
· Orion’s customers shouldn’t have to
compensate Orion for the loss of revenue after the earthquake. The Commission
believes that its approach strikes a balance between adequately incentivsing
disaster recovery whilst also protecting customers
from ex-post revenue recovery.
This
article concludes Pipes & Wires analysis of the Orion CPP.
NZ
– setting the 2015 – 2020 Default Price-Quality Path
Introduction
Electricity
distribution businesses (EDB’s) that do not meet the consumer ownership
criteria set out in s54D of
the Commerce Act 1986 are subject to a
Default Price-Quality Path (DPP) for the five year period 1st April
2010 to 31st March 2015. The Commerce Commission is commencing work
on the DPP that will take effect from 1st April 2015, and it is the
initial stages of this work that forms the subject of this article.
Legal
framework
The legal framework
for regulating goods and services is set out in Part 4
of the Commerce Act 1986, with Subpart
9 dealing
specifically with EDB’s. In this context, s53P(3) requires the
Commission to choose either of the following two options…
· The
prices that applied at the end of the preceding period, or
· Prices
based on the current and projected profitability, as determined by the
Commission.
Initial
stages of the Commission’s work
The initial stages
of the Commission’s work included publication of a preliminary
financial model and an accompanying paper which
focus on setting the starting prices based on current and projected
profitability as of November 2014 (except for the WACC, which will be
determined by 30th September 2014) . Key features of the model
include…
· A data
inputs sheet that includes industry-wide parameters and EDB-specific
parameters.
· A data
selection sheet from which each EDB picks its own name, which then pulls in the
parameters specific to that EDB.
· Calculation
sheets which calculate the revenue that an EDB would need to earn in the year
ending 31st March 2016 so that forecast revenue for the five year
period equals forecast costs. A building block approach based on return on RAB,
depreciation, OpEx and tax has been adopted.
· An
outputs sheet which includes the maximum allowable revenue (MAR) for each EDB
for the year ending 31st March 2016 based on the industry-wide X
factor and any applicable alternative X factor, along with the present value of
the building blocks allowable revenue (BBAR) for each EDB.
The model includes
a few amendments due to removal of the mid-term reset in the current five year
period.
Next steps
The Commission will receive submissions on the preliminary financial
model until 14th February 2014.
NZ – determining Transpower’s Price-Quality Path
Introduction
The Commerce Commission is required to determine the Individual
Price-Quality Path (IPP) that will apply to Transpower for the second regulatory control period (RCP2)
by 30th November 2014. This article examines the key features of the
RCP2 Expenditure Proposal submitted by Transpower in early December 2013.
Legal framework
The legal framework is Part 4 of the Commerce Act 1986, in particular Subpart 7 which provides for the Commission to set an IPP
(which Transpower is currently subject to).
Key features of the RCP2 Proposal
Key features of the Proposal include (as usual, the blank columns are
for future determinations)…
|
Parameter |
Proposal |
Draft
Determination |
Final
Determination |
|
Nominal commissioned base CapEx |
$1,250.6m |
|
|
|
Nominal OpEx |
$1,469.8m |
|
|
Pipes & wires will make further comment as the Commission releases
its decisions over the next 11 months or so.
NZ – exempting the AGS Pipeline from the regulatory
regime
Introduction
The purpose of regulation is to emulate the downward pressure on prices
and the upward pressure on quality that a business operating in a competitive
market would be subject to. This article examines Contact Energy’s application
to have its AGS Pipeline exempted from the information disclosure requirements
and the price-quality requirements under Part 4 of the Commerce Act 1986.
The AGS Pipeline
The AGS Pipeline is a 450mm nominal diameter pipeline about 8.7km long
that connects Contact’s Ahuroa Gas Storage facility (AGS) to Contact’s TCC and Stratford power
stations and also to the Vector gas transmission pipelines.
Legal framework
The operative legislation is the Commerce Act 1986, and in particular…
· Subpart 10 of Part 4 which declares all gas pipelines to be
subject to both information disclosure (Subpart 4) and price-quality regulation (Subpart 6) unless specifically exempted.
· s55A(6) which requires inter alia that the pipeline owner does not have a substantial
degree of market power.
· Schedule 6 which lists the specific pipelines that are
exempt from Part 4.
Contact Energy’s application
The basis of Contact’s application is that it does not have
substantial market power because…
· Contact will be the only user of the AGS Pipeline,
and the transported gas is owned by Contact.
· The points at which Contacts gas leaves the AGS
Pipeline are either subject to regulation (Vector’s open access regime) or
already owned by Contact (TCC and Stratford).
· Customers could switch to other gas suppliers or
other energy sources if Contact tried to raise prices on the AGS Pipeline.
The Commission’s proposed recommendation to the
Minister
The Commission proposes to recommend to the Minister of Commerce that
the AGS Pipeline be added to the exempt pipelines in Schedule 6 on the basis
that it does not have substantial market power, and in any case can be removed
from Schedule 6 if it ever did obtain substantial market power.
At the time of writing this article, the Commission were consulting on
its proposed recommendation. Pipes & Wires will examine the Commission’s
final recommendation to the Minister is a couple of months.
Australia
Tas –
will Aurora Retail survive ?
Introduction
Pipes
& Wires #121, #127 and #128 have
examined the introduction of Full Retail Contestability (FRC) in Tasmania, the
abandoning of the sale of Aurora Energy’s retail
business, and concerns over whether Aurora Retail could remain viable. This
article examines recent political discussions about that viability.
Key
issues in the argument
· The
political Opposition has taken the line that Aurora is vulnerable to
competition, and has asked how many customers Aurora Retail could lose before
becoming unviable.
· Aurora
believes that it could adjust its structure and operations to match the
eventual retail customer numbers, and in any case it believes that many
domestic customers will remain with Aurora noting that 88% of customers that
already had a choice of energy supplier has decided to stay with Aurora.
Which scenario will play out ? Aurora seem
confident that its Retail business will remain viable, so it will be worth
re-examining this next year.
UK
and Europe
Germany – slowing the transition to
renewable energy
Introduction
To
date Germany has led Europe’s transition to renewable energy with its “Energiewende” (the politically supervised shift
from nuclear and fossil to renewable). However the pace of that shift going
forward now seems to be slowing within Germany’s post-election coalition
government. This article examines recent moves.
Electricity supply and pricing
Increasing
generation from wind farms and solar panels has caused an over-supply, driving
down wholesale market prices. Those generators, however, get paid a fixed price
which is in turn being recovered from customers through tariff mechanisms. It
is those increasing prices that are concerning domestic customers, industry leaders
and politicians alike.
The coalition government’s position on
renewables
The
coalition takes a central position in the Emissions – Security – Price
triangle, which represents a marked shift from the Emissions corner that
Germany had worked itself into. The coalition has specifically noted that
future renewables will have to correctly include the cost of additional
transmission lines and of quick-start generation.
Possible scenarios for the renewable
transition
Recently
completed coalition summit talks suggest that Germany’s transition to renewable
energy will be slowed to a more modest pace that is likely to embody the
following features…
· Development of future renewable
resources may be restricted to geographical areas close to existing
transmission line corridors.
· New on-shore wind farms will only
receive subsidies if they are built in “strong wind” areas. This particular
policies critics claim it will effectively choke wind farm development in
southern Germany.
· A broad deconstruction of subsides that
favor renewables.
So
on the whole, it looks rather glum for Germany’s renewable sector but hopefully
a lot better for customers and industry alike.
UK – setting the equity market return
for RIIO
Introduction
OFGEM
is currently consulting on its methodology for assessing the equity market return for the RIIO price controls in light
of the Competition Commission’s WACC determination for Northern Ireland
Electricity (NIE). This article examines OFGEM’s thoughts.
The NIE decision
The Competition Commission provisionally determined a
WACC of 4.1% for NIE’s transmission and distribution networks. It is noted that
although NIE’s business is similar to the DNO’s in England, Scotland and Wales,
the regulatory regime is slightly different.
OFGEM’s proposed approach
OFGEM
believes that although the cost of debt in the NIE determination is similar to
the RIIO costs of debt, the Competition Commission’s giving of greater weight
to contemporary equity market returns is materially different to what it (OFGEM)
has historically adopted. OFGEM has noted the following…
· That the giving of greater weight to
contemporary returns will predominate on the low interest rates of recent
years, and skew allowable returns downward.
· That recent share trading and transactions
imply market values greater than RAB, suggesting that a longer term view of
higher WACC’s is implied.
· That there appears to be less
uncertainty around equity market returns than around specific WACC components
such as the risk-free rate and the equity risk premium.
Next steps
OFGEM is holding a workshop
on 7th January 2014, and will receive submissions until 10th
January 2014.
General stuff
Consulting services that may be of
interest to clients
Utility
Consultants wide expertise extends well beyond the above projects ... if you
need energy network advice chances are Utility Consultants has done work in
that area. Here’s a sample of work done for clients over the last few years
that demonstrate the breadth of skills, insight and experience that is
available....
· Prepared an independent engineer’s
report to justify proposed alternative asset lives.
· Advised an electricity business on the
regulatory implications of bringing externally contracted field services back
in-house.
· Identified economic and regulatory
arguments to support inclusion of transmission interconnection charge risk into
network tariffs.
· Advised lines businesses on a
regulator’s proposed treatment of CapEx and OpEx.
· Advised an international investor on
gas distribution policy and regulatory trends.
· Identified national energy policy
implications for lines businesses.
· Assisted a lines business to identify
the burden of proof implied by regulatory determinations.
· Suggested amendments to a gas
transmission AMP to strengthen the economic arguments.
· Identified electricity network
investment characteristics as part of an acquisition study.
· Developed an AM framework for a gas
distribution business to link AM to regulatory requirements.
· Identified OpEx – CapEx tradeoffs for an electricity lines
business.
· Performed various substation growth and
reinforcement assessments.
· Performed network physical and business
risk studies.
· Compiled disaster recovery and business
continuity plans.
Pick
here to download a profile of recent
projects, or here to contact Phil.
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. It looks really cool printed in color
as an A2 or A1 size.
A bit of light-hearted humor
What
if price control had been around in the 1920’s and 1930’s ? A collection of
photo’s with humorous captions looks at some of the salient features of price
control. Pick here to download.
Conferences & training courses
The following
conferences and training courses are planned...
· Myanmar Oil & Gas Summit – Yangon, 27th
– 28th January 2014.
· Kazakhstan Oil & Gas Summit – Almaty, 27th
– 28th February 2014.
· Third annual Downstream Energy Sector conference – Auckland, 5th
– 6th March 2014.
· East Africa Oil & Gas Summit – Dar Es
Salaam, 27th – 28th March 2014.
· Fundamentals of the NZ
electricity industry – Wellington, 1st – 2nd
April 2014.
· Fundamentals of the NZ
electricity industry – Auckland, 6th – 7th
May 2014.
· European Wholesale Energy
Markets – London, 11th – 12th
June 2014.
Utility
Consultants takes no responsibility for the content of individual courses or
conferences, nor for any administrative or travel arrangements.
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…
· Wonders Of World
Engineering (published 1937) – in particular editions 1 to 27.
· Distribution Of Electricity (WT Henley,
the cable manufacturer)
· Northwards March The Pylons.
· Two Per Mile.
· Live Lines (the old ESAA journal).
· The Engineering History Of Electric
Supply In New Zealand.
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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.