From the
editor’s desk…
Welcome
to Pipes & Wires #131. This issue has a narrower geographical coverage, and
embodies two dominant themes - the cost of capital, and a resurgence in
coal-fired generation. In between that we look at the increased scrutiny that
UK gas suppliers are likely to face, conversion of publicly owned distribution
networks to municipal ownership in Germany, and the tail end of the NSW generation
privatisation. So … happy reading until next month.
Correct email address
Please
note that my correct email address is phil.caffyn@utilityconsultants.co.nz. Please don’t use phil.caffyn@clear.net.nz as this does not get through.
Recent client projects
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 from Utility
Consultants....
· Examining the economic efficiencies of
an EDB’s pricing methodologies.
· Advised on the wider philosophical and
potential tax issues of the way consumer discounts are paid.
· 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.
New Zealand
NZ – revisiting the WACC
Introduction
Pipes & Wires #130 devoted a lot of attention to recent
WACC determinations. This article notes the Commerce Commission’s intention to consider reviewing or amending the Input Methodologies (IM’s)
for the WACC.
Background
Back
in December 2010 the Commission set the IM’s that inter alia defined how various inputs to regulated revenues such as
the WACC would be determined.
In
late 2013 the High Court dismissed a number of appeals bought against the WACC
IM’s, however the High Court questioned whether the use of the 75th
percentile to estimate a WACC was justified, and indeed whether it was
inconsistent with the objective of limiting the ability of a regulated supplier
to earn excessive profits.
Several
customer groups subsequently requested the Commission to review the WACC IM’s
prior to finalizing the electricity default price-paths (DPP’s) and
Transpower’s individual price path (IPP). This has created investment
uncertainty which the Commission is understandably concerned about.
Broad legal framework
The broad
legal framework for the IM’s includes…
· s52R – the purpose of IM’s is to promote
certainty … in relation to rules, requirements and processes.
· s52T(1)(a)(i) – requires the IM’s to include a
method for evaluating or determining … cost of capital.
The Commission’s intentions
The
Commission has sought views on the following issues…
· Whether the investment incentives
embodied in the 75th percentile will be weakened until the
Commission addresses the High Court’s concerns.
· Should a review of the WACC IM be
bought forward ?
· How might a review of the WACC IM’s be
practically completed in time to reset the electricity DPP’s in late 2014 ?
· If a lesser WACC than that based on the
75th percentile is considered appropriate, how might that be
reflected in future prices ?
· What evidence is there to support the
adoption of the 75th percentile, or credible alternatives
?
Pipes
& Wires will provide further analysis as the Commission gathers responses
and publishes its conclusions.
NZ – assessing the effectiveness of airport
information disclosure
Introduction
Pipes & Wires #125 examined the Commerce Commission’s
report to the Ministers of Commerce and of Transport on how effectively
information disclosure has promoted the purpose of Part 4
of the Commerce Act 1986 for Auckland Airport. This article examines the
Commission’s assessment for Christchurch Airport, and compares those findings
with the findings for Auckland and Wellington.
Regulatory framework
Part
4 of the Commerce Act 1986 establishes the regulatory framework for regulated
goods and services as follows...
·
S52A(1) defines the purpose of Part 4.
·
Subpart
4 provides for information disclosure regulation
·
Subpart
11 specifically covers airport services.
The
Commission has carried its assessment of the information disclosure
effectiveness under s56G of
the Act.
Findings in regard to Christchurch
Airport
The
Commission’s findings in regard to Christchurch Airport as follows…
·
Information
disclosure has not been effective in limiting Auckland Airport’s ability to
earn excessive profits.
·
Information
disclosure has not been as effective in promoting innovation, service quality
and pricing efficiency as was expected.
·
The
Commission has been unable to conclude whether information disclosure has been
effective in promoting operational efficiency, efficient investment and sharing
of efficiency gains (principally because of the time-frame over which these
parameters must be measured).
The
Commission also notes that the Input Methodologies used to estimate expected
profits are under review by the High Court, and it is possible that the Court’s
judgment may require the Commission’s conclusions to be altered.
Comparing the Christchurch findings
with Auckland and Wellington
The
following table compares the Christchurch findings with Auckland and Wellington…
Aspect |
|||
Has
information disclosure been effective in limiting the ability to earn
excessive profits ? |
No |
Yes |
No |
Has
information disclosure been effective in promoting innovation, service
quality and pricing efficiency ? |
Not
as effective as expected |
Yes |
Yes |
Has
information disclosure been effective in promoting operational efficiency,
efficient investment and sharing of efficiency gains ? |
Unable
to conclude for sure |
Unable
to conclude for sure |
Unable
to conclude for sure |
Translating those findings to the
electricity lines and gas pipes sectors
The
following issues are worth considering....
·
Airlines
appear to have significant counter-veiling power in negotiating prices and
service levels. In a similar vein, we’ve seen how shipping companies have moved
their business around various ports which suggests both a high degree of
counter-veiling market power and competitive choices. Arguably, airlines (and
shipping companies) seeking the best deal would be able to obtain price and
quality information through commercial negotiation rather than relying on
information disclosure.
·
One
of the interesting observations to emerge from the relaxing of regulation
around competitive services (such as connections and metering) in the UK
electricity distribution sector is the increase in innovation as the industry
moves from a regulated model to a competitive model. This strongly suggests
that higher levels of innovation will be driven by competitive arrangements
rather than by regulation. We are seeing similar increases in innovation and
customer focus as retail electricity price caps are removed in various
Australian states.
·
I’d
be surprised if there were any long-run operational inefficiencies in the
electricity lines sector. My observation is that most people work long and
hard, and there is certainly no clear evidence of poor productivity or goofing
off.
·
I’d
also be surprised if there were any long-run investment inefficiencies. From
what I’ve seen, investment has been targeted at what customers want, and it
seems to be done at least cost. If anything, we probably need more investment
after long periods of low investment following the reforms of the early 1990’s.
NZ –
determining Transpower’s information disclosure requirements
Introduction
Requiring monopoly infrastructure
businesses to disclose various performance measures according to a prescribed
template is an accepted part of NZ’s regulatory regime. This article examines
the Commerce Commission’s recently determined information
disclosure requirements that will apply to
national grid operator Transpower from 1st July 2014.
Legal
framework
The legal framework for information
disclosure is set out in Subpart 4 of Part 4 of the Commerce
Act 1986. This clearly
states that the purpose of information disclosure is to ensure that sufficient
information is readily available to interested parties to assess whether the
purpose of Part 4 (set out in s52A of
the Act) is being met.
Key
features of the determination
Transpower will be required to publicly
disclose the following information…
· Financial
information related to its transmission line services including the RAB, Actual
OpEx, Commissioned CapEx, Comparison of Forecasts for OpEx and Base CapEx,
Major CapEx, Vanilla WACC, Vanilla ROI and Post-Tax ROI.
· Sufficient
explanations for variances between forecast and actual parameters.
· Related
party transactions, including the basis used to value the transaction.
· Regulated
revenue.
· Investment
contracts for which the Transmission Pricing Methodology does not apply.
· Various
grid management information including system statistics, grid demand and
injection, connection capacity along with actual and forecast demand, quality
of supply measures, and interconnection assets.
· An
integrated transmission plan that includes asset condition and age, an assessment
of asset management maturity (AMMAT), spend forecasts, and material changes to
strategic direction and policy.
Interested
parties should refer to the complete determination.
UK
and Europe
Germany – coal makes a come back
Introduction
For
a while coal seemed to have a bleak future as policies aimed at reducing CO2
emissions began to bite harder into coal-fired generation. This article
examines a recent resurgence in hard coal-fired generation in Germany.
Recent moves in Germany
Recently
released official figures indicate that 10 new hard coal-fired stations
totaling just on 8,000 MW are expected to start generating over the next 2
years. This is in addition to increased generation from existing hard-coal and
lignite-fired generation.
The changing dynamics of fuel prices
Hard
coal-fired electricity is expected to deliver a profit of about €9 per MWh as
the price of both coal and CO2 emissions drop to record lows,
compared to gas-fired generation which is expected to lose about €19 per MWh.
Possible implications of all this
So
what are the implications of all this ? Some thoughts…
· CO2 emissions will obviously
increase, but hopefully the high prices and declining reliability that have
crippled German industry will ease.
· If the profit spread between coal and
gas-fired generation remains high, it is possible that existing gas-fired
plants will be further marginalized. That could well see many of those
gas-fired plants permanently closed leaving no renewable buffering capability.
· Recently acquired coal-fired generation
in the Netherlands and Belgium that is being “long-lined” into Germany (by
recently divested transmission lines) could be marginalized by low-cost
coal-fired generation within Germany.
· The disconnect between Germany’s climate change policy
and actual practice will widen, possibly leading to more vigorous political
intervention.
Pipes
& Wires will continue to follow this issue as more coal-fired generation
emerges.
UK –
gas suppliers face increased scrutiny
Introduction
The
UK’s secretary of state for energy, Ed Davey, has recently written to OFGEM suggesting that the margins of
Britain’s six biggest gas suppliers be investigated and that British Gas (BG) be broken up. This article
examines Davey’s thinking and also looks at the possible implications of a
break up.
Davey’s apparent concerns
So
what exactly are Davey’s concerns ? Are they genuine,
or is it just a “I’ll match yours and raise you one” response to the Labour
oppositions threat of a price freeze and market reform if they win the next election ? It appears that Davey’s concern are two-fold…
· The reportedly high margins on retail gas
sales, which Davey claims are about 5x the margin on retail electricity sales.
· BG’s market share of about 40%, which
is “simply not right” according to the Federation of Small Businesses.
Possible break-up scenarios
“Break-up”
is obviously a very extreme measure, however it would be unwise to completely
dismiss the possibility of a forced break-up of some big electric and gas
companies. Possible “break-up” scenarios include…
· A literal “break-up” in which specified
companies are required to divest whole blocks of retail customers until their
market share is reduced to a politically acceptable level.
· By organic means, such as a moratorium
on accepting new customers in the expectation that market share will decline as
customers switch suppliers.
Likely industry and investor responses
Well
for a start, both Centrica (BG) and S&SE shares dropped further on the FTSE 100, on the back of a general decline over
the previous 6 months as Britain’s high energy bills have become a political
football. But what could this mean for the longer term ?
A couple of thoughts…
· Unreasonable political and regulatory
pressure will make the UK a less preferable investment destination. Four of the
big six gas suppliers are part of multi-nationals that could well divert
investment funds to other more investor-friendly jurisdictions. E.On is already directing its investments
away from Germany towards Turkey.
· An increasing disconnect between
politicians who on the one hand expect the big electric and gas companies to
act as instruments of policy whilst on the other hand creating investment
uncertainty for them.
Pipes
& Wires will watch this one closely as OFGEM’s investigation unfolds.
Germany – “muni-ising” the urban
networks
Introduction
“Muni-ising”
privately owned electric distribution networks seems very fashionable,
ostensibly to increase renewable generation. Following on from Pipes & Wires analysis of the attempts to
muni-ise the electric network in the US city of Boulder, we examine two attempts to muni-ise
networks in Germany.
Hamburg – a successful vote to muni-ise
The
city of Hamburg narrowly voted to buy back its electric network from Vattenfall
Europe at a cost of €550m, and may also buy back the district
heating network for a further €950m. The electric network supplies 1,100,000
customers. Not surprisingly, various electric companies including E.On Hanse and Alliander NV are interested in operating the network on a concession
basis.
Berlin – an unsuccessful vote to
muni-ise
A
similar vote in Berlin fell short of the required 25% of eligible voters (and
not simply 25% of votes cast), meaning that Vattenfall will continue to own the
Berlin network. In any case, the city of Berlin would be unable to afford to
buy back the electric network after having bought back the water supply network
and having €60b of debt on its balance sheet.
The issues behind the muni-isations
There
seems to be a couple of key issues behind the muni-isation trend…
· A growing dislike that profits are
leaving the district. This of course overlooks the fact that the respective
cities were paid for their networks at the time of sale … they weren’t just
given away.
· A growing dislike of rising electricity
prices. This ignores the real cause of electricity price rises in Germany which
is the increasing cost of wind and solar.
· A view that “there isn’t enough
renewables” and that network owners like Vattenfall are using network ownership
to create captive markets for their own coal-fired generation businesses.
Again, more wind and solar is only likely to increase costs and diminish
reliability.
· A growing dislike of capitalism and particularly
the big electric companies which seem to be the visible face of that
capitalism.
Most
of these reasons seem pretty shallow and technically incorrect.
Some of the commercial issues
A
few commercial issues that spring to mind (but I’m guessing never made it on to
the ballot papers) include…
· A smaller network would prima facie mean reduced operating
scale.
· The energy sold to a muni-ised network
may come at a less favorable price.
· The cost of capital for the network
business may increase, especially if the network business gets rolled into a
debt-laden municipal balance sheet.
· Rating agencies may look less favorably
upon smaller municipally-owned networks.
· The municipalities themselves may
resort to the same profit stripping that the big electric companies are being
accused of. On the other hand, property taxes might be used to subsidise the
electric networks if the need to make muni-isation work becomes apparent.
· One way or another, increased wind and
solar are likely to increase customer bills.
Just
like the Boulder muni-isation, it will be interesting to see how Hamburg works
out. So it might be a case of “be careful what you wish for”.
UK – determining the cost of equity for
RIIO – ED1
Introduction
The
cost of equity is a critical building block component for any infrastructure company’s
revenue model, and is usually subject to much dispute. This article examines
OFGEM’s recent cost of equity determination that will apply to the RIIO – ED1 price control.
The RIIO – ED1 price control
The
RIIO – ED1 price control is an output based regulatory model that provides strong incentives for
the UK’s 6 electric distribution companies to deliver a range of customer and
public policy outcomes in return for a given revenue base. The control period
will be 8 years starting on 1st April 2015.
Fast-tracking the approval of business
plans
RIIO
– ED1 includes the strong incentive mechanism to “fast track” the determining
of a price control where OFGEM considers an electric company’s business plan.
OFGEM has concluded that Western Power’s business plans were sufficiently robust to be fast
tracked, however acceptance of that fast track process would require Western
Power to accept a 0.3% reduction in the cost of equity.
OFGEM’s cost of equity determination
OFGEM
has reduced its cost of equity central reference point for RIIO – ED1 from the
6.3% used for the business plan assessment in November 2013 to 6.0% (this is
the 0.3% reduction that Western Power would have to accept to have its business
plan fast tracked). This corresponds to the lower bound of the 6.0% to 7.2%
indicative range included in OFGEM’s strategy decision in March 2013.
Pipes
& Wires will comment further as OFGEM assesses the remaining business plans
and issues its determinations.
Australia
Queensland – coal makes a come-back
Introduction
It
seems that coal is making a come-back in many places around the world. This
article examines the restart of two coal-fired generation units in the
Australian state of Queensland whilst a gas-fired unit is withdrawn.
The generation plant involved
The
generation plant involved is…
· The two 350 MW coal-fired units at Tarong that were withdrawn in late 2012 due
to over-supply and weak prices. These units will be returned to service during
the 2014 year.
· The 385 MW gas-fired unit at Swanbank E that will be withdrawn from October
2014 for up to 3 years.
All
of this plant is owned by Stanwell
Corporation.
Stanwell’s markets and strategy
Stanwell
operates in two markets…
· A gas market in which prices are
increasing.
· An electricity market in which prices
are weak.
Stanwell
has concluded that it is more profitable to sell the gas into a buoyant gas
market that turn that gas into electricity only to sell it into a weak
electricity market.
NSW – AGL buys Macquarie Generation
Introduction
The
planned privatisation of the NSW Governments’ generation businesses seemed to go
quiet for a while, however news emerged recently that AGL Energy will buy Macquarie Generation subject
to regulatory approval. This article examines the deal and looks at the market
dominance issue.
The deal and the assets
AGL
Energy will pay the NSW government $1.7b for assets that include …
· Bayswater, a 4 x 660 MW hard-coal fired station.
· Liddell, a 4 x 500 MW hard-coal fired station.
· The 50 MW Hunter Valley gas turbines.
· The Liddell solar farm.
Unsuccessful
bidders included ERM Power (who are thought to have bid about
$300m less than AGL) and Marubeni. Both of these bids are understood to
have been below the retention value.
Market dominance and regulatory
approval
The
completed acquisition would result in AGL, Origin and EnergyAustralia holding an 80% share of NSW’s
generation and over 85% of the retail market share. The Australian
Competition & Consumer Commission (ACCC) believes the acquisition could
lead to a substantial lessening of competition in the market, and has revealed
serious concerns about the deal.
For
its part, the NSW Government is very clear that it will retain ownership if the
ACCC does not approve the AGL acquisition.
General stuff
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.
Recently released book “Small
Hydroelectric Engineering Practice”
Well-known
hydroelectric engineer Bryan Leyland has recently published a book entitled
“Small Hydroelectric Engineering Practice”. This is a comprehensive reference
book covering all aspects of identifying, building and operating hydroelectric
schemes between 500kW and 50MW. Pick here for more details.
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...
· Indonesia Oil & Energy Summit – Bali, 11th
– 12th 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.
· Electric Utility
Transmission Ratemaking – Pasadena, 23rd – 24th
April 2014.
· Fundamentals of the NZ
electricity industry – Auckland, 6th – 7th
May 2014.
· Libya Oil &
Gas – London, 29th – 30th May 2014.
· European Wholesale Energy
Markets – London, 11th – 12th
June 2014.
· Africa Oil & Gas Expo –
Johannesburg, 9th – 10th October, 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,
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