Pipes & Wires

INSIGHT AND ANALYSIS OF COOL ENERGY & INFRASTRUCTURE STUFF

Issue 149 – February 2016

From the editor’s desk…

Welcome to Pipes & Wires #149.

Regulatory policy

NZ – amending the Electricity Industry Participation Code

Introduction

The Electricity Industry Participation Code provides the detailed regulatory framework for New Zealand’s electricity industry. This article notes a range of broad amendments that provide a “general clean up” of the Code after 5 years of operation.

Regulatory framework for the Code

The starting point for the Code is Subpart 3 of Part 2 of the Electricity Industry Act 2010. In particular, ss34 to 41 of the Act provide for amending the Code.

The significant amendments to the Code

Significant amendments to the Code include…

· Part 6 (Distributed generation). Insertion of new Clauses 6.2A and 6.2B to address the connection of distributed generation to an embedded network.

· Part 12A (Distribution). Insertion of a new Clause 12A.4A to address the acceptability of prudential requirements, and how the distributor must invest any prudential deposit provided in cash.

· Part 12A (Distribution). Revoking of the previous Clause 12A.6 to remove the distributor indemnity.

· Part 12A (Distribution). Revoking of the previous Schedule 12A.1 to remove the distributor indemnity provisions in that Schedule. Note that this is separate from the Electricity Authority’s planned insertion of an entirely new Part 12A to include the Default Distribution Agreement.

Like all legal and regulatory matters, interested parties will need to read the official documents in their entirety.

Energy policy

UK – providing clear investment signals for new generation

Introduction

Most of us well understand the importance of energy policy providing inter alia clear investment signals for new generation. This article examines the UK Secretary of Energy Amber Rudd’s recent “energy policy reset” speech to see if it will provide clarity for generation investors.

The mixed signals in the UK

Just to recap, the UK electricity market seems to embody quite a few mixed and confused signals, but probably the most confusing signal is the disconnect between renewables squeezing gas and coal-fired generation out of the market when those renewables run, but then on the other hand expecting those very same gas and coal-fired generation to immediately step in when the wind stops blowing (readers will probably recognise that a similar issue has also emerged in Germany). Not surprisingly, gas and coal-fired generation is getting shut down, leaving a dangerously low reserve capacity margin (refer to Pipes & Wires #144 and #148).

Sure there is the capacity market (refer to Pipes & Wires #143). Given that it has contracted a whisker under 50,000 MW of back-up generation for the 2018/19 period at a cost of £990m, it would appear that there are some pretty strong investment signals embedded in that market.

Amber Rudd’s recent energy policy reset speech

Some of the key features of Amber Rudd’s speech include…

· A statement that energy security has to be the number one priority, but then immediately overshadows that with an apparently greater need to address climate change.

· An apparent view that all 3 components (secure, cheap and clean) of the energy trilemma triangle can be achieved.

· An emphasis that the market structures set in place by the Tories in the early 1980’s required government intervention to make them work.

· A recognition that the Renewable Energy Target of 2007 has left a “legacy of ageing, often unreliable plant” and “an electricity system in which no form of generation … can be built without government intervention”.

· A recognition that coal-fired generation hasn’t declined due to increased renewables, and indeed has increased.

· The view that Britain having the cheapest and most secure gas supplies in Europe has resulted from investors correctly interpreting market signals.

· A clear signal that shale gas has a place in the future.

· A view that an advanced economy cannot rely on polluting, carbon-intensive, 50 year old coal-fired power stations, along with a clear signal that gas-fired generation will displace coal.

· A strong view that nuclear has a definite place, coupled with the statement that “climate change is a big problem”.

· An emphasis that off-shore wind farms have a definite place, despite an emphasis of “getting tough on subsidies”.

· A seemingly mixed view on government intervention, which as we all know, spooks investors.

So is the policy reset likely to provide stronger investment signals ??

I can’t see it myself. On the one hand there seems to be a strong head-line call to the electric and gas companies to step up in a matter of national importance, but the rest of the speech contains all the things that spook investors … government invention, reform packages, threats of greater competition to keep prices down, getting tough on subsidies. Probably 2026 would be a good time to review this … maybe Pipes & Wires #260 will examine it.

Mergers & acquisitions

NZ – Maui Pipeline sold to First State Funds

Introduction

Pipes & Wires #148 examined the recent purchase of Vector’s gas transmission and non-Auckland gas distribution businesses by First State Funds. This article continues that theme by examining First State’s purchase of the Maui Pipeline.

Description of the Maui Pipeline

The Maui Pipeline is a welded steel pipeline of approximately 800mm diameter which stretches 307km from Oaonui to Huntly over some very rugged terrain on the west coast of the North Island. The pipeline includes 6 production stations that inject gas directly into the pipeline.

Annual gas throughput is about 150 PJ, of which about half goes to Huntly Power Station and the two Methanex plants.

The pipeline owners

The pipeline’s current owner is Maui Developments, which has the following owners…

· Royal Dutch / Shell 83.75%.

· OMV 10%.

· Todd Energy 6.25%.

The deal

First State has agreed to purchase the pipeline for $335m from Maui Developments subject to regulatory approvals. The parties hope to complete the deal in mid-2016.

US – a new giant emerges

Introduction

Consolidation, geographical diversity, increasing scale and a transition to renewable generation seem to be characterizing the United States electricity sector. This article notes the formation of a new energy giant, Avangrid, with operations in 25 US states.

The formation of Avangrid

Avangrid has been formed from the amalgamation of Iberdrola’s US subsidiary and UIL Holdings, which has assets of $30b allocated amongst 3 operating subsidiaries…

· Iberdrola USA Networks, which supplies electricity and gas to 3,100,000 customers in Connecticut, Maine, Massachusetts and New York through its regulated network businesses. Annual revenues are about $8.3b.

· Iberdrola Renewables, which owns 6,000 MW of wind and solar generation, along with 630 MW of gas-fired generation.

· Iberdrola Energy Holdings, which oversees Avangrid’s natural gas businesses

Background to UIL Holdings

UIL Holdings was formed in 2000 after Connecticut deregulated its energy markets. UIL is the parent company to the following electric and gas companies that supply about 710,000 customers…

· United Illuminating Company, a vertically integrated electric company supplying 325,000 customers in Connecticut.

· Connecticut Natural Gas, a company supplying 165,000 customers in Connecticut.

· Southern Connecticut Gas, a company supplying 185,000 customers in southern Connecticut.

· Berkshire Gas Company, a company supplying 36,000 customers in western Massachusetts.

UIL’s gas subsidiaries have proud histories dating back almost 170 years.

Iberdrola’s background

Iberdrola began life in 1901 as the Hidroeléctrica Ibérica, and now is one of the world’s 5 largest electric companies with 45,000 MW of installed generation capacity, annual revenues of about €31b and assets of about €96b. Iberdrola’s global energy businesses include the ScottishPower group, and Iberdrola USA.

The strategy underpinning Iberdrola’s acquisition of UIL

Like many of the European giants that have emerged over the last 15 years or so, Iberdrola faces many pressing issues in its core market of western Europe, including

· Sluggish or even non-existent growth in kWh consumption.

· Pressure to increase renewable investment.

· Uncertain earnings from traditional generation sources.

So not surprisingly, regulated network revenues and the opportunity to extract some amalgamation and vertical integration synergies were seen as very attractive by Iberdrola.

Global – Shell captures BG

Introduction

Pipes & Wires #143 examined Shell’s £47b bid for British Gas, ostensibly to boost its presence in the LNG market and correspondingly reduce its exposure to languishing crude oil prices. This article notes the closing of that deal for the considerably lesser sum of £36b.

Re-capping the deal

The original deal was a cash-plus-shares offer as follows…

· 0.5 Shell B shares, and

· £3.83 cash.

for each BG share, valuing BG at about £13.50 per share which was about a 50% premium. That valued BG at about £47b (May 2015) and the merged company at about £180b.

Key aspects of the deal

A few key features of the deal include…

· Shareholder approval for the deal was very strong … 99.53% of BG’s shareholders and 83% of Shell’s shareholders voted in favor of the deal.

· The markets also approved of the deal, with both BG and Shell shares rising slightly.

· The merged Shell – BG will overtake Chevron as the worlds’ 2^nd largest oil and gas company, and will closely challenge ExxonMobil as the largest.

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....

· Leading an energy trust workshop on future trends for the distribution industry.

· Facilitating an executive workshop on the future trends and issues for the distribution industry.

· Advising a major global investment bank on the revenue and capital cost characteristics of the New Zealand generation industry.

· Assessing the investment characteristics of proposed CapEx increases to an investor-owned electric network.

· Assessing three EDB’s asset management practices against ISO 55000:2014.

· Assessing an EDB’s compliance with the lines – generation separation requirements of the Electricity Industry Act 2010.

· Assessing an EDB’s compliance with the Electricity Industry Participation Code.

· Compiling safe operating procedures for a wide range of distribution switches.

· Advising an investor on the investment characteristics and regulatory constraints of small hydro development and grid connection.

· Reviewing the engineering aspects of an EDB’s lines pricing methodology.

· Advising a major global consultancy on specific features of emerging electricity transmission and distribution regulatory regimes, including period length, potential for re-opening determinations, caps & collars, total expenditure levels and incentive mechanisms.

· 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 by EDB’s.

· 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.

Regulatory decisions

NZ – gas under pressure

Introduction

The Commerce Commission recently released its cost of capital decision for any customised price-path (CPP) proposals made by…

· Vector for its gas transmission or gas distribution businesses (noting that the transmission and non-Auckland distribution networks were recently sold).

· GasNet for its gas distribution business.

prior to the next CPP WACC Determination in December 2016. This article examines the key features of that determination.

Regulatory frameworks

The regulatory frameworks are set out in…

· Clauses 5.3.22 to 5.3.29 of the Gas Distribution Services Input Methodologies Determination 2012.

· Clauses 5.3.18 to 5.3.25 of the Gas Transmission Services Input Methodologies Determination 2012.

Key features of the gas distribution WACC’s

Key features of the gas distribution WACC’s include…

	3 year	4 year	5 year
Mid-point Vanilla WACC	6.18%	6.25%	6.33%
67^th percentile Vanilla WACC	6.71%	6.78%	6.86%

NZ – gas still under pressure

Introduction

Separately to the above determination, the Commerce Commission also recently released its cost of capital decision for Maui Developments for the 2017 information disclosure year. This article examines the key features of that determination.

Regulatory frameworks

The regulatory framework is set out in Clauses 2.4.1 to 2.4.8 of the Gas Transmission Services Input Methodologies Determination 2012.

Key features of the gas distribution WACC’s

Key features of the gas distribution WACC’s include…

	25^th percentile	Mid-point	75^th percentile
Vanilla WACC	5.58%	6.39%	7.20%
Post-tax WACC	4.99%	5.80%	6.61%

NZ - previous WACC decisions

Some of the Commissions’ previous WACC decisions are as follows.

WACC decision applies to	Approx date	Mid-point WACC	75^th (or 67^th) percentile WACC
Maui Developments for 2017 year	January 2016	Vanilla 6.39%	75^th percentile post-tax 6.61%
Vector and GasNet for any CPP during 2016	December 2016	Vanilla 6.18% to 6.335.	Vanilla 6.71% to 6.86%.
Powerco gas distribution for 2016 disclosure year.	October 2015	Vanilla 6.26%, post-tax 5.69%.	Vanilla 7.07%, post-tax 6.5%.
Vector and Powerco gas pipelines for year ending 30^th June 2016.	July 2015	Vanilla 6.65%.	Vanilla 75^th percentile 7.46%.
Transpower for year ending 30^th June 2016	July 2015	Vanilla 5.95%.	Vanilla 67^th percentile 6.41%.
Maui CPP application before June 2016	June 2015	Vanilla 6.63% to 6.71%.	Vanilla 67^th percentile 7.16% to 7.23%.
All electricity distribution for year starting on 1^st April 2015.	April 2015	Vanilla 6.02%, post-tax 5.37%.	Vanilla 6.49%, post-tax 5.84%.
Wellington Airport for year starting on 1^st April 2015.	April 2015	Vanilla 6.93%, post-tax 6.71%.	Vanilla 7.91%, post-tax 7.69%.
Powerco gas CPP application before April 2016.	March 2015	Vanilla 6.70% to 6.72%.	Vanilla 7.23% to 7.25%.
Maui Developments for 2016 disclosure year	January 2015	Vanilla 7.08%.	Vanilla 7.89%.
Vector, GasNet CPP application before December 2015.	December 2014	Vanilla 7.11%, 7.14%, 7.22%.
All electricity CPP applications after 30^th September 2014.	September 2014	Vanilla 6.58%, 6.64%, 6.72%.
Auckland, Christchurch Airports for 2015 disclosure year.	July 2014	Vanilla 7.64%.	Vanilla 8.63%.
Vector, GasNet for 2015 disclosure year.	July 2014	Vanilla 7.54%.	Vanilla 8.35%.
Transpower for 2015 disclosure year.	July 2014	Vanilla 6.83%.	Vanilla 7.55%.
Wellington Airport for 2015 disclosure year.	April 2014	Vanilla 7.70%.
EDB’s for 2015 disclosure year.	April 2014	Vanilla 6.89%.
Powerco gas CPP applications before March 2015.	March 2014	Vanilla 5-year 7.54%.	Vanilla 5-year 8.35%.
Maui pipeline (gas transmission).	January 2014	Vanilla 7.64%, post-tax 6.85%.
Vector, GasNet CPP applications before December 2014.	December 2013	Vanilla 7.56%.
All CPP applications before 30^th September 2014	September 2013	Vanilla from 6.26% to 6.69%.	Vanilla from 6.97% to 7.41%.
Transpower	July 2013		Vanilla 6.85%, post-tax 6.17%.
Vector gas distribution, GasNet	July 2013		Vanilla 7.65%, post-tax 6.97%.
Auckland & Christchurch airports	July 2013		Vanilla 8.00%, post-tax 7.75%.
All electricity distribution	April 2013		Vanilla 6.83%, post-tax 6.14%.
Maui pipeline (gas transmission)	February 2013		Vanilla 7.46%, post-tax 6.80%.
All gas distribution and gas transmission DPP’s	December 2012		Vanilla 6.63%.
Vector, GasNet CPP’s	December 2012	Vanilla 6.39% (5 years).
Powerco gas distribution	October 2012	Vanilla 6.83%, post-tax 6.12%.

Electricity markets & tariffs

Aus – calls for tariff reforms in Western Australia

Introduction

Cost-reflective electric tariffs seem to be a very vexed issue. The widening political gap between policy makers on the one hand agreeing that they are a good thing at a conceptual level but then on the other hand regulators challenging electric companies attempts to implement them at a practical level shows no signs of narrowing or reconciling. This article examines recent calls for the introduction of cost-reflective tariffs in Western Australia.

Digging a bit deeper into the call for cost-reflective tariffs

The recent call for the introduction of cost-reflective tariffs included the important concepts…

· The need to reflect the time of electricity consumption and the prevailing demand on the grid in order to allocate the increased cost of that electricity to those users.

· The increased penetration of roof top solar that is eroding the traditional kWh-based revenue base.

· The increasing penetration of home batteries that are shifting the traditional demand profile to time periods that no longer align with when “electricity was more expensive”.

· Increasing penetration of air conditioners that are driving the electric company’s capital costs way ahead of its kWh-based recovery of those costs.

The political difficulties around cost-reflective tariffs

Probably the most obvious answer would be to … well … jack up the kWh-based charges to restore the revenue base to a level that recovers the true economic cost of supply. There are, however, two problems with this approach…

· It strengthens the incentives to reduce kWh consumption for those who can (potentially leading to the death spiral that requires further increases in kWh-based charges).

· Those who can’t reduce consumption end up paying higher electric bills. Then the various social agencies and interest groups will squawk at government level, which generally results in a back-down or dilution of any move away from the prevailing mix of fixed and variable charges.

Just to provide a bit of balance to the discussion, it is worth noting that various electric companies attempts to reduce the kWh-based charges and correspondingly increase the kW-based charges have met with considerable resistance from the roof top solar industry.

What might the answer be ??

As long as electric tariffs reside in the political domain and can be influenced by social and renewable energy lobbies it is not clear that we ever will get clear up-front direction and leadership from (any) government. What will probably happen is that kWh-revenue will be both eroded (by solar) and increasingly mis-matched to the actual costs of electricity (by batteries and air conditioners), leading to an unwillingness to invest in grids and networks.

US – solar takes a hit in Nevada as tariffs are realigned

Introduction

Realignment of tariff components to prevent revenue erosion from rooftop solar is a sensitive issue with the solar industry. This article examines recent changes to the fixed and variable tariffs in the US state of Nevada … a state that most of us associate with unending sunshine and unending gambling tables.

The traditional setting of electric tariffs, and the impact of rooftop solar

Historically many electric company tariffs are compiled simply by dividing the company’s total fixed costs by an assumed annual per-customer kWh consumption to derive a per-kWh tariff (this was typically about 8,000kWh per year in New Zealand, and I’m sure other locations have a similarly derived figure). Those customers with solar behind the meter will consume fewer kWh, hence the revenue from those customers declines. However the company’s fixed costs won’t have declined, leading to potential deficits.

Responses to declining revenue

Two approaches to addressing declining revenue are available…

· Simply increase the per-kWh tariff, which does two things…

· It makes installing generation even more attractive as the avoided cost of imported kWh is greater, which can lead to a death spiral (kWh consumption declines even further, so per-kWh tariffs are increased, increasing the incentive to install generation, further reducing kWh consumption etc).

· It means those who choose not to install generation behind the meter will pay even higher per-kWh tariffs, thereby subsidising the free-riders who have installed generation.

· Increase the fixed tariff and reduce the variable tariff which does two things…

· It dampens the revenue impact due to declining kWh (because the kWh revenue foregone is reduced).

· It improves recovery of fixed costs by guaranteeing a minimum monthly revenue.

It is this increasing of fixed tariffs that has got the solar industry in Nevada spewing mad.

Recent events in Nevada

The following events recently occurred in Nevada…

· Nevada Power sought regulatory approval to increase its monthly fixed connection charge from $12.75 to $17.90 on 1^st January 2016 and then to $38.51 on 1^st January 2020, and to also reduce its feed-in tariff from 11c per kWh to 9c per kWh on 1^st January 2016 and then to 2.6c per kWh on 1^st January 2020.

· The Alliance for Solar Choice (TASC) requested the Nevada Public Utilities Commission to delay the new tariffs that were schedules for 1^st January 2016.

· The staff of the PUC recommended that the request to delay be denied ie. Nevada Power will be allowed to proceed with the tariff increases.

· Solar advocates claim that the PUC’s decision will mean the end of the solar industry in Nevada, and indeed one supplier (Solar City) has announced it will no longer supply or install solar in Nevada.

So what do we make of all this ??

In all disputes there is obviously the first party’s side of the story, the second party’s side of the story and them there is the truth. So what are the party’s respective stories ??

· The solar industry’s side of the story is that the increase in fixed tariffs and the reduction in feed-in tariffs are undermining the benefits of solar.

· The electric company’s side of the story is that increasing penetration of solar is eroding its revenue, and that solar customers are free-riding the distribution network at the expense of non-solar customers.

Both of these respective sides of the story have a lot of truth ... it is certainly undeniable that tariff rebalancing undermines the benefits of solar, and it is also undeniable that nett-metered solar erodes kWh revenue and results in subsidies.

If we peel back the layers on this, however, it becomes apparent that the solar industry feels entitled to subsidies whilst the electric company simply wants to recover the true cost of distribution network service provision.

Aus – the benefits of retail competition become apparent in NSW

Introduction

Keeping a lid on retail electricity prices continues to be a political hot potato, with the political right advocating that full retail deregulation will result in lower prices and conversely the political left arguing that retail price caps are necessary to restrain retail prices … a classic ideological argument of competition versus regulation. This article notes an IPART review that indicates retail price deregulation is working well in the Australian state of New South Wales.

The status of retail price deregulation

The status of retail deregulation is as follows…

Jurisdiction	Status of retail electricity deregulation
Victoria	Introduced on 1^st January 2009
South Australia	Introduced on 1^st February 2013
Tasmania	Introduced on 1^st July 2014
NSW	Introduced on 1^st July 2014
Queensland	Delayed pending further study

Recent evidence in NSW

The recent IPART review concluded the following…

· That there are no substantial barriers to retail market entry, citing 4 new retailers as evidence.

· That there is a reasonable level of customer switching to obtain a better deal.

· That the retail prices paid by most small customers declined in all network areas over the first 12 months of deregulation.

· That there is healthy rivalry between retailers who are competing both on lower prices and innovative non-price attributes such as flexible payment plans and energy advice.

Deregulation in other states

A quick look at other states that deregulated sooner reveals the following…

· Pipes & Wires #128 noted that electricity prices decreased in Adelaide (South Australia) by 2.7% during the first 12 months of retail price deregulation, whilst the nation-wide average price increased by 6.1%.

· Clear evidence of price reductions in Victoria seems to be a different story. St Vincent de Paul Society’s six monthly analysis of electricity prices suggests that Victorian’s are paying between $500 and $800 more than necessary and could achieve lower prices by switching retailers rather than remaining with the “standing offer” that each retailer was required to offer at the start of deregulation. Other commentators reports seem to support this view that the high average retail prices being paid in Victoria are because customers aren’t switching, rather than because lower priced tariffs aren’t there.

So it would seem that lower retail prices are there if customers are prepared to look for them.

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.

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...

· No events scheduled.

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…

· Economic Operation Of Power Systems (Kirchmayer).

· 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.

Cool stuff

Newly published book – “Keeping The Lights On”

Well-known electricity historian and author Helen Reilly has recently published her latest book “Keeping The Lights On – The History Of System Operations In New Zealand 1939 – 2013”. Pick here to order your copy for only $46.50 from Grid Heritage. It’s a thoroughly good read, and complements Helen’s previous book “Connecting The Country”.

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.