From the
editor’s desk…
Welcome
to Pipes & Wires #156. This issues starts with a look at 2 large mergers in
the United States, and then looks at the possible reinstatement of coal-fired
generation in New Zealand.
We
then look at some critical cost of capital and tariff issues, and conclude this
issue with an examination of some of the issues that are vexing the proposed
Hinkley Point C nuclear station in the UK. So … until next month, happy
reading…
Recent client projects
Estimate load group
peak demands
· Client – electricity distributor.
· Location – New Zealand.
· Project – this project involved critiquing the assumptions
used to estimate an electricity distributors’ load group peak demand, including
peaks, diversity, load factor and seasonal variations.
Assess regional
variation of retail electricity tariffs
· Client – electricity trust.
· Location – New Zealand.
· Project – this project involved comparing the regional
variations of a major electricity retailer’s tariffs on behalf of an
electricity trust, including discounts and use of night-day split data from the
retailer.
Provide board
assurance on key operational matters
· Client – electricity distributor.
· Location – New Zealand.
· Project – this project involved evaluating two key
operational aspects of an electricity distributor, and providing the board with
assurance that operations were compliant with statutory requirements, aligned
to industry practice and were optimising the distributors risk exposure.
Pick
to here to download a profile of recent projects, or here to contact Phil.
Mergers & acquisitions
US – the Great Plains – Westar merger attracts wider
attention
Introduction
Pipes & Wires #153 examined the proposed merger of Great Plains
Energy and Westar Energy to form an enlarged electric company supplying 1,500,000
customers in Kansas and Missouri. This article examines recent moves to allow
scrutiny of the merger over and above the originally identified regulatory
bodies.
The original regulatory approvals
The
following regulatory approvals will be required…
· Kansas Corporation
Commission.
· Federal Energy
Regulatory Commission (FERC).
· Nuclear Regulatory
Commission.
The KCC decision
The
Kansas Corporation Commission has decided to allow a wide range of additional
intervenors, including large electric customers, electric companies that buy
wholesale power from Great Plains subsidiary Kansas City Power
& Light (KCPL), and local chapters of labor unions. This comes on
the back of a restatement by the KCC of the criteria that it will use to assess
the merger, including the financial stability of the merged companies, local
economic impacts, local job market impacts, public safety and the environment.
Missouri’s jurisdiction over the merger
The Missouri Public
Service Commission (PSC) has claimed that it too has jurisdiction over the
merger, even though Westar supplies only Kansas.
Back
in 2008, KCPL acquired Aquila (which had customers in Missouri). That
acquisition included an agreement by KCPL that it would not acquire any further
electric companies without the Missouri PSC’s approval. Great Plains is
disputing Missouri’s jurisdiction on the basis that Great Plains is only a
holding company and is not subject to Missouri’s regulation.
Next steps
The
KCC expects to rule on the merger by 24th April 2017. Pipes &
Wires will comment further on both the specifics of the deal as they occur, and
also the emerging trend of adopting ever-widening assessment criteria that seem
less and less relevant to an electric company merger.
US – appealing the Exelon – Pepco merger
Introduction
Pipes & Wires #151 noted that the Exelon – Pepco merger received its final
approval from the Washington DC Public Service Commission (PSC) in March 2016. This article notes an appeal to that
approval.
The final closing of the deal
The
PSC voted 2 -1 to approve the merger, after a long series of approvals in
several states and by the FERC. The merger has created America’s largest electric company
with about 9,800,000
customers, 35,000MW of generation and annual revenues of about $29b.
The appeal
The
appeal has come from the Washington DC Office of People’s Counsel (OPC). The OPC claims a number of procedural weaknesses
that appear to stem from the multiple submissions that were required to obtain the
PSC’s approval, whilst the PSC claims that it has followed the required legal
standards even if the approval process was unconventional.
The
OPC believes that the claimed procedural weaknesses must be addressed by the DC Court of Appeals, and it expects to file papers detailing the basis for
appeal and the remedies sought. Pipes & Wires will comment further as the
OPC’s appeal proceeds.
System operations & security
NZ – improving system security
Introduction
Closure
of thermal generation ostensibly to reduce CO2 emissions has been a
major theme of the electricity sectors in the UK, South Australia, Tasmania and
New Zealand. This article examines a recent announcement from New Zealand that Genesis Energy might return a third 250MW coal and gas-fired steam turbine
generator at Huntly to service, and considers what the implications might be
for system security.
The gradual closure of thermal generation
Pipes & Wires #145 noted the following closure of thermal generation…
|
Effective
date |
Closure |
MW withdrawn |
Cumulative
MW withdrawn |
|
October
2014 |
Huntly
#3. |
250 |
250 |
|
June
2015 |
Huntly
#4. |
250 |
500 |
|
September
2015 |
Otahuhu
B. |
400 |
900 |
|
Late
2015 |
Southdown. |
140 |
1,040 |
|
Late
2018 |
Huntly
#1 and #2. |
500 |
1,540 |
Subsequent
to that article, Genesis announced that Huntly #1 and #2 would remain in
service until 2022 under an agreement with other market participants.
Possible plans for Huntly
In
August 2016, Genesis announced that it may return one further 250MW coal and
gas-fired steam turbine to service if “market conditions allow”, noting that this
generator is full coal capable.
Interpreting the plan to possibly reinstate the third
generator
Exactly
how long Tiwai smelter will continue operating (and therefore what the national
demand curve will look like) seems to be the focal point for deciding whether
generators such as Huntly should remain open.
Perhaps
the more critical issue is that of system security. A review of Transpower’s 2016 Security Of Supply Annual Assessment reveals the following conclusions…
· The key system security measures would fall below the
security standard in the winter of 2019 if the announced closure of the two
Huntly generators were to actually occur in late 2018.
· The measures would continue to be lower than the security
standard until beyond 2025 unless there is further generation investment.
· The winter security measures were lower in the 2016
Assessment than they were in the 2015 assessment due to the Southdown closure
and the proposed Huntly closures.
Hopefully
the decisions to return 500MW of secure generation to service, along with the
possibility of a further 250MW of secure generation being returned to service
will lead to a more favorable conclusion in 2017.
Regulatory decisions
NZ – reducing the asset beta for gas pipelines
Introduction
Most
of us have are aware of the importance of the various parameters used to
estimate the cost of capital for regulated infrastructure. This article notes
the Commerce Commission’s draft decision to reduce the asset beta for gas
pipelines from 0.44 to 0.34.
What exactly is the asset beta ?
The
asset beta (β) is a measure of whether an investment is more or less volatile
than the market in general, as measured by the fluctuation of price around the
mean. A key feature of the asset beta is that it represents the undiversifiable
risk ie. the risk that is inherent to the asset, and which cannot be avoided by
altering the portfolio of investments held.
It is
generally accepted that the investment returns from regulated infrastructure
are less volatile than the market at large, and should therefore have an asset
beta less than 1. How much less than 1 tends to be the sticky point at which
infrastructure owners and regulators differ, with regulators generally always
claiming that the “risk” associated with infrastructure earnings is less than
what owners claim.
Note
that the asset beta is different from but related to the equity beta, which
depends on capital structure ie. the asset beta is independent of debt and
equity.
The draft decision
Paragraph
259.2 of the draft decision states “(we propose to) reduce the asset beta from 0.44 to
0.34, based on updated analysis suggesting that the 0.1 upwards adjustment to
the asset beta for GPB’s (that we made in 2010) should no longer be applied”.
The draft decision presents an extensive analysis of listed electric and gas
company stocks to reach the (draft) conclusion that the upwards adjustment of
0.1 is no longer applicable.
The impact on investment
The
asset beta is a component of the capital asset pricing model (CAPM), hence any
reduction in the asset beta will also reduce the estimated return or allowable
WACC. That in turn reduces both an infrastructure owners’ willingness to invest
in new (or replacement) assets, and their ability to attract capital to the
business.
On the
face of it, some might question how such a reduction in the ability to attract
capital is consistent with the incentive to invest in replacement, upgraded and
new assets set out in the Part 4 Purpose Statement in s52A of the Commerce Act 1986.
Next steps
As of
late August 2016, the Commerce Commission is working through the various
submissions and will hold a workshop (on 7th September) on key WACC
topics. Pipes & Wires will comment further as the Commission’s final
decision emerges.
Aus – framing up the electricity transmission resets
Introduction
The Australian Energy
Regulator (AER) recently released its Final Framework & Approach
(F&A) papers for the ElectraNet transmission business in South Australia and for the Murraylink interconnector between Victoria and South Australia for the
5 year regulatory control period starting on 1st July 2018. This
article examines the key components of those Final F&A’s to provide some
context for analysing the “numbers” as they emerge.
Regulatory framework
The
regulatory framework for the F&A is set out in Clause 6A.10.1A of the National Electricity Rules. This inter alia
requires the AER to publish its intended approach to various incentive and
efficiency schemes.
Key components of the final F&A
The
AER requires ElectraNet and Murray Link to include the following information in
their revenue proposals (rate cases)…
|
Scheme |
Scheme
component |
ElectraNet |
Murray
Link |
|
Service
Target Performance Incentive Scheme (STPIS) |
Proposed
values for service component parameters |
l |
l |
|
Data
for its market impact component |
l |
l |
|
|
Capability
incentive parameter action plan. |
l |
|
|
|
Efficiency
Benefit Sharing Scheme (EBSS) |
Formulae
for calculating efficiency gains & losses |
l |
l |
|
Adjustments
to forecast or actual OpEx when calculating carryovers |
l |
l |
|
|
Approach
to determining carryover period |
l |
l |
|
|
Capital
Expenditure Sharing Scheme |
Proposes
to apply latest version of CESS |
l |
l |
|
Provision
for ex-post review |
l |
|
|
|
Expenditure
Forecast Assessment Guideline |
Intend
to apply a range of assessment methods including benchmarking, trend
analysis, methodology review, governance and policy review, cost-benefit
analysis, and detailed review of individual projects. |
l |
l |
|
Depreciation |
Propose
to use forecast depreciation approach to establish opening RAB for the 2023 –
2028 regulatory control period. |
l |
l |
Next steps
The
next steps are for ElectraNet and Murray Link to submit their revenue proposals
by 31st January 2017. After a consultation period, the AER will
indicatively publish its Draft Determinations in September 2017.
Germany – setting the cost of equity
Introduction
The
German infrastructure regulator (the Bundesnetzagentur) has recently published its draft cost of equity decision
that it expects will apply for the gas regulatory period that starts on 1st
January 2018 and for the electricity regulatory period that starts on 1st
January 2019. This article examines some of the features of that draft
decision.
The Bundesnetzargentur’s draft decision
The
draft cost of equity is 6.91% after tax, which is a reduction from the 7.39%
after tax applicable to the current regulatory period. The Bund says that this
reflects a decline in observed equity market returns.
Key features of the draft decision
Key
features of the draft decision include…
· Risk-free rate based on 10 year average – 3.80%.
· Risk premium – 3.59%.
· Impact of corporate tax – 1.66%.
· Pre-tax cost of equity – 9.05%.
· Post-tax cost of equity – 7.39%.
The decision to apply the same cost of equity to electricity
and gas
The
same (draft) cost of equity will be applied to both electricity and gas, as the
Bund reasons that the risks of both businesses are comparable. A little thought
reveals that gas tends to be a more discretionary fuel, but then electricity
(networks) face a lot of competition from rooftop solar. So while the maths
might result in similar asset betas (and hence cost of equity) for electricity
and gas, it would seem to be stretching it to claim that the risks are
comparable … it could be argued that a post-tax return of 7.39% from a gas
business is less acceptable than a 7.39% post-tax return from an electricity
business.
NZ – resetting the gas pipeline default price path (DPP)
Introduction
The
Commerce Commission recently released its policy for setting price paths and quality standards to seek feedback on the default price path (DPP) that will
apply to certain gas pipeline businesses for the 5 year period starting on 1st
October 2017. This article examines the key features of that policy.
Regulatory framework
The
regulatory framework for gas pipelines includes the following components of Part 4 of the Commerce Act 1986…
· The Part 4 purpose statement (s52A).
· The purpose of default and customised price-quality
regulation (s53K).
· The requirements for resetting a DPP (ss 53M, 53O and 53P).
Gas pipelines businesses that will be subject to the DPP
The
following gas pipeline businesses will be subject to the DPP unless that
business applies for and is granted a customised price path (CPP)…
· First Gas (distribution).
· Powerco.
· Vector.
· GasNet.
· First Gas (transmission).
Key features of the policy paper
Key
features of the policy paper include…
· An initial view to rely more heavily on pipeline businesses’
forecasts (after having capped asset management plan forecasts to historical
spend levels), whilst also noting the incentives for businesses’ to pad their
forecasts.
· An expectation of greater scrutiny of pipeline businesses’
forecasts in return for greater reliance on those forecasts as a starting
point.
· An expected reliance on the discretion provided by the Input
Methodologies to assess forecasts.
· An intention to adopt the CPP Expenditure Objective for the
assessment criteria.
· A view that DPP’s could be tailored to the unique
circumstances of each pipeline business, whilst also recognising that a DPP is
not expected to address every circumstance that a pipeline business may face.
· A clear recognition by the Commission of the differing cost
drivers between transmission and distribution.
· More extensive modeling of future gas demand as a revenue
driver.
· Proposed changes to how gas supply interruptions are
measured.
Next steps
The
Commission will receive submissions on the policy paper until 28th
September 2016. After a period of consultation that includes consideration of
the Input Methodologies review, the Draft DPP Decisions are expected in
February 2017.
Greece – gas tariff adjustment threatens gas network sale
Introduction
The
value of any infrastructure asset is strongly related to its allowable tariffs.
This article examines recent events in Greece in which a lower-than-expected
tariff increase threatens to derail the sale of a gas pipeline business
reinforces just how strong that linkage is.
A bit about DESFA
DESFA is the Greek national gas transmission company, which also
operates gas distribution networks and the Revithoussa LNG terminal. Annual revenue is about €190m and the asset base is about
€1.3b.
The intended sale of DESFA
The
sale process began in 2013 when SOCAR from Azerbaijan won the tender to purchase a 66% stake in
DESFA for €400m, however completion of the deal was delayed in late 2014 when
the European Union raised anti-trust concerns over SOCAR holding a controlling
stake. This required SOCAR to on-sell 17% of DESFA to reduce its eventual stake
to 49%. That 17% stake was bought by the Italian gas company Snam.
The proposed gas tariff amendment
The Energy Ministry has introduced legislation that would amend the DESFA
Tariff Policy without consulting the intending buyers that have the practical
effect of a lower-than-expected tariff increase. Not surprisingly, SOCAR has
indicated that it may withdraw from the purchase arrangement, whilst the
Ministry remains adamant that it will not withdraw the legislation amending the
Tariff Policy.
Nuclear
UK – further delays to Hinkley Point C
Introduction
Pipes
& Wires has been following the long and tortuous path to getting Hinkley Point C approved. This article examines the good news, the bad news
and some thorny issues.
EDF’s approval
EDF’s board voted 10 – 7 to approve the Hinkley Point C
investment in late July 2016. It is understood that 6 of the 7 votes against
were from staff representatives on the board who may have been concerned that
the required investment and risks could threaten EDF’s survival.
The UK Government’s decision to review the deal
Within
hours of EDF’s approval, the UK Government announced a review of the project
that it expects to complete by the spring of 2017. That review is expected to
examine a range of thorny issues.
The thorny issues
The
thorny issues (some of which will be examined by the UK Government) include…
· Construction delays and cost escalations at other nuclear
stations such as Flamanville that are using similar technology (refer to Pipes & Wires #151 and #155).
· Concern over the 33% stake in the project held by China General
Nuclear Power, which comes with permission to build a further nuclear station at
Bradwell in Essex.
· The 35 year commitment to a minimum price of £92.50 per MWh.
Further concern has arisen that the wholesale price of £70 per MWh based on
gas-fired generation at the time that the £92.50 MWh minimum price was
calculated about 3 years ago is now more like £40 per MWh, leading to an even
greater subsidy.
· Exactly what will replace the 23,000 MW of coal and nuclear
generation capacity marked for closure over the next 15 or so years ?
· The rapidly declining cost of solar and batteries makes new
nuclear less commercially attractive.
Pipes
& Wires will comment further as the UK Government completes its review.
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.
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.
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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.
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Consultants Ltd accepts no liability for action or inaction based on the
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