Pipes & Wires
THE MONTHLY
CLIENT NEWSLETTER FROM UTILITY
CONSULTANTS
Issue 35 – November 2004
From the
director…
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Welcome
to Pipes & Wires #35. This issue has a distinct New Zealand and
Australian content, but then a lot is happening “down-under”. We
begin with updates on some big deals in New Zealand and Australia, and then
have a brief discussion of financial transmission rights as a lead-in to the
expected industry consultation period. We then
examine some regulatory matters – a cost of capital issue, the shape of the
impending 3 year water price controls in Victoria, Australia, and how the
passage of the Electricity & Gas Industries Bill has re-shaped the
regulatory and governance boundaries of the New Zealand electricity & gas
sectors. |
NZ – update on the Powerco and NGC
sales
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Following on from Pipes
& Wires #34, we’ll present a progress update and analysis on the sale
of Powerco to Prime Infrastructure and
the sale of AGL’s 66.05% stake in NGC to Vector. |
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The Powerco sale Prime Infrastructure’s offer to
purchase Powerco shares closed earlier this month with a 94.6% acceptance,
which is sufficient for Prime to compulsorily acquire the outstanding shares.
After a month that sorely tried the Takeovers
Panel in regard to share and bond holdings with Australian registered
addresses, the Overseas Investment Commission
recommended to the Minister of Finance that the deal be approved. It appears,
however, that the Minister was reluctant to approve the deal but |
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was
advised that a decision to decline the deal could probably be over turned by
a judicial review. The NGC sale Vector’s conditional bid for
66.05% of NGC seemed to be going very well – almost too well - until it hit a
slight snag on 2 November. An exemption from the requirements of the Takeovers Code had been sought to
enable Vector to acquire AGL’s New Zealand holding company AGL (NZ) Ltd
(which holds 64.2% of the shares) instead of actually acquiring the NGC
shares, but the Takeovers Panel declined to grant an exemption. Vector
subsequently indicated that it will jointly discuss with AGL the alternative
ways of acquiring the shareholding that formed part of the initial sale
agreement. |
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Aus – the end of the Epic journey
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Background After a long and drawn-out
process a consortium comprising DUET, Alinta and ALCOA has finally been confirmed as the
new owners of the Dampier – Bunbury Natural Gas Pipeline (DBNGP) for a
consideration of $1.86b. |
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The underlying gas contracts The sale process was
complicated by the lack of a completed agreement between the DBNGP owner and
the key users. A finalised 25 year deal between the consortium and key users
(which includes Western Power,
Alinta and ALCOA) has ended months of discussions and enabled the sale &
purchase to go unconditional. It is understood that the negotiated tariffs
are greater than those originally proposed. |
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Plans for the future The DBNGP’s average daily
throughput of 550TJ is currently insufficient to supply all users, even to
the point of predicted power blackouts this summer. The consortium has
committed to expanding the capacity by an additional 100TJ per day over the
next 4 years. It is understood that the state government will provide
financial assistance for this expansion. The end of an Epic journey So the Epic journey has finally
come to an end, the Gas Code has been exhaustively examined and re-examined, |
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and Epic’s shareholders lost about $500m.
Hopefully this won’t dampen investors’ enthusiasm for Australian (and New
Zealand) infrastructure. |
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NZ – moving toward Financial Transmission
Rights
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What are FTR’s ?? Financial Transmission Rights
are financial instruments that entitle the holder to be compensated (or in
some circumstances to pay compensation) when the holders ability to transact
business between two nodes of a transmission grid becomes restricted. These
restrictions are also referred to as “constraints” or “congestion” whilst
FTR’s are also known as “Financial Congestion Rights” or “Transmission
Congestion Contracts”. |
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What exactly is a constraint ?? Transmission lines have a finite
capacity governed by the physical properties of the conductors which gives
rise to “line losses”. Once that finite capacity is reached the line becomes
“constrained” and the losses become excessive. Capacity constraints are
usually deemed to occur when a line carries more than a certain percentage of
its rated current for more than a specified duration. The complex math that is used
to simulate transmission grids models the effect of line losses by assigning
different prices for delivered energy to different nodes. These are referred
to as “nodal prices” and can be significantly different on either side of a
constraint. Intuitively, relieving the constraint by increasing the conductor
rating will cause the nodal price difference to collapse to the level of the
losses. What is the effect of losses and constraints
?? Put simply a constraint limits
the amount of electricity that can be |
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transmitted along
a line. Transmitting electricity across a constraint from a low-cost
generator may in fact cost more than running a high-cost generator on the
same side of the constraint as the load. This distorts the usual least-cost
dispatch process as out-of-merit plant may be scheduled to run and gives rise
to what in New Zealand are referred to as loss & constraint rentals. This
total pool of loss and constraint rentals is rebated to distributors by
Transpower in proportion to where Transpower gathers its revenue from. Mixed hydro-thermal systems
such as New Zealand can have very volatile loss & constraint rentals,
meaning that a distributors annual Transpower charges can vary dramatically
year on year. Although these loss & constraint rentals may only be a few
percent of a distributors line charges, they can be very high for individual
half-hours. |
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What can FTR’s do ?? FTR’s are a more precise way of
“staking a claim” to the pool of loss & constraint rentals and act as a
perfect hedge against transmission losses and congestion. FTR’s are funded
from the pool of loss & constraint rentals, and are usually allocated by
auction. Being allocated an FTR entitles the owner of the FTR to be
compensated for the effects of losses and constraints. The next part of the Electricity Commission’s
consultation on Part F of the Electricity Governance Rules will be coming
soon, in which industry participants will have the opportunity to contribute
to how FTR’s will operate within New Zealand. For advice on FTR’s including
on making any submissions to the Electricity Commission, pick here
or call Phil on (07) 854-6541. |
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Finance - is WACC out of whack ???
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Introduction Not surprisingly arguments over WACC feature prominently in the
regulatory determinations we discuss in Pipes & Wires. On the one hand
utilities argue that regulators are setting the WACC too low through a rigid
adherence to a particular theoretical model, whilst on the other hand
regulators argue that the margin that utilities want to add to the regulators
estimates of WACC is unjustified. This article discusses the findings of some recent
work by Prof. Glenn Boyle from the Institute
for the Study of Competition and Regulation at Victoria University which highlights the
important role that the often-ignored unsystematic risk plays in determining
WACC and suggests that the “unjustified margins” might in fact be justified. |
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The CAPM and
Asset Beta Most of us are familiar with the Capital Asset Pricing Model (CAPM)
and its dependence on the Asset Beta (which measures the “riskiness” of an
individual investment relative to the market as a whole). Most of us would
also agree that pipes & wires utilities tend to embody a reasonably low
risk (certainly less than the market as a whole) and it is at this point that
the divergence of views on the actual “riskiness” emerges. |
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The industry
experience Most recent regulatory determinations in Australia and New Zealand
conclude that the WACC for a pipes & wires utility is about 6% to 6.5%
based on the CAPM. Recent research in the pipes & wires sectors, however,
has indicated a WACC between 10% and 11.5%, or about 4% greater than that
suggested by the “classical” CAPM approach. |
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The answer
seems to lie in the unsystematic risk One of the assumptions implicit in the CAPM is that investors should
not be rewarded (through a higher WACC) for accepting risks that they could
diversify through more prudent investment processes. However, the real world
imposes many constraints upon the capital raising and investment processes
that the CAPM ignores. These constraints
include financial market frictions such as transaction costs and imperfect
information, investment irreversibility and the investing firms’ finite
resources. Thus the recent research outlined above seems to fit well with an
observed margin of about 4%. |
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Aus – water under pressure in Victoria
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Background Most of us are familiar with
price regulation of pipes & wires businesses. This article examines the
development of pricing arrangements for the 3 year regulatory control period in
Victoria, Australia commencing on 1 July 2005. Average price increases
between 1.7% to 14% per annum and a state-wide capital spend of $1.9b are
expected over this period. |
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Industry structure The Victorian water industry
is split geographically three ways, with one of those splits (metropolitan
Melbourne) being further split along functional lines…. ·
Rural Victoria is supplied by 5 Rural Water
Authorities. ·
Regional urban Victoria is supplied by 15
Urban Regional Water Authorities. ·
Metropolitan Melbourne is supplied by a
single bulk supplier (Melbourne
Water) which supplies 3 distributor / retailers (City West Water, South East Water and Yarra Valley Water). |
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Broad regulatory framework The water industry regulatory
framework is defined by the Water Industry Act 1994, particularly Part 4D
which provides for a Water Industry Regulatory Order to be made. The ESC’s powers and responsibilities are
outlined in the Essential Services Commission Act 2001, particularly Section
33 which provides for the ESC to make price determinations. The Water Industry
Regulatory Order 2003 provides a further level of detail about what goods
and services may be regulated and what approach the ESC can adopt in
regulating prices. |
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The regulatory process to date Most Pipes & Wires
readers will be familiar with the processes that OFWAT and OFGEM have used in the UK. This process
began in Victoria in February 2004 with the publication of Consultation Paper
#1 by the ESC. This paper invited comment on key regulatory issues, and
outlined the content of the Water Plans which each utility would be required
to prepare. Each water utility’s Plan is expected to address 4 reasonably
distinct areas… ·
The nature and levels of service it expects
to provide. ·
How it intends to provide those services. ·
The expected revenue required to provide
those services. ·
The prices likely to result from that
expected revenue requirement. These Plans form the starting
point for the ESC’s assessment of the expected prices and have been open for
public consultation. A draft pricing decision based on the feedback from the
consultation period and the ESC’s own analysis is expected to be released in
January 2005. Following a consultation on the draft, a final decision is
expected in May 2005 which will take effect on 1 July 2005. |
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NZ – electricity industry consultation
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The Electricity Commission
has recently released two papers for consultation… ·
Group
offer and dispatch of interruptible load ·
Security
of supply policy development Submissions on both of these
papers close on 3 December 2004. For more advice on these issues,
or for assistance in preparing your submission pick here
or call Phil on (07) 854-6541. |
NZ – the Bill becomes law
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Introduction The long-awaited and
much-debated Electricity & Gas Industries Bill 2003 received its final
reading and most parts were passed into law last month. As outlined in Pipes
& Wires #29 the Bill sought to amend 5 statutes to ensure a
consistent and integrated approach to industry governance and regulation that
inter alia recognised the need for
security of gas supply to underpin security of electricity supply. |
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Final shape of the Bill Just prior to the final reading
the Bill was divided into 5 separate Bills as follows… ·
The Electricity Amendment Bill. ·
The Electricity Industry Reform Amendment
Bill. ·
The Commerce Amendment Bill. ·
The Gas Amendment Bill. ·
The Crown Minerals Amendment Bill. |
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Key impacts of the enactment The broad structure of the
original Bill and its final form is outlined in the following table…
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For more information To discuss how the enactment of
the Bill may impact on your business pick here
or call Phil Caffyn on (07) 854-6541 or Christopher Hayes on (09) 916-3766.
Thanks to Phillips Fox for their
assistance with this article. |
Conferences & events
·
Metering, Billing & CRM Middle East
– Dubai (1 – 3 February 2005)
This event
provides a major networking platform for stakeholders involved in the
Middle-East water, gas and electricity utilities sector concerned with
customer-end technologies (metering, billing and CRM/CIS systems).
·
Principles
& Economics of Petroleum Exploration, Production & Development – Wellington (22 – 23 February 2005)
Conferenz announces the
two-day Principles & Economics of Petroleum Exploration, Development &
Production seminar. This seminar will cover all aspects of the petroleum
business, including data acquisition and interpretation, prospect generation
and risk analysis, drilling the well, and developing and producing a field. At
the end of the course, participants will be able to understand the issues
involved and terminology used, which will result in improved communication
within and across businesses and agencies. The seminar trainer is Steven
O’Connor, Director, DILIGENZ Ltd.
·
NZ Power Summit – Auckland
(15 – 16 March 2005)
Conferenz is
delighted to confirm the dates for our 7th Annual NZ Power Summit, New
Zealand's largest power summit for 2005, and the first point of reference for
all key decision-makers and executives working within the energy sectors. With
an audience of the highest level delegates and speakers, the 2005 NZ Power
Summit represents an unprecedented opportunity to network with other senior
energy executives and new business contacts.
The 2005 NZ Power Summit will be featuring key regulatory decision-makers, 2
international addresses, 16 chief executives and many other industry experts.
·
Metering, Billing & CRM America –
Las Vegas (10 – 15 April 2005)
This
event provides a major networking platform for stakeholders involved in the
North American water, gas and electricity utilities sector concerned with
customer-end technologies (metering, billing and CRM/CIS systems).
·
Metering, Billing & South
African Prepayment Week –
Cape Town (June 2005)
SPIntelligent will again
be hosting the hugely successful 6th Annual Metering, Billing, CRM / CIS Africa 2004 which will be co-located
with the 4th annual South
African Prepayment Week (SAPW) conference and exhibition in Cape Town.
This event has been
supported by utilities, government bodies and vendors throughout Africa for the
last six years and is a calendar highlight for companies involved in metering, billing
and CRM / CIS. The event provides a forum for electricity, water and gas
stakeholders to discuss pertinent issues on the value of metering, billing
systems and CRM / CIS in the revenue cycle chain in utilities.
Co-located is the South African Prepayment Week
conference and exhibition, which provides an opportunity for electricity, water
and telecommunications prepayment experts to discuss the latest developments
affecting the industry in South Africa, while at the same time providing a
forum to showcase the vast experience of the industry to an international
audience.
Links to cool stuff
·
Energy21
News (distributed generation & demand response) – Centre for Advanced
Engineering.
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Disclaimer
These articles are of a general nature and
are not intended as specific legal or consulting advice. They are correct at
the time of writing. 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.