From the director…
Welcome
to Pipes & Wires #89. Here in New Zealand (at least in the Waikato) the
summer seems to be going on endlessly, with the added delight of spectacular
early evening thunder storms.
However
it’s back to work and Pipes & Wires kicks off 2010 by examining some recent
regulatory decisions and policy in the UK, Australia and NZ. We then take a
quick look at a water company divestment in the US in the context of
reshuffling Europe’s energy sector and close this issue with a look at the
unfolding pan-European electricity market.
As
the economy shows some signs of recovering, 2010 is tipped to be a big year for
M&A activity which Pipes & Wires will be closely following.
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Regulatory determinations
UK – final water & sewage pipes
decision
Introduction
Pipes
& Wires #67, #75
and #85
have followed the compilation of PR09,
the price controls that will apply to the major UK water and sewage businesses for
the 5 years from 1st April 2010. This article examines the key
aspects of OFWAT’s
final determinations and compares that to the draft determinations and what
was originally sought by the businesses.
Comparison of the final and draft
determinations with what was originally sought
Comparisons
of the final and draft determinations with what was originally sought are as
follows...
|
Parameter |
Originally
sought |
Draft
determination |
Final
determination |
|
Change
in household bill (nation-wide
average) |
Increase of £31 |
Reduction of £14 |
Reduction of £3 |
|
Nation-wide
CapEx |
£24b |
£21b |
£22b |
|
Nation-wide
OpEx |
3.8b |
£3.7b |
3.7b |
|
Post-tax
WACC |
4.7% to 5.0% |
4.5% |
4.5% |
Comment
Overall
the final determination seems pretty reasonable. In amongst what seem rather
harsh knock-backs on the change in (nation-wide average) household bill OFWAT’s
expectations of continuing efficiency gains seem reasonable enough. What does
need to be said is that the determination is a very readable document – good on
ya, OFWAT.
Aus – draft Queensland and SA wires
decisions
Introduction
Pipes
& Wires #84 examined the Regulatory Proposals submitted by ETSA Utilities, Energex and Ergon Energy to the Australian Energy Regulator (AER) for the 5
year control period beginning on 1st July 2010. This article
continues that theme now that the draft decisions have been released, and will
continue until the final decision is released around about May 2010.
Proposed parameters for ETSA
The
parameters proposed by ETSA are as follows...
|
Parameter |
Proposal |
Draft decision |
Revised
proposal |
Final decision |
|
Total
CapEx |
$2,315.4m |
$1,628.2m |
$1,793m |
|
|
Total
OpEx |
$1,131.1m |
$1,044.0m |
$1,081m |
|
|
Opening
RAB |
$3,011m |
$2,768.4m |
$2,983.2m |
|
|
Risk-free
rate |
4.22% |
5.37% |
5.37% |
|
|
Nominal
vanilla WACC |
9.04% |
10.02% |
10.02% |
|
|
P0 |
-10% |
-10.95% |
-9.18% |
|
|
Smoothed
X |
-10% |
-3.90% |
-9.18% |
|
Proposed parameters for Energex
The
parameters proposed by Energex are as follows...
|
Parameter |
Proposal |
Draft decision |
Revised
proposal |
Final decision |
|
Total
CapEx |
$6,466.0m |
$5,718.3m |
$6,069.5m |
|
|
Total
OpEx |
$1,843.1m |
$1,586.3m |
$1,616.7m |
|
|
Opening
RAB |
$7,903.2m |
$7,887.4m |
$7,841.5m |
|
|
Risk-free
rate |
5.08% |
5.44% |
5.44% |
|
|
Nominal
vanilla WACC |
9.49% |
10.06% |
10.06% |
|
|
P0 |
-25.3% |
-23.03% |
-26.5% |
|
|
Smoothed
X |
-8.4% |
7.00% |
-8.4% |
|
Proposed parameters for Ergon
The
parameters proposed by Ergon are as follows...
|
Parameter |
Proposal |
Draft decision |
Revised
proposal |
Final decision |
|
Total
CapEx |
$6,032.9m |
$5,012.8m |
$6,274.2m |
|
|
Total
OpEx |
$1,992.6m |
$1,514.2m |
$1894.1m |
|
|
Opening
RAB |
$6999.4m |
$7,105.4m |
$7,173.98m |
|
|
Risk-free
rate |
5.08% |
5.44% |
5.44% |
|
|
Nominal
vanilla WACC |
9.49% |
10.06% |
10.06% |
|
|
P0 |
-27.05% |
-26.63% |
-39.51% |
|
|
Smoothed
X |
-7.69% |
-4.90% |
-6.42% |
|
Comments
CapEx
in particular was knocked back for all 3 distributors. The AER presented a
range of reasons for these knock backs including proposed CapEx not reflecting
projected demand growth, not reflecting efficient costs, and projected growth
rates and cost escalators not adequately considering the global financial meltdown.
Pipes & wires will make further comment as the final decisions emerge over
the next few months.
Disclosure of interest
UMS
Group Asia Pacific in association with Utility Consultants advised
ETSA Utilities on some parts of its Proposal.
UK – final wires decision
Introduction
Compilation
of the 5th
electricity distribution price control review (DPCR5) which runs for the 5
years starting on 1st April 2010 has come to completion with the
release of the final decisions.
Key features of DPCR5
Key
features of DPCR5 include...
·
A view that an efficient distribution
business should earn a baseline shareholder return on equity of between 7.1%
and 9.6%.
·
A view that a poorly performing company
could earn as low as 3% whilst a high performing company could earn up to 13%.
·
An expectation that customers will
share between 49% and 55% of efficiency gains through lower prices.
·
Inclusion of a number of mechanisms to
ensure that shareholder returns are not achieved by simple cost-cutting.
Revenue allowances
OFGEM’s final proposals set out a range of
revenue allowances totaling £22b over the 5 years period, from an increase of
11.1% per year (X=-11.1%) for ScottishPower’s MANWEB
business to a decrease of 4.3% per year (X=4.3%) for ScottishPower’s
Scottish distribution business.
This
article concludes Pipes & Wires coverage of DPCR5, however further comment
will be made on OFGEM’s “RPI-X@20”
review as details emerge.
Aus – the Victorian electricity
distribution proposals
Introduction
This
article examines the key features of the proposals submitted by the 5
electricity distribution businesses in the Australian state of Victoria. This
article will set some context for examining the Australian
Energy Regulators’ (AER) draft and final decisions over the next 10 months
or so.
Background
The
legal framework for electricity price decisions is the National Electricity Rules (NER),
which includes the following requirements…
·
The requirement for an electricity
distributor to submit a Proposal for the next price control period 13 months
prior to the start of that period. The next control period for the Victorian
distributors’ starts on 1st January 2011, hence their Proposals had
to be submitted by 30th November 2009.
·
Setting out what a Proposal must
contain.
·
The requirement for the AER to make its
Final Decision at least 2 months prior to the start of the next control period.
Key features of the proposals
The
key features of each business’ proposals include...
|
Business |
Key features |
|
· A forecast demand increase of about 180MW over the control
period (just over 10%), but with a decline in energy throughput. · A nett CapEx of about $1.06b for the control period. · An OpEx of about $244m for the control period. |
|
|
· An expectation of hotter, drier, windier summers with
increased fire risk. · Recognition that a number of government policy initiatives
(especially moves toward solar hot water and carbon pricing) will impact on
demand and energy throughput. · Proposing a pass-through mechanism for the uncertain costs
expected as part of known regulatory shifts. · Plans for 4 new zone substations over the control period. · A forecast CapEx of $669m. |
|
|
· A forecast demand increase of about 250MW over the control
period (just under 10%), but with a decline in energy throughput. · Recognition of a range of government policy initiatives
that will impact on demand and energy forecasts. · A nett CapEx of about $1.58b for the control period. · An OpEx of about $900m for the control period. |
|
|
· An established view that climate change has already made
network management and operation more expensive, especially increased fault
restoration costs. · Recognition that asset utilisation levels are approaching
manageable limits. · A view that the pending control period will see an
increase in customer responsiveness to real-time pricing and demand signals. · A reduced ability to access traditional sources of credit
due to the business being viewed as having a higher risk with the
consequences that future funding is likely to cost more. · A forecast CapEx of $1.37b for the control period. |
|
|
· A forecast investment level that is beyond the funding
capabilities of revenue, and will need equity and debt issues. · Climate change responses and aging assets are not only
putting upward pressure on costs, but are making future costs more uncertain. · An expectation that further efficiency gains are possible. · Concern around domestic air conditioning penetration that
is driving summer peak demand at more than twice the rate of energy
consumption increase. · An expected bow wave of renewals. · Hotter, drier, windier weather patterns potentially
leading to more outages. |
These
issues certainly give some insight into the increasing complexities of running
a lines business. Pipes & Wires will comment further when the draft
decisions emerge about June 2010.
NZ – the initial electricity lines
default reset
Introduction
The Commerce Commission is (was) required to
publish a summary of the Default
Price Path (DPP) that would apply to those electricity lines businesses
that do not meet the requirements to be consumer-owned 4 months before the
commencement of that DPP. This article examines the legal background and the
key features of the Commission’s summary that was released on 30th
November 2009.
The legal framework
The
legal framework for compiling the DPP applicable from the 1st April
2010 is set out in s54K of the Commerce Act 1986. In particular, the process
set out in s53P must be adhered to.
Key features of the decision
Key
features of the decision include...
·
Starting prices will be the prices
prevailing on 31st March 2010.
·
The annual rate of change of prices
(ie. X) will be 0%.
·
No increase in SAIDI or SAIFI. The
precise process to be followed is set out in Schedule 3 and includes
compilation of a non-zero data set and use of 2.5β.
·
No input methodologies will apply to
this DPP until applicable input methodologies determinations have been made.
Pipes
& Wires will comment further as the commission releases its various
decisions.
Regulatory policy
NZ – setting the WACC
Introduction
The
importance of setting a realistic WACC for regulated pipes & wires
businesses is probably one of the most critical and contentious issues around.
This article takes a brief look at progress on setting the WACC for regulated
businesses in New Zealand following the Commerce
Commission’s conferences in November 2009.
Legal framework
The
legal framework for the WACC (and all the other associated parameters) is set
out in Subpart
3 of Part 4 of the Commerce Act 1986 under the formidable title of Input
Methodologies. The purpose of the Input Methodologies is to promote certainty
for suppliers (of regulated services) and consumers in relation to rules,
requirements and processes, and explicitly notes at s52T(1)(a)(i) that Cost of
Capital must be included in the overall Input Methodologies.
The emerging picture
Most
of us are well aware of the Commission’s work on Input Methodologies, including
the Cost of Capital workshop on the 12th and 13th of
November 2009. Specific comment is made on the 2 papers that were posted on the
Commission’s website....
·
Effects
Of Leverage On WACC Under Two Different CAPM’s which compares the effect of
leverage on WACC and cost of equity under the Classical CAPM and the
Brennan-Lally CAPM. This short and very readable analysis notes that under the
Classical CAPM the WACC decreases as leverage increases to reflect the tax
deductibility of interest in the absence of dividend imputation, whilst under
the Brennan-Lally CAPM the WACC increases as leverage increases to reflect the
increasing debt premium.
·
WACC
And Leverage which starts by noting that using the simplified Brennan-Lally
CAPM in conjunction with the simplified Beta gearing model gives an increasing
WACC as leverage increases, thereby suggesting that leverage is undesirable
(and if it is, why do so many supposedly rational firms lever their balance
sheet ?). The thrust of Lally’s
arguments is that the debt premium (which arises due to 3 factors) increases
with increasing leverage. Again, a very readable and succinct paper.
The
Commission subsequently called for submissions which closed in early December. Pipes & Wires will closely follow further
work as the all important WACC number hopefully comes closer to being revealed.
Mergers & acquisitions
US – RWE divests American Water stake
Introduction
News
emerged late last year that German utility giant RWE
was reducing its stake in American Water.
This article quickly examines that deal but then focuses on the wider picture
of RWE in a reshuffling European industry and what we might infer from this
relatively straightforward deal.
Background
Back
in 2003, RWE subsidiary Thames Water
completed its acquisition of American Water with the publicly stated view of
positioning RWE as a leader in the regulated North American water
business. Subsequently RWE began to sell
its American Water stakes, including the following deals...
·
In April 2008, RWE sold a 36% stake
through an IPO that raised about US$1.2b (long-time readers may recall a
similar approach used by Spark
Infrastructure and SP AusNet in
Australia).
·
In August 2009 RWE reduced its stake
from 46.6% to 26.5% amidst huge demand for shares that was expected to raise
about US$650m.
The deal
Most
recently RWE planned to reduce its stake in American Water from 23.5% to 2.1%
(the original intention appeared to be a total divestment), and expected to
raise about US$784m. However, subsequent to that announcement, RWE then decided
to sell the remaining 2.1% as well. So, all up, RWE should raise about US$2.6b
which is comparable to the value of many recent “second tier” European
acquisitions.
The bigger issues
Given
that 6 years ago RWE planned to be a leader in the North American water
business, something has obviously changed very significantly. A couple of
issues could be...
·
The impending unbundling of the
European energy sector that is likely to provide opportunities for carving out
new niche positions (probably along the lines of a significant divide between
lines and energy) which requires a retraction of global focus to more regional.
·
The need to free up cash to make
acquisitions in the expected reshaped European industry (or maybe just to free
up cash to pay the bills).
·
Possibly a need to deleverage the
balance sheet (a bit like Electricité De France).
·
A declining attractiveness of the North
American water industry relative to RWE’s other investments.
A
couple of clues include...
·
RWE’s restructuring of its’ UHV
transmission grid business RWE
Transportnetz Strom into a fully functional enterprise called Amprion that will report directly to RWE’s
group chief executive, suggesting that some strategic positioning is going on (Pipes
& Wires #86).
·
Pipes
& Wires #88 noted that the first structural reshuffling has already
begun (albeit driven by regulation rather than the market) as E.On sold its 380kV and 220kV transmission grid
business Transpower
Stromübertragungs GmbH to state-owned
Dutch transmission utility TenneT.
My
guess is that the American Water sell-down (and the formation of Amprion) does
represent some serious re-positioning by RWE, which Pipes & Wires will
definitely be following.
Energy markets
Holland – forming the north-west
electricity market
Introduction
Pipes
& Wires #88 examined the sale of E.On’s
380kV and 220kV transmission grid business Transpower
Stromübertragungs GmbH to state-owned
Dutch transmission utility TenneT, and
noted the comment that this may give Holland access to E.On’s low-cost coal-fired
generation in Germany (although a more formal statement from TenneT used the
phrase “price equalisation”). Given that those transmission lines are already
largely in place, this article examines why a simple change of ownership might
suddenly create a market entry point.
Is there actually any price difference
between the markets ?
A
good starting point would be to see just how much of a difference in wholesale
price there actually is between Holland and Germany because, intuitively,
coal-fired generation should be more expensive than gas-fired (and if there
really was that much of a gap, wouldn’t someone have already built new
transmission lines to capture that advantage ?). Precise information proved
hard to find, but some broad figures from 2007 suggested that domestic
electricity was about 10% more expensive in Holland than in Germany, and
industrial electricity was pretty much the same price. That certainly doesn’t
seem anything to build a long-term business model on, however reading a bit
further reveals that formation of a north-west European electricity market
would enable interconnection of surplus capacity, and it is this factor that is
likely to put downward pressure on prices.
Forming the north-west electricity
market
I
guess the question needs to be asked why has it taken an apparently
straightforward change of ownership from E.On to TenneT to promote the
formation of a north-west market. Surely the commercial incentives to either
build or not build new transmission lines haven’t changed, or is there
something that ownership can do that regulation can’t ? Pipes & Wires will
leave this story here, but will continue to examine these sorts of issues as
the European market reshuffles.
A bit of light reading…
Book review – “Connecting The Country”
Helen
Reilly’s latest book “Connecting The Country” is a history of NZ’s national
grid from 1886 to 2007 that interestingly enough splits into the development of
the AC and DC systems. Filled with photos, anecdotes and witty stories this is
a really worthwhile read.
Order
your copy from Transpower’s
web site … cost is $60 incl. GST.
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…
·
White Diamonds North.
·
Northwards March The Pylons.
·
Marlborough Will Shine Through.
Conferences & events
·
Smart Grids Summit
(Wellington) – 23rd February 2010.
CapEx – general interest stuff
Levels of service and their impact on
CapEx
This
presentation was made at the Infrastructure CapEx Summit in November 2008. If
you’d like a copy, pick here.
Upsizing – the other half of the hidden
side of CapEx
This
presentation was made at the Electricity
Engineer’s Association conference in June 2008. If you’d like a copy, pick here.
Getting the CapEx right in the
infrastructure sectors
This
presentation was made at the NZIGE
Spring Technical Seminar in September 2007. If you’d like a copy, pick here.
Renewals – (half) the hidden side of
CapEx
This
presentation was made at the Electricity Networks Asset Management Summit in
November 2007 on the broad topic of asset renewals. If you’d like a copy, pick here.
PAS 55 – the emerging standard for
asset management
To
find out more about improving your asset management activities through adopting
the emerging global standard for asset management PAS 55-1:2004 pick here
or call Phil on +64-7-8546541, or to request a Slide Show on implementing PAS
55-1 pick here.
Website promoting best practice CapEx
Utility Consultants is pleased to announce the release of a specialist website
dedicated to promoting best practice CapEx policies, processes and planning in
the infrastructure sectors.
Assorted conference papers
Utility
Consultants has recently presented the following conference papers which are
available upon request…
·
“Tariff
control of Pipes & Wires utilities – where is it heading??” – presented
at the NZIGE Spring Technical Seminar,
October 2006.
·
“Setting
service levels for utility networks” – presented at the Electricity Network
Asset Management Summit, November 2006.
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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.
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Consultants Ltd accepts no liability for action or inaction based on the
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