Challenges to Transpower's North Island grid upgrade continue

The battle is still being fought against Transpower's North Island grid upgrade proposal for the supply of electricity into, and north of, Auckland, both under the Board of Inquiry, which is now underway, and through the courts. In this article, senior associate Louise Hill provides an update on recent events and outlines why one interest group was unsuccessful in the first judicial review application to be heard on an aspect of the grid upgrade.

Background and summary

In July 2007, the Electricity Commission (the Commission) gave its final approval to Transpower's proposed North Island Grid Upgrade plan for the supply of electricity into, and north of, Auckland (the North Island Grid Upgrade Proposal). This was followed in August 2007 by the Commission's approval of Transpower's separate (but related) proposal for some remedial works to the existing switchyard at Otahuhu and the construction of new gas insulated switchgear at the site (the Otahuhu Proposal).

Both the North Island Grid Upgrade Proposal and the Otahuhu Proposal are "investment proposals" which means that, in accordance with the Electricity Governance Rules 2003 (the Rules), Transpower may recover the costs of the investment from designated transmission customers once the proposals have been approved by the Commission.

As reported in the Winter 2007 issue of Commercial Quarterly, the consultation period leading up to the Commission's approval of both proposals was marked by public protests and controversy over what form these upgrades should take and whether the proposals represent the most appropriate and cost effective option for ensuring security of electricity supply to the upper North Island. As outlined below, the path for the proposals to be approved is still not particularly smooth.

The North Island Grid Upgrade Proposal is currently being considered by the Board of Inquiry, despite a request from one interest group to delay the hearings until its application for judicial review was heard. The hearings are scheduled to last until August 2008.

On another front, the Major Electricity Users' Group (MEUG) applied for judicial review to challenge the decision of the Commission approving the Otahuhu Proposal, but was unsuccessful. In essence MEUG's challenges indicated that MEUG preferred a cheaper, short term option to the Otahuhu Proposal.

Protests continue – Board of Inquiry

The Board of Inquiry hearings into the North Island Grid Upgrade Proposal began on 25 March and are expected to last for a few months due to the number and nature of the submissions received by the Board.

The Minister for the Environment called in Transpower's Notice of Requirements and applications for resource consents relating to the North Island Grid Upgrade Proposal under section 141A of the Resource Management Act 1991 (the RMA) and referred the matter to a Board of Inquiry because the North Island Grid Upgrade Proposal had "aroused widespread public interest regarding effects on the environment" and involves "significant use of natural and physical resources and the proposed transmission line crosses so many councils' boundaries". The call in process effectively combines the councils' consideration and the Environment Court appeal process under the RMA, and means that one body hears Transpower's applications for resource consent, as opposed to the nine affected councils.

An attempt was made on behalf of one interest group, New Era Energy Inc, to adjourn the Board of Inquiry's hearings until the outcome of its judicial review proceedings (filed in December 2007) challenging the lawfulness of the Commission's decision approving the North Island Grid Upgrade Proposal was known. However, following a public consultation on this request, the Board of Inquiry found that the existence of New Era Energy's proceedings did not justify the Board postponing the hearings.

The Board of Inquiry will issue a draft decision after the hearing process ends. Councils, submitters, Transpower and the Minister will then have an opportunity to comment before the Board makes its final decisions. The Board's final decisions can only be appealed to the High Court on points of law.

Judicial Review of the Otahuhu Proposal

Although New Era Energy Inc is still awaiting a hearing on its application for judicial review challenging the Commission's decision in relation to the North Island Grid Upgrade Proposal, a decision on MEUG's application for judicial review of the Commission's decision in relation to the Otahuhu Proposal was handed down by the court in March¹.

All parties accepted that MEUG had the right to be heard. As Justice Wild stated, MEUG, being the representative of New Zealand's major electricity users, "has a very real interest" in an efficient and quality electricity transmission network. Initially MEUG sued only the Commission. Transpower was joined to the proceedings at its own request.

In general, the grounds for a judicial review of the Commission's decision on any grid upgrade proposal are limited to a challenge based on the processes taken by the Commission in reaching its decision and in particular whether they gave due consideration to alternative proposals.

MEUG sought judicial review of the Commission's decisions on the Otahuhu Proposal alleging that the Commission had:

• erroneously interpreted clause 4.1 of the Grid Investment Test in the Rules;

• failed to evaluate or require Transpower to evaluate appropriate alternative projects; and

• in approving the Otahuhu Proposal, adopted an erroneous figure for the high impact low probability assumption (HILP) related reliability benefits used in its NPV analysis.

The High Court rejected all three grounds. A brief outline of the Commission's reasoning, MEUG's grounds for review and the court's decision is set out below:

(1) First ground: Erroneous interpretation of Grid Investment Test
Commission's reasoning	MEUG's reasoning	Court's decision
The Commission must take a long-term view of investment proposals when applying the Grid Investment Test under the Rules, in determining what is necessary to meet the N-1 reliability standard. If the Commission adopted the MEUG analysis, this would lead only to the approval of least initial cost projects and incremental, piecemeal developments.	The Commission erroneously interpreted clause 4.1 of the Grid Investment Test in the Rules. Improvements beyond the minimum necessary to meet the N-1 standard may only be justified on economic grounds – that is, they must maximise expected net market benefits, such benefits being greater than zero. In addition, if a proposal contains work necessary to meet the N-1 standard and work which is beyond the minimum necessary to meet the N-1 standard, this must be disaggregated and treated separately.	The Grid Investment Test does not require the Commission to disaggregate the proposals in the manner contended for by MEUG. It is up to Transpower to formulate the proposals and to submit them to the Commission for approval. MEUG's proposal that only the least initial cost project that meets N-1 should be adopted, by restricting initial investment and therefore cost to the minimum necessary is not consistent with the relevant objectives of the Electricity Act and the Rules: reliability, efficiency and promoting certainty for investment in transmission. The MEUG proposal is also not consistent with the emphasis in the Act, the Rules, and the grid reliability standard, on taking a long term view of developments of the national grid and proposals for investments in it.

(2) Second Ground: Failure to evaluate appropriate alternative projects
Commission's reasoning	MEUG's reasoning	Court's decision
The alternatives to the Otahahu Proposal considered by the Commission in determining that the Otahuhu Proposal met the requirements of the Grid Investment Test were only two proposals put forward by Transpower. The Commission did not consider other, short term, cheaper options proposed by MEUG.	The Commission failed to evaluate or require Transpower to evaluate appropriate alternative projects. MEUG suggested three alternatives that should have been considered by the Commission against the proposal by Transpower. The only alternative projects considered by the Commission were those presented by Transpower. MEUG submitted that the failure by the Commission to evaluate any short or medium term alternatives was "extremely imprudent", particularly as short term options would give the Commission more optionality as to grid investment planning.	The court accepted that this was an argument on the Commission's decision making process and to succeed MEUG would have to show that the decision of the Commission was unreasonable – one no reasonable electricity commission could have reached. The decision of the Commission was not unreasonable – the Commission took a reasonable approach and considered the options presented to it (which did not include all of the options now presented by MEUG), and rejected the option suggested by MEUG in its submission based on analysis that was the sort of expert assessment which the court stated "the Commission was well placed to make, and the Court ill placed to second guess".

(3) Third ground: Adopted erroneous high impact low probability assumption
Commission's reasoning	MEUG's reasoning	Court's decision
The Commission's assessment of the "high impact low probability" (HILP) assumption was critical to its decision on the Otahuhu Proposal. (A HILP is a very unusual occurrence which has a very substantial impact, for example the events which caused the June 2006 Auckland power outage.) From the Commission's decision it appeared that the Commission found it difficult to assess the value of the HILP, and relied not just on the quantitative data, but also on qualitative factors. Commissioner Pinnell gave a dissenting decision, stating that "Transpower's estimate of HILP-related reliability benefits [are] overstated by more than order of magnitude. I conclude that the difference in reliability between the alternatives and the proposal is immaterial".	In approving the Otahuhu Proposal the Commission adopted an erroneous figure for the HILP related reliability benefits. The Commission made conflicting statements in its decision as to the HILP and the basis for assessment of the value of the HILP. MEUG stated that the information on which the Commission based its HILP assumption was inadequate, and thus the Commission could not be reasonably satisfied that the proposed investment maximised the expected net market benefit or minimised the expected net market cost compared with alternatives and that that conclusion is sufficiently robust having regard to the results of sensitivity analysis.	As with the second ground, the court accepted that this was an argument on the Commission's decision making process and to succeed MEUG would have to show that the decision of the Commission was unreasonable. The Commission needed to select a HILP factor based on its judgement, guided by the available data. In its opinion all the Commission was required to do under the Grid Investment Test was select a HILP factor based on its judgment guided by the available data. Faced with statistical data upon which it could not safely rely, the Commission "adopted a notional probability", albeit one that erred on the side of caution. In the court's view this was not unreasonable in the circumstances.

Reasons for court's rejection of MERG's grounds of review

Erroneous Interpretation of the Grid Investment Test

Under the Grid Investment Test in the Rules, there are two tests to be applied by the Commission in considering whether or not a grid upgrade proposal should be approved, depending on the type of investment:

• for investments that are necessary to meet the N-1 reliability standard (i.e. the grid will continue to operate following one failure), the proposed investment must maximise the expected net market benefit or minimise the expected net market cost compared with a number of alternative projects, and if sensitivity analysis is conducted, a conclusion that a proposed investment satisfies this test is sufficiently robust having regard to the results of that sensitivity analysis;

• for any other proposed investment, the proposed investment maximises the expected net market benefit compared with a number of alternative projects, and the expected net market benefit of the proposed investment is greater than zero, and if sensitivity analysis is conducted, a conclusion that a proposed investment satisfies this first test is sufficiently robust having regard to the results of the sensitivity analysis.

In essence, the difference is that the first test requires the Commission to choose the least cost alternative, while the second test requires the Commission to choose the least cost alternative which also has a positive net market benefit – that is, unless an investment is required to meet the N-1 reliability standard, it will only be approved if the investment has a positive net market benefit.

In its initial submissions to the Commission MEUG had submitted that improvements beyond the minimum necessary to meet the N-1 safety net may only be justified on economic grounds – that is, such investments must maximise expected net market benefits, such benefits being greater than zero. The Commission did not agree with this interpretation. The Commission considered that such an approach would lead only to the approval of least initial cost projects, and incremental, piecemeal developments. The Commission stated that MEUG's interpretation does not reflect that the Grid Investment Test requires a long-term view of investment proposals.

MEUG accepted that some of the work outlined in the Otahuhu Proposal was necessary to meet the N-1 reliability standard, and this should be considered separately from work which is beyond the minimum necessary to meet the N-1 reliability standard.

Justice Wild rejected this ground of review, stating that the Grid Investment Test does not require the Commission to disaggregate the proposals in the manner contended for by MEUG. It is inappropriate for the Commission to do so. It is up to Transpower to formulate the proposals and to submit them to the Commission for approval.

Justice Wild also stated that MEUG's proposal that only the least initial cost project that meets N-1 should be adopted, by restricting initial investment and therefore cost to the minimum necessary, is not consistent with the relevant objectives of the Electricity Act 1992 (the Act) and the Rules: reliability, efficiency and promoting certainty for investment in transmission. The MEUG proposal is also not consistent with the emphasis in the Act, the Rules, and grid reliability standard, on taking a long term view of developments of the national grid and proposals for investments in it.

The court stated that the Grid Investment Test requires the Commission to make assumptions about the development path that would be followed over the (minimum 20 year) analysis period if the particular investment proposed by Transpower is constructed. Thus, the expected net market cost includes the initial costs of the investment proposals, plus those costs that would be incurred for other investments likely to be required over the analysis period. If Transpower proposes an investment with a short term focus, the Commission is required under the Grid Investment Test, to adopt modelled projects ensuring that the required analysis over the 20 year period is able to be conducted. The existence of cheaper (in terms of initial investment cost) alternatives does not mean that a proposed investment cannot be considered and approved by the Commission under the first limb of the Grid Investment Test. But it will be evaluated against those alternatives. MEUG's concerns, which the Commission accepts are legitimate and very real, are taken care of by the comparative analysis required by the Grid Investment Test.

Alternative projects

The second and third grounds of MEUG's judical review application challenged decision-making by the Commission (as an expert body) in technical areas. As such, the court noted that these grounds would only succeed if the decision-making process was exposed as unreasonable. MEUG could only succeed on the second and third grounds if it persuaded the court that no reasonable electricity commission with the Commission's statutory task and, having before it information available to the Commission here, could have reached the decisions the Commission did.

In its second ground for challenging the decision of the Commission, MEUG argued that the Commission failed to evaluate or require Transpower to evaluate appropriate alternative projects. MEUG suggested three alternatives that should have been considered by the Commission against the proposal by Transpower (all were cheaper, more short term projects). The only alternative projects considered by the Commission were those presented by Transpower. MEUG submitted that the failure by the Commission to evaluate any short or medium term alternatives was "extremely imprudent", particularly as short term options would give the Commission more optionality as to grid investment planning (for example, a new power station could be built north of Auckland which would mean the potential repairs subsequent to a short term fix would be unnecessary). MEUG argued that the mis-application of the Grid Investment Test meant that the Commission gave too much weight to long term projects, and departed from the economic efficiency imperatives of the Act and the Rules.

MEUG's second ground for reviewing the decision of the Commission failed because the court did not consider MEUG had established unreasonableness on the part of the Commission in its alleged failure to evaluate or require Transpower to evaluate appropriate alternative projects. The court considered that the Commission has discretionary power to ask Transpower to evaluate alternative reliability investments and the Commission's exercise of that discretionary power was not unreasonable. The court considered that the approach taken by the Commission in its assessment of the Otahuhu Proposal was not unreasonable. That approach included the following:

• the Commission had published Transpower's proposal and sought written submissions, including as to any alternative project that should be considered. MEUG and other submitters submitted that Transpower should have included one of the three options now proposed by MEUG (the IGE option). No other option was advanced;

• the Commission considered the IGE options. It heard submissions before rejecting the proposal in its final decision because of the risk of stranding assets that the option entailed, the lack of any significant difference between the IGE option and one of Transpower's alternative options and that the IGE option was less efficient, when assessed over time, than either Transpower's second alternative or the Otahuhu Proposal.

The court also took into consideration the point made by the Commission and Transpower, which the court accepted, that even if the IGE option had been considered by the Commission as an alternative project, the result would have been no different, so any error in omission is immaterial. The court also considered it instructive that two of the options now proposed by MEUG were not advanced to the Commission when it sought suggestions as to other alternatives. The court accepted that this undermined MEUG's submission that the Commission was not reasonable in not looking at these options.

The court also did not accept MEUG's argument that the Commission unreasonably failed to consider the benefits of optionality (essentially the "wait and see" approach). On the evidence Justice Wild was satisfied that the Commission did weigh up the potential advantages of preserving optionality.

Interestingly, the court stated:

"Perhaps the main reason why the Commission did not consider the IGE option as an alternative project was its view that there was no significant level of uncertainty about future requirements at Otahuhu which made the IGE opotion – with its lower initial investment and consequent optionality benefits – the appropriate one. I agree with the respondents that the analysis (it is an NPV analysis with modelled projects substantially corresponding to option 1) carried out by the Commission is the sort of expert assessment which the Commission is well placed to make, and the Court ill placed to second guess."

Erroneous HILP

The focus of MEUG's challenge on the third ground was on the alleged inadequacy of the information on which the Commission based its high impact low probability assumption used to calculate its NPV analysis. The Commission's high impact low probability assumption (HILP assumption) was critical to the Commission's NPV analysis of the Otahuhu Proposal and the alternative options.

In its final decision on the Otahuhu Proposal, the Commission made conflicting statements on its basis for determining its HILP assumption. First it noted that it was not satisfied that it could safely rely on its own 1 in 500 year HILP assumption and instead chose to rely on Transpower's view that the June 2006 substation wide event at Otahuhu was a 1 in 100 year occurrence. But, later in its decision, it also noted that it "chose to exercise judgment, and adopted a notional probability reflecting that judgment, as to whether it is prudent to have Auckland… exposed to the prospect of a single major substation being affected by a low probability but high impact event."

MEUG argued that as a result of using inadequate information for its HILP assumption (as put forward by Transpower), the Commission could not be "reasonably satisfied" (as required by the Grid Investment Test) that:

• the proposed investment maximises the expected net market benefit or minimises the expected net market cost compared with a number of alternative projects; or

• that conclusion is sufficiently robust having regard to the results of the sensitivity analysis.

The court disagreed. In its opinion all the Commission was required to do under the Grid Investment Test was select a HILP factor based on its judgment guided by the available data. Faced with statistical data upon which it could not safely rely, the Commission "adopted a notional probability", albeit one that erred on the side of caution. In the court's view this was not unreasonable in the circumstances. This was particularly so given the critical importance of the Otahuhu substation in the coming years and the fact that both Vector and Genesis had also supported the Transpower's one in 100 year probability rate adopted by the Commission. The Grid Investment Test involves a qualitative as well as quantitative assessment, leaving scope for different views.

To access a copy of the Major Electricity Users' Group Inc v Electricity Commission decision click here. For further details on the Board of Inquiry Upper North Island Grid proposal visit the Ministry for the Environment's website

For further information, please contact:

Garry Downs
Partner

Chris Gordon
Partner

Louise Hill
Senior Associate

 

¹ Major Electricity Users' Group Inc v Electricity Commission (Unreported Judgment HC Wellington, Wild J CIV -2007-485-2508 14 March 2008)

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.