Reform - relevant to distribution companies and transmission

Garry Downs, Partner and Andrew Brown, Partner | July 2000

The Ministerial Inquiry into the Electricity Industry recently produced a report of its findings and recommendations. A summary of, and brief commentary on, the more significant recommendations relevant to distribution companies and transmission is set out below.

The report states that the key broad objectives of the reform are to promote competition in the generation and retail areas and to better the regulatory framework for transmission and distribution so that outcomes mirror those that would be achieved with effective competition.

Wholesale Market

A New Single Market Body

The report recommends that there should be a clearer distinction between the financial and physical wholesale markets. No need was seen for any special regulatory framework for the financial market other than that which presently governs financial markets generally.

The report provides that the bodies currently governing the wholesale market (NZEM/MARIA/MACQS) should be replaced by a new single market body, with a clearer distinction between the physical and financial wholesale markets. The new body should:

• have a majority of its Board members independent of the industry;
  
  
• require compulsory membership for all generators, distributors, retailers and Transpower;
  
  
• be largely self-regulated with guiding principles; and
  
  
• take into account the views of all industry participants, including consumers.

The report recommends that the Government endorses the use of the present NZEM guiding principles, revised to emphasise the need for promoting enhanced competition and active demand-side participation in the market.

The report recommends that the Government should invite the industry to put this new structure in place within a year, and if this is not achieved, the Government should legislate for the regulatory powers to achieve this.

Comment: It will be a difficult task to put together the NZEM (spot market rules), MARIA (physical despatch rules) and MACQS (agreement on quality of supply) as there is no commonality of interest between generators, Transpower, distributors and retailers.

Unless the industry can come up with an effective means of ensuring compulsory membership of the new body, it is likely that legislation will be introduced to ensure that the element of compulsion exists.

There may be considerable reaction to the recommended composition of the new Board and questions raised as to whether independent directors will have sufficient knowledge and incentive to provide the necessary guidance and leadership.

Real Time Prices

The report provides that the wholesale market should have real time price signals. It recognises that more accurate prices would allow generators and customers to make better decisions based on more accurate information. The report also suggests that wholesale market bidding information should be released after one month. This is intended to keep the market and the public informed without compromising commercial positions.

Comment: The recommendation that the market moves to a real time market environment reflects the current Government's views on energy efficiency and the need for allowing real demand response.

Transmission

Bringing Transpower Closer to the Market

The report suggests that the Government sets Transpower specific objectives, which should be incorporated in a revised Statement of Corporate Intent. This would ensure Transpower:

• provides services that meet pre-determined minimum standards of quality, security and reliability;
  
  
• provides services at a quality and quantity demanded through a process of agreement with users of those services;
  
  
• makes its services (e.g. grid connection) contestable wherever possible;
  
  
• continuously improves the efficiency with which its services are produced, so as to produce them at the least cost for value;
  
  
• earns a commercially appropriate return, having regard to the mix and size of commercial activities being undertaken, and before allowing for losses and costs properly chargeable to the shareholder; and
  
  
• prices its services in a manner consistent with the specific pricing principles determined by the Government and, subject to those principles, according to the pricing methodology determined by the market.

The report recommends that Transpower should be required to seek the optimum trade-off between minimising maintenance costs of the network and minimising transmission losses. The pricing of new and replacement investments in the grid should provide grid users with strong incentives to identify least-cost investment options. As well, the sunk costs of the transmission grid should be allocated in a way that minimises distortions to decisions about the use of, and new investment in, the grid.

Comment: If the report's recommendations are implemented, Transpower will be required to develop a transmission pricing methodology in conjunction with the market i.e. under the direction of the new market body. In this way, Transpower would be enjoined to work with retailers and distributors to develop solutions to grid constraints using demand-side input. This is consistent with the trend to give the demand-side more power in the market.

Financial Transmission Rights

The report recognises that Transpower is proposing to introduce financial transmission rights (FTRs - financial hedges that protect participants from price spikes as a result of constraints). The report supports the development of FTRs and suggests that FTRs should be auctioned in the financial markets, with the proceeds re-distributed to relevant Transpower customers.

Comment: There is much work yet to be done on the design of FTRs and the way they will be auctioned and the proceeds redistributed. The extent to which they will provide the necessary signals to direct new investment opportunities and avoid transmission constraints is yet to be fully understood.

Distribution Companies

Information Disclosure

The report provides that the Commerce Commission should be responsible for the content and design of revised information disclosure regulations, focusing on output and performance indicators that are meaningful to consumers. The Commission should collect this additional information from distribution companies as it considers necessary, undertake analysis of the information and publicly present the results of that analysis, and undertake enforcement of any breaches of the regulations.

Comment: The transfer of the responsibility for the collection of information from the Ministry of Economic Development) to the Commerce Commission is an interesting development. This new role will require the Commission to change its culture and develop new skills and attract different personnel. The idea that the Commission should carry out what is generally considered to be a core Government activity reflects the confidence which Government and other bodies have in the Commission.

Asset Values

The report recommends that the Commerce Commission undertake a re-calculation of distribution and transmission asset values (based on the present mandated valuation methodology of optimised deprival value) to a common and specific basis and mandate future asset valuation methodologies.

Statement of Corporate Intent

The report recommends that all distribution companies that are majority owned by trusts and local bodies be required to have, and act in accordance with, a Statement of Corporate Intent modeled on Transpower's. In addition, the Government should legislate to require such distribution companies to be subject to the Local Government Official Information Act, the Public Finance Act and the Ombudsman Act.

Comment: These requirements would necessitate legislative provision and infer that the Inquiry's perception of trust-owned distribution companies is that they are akin to State Owned Enterprises and should have similar governance and accountability requirements.

Targeted Price Control

The report recommends that the Commerce Commission be given the power to impose price control on individual distribution companies.

Comment: Once again the Commission would be called upon to regulate this part of the industry. It will be interesting to see whether this recommendation is implemented and, if so, how the Commission uses its power.

Maintenance of Lines

The report suggests that the Electricity Act be amended to provide that:

• lines meeting certain tests (e.g, that the landowner has not objected to the presence of the lines within specified periods) are deemed to be lawfully fixed;
  
  
• work that does not result in further environmental impact is regarded as maintenance; and
  
  
• the point of supply is at the boundary of the consumer's property.

  Comment: This recommendation meets the express concerns of distribution companies arising from confusion over the statutory allocation of responsibility for maintaining lines. However, it is unclear whether it will address the issue of the distribution companies' right to enter other parties' property to enhance or change the character of, rather than merely maintain, lines.

Generation Ownership and Fixed Line Charges

The report recommends that the Electricity Industry Reform Act be amended to incorporate a ceiling permitting distribution companies to own generation that does not exceed five per cent of their networks' maximum demand or retain present generation up to 5MW, whichever is greater.

Comment: This is consistent with the impetus for distributed generation being built to avoid transmission and distribution costs.

The report suggests that fixed network charges should account for no more than 25 per cent of a typical household's electricity bill. The Energy Efficiency and Conservation Authority should monitor market developments for fixed charges and involve the Commerce Commission where necessary.

An Electricity Watchdog

The report recommends the establishment of an Electricity Ombudsman scheme, for the benefit of consumers, to apply to distribution and retail companies. The scheme would provide for procedures and funding of the Ombudsman, and for fines to be levied and compensation to be provided to consumers. The industry should be allowed six months to establish the Ombudsman scheme, after which the Government should look at other options to get the scheme running.

Comment: It appears the Ombudsman scheme, to be set up by the industry without any statutory backing, is modelled on a similar scheme in the Banking and Insurance industry. For the scheme to be effective, the industry should not be afforded the opportunity to challenge the authority of the Ombudsman. It is arguable that such an officer could not successfully levy fines and require compensation to be paid to consumers unless he or she has statutory or contractual powers. It would seem unlikely that an Ombudsman could open up contractual provisions without both parties' approval in matters such as pricing. However, an Ombudsman could make a positive contribution to ensuring adherence with standard practices.

Consumer Guarantees

The report recommends that the Consumer Guarantees Act (which provides certain minimum consumer guarantees and rights of redress) should apply to electricity so that distributors and retailers would be obliged to supply electricity to the same standards as other goods and services supplied to consumers. Accordingly, electricity would have to be fit for its common purposes and as free from minor defects and as safe as a reasonable consumer would expect, having regard to the nature of the product, the statements used to describe it and all other factors relating to its supply.

Comment: The suggested amendment is not an easy matter for the industry, in that requiring retailers to supply electricity fit for its common purposes and free from minor defects is only half the answer. There is a need for a chain of liability from the consumer to the retailer to the distributor to Transpower and possibly, ultimately, to the generator. Otherwise, the retail or distribution company would have to bear the full brunt of any system disturbances. The report suggests that such problems would not be insurmountable.

What now?

The bulk of the above recommendations are either legislative changes (e.g. to the Commerce Act) or would be left to the industry to find effective solutions within a time constraint imposed to ensure there is change.

The Minister of Energy has said that the Government will now consider the recommendations and announce decisions within the next few months, although legislation is likely and may be introduced as early as October.