Reform - relevant to retail companies and generators

Garry Downs, Partner and Peter Castle, 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 retail companies and generators 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 objectives of:

• promoting enhanced competition within the market where possible and, where it is not, seeking outcomes that mirror those that would apply in competitive markets;
  
  
• enhancing the efficient and effective operation of the market;
  
  
• promoting active demand-side participation in the market; and
  
  
• ensuring that equally competitive terms apply between participants.

The report provides that the new body's Board should have direct responsibility for ensuring that wholesale market developments are consistent with its guiding principles and be given the necessary powers to achieve this. It is proposed to extend the subjects covered by the existing NZEM to include registration, pool rules, dispatch, security, constraint standards, reconciliation, settlement, transmission and distribution pricing methodology and enforcement.

The report states that the rules of the new body need to be enforceable and supports the retention of a revamped Market Surveillance Committee, which will:

• be directly accountable to the Board;
  
  
• be able to recommend changes to the rules;
  
  
• have its powers strengthened to allow it to obtain all necessary information;
  
  
• have a permanent and dedicated staff; and
  
  
• pro-actively guard against market gaming.

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. It is also recommended that the Government issues a statement of economic policy, under section 26 of the Commerce Act, that endorses the new market structure.

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 a 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. Although a number of initiatives have been or are being pursued to improve price signals, the report recommends the adoption of new technologies to achieve this within 18 months. The report recognises that more accurate prices would allow generators and customers to make better decisions based on more accurate information. Retail companies and consumers would make savings available by reducing requirements during times of peak demand or constrained supply.

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 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 provides that Transpower's principal objectives should be to achieve a balance between a fair return for the use of the transmission system, based on commercial principles, and ensuring the availability of efficient, reliable and environmentally sustainable energy services at the lowest cost.

The report states that Transpower should be required to develop a pricing methodology in conjunction with the market, i.e. under the direction of the new single market body.

Comment: Transpower would be encouraged 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.

Retail Companies

Switching

The report comments that the new switching protocol, introduced in April this year, together with the bedding down of retailers' systems, will resolve the problems previously experienced in the retail sector, such as the administrative difficulties of switching customers from one company to another. The report recommends that the enforcement, and any future development, of the switching protocol should be the responsibility of the new wholesale market body.

An Electricity Watchdog

The report recommends the establishment of an Electricity Ombudsman scheme to apply to retail and distribution companies. The scheme would provide for:

• all consumers to have access to the scheme;
  
  
• the means for appointing the Ombudsman and holding him or her to account;
  
  
• funding of the Ombudsman;
  
  
• the procedures to be followed by the Ombudsman in resolving disputes; and
  
  
• fines to be levied and compensation to be provided to consumers.

The report suggests that 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 is to be set up by the industry without any statutory backing, modelled on a similar scheme to 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, without both parties' approval, an Ombudsman could open up contractual provisions in matters such as pricing. However, an Ombudsman could make a positive contribution in 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 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.

A retailer or distribution company that failed to perform to the standards required by the Act would have to remedy that failure.

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.

Use of System Agreements

The report recommends that the development and use of system agreements (which outline the terms and conditions applying to retail companies using distribution networks) should remain an issue for the industry to resolve under the direction of the new governing body. In particular, the interests of retailers are to be given equal weight in drawing up a model use of system agreement.

Comment: Ideally there should be a set of base terms for the use of systems which parties can add to and modify to reflect their particular arrangement. These base terms should address the key issue of risk allocation, matching responsibility for risk with the party best able to manage the risk.

Pre-payment Meters

The report states that a number of retail companies have been withdrawing their pre-payment meters, in spite of advantages to both themselves and customers. The report recommends that the Government impose an obligation on retail companies to supply pre-payment meters at a reasonable cost.

Comment: The whole question of the cost and availability of prepaid meters has been much debated within the retail electricity industry. To require that retailers make such meters available to all consumers in all regions of New Zealand may compromise the commercial position of certain retailers. Any sanction on retailers who are not prepared to provide such facilities should be a market one, i.e. customers voting with their feet, rather than inviting a regulatory response.

What Now?

The bulk of the above recommendations either involve legislative changes (e.g. to the Commerce Act) or will 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.