ELECTRICITY REFORM: THE WAY FORWARDFinance
Energy Minister Max Bradford and Finance Minister Bill Birch today announced the Government's direction on electricity reform.
"The key objective of the reforms is to get strong downward pressure on costs and prices where the benefits flow to consumers, as well as achieving improved economic outcomes," Mr Bradford said.
"Electricity is a significant cost to industry. The cost of producing and distributing electricity has to be internationally competitive. This round of reforms will go a long way to reaching that objective."
Mr Bradford said there were four areas touched by the Government's integrated reform package: generation, national transmission, distribution and retail. The package requires increased efficiency at all levels, including more competition in generation and retail.
"In national transmission, substantial progress has been made in refocussing Transpower on reducing its costs, as evident in its new Statement of Corporate Intent.
"At the generation end, lower costs and prices will flow from more generators in the wholesale market. The proposals we are discussing with ECNZ are part of this.
Mr Bradford said real competition in generation would deliver lower wholesale prices.
"However, consumers will get the benefit of lower wholesale prices only if they can effectively choose who supplies them with power. Significant reform is therefore required at the retail and local distribution end of the business."
Mr Bradford said lines businesses and the energy supply businesses of power companies needed to operate on a strictly arms-length and transparent basis. Lines were natural monopolies whereas the retailing business should be fully competitive. "Reform options include corporate or ownership separation of the lines and energy businesses."
Corporate separation requires power companies to set up separate companies and boards, but does not require any change in ownership. Ownership separation involves separate ownership of the lines and energy business. This may, for example, require trust owned power companies to set up a separate trust for the retail business.
Mr Bradford said decisions on which options to choose would be made by the Government early in 1998, after consultation with representatives of the retail power companies.
"In addition, further work is well under way to strengthen regulatory requirements on lines businesses. Because lines are not subject to competition, effective regulatory arrangements are required to ensure costs are minimised and margins are not excessive."
Mr Bradford said rules for valuing line assets will also be strengthened.
"At the retail end, the Government will also ensure that low cost arrangements for measuring and reconciling data between competing retailers are put in place to facilitate competition.
"I will be talking to EMCO and ESANZ at an early stage to ensure effective and timely implementation of metering and data reconciliation arrangements."
As ECNZ's shareholding Minister, Mr Birch said at the generation end, the Government's preferred option - which is being discussed with ECNZ - was to split the enterprise into competing state-owned generators.
"This will lower wholesale prices, better reflecting the expected surplus of capacity over the next five to eight years. Lower prices will strengthen the competitiveness of our businesses.
"The Government is also committed to ensuring that lower prices flow through to residential consumers. The Government's reform in the retail sector will be designed to ensure that this happens," Mr Birch said.
The Ministers said details on the form of the package would be finalised early next year following further consultation with the ECNZ Board and other interested bodies.
"Any reform that the Government implements will be based on thorough and comprehensive analysis. Obviously, there is room for different views on the analysis, but the Government's overall objective is to deliver better economic outcomes as well as choice of electricity supplier and lower power prices to consumers," the Ministers said.
"Full background to the decisions will be provided when the details are announced in the new year."
The Ministers noted that the announcements were made on behalf of Cabinet and had the full support of the Prime Minister, the Treasurer and the Minister of State Owned Enterprises.
[EMCO is the electricity Market Company which runs the wholesale electricity market, and ESANZ is the Electricity Supply Association, which represents most electricity power companies.]
Sarah Moodie, press secretary,
Office of the Minister of Energy
04 471 9836 wk. 04 477 4562 hm. 025 424 565 mob
Questions and Answers
The Government earlier said it intended to make full decisions prior to Christmas. Why hasn't it met this timetable?
The leadership change in the Coalition Government has meant that the timetable to complete full consultations with the ECNZ Board and other parties was delayed. This will now be concluded in the New Year.
Why is further reform in the retail and line distribution sector required?
Lines businesses of retial pwoer companies are not subject to competition. Except in very rare circumstances, it is not economic for a competitor to provide separate lines. In contrast, the energy retailing business should be competitive. Already there is quite vigorous competition for large users.
However, the extent of competition overall is disappointing. Barely 3% of total electricity sales are traded across regional boundaries. The barriers to more extensive competition include
access to lines and cross subsidies; integrated line and energy businesses have incentives to make access to lines for competing retailers difficult, and to cross subsidise retailing from the lines businesses.
the costs of metering and data reconciliation: electricity is now bought and sold at the wholesale level on a half hourly basis. Competing retailers need to measure the total demand of their customers on a half hourly basis so they can pay the incumbent for their share of the power taken off the national grid. The costs of the current measurement and reconciliation system are high. Cheaper options are available. However incumbent retailers have incentives to delay the development of low cost alternatives.
Other problems in the distribution and retail sector include
the lack of pressure on lines businesses to reduce costs and prices because they are not subject to competition
the ability of power companies to pass on to their captive line or retail customers the costs of investments in generation which become uneconomic.
What are the current rules for valuing lines businesses and why do they need to be strengthened?
Lines are currently valued using the ODV methodology. ODV stands for Optimised Deprival Value, which is a standardised methodology for valuing businesses which are not subject to competition.
Businesses in competitive markets are valued on the basis of their expected future revenues. This methodology is not appropriate for natural monopoly businesses since they can set prices without the discipline.
In essence, ODV valuations are based principally on the replacement cost of existing lines after eliminating any unnecessary assets. The replacement cost is depreciated to recognise the limited remaining life of the existing assets.
While this is a standard methodology for valuing natural monopoly assets there are indications that some line businesses may have taken advantage of looseness in the ODV specifications to push up their asset values. The Government intends to address these weaknesses in the ODV regime.
ECNZ has advised that further breakup would lead to a loss of value to the Crown and a requirement for taxpayer funding to strengthen the balance sheet of the new SOEs. Is this valid?
More competition in generation will lead to lower prices. ECNZ agrees this will occur. The reduction in value of the Crown's generation assets reflects this reduction in prices. The Government is willing to accept this value reduction in order to achieve net gains to the economy, providing the gains flow to consumers: the result will be more efficient investment in generation, lower costs and less harm to the environment.
The extent of price reductions and hence value losses is uncertain. Independent analysis for the Government indicates that the value reduction would be less than ECNZ has advised, and that taxpayer funding to support the balance sheets of the new SOEs is less likely to be required. These issues will be subject to further consultation with ECNZ.
Is further breakup of ECNZ intended to allow privatisation?
No. The Coalition Agreement does not provide for it. The purpose of further breakup is to put further downward pressure on costs and prices. This will benefit the economy and ensure that new power stations are not built until they are needed.
The new companies resulting from further breakup will continue to be state owned.
What is the configuration of any new generation breakup?
This is subject to further work and consultations with the ECNZ board. Decisions will be announced early in the new year.
Is the breakup of ECNZ likely to lead to adverse environmental impacts, increased water spill or security of supply risks?
The Government has recieved a range of independent analysis and views on these issues. The Government intends to work through these issues through with ECNZ in the new year.