Closing Address To The Meug Seminar

  • Max Bradford
Enterprise and Commerce

Ladies and gentlemen .... thank you for the invitation to close your seminar. I hope it has been a productive day. I propose to take this opportunity to update you on where we are at in the implementation of the electricity reforms.

Progress with the Reforms

We are now about to enter a most exciting and significant phase of the electricity industry reforms, but before discussing that, let's review the electricity reform package of 8 April 1998, almost a year ago.

The reform package was designed to create a better deal for electricity consumers.

This package included:

- The separation of electricity distribution from retailing and generation;
- Improved information disclosure requirements;
- The introduction of a low-cost system for switching electricity retailer;
- An increased threat of price control on electricity lines businesses; and
- The split of ECNZ into three competing electricity generators.
- The Electricity Industry Reform Act required electricity companies to separate their distribution from their retailing and generation activities.

Alternative methods and time frames for achieving full ownership separation were provided. Depending on the option chosen, the final date for compliance is 31 December 2003.

Who would have predicted a year ago that companies would move so quickly and comprehensively to their chosen form? After an initial period of grumbling, the industry settled down to take advantage of the opportunities that lay ahead. It appears that the process will have been completed by 1 April - less than 12 months after the announcement and in accordance with the timetable set by the Government.

In spite of loud assertions from some parties in the industry, and our political opponents, the Electricity Industry Reform Act has proven to be a robust legal framework without the need for any amendment.

Very significant rationalisation has taken place, especially in retailing.

Companies are focused more clearly on adding value to their chosen businesses rather than using their lines to frustrate competition in retailing.

Entrepreneurial retailing and conservative lines management was never going to be a combination to deliver good commercial and competitive outcomes.

The consumer trusts for the most part have sold their retail businesses and are now cash rich to the extent of an estimated 600 to 700 million dollars. This gives them the opportunity to reinvest in order to generate many millions a year in revenue which can be distributed to local communities, or distribute the cash directly.

Key components of the reform package have not yet been fully implemented, however, we have already seen some significant benefits.

Four of these measures are to be introduced next month. They are:

- split of ECNZ;
- introduction of profiling;
- strengthened information disclosure requirements; and
- enhanced threat of price control on lines companies.

Consumers will be better off, and New Zealand's international competitiveness will be enhanced very significantly. Already, the recent price reductions suggest a savings for households of about $25 million a year, and another $24 million for commercial and industrial users.

(Ministry of Commerce figures based on the Stats NZ quarterly figures Sept-Dec 98 on electricity price drops.)

1 April 1999

A week from today will be a significant time in New Zealand's electricity history. Two components of the reforms that are crucial to competition and lower prices kick in.

The two measures are of course:

- the split of ECNZ; and
- the introduction, through a profiling arrangement, of the fully contestable retail market.

Let's look at these two events in more detail.

Split of ECNZ

The Electricity Reform Transition Unit made a final recommendation to the Government in December 1998 about the split of ECNZ following:

- completion of consultations with Maori on Treaty issues
- certification that the new SOEs will be commercially viable and will compete vigorously;
- confirmation that market participants accept responsibility for security of supply; and
- advice on arrangements to address any environmental issues.

The reason for the split of ECNZ is to increase competition in electricity generation. This will result in lower wholesale electricity prices than otherwise to the benefit of consumers.

Final recommendations to Government by ERTU stated that initial estimates of average wholesale price reductions of 10% were conservative. Revised predictions were for average wholesale price reductions of 14-22% compared to ECNZ intact.

ERTU also predicted that dry year risk would be managed more efficiently, and that there would be net environmental benefits from the split.

The Government agreed that the split would come into force on 1 April 1999.

Dry Year Risk

New Zealand's electricity system is heavily dependent on hydro generation. High inflow variability and the small size of New Zealand's lakes imply security of supply risk from a dry year.

Like any other generation systems, there are also other risks from plant failure and transmission outages or the effect of winter temperatures on demand. These risks remain regardless of the split of ECNZ, but the split will mean that they are managed more efficiently.

Spot prices vary in the short to medium term depending on a range of factors such as hydro inflows.

The signs are that we may be in for a so-called dry year. Present lake levels are below average for this time of year, but hydro storage is still well above this time in 1992, when a serious shortage occurred.

Although spot prices have risen, they are similar to 1997 when hydro storage levels were also low. Forecasts also suggest that April will also be dry over most of the country

Since the 1992 dry year crisis, electricity demand has grown substantially, by 5-5,500 GWh/year or about 15%. However, as a result of the Government's reforms which encouraged the private sector to build new capacity, our net supply capacity has increased by over 9,000 GWh/year.

Dependence on hydropower has also reduced since 1992. New combined-cycle power plants such as TCC (379 MW) and Southdown (115 MW) have decreased New Zealand's dependence on hydro.

In 1992, outages were avoided only by ad hoc cooperation between ECNZ, other small generators, retailers and consumers. In the new competitive market, changing spot prices and contract prices send early and strong signals to all buyers and sellers about changing hydro conditions. Information available to market participants has also increased dramatically since 1992.

It is vital that price signals are allowed to work. Rising spot prices will encourage careful management of water reserves, increased thermal generation, and demand reductions.

On 15 December last year the Government issued an updated policy statement on the management of electricity supply risk. The policy statement outlines the need for market participants to undertake prudent management of supply risks and makes it clear that the Government will not step in to rescue companies which have failed to put in place adequate protection.

When the lakes are low, as they are now, prices will be, and should be, higher than in a normal or wet year. This is not an indication of a failure of the reforms but a natural and important market response to falling hydro levels.

Increased competition in electricity generation and retailing, and the increased threat of price control on lines, will help keep retail prices down.

ERTU's predictions of wholesale price reductions are not wrong. They were based on averaged or typical year predictions. Actual prices will vary significantly year to year depending on hydrological conditions.

Some commentators have suggested this week that electricity prices will rices because of the sale price of a cornerstone share of Contact Energy.

However, there is no reason electricity prices should increase following the sale of Contact Energy to Edison Mission Energy. Edison is a new entrant, bringing new expertise and giving a boost to competition in the New Zealand generation market.

Those making these predictions have completely failed to look at the history of asset sales. Concerns about price rises were also raised when Telecom was sold almost ten years ago. In that case, we have benefited from dramatic price reductions - as every consumer knows toll prices have been tumbling down - to quote Telecoms own advertising.

Since March 1991, the overall price of residential local and long distance calls has reduced by around 25% in real terms. Over that period, the price of residential long distance calls in particular has reduced by around 50% in real terms.

Profiling

The policy package of April last year included a requirement that the industry develop by 1 April this year a low cost system to enable all electricity consumers to change supplier if they wish.

The industry, lead by M-co, has done an enormous amount of work in a very short period of time to ensure that the necessary arrangements are in place to enable retailers to compete for small consumers using a profile-based reconciliation system from 1 April.

The project team is proactively assisting industry parties to ensure a maximum number of firms will be ready on 1 April, securing a smooth transition to the new competitive environment. Again, looking back 12 months I doubt that any of us anticipated the speed of progress to competition and lower prices.

Let me quote from my own media release on 3 July 1998 marking the passage of the Electricity Industry Reform Act: "For consumers, the most important benefit will be lower prices - expected to be seen within a year to 18 months".

Well as we all know, competition and lower prices had begun to happen by September last year - only two months after the Act was passed and five months following the announcement of the reform package.

The benefits of the reforms happened well before even I expected, and that is a credit to the companies and the powerful forces of competition.

I anticipate that we can look forward to vigorous competition, keen retail prices, and improved efficiency and service.

Information Disclosure

The reform package called for improved information disclosure to:

- Increase the transparency of excessive costs, profits and prices in distribution;
- Increase the focus of lines businesses on reliability and security; and
- Make disclosed information more accessible to the general public.

The Electricity (Information Disclosure) Regulations are being amended to achieve this. The new Regulations will be promulgated very soon so they will be in place for the 1998/99 financial year.

The Regulations will require lines businesses to use a mandatory avoidable cost allocation methodology to determine the allocation of costs, revenues, assets and liabilities between line and "other" activities.

This requirement will provide a consistent and robust basis for assessing whether natural monopoly lines businesses are earning excessive profits and/or incurring excessive costs.

Picking up on the recommendations of the Ministerial Inquiry into the Auckland Power Failure, the new regulations include the requirement for disclosure of asset management plans and security standards by line businesses.

Asset management plans are to be disclosed annually from the 1999/2000 financial year, following requirements set out in a new Handbook to be issued by the Secretary of Commerce.

The disclosure of asset management plans will provide strong incentives for line businesses to maintain good practices, and will help companies in demonstrating that they follow high standards.

One of the issues officials have been working on since the reforms were announced is the user-friendly summaries of the disclosed information.

The purpose of these summaries is to enable ordinary New Zealanders to interpret the information disclosed by their local lines company and come to some conclusion about how well it is performing in comparison to other lines companies.

Officials are preparing a format to be released each year which shows the performance of all lines companies in the three critical areas of charges, profitability and service disruption.

Consultation on the proposal for implementing this important component of the reforms will take place soon.

Specific Thresholds for Price Control

Officials are currently in the process of developing the final component of the reform package announced in April last year - increasing the threat of price control on electricity lines businesses.

There is a risk of significant excess costs and profits in lines, which are ultimately passed on in higher prices to electricity consumers. These need to be removed from the line businesses as part of the Government's wider strategy of reducing costs for the benefit of consumers and businesses.

The Government intends to empower the Commerce Commission to impose time-limited price control within criteria or thresholds set by the Government.

The thresholds to be used by the Commerce Commission form a complementary two-part regime. First, the Commission could apply price control at any time if competition is limited and price control would be in the interests of consumers.

Secondly, line companies which breach new "specific thresholds" would be subject to price control, unless the Commerce Commission is satisfied that price control would not be efficient.

As you are aware, a discussion paper was released in December on the proposed specific thresholds scheme. Further consultation has also been undertaken as the specific thresholds were amended following consideration of the submissions received.

I understand that MEUG's submission mentioned that the thresholds formula, given that does not start for two years, is a second best option. And that a regime that will act quicker and without the heavy hand of a regulator is more likely to be in New Zealand's long term best interest.

Let me offer you some comments. The Government has specifically decided not to place all lines companies under price control.

The purpose of the proposed scheme - and this is unchanged from the April 1998 reform package - is to enhance the credibility of the threat of price control.

Lines companies need to feel the full force of the threat and not just think it is a threat the Government will not carry out. Lines companies can avoid falling under price control by reducing costs and making efficiency gains.

That in my view is how it should be as it mimics competitive markets. It also puts responsibility in the hands of companies, not Government. For some companies, the inevitable outcome might be they merge with another lines company. We now have 32 lines businesses, far more than we need for a small country.

I do not see the two year wait as a particular problem. The threat, and the pressure on lines businesses, start as soon as the final decision is announced, if it hasn't started already. Moreover, the general criteria for price control will place immediate pressure on lines companies, as they will be in place as soon as legislation is passed.

Changes to the Commerce Act

Specific provisions of the Commerce Act are under review with changes announced in February to the penalties and remedies sections of the Act.

The toughening of penalties and remedies should help discourage anti-competitive behaviour, and increase the incentive for private actions to be taken.

The competition thresholds of the Act relating to business acquisitions and trade practices are also currently under review.

A discussion paper on these further changes to the Commerce Act will be released shortly. The discussion document also sets out some proposed amendments to the price control provisions of the Act.

These proposals aim to bring the Act's provisions into line with current approaches to price control overseas, and do not signal any change to the Government's approach to price control generally. However, the amendments will apply to the electricity price control scheme.

Conclusion

I am heartened by the results of the reforms so far. A year on, I am in no doubt about their appropriateness and effectiveness. The electricity industry is rising to the challenges and customers like yourselves and households are already seeing the benefits. And there are more benefits to come.