MEUG Headline Issues ¨C a work-in-progress

MEUG Headline Issues - a work-in-progress

Attached is 4 page paper by MEUG listing Headline Issues in the electricity sector.

The paper is a 'work-in-progress' following agreement at the recent MEUG AGM of the strategic objectives of the group.

Future drafts of the paper will be developed as new factual information is received or a compelling case is accepted by MEUG to change the views expressed in the paper.

Feedback is welcome as MEUG will be discussing this and future versions of the paper on an on going basis. The MEUG Headline Issues paper is not confidential and circulation to others that may be interested is welcome.

MAJOR ELECTRICITY USERS' GROUP

24 June 2005

Improving the efficiency of the electricity sector and providing greater value for consumers:

Headline issues

Changes needed to current policy direction:

- Pre-occupation with renewable generation and in particular wind must be revised to focus on providing adequate and secure supplies of competitively priced electricity;

- Barriers to entry for new generators and new retailers must be lowered;

- Environment for investment in New Zealand by energy intensive industries must be changed from negative to positive and improved access to internationally competitively priced supplies of electricity;

- No C-tax, instead have climate change policies reflecting NZ contribution to issue;

- The RMA needs a comprehensive overhaul including Part II rather than a tune-up; and

- Environmental issues should complement energy sector policies that support GDP growth, rather than being main driver of energy policies.

Current policies that need greater priority from government and regulators:

- Investigating the existence and use of market power and improving competition in wholesale (both spot and hedge markets) and retail markets ¨C both the Electricity Commission and Commerce Commission need to make this a higher priority; and

- Improved transparency of cost components on final consumer invoices (including invoices to households) such as details of EC levies, and split of line and energy charges.

Current policies that are supported:

- Grid investment decision process being developed and then implemented by the Electricity Commission using economic criteria rather than be driven by political or vested interests;

- Continuous improvement by the Commerce Commission of the regulatory threshold regime for Transpower and the 27 Electricity Line Businesses (distributors); and

- Continuous improvement by the Electricity Commission of detailed wholesale and retail market rules.

Policy issues that need to be addressed in the longer-term:

- Electricity Commission role and relationship with Ministers;

- Improving capital market pressures on SOE suppliers; and

- Review of dry-year security of supply policy by Electricity Commission due end of 2006 needs to be comprehensive.

Changes proposed by others to current policy direction that need to be treated cautiously:

- Re-integration of line monopolies into energy supply.

Improving the efficiency of the electricity sector and providing greater value for consumers:

Analysis

Supply Chain Policy Issue and solutions

Overall governance and policy settings

Total cost of electricity supply approx. $4b pa The Electricity Commission (EC) is not as independent from the Minister as the other regulator in the industry, the Commerce Commission . Improvements to the statutory basis of the EC need to be identified and implemented. This is a political issue.

The Government Policy Statement (GPS) on electricity has an environmental bias. Environmental issues are important, but should complement the over-arching goal of economic growth . A political will to change the GPS is needed. The environmental bias over economic growth is also evident in the Freshwater Programme of Action and GPS requirements for the EC to implement energy efficiency programs .

Generation

Refer wholesale market turnover below ¨C most of those costs are for generation

$15/t CO2 tax from April 2007 will add approx. $400m pa to power bills without any environmental gain, yet reduce GDP . The C-tax should be removed and other climate change mitigation policies consistent with NZ contribution to this global problem and our trading partners be introduced . A political U-turn is needed.

The RMA remains a significant detriment to timely and lowest cost generation being built. A fundamental review of the RMA is needed rather than the current tune-up, particularly the trade-off between the benefit of infrastructure of national interest and regional impacts . A political decision is needed.

Wholesale market

Cost approx. $2.3b pa

Includes System Operator and ancillary services $65m , EC $13m pa and balance generation The demise of net retailers over the last few years and lack of new entrant generators are symptoms of increasing market power by the 5 vertically integrated suppliers. A conservative estimate of the cost to consumers of this market power is $120m pa . In a market with effective competition high prices will encourage new entry. The problem in the electricity industry is that there appear to be barriers to entry that sustain the dominance of the existing vertically integrated suppliers. The incumbent suppliers benefit from keeping the spot, hedge and retail markets short to keep prices high. The EC and Commerce Commission are conducting a joint review of competition. This work and other competition enhancing changes need to be a priority.

Three of the 5 vertically integrated suppliers in the market are SOE and because of the weaker capital market pressures than private companies, inefficiencies and misdirected use of resources are likely. Improving capital market pressures on SOE in the electricity sector will require a political initiative .

The EC is responsible for continuous improvement of the rules governing the wholesale and retail market and this should continue.

Dry-year reserve

Cost approx. $29m pa The decision to build Whirinaki power station and the dry-year policy in the GPS was politically motivated. The EC is required to review the dry-year reserve policy by the end of 2006 and MEUG welcome this because there is a risk if the policy continues it may distort or undermine investment in the ¡°normal¡± energy market. In the meantime MEUG object to consumers having to pay a levy to recover the costs of Whirinaki .

Transmission

Cost approx. $455m pa Finalisation and then implementation by the EC of rules determining transmission contract structure, counterparties, pricing and investment. This is business-as-usual (BAU), but shouldn¡¯t underestimate complexity and risks of political and vested interest pressure.

Refer RMA issues under generation above.

Continuous improvement of the regulatory thresholds set by the Commerce Commission for Transpower is needed. This is a BAU issue.

Distribution

Cost approx. $1,155m pa Continuous improvement of the regulatory thresholds set by the Commerce Commission for the 27 electricity line businesses (ELB) at the distribution level is needed. This is a BAU issue .

There is a risk of ELB re-integrating into supply (generation and retailing) without adequate constraints on excess profit taking or reintegration leading to barriers to entry. Some ELB are actively seeking political sponsors to change this policy.

Retail

Cost approx. $360m pa Problems with retail competition are noted under wholesale market above.

Consumers More detailed cost information on final bills should be required to allow consumers to understand and react to changes in costs . Even for larger users¡¯, there is a wide gap between information and analysis suppliers can access compared to consumers. Improved access to information is an issue to be considered by the EC.

Improving the efficiency of the electricity sector and providing greater value for consumers:

Notes to the analysis

1. Issues on the governance of the Electricity Commission were set out in a report by Dr Graham Scott of LECG in a report on the Electricity and Gas Industries Bill 2003, January 2004. The parties in support of that report co-signed a cover letter. Those parties were Business NZ, Contact Energy, ENA, Federated Farmers, Genesis Energy, MEUG, Mighty River Power, Meridian Energy, Powerco, Trustpower, Vector and Unison. The bill was partly amended to accommodate issues raised in that report; but not completely. Hence this remains an issue.

2. The importance of the GPS is that it sets the agenda and priorities for the EC, and is the benchmark against which the performance of the EC is measured. Apart from an environmental bias, the GPS needs to be updated because even though it was gazetted in October 2004, most of its drafting took place when the EC began actively managing the market from 1 March 2004. Our understanding of issues and priorities since that date has moved on. While environmental bias in the GPS is the major concern, there are also policies that would be better managed through welfare support rather than electricity policy such as requiring retailers to offer minimum fixed costs tariffs to households.

3. Refer EC consultation paper, Proposed request for appropriation 2005/06 financial year, 21 April 2005, p6 reports EC electricity efficiency budget proposed for 2005/06 of $6.933m and 2006/07 of $9.778m. MEUG has reservations on this programme given EECA are supposed to be already doing similar if not the same work. As commercial users¡¯ are already incentivised to use power efficiently, it¡¯s unclear what this programme will really add, and why consumers will be levied to fund the programme.

4. MEUG estimate excluding any rebates NGA firms might receive.

5. As part of the package of material released by the Minister on 4 May 2005 when announcing the C-tax, in the Q&A section the question was put, ¡°What will the overall impact be on the economy?¡± And the answer was, ¡°A very small but negative impact on economic activity (measured by GDP) is expected. Depending on the international emissions price, GDP in 2010 is likely to be in the order of 0.03% lower than it would have otherwise have been. [NB 0.03% total change, not 0.03% per annum]¡±

6. The Greenhouse Policy Coalition produced an excellent analysis of current climate change policies and a way forward including removal of the C-tax (refer www.gpcnz.co.nz).

7. As well as the issue of comparing projects of national importance with regional impacts, other key RMA issues are the scope of the RMA is not clear because key terms such as ¡°environment¡± are not defined. Another key issue is mechanisms for allocating natural resources need to be carefully considered. These key issues to be considered by a fundamental review of the RMA were canvassed in a submission by the Core Industries Group to the Government on 1 July 2004. The Core Industries comprised AIAL, BP, Business NZ, Contact Energy, ENA, FBL, Foodstuffs, MEUG, MIA, Methanex, MRP, NZBRT, NZRC, NZ Steel, Norske Skog Tasman, Nelson Pine Industries, Rayonier, NZ Seafood Industry Council, Solid Energy, Trustpower and Vector.

8. MEUG estimate based on MED Energy Data File, January 2005, estimate of energy cost is $2,644m for year ended 31 March 2004. From this have netted MEUG rough estimate of retail margin/costs noted below of $360m pa to get estimate of wholesale market costs of $2,274m pa. Note that year by year wholesale costs can vary widely dependent on generation mix used, eg very dry-year lots of thermal and costs much higher than very wet year when minimal thermal used.

9. Refer Transpower Annual Report for the year ended 30 June 2004, p 46. This is wholesale market services revenue, assumed to include System Operator contract with EC and ancillary services purchases.

10. Refer EC consultation paper, Proposed request for appropriation 2005/06 financial year, 21 April 2005, p1 reports Electricity Governance functions of $47.577m. From this is netted MEUG estimate of System Operator contract value with EC of $25m, giving EC cost covering staff and minor service provider costs (M-co and ems) of approximately $13m pa.

11. MEUG rough estimate assuming consumers paying at least 5% more than what they should, ie 5% of wholesale market turnover of $2.3b ¡Ö $120m pa. This excludes any over-charging on retail margins.

12. Other competition enhancing options that need to be investigated include synthetic separation of generation and retailing, changing from a gross to a net pool design, greater provision of information for end consumers to make decisions and provide some countervailing power to suppliers, improving monitoring consistent with approaches of usual OCED regulators etc

13. Improving capital market pressures can take a number of forms. At one extreme is immediate privatisation ¨C this would not be supported by MEUG until adequate changes to improve competition had been completed.

14. Refer EC consultation paper, Proposed request for appropriation 2005/06 financial year, 21 April 2005.

15. There are several aspects to the objection to pay the Whirinaki levy. First, it¡¯s questionable if it was ever needed rather it was a politically motivated insurance decision and therefore should be a charge against Consolidated Account rather than levied on electricity users¡¯ that didn¡¯t need the plant. Second, the dry-year risk arises because generators that have or build new hydro subject to dry-year risk fail to have back-up supplies. Those generators should be levied the tax, rather than it being smeared across all users. Third, there is a risk when a dry-year occurs and all North Island thermal are running that Whirinaki output will be constrained because of transmission constraints. Just when you need Whirinaki it won¡¯t be available ¨C therefore why should the levy be payable during those periods. Fourth, the levy formula appears to over-recover costs assuming the plant remains in the ownership of the Government after the consents at Whirinaki expire in 10-11 years time.

16. Refer Transpower Annual Report for the year ended 30 June 2004, p 46. This is only transmission services revenue, ie excludes wholesale market services revenue that for this analysis is included in the wholesale market costs.

17. Refer disclosures by ELB for year ending 31 March 2004. The cost is estimated as total ELB revenues less transmission expenses. The latter costs are covered under transmission in the table.

18. The Commerce Commission has to date focused on aggregate ELB performance when setting thresholds. MEUG has suggested and the Commission is starting to take a greater interest in how given a revenue cap with the threshold, line tariffs are then decided and whether those will enhance economic efficiency or not, including issues of cross-subsidies across regions or consumer classes.

19. MEUG rough estimate assuming 1.8m consumers in NZ (refer MED Energy Data File January 2005, p129) and retail margin (cost to serve and profit) is $200/consumer average.

20. Some retailers already provide a good breakdown of costs on household bills, eg Mighty River Power through their Mercury Energy retail brand in some areas.

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