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Competition in New Zealand's electricity business
IN DISCUSSION
Competition in New Zealand’s electricity business Clark W. Gellings
The utilities in New Zealand are well on their way toward privatization and open competition. Using the venue of New Zealand’s third annual customer convention as a forum, Utilities Policy asked one of the convention’s keynote speakers, Clark Gellings to report through discussions with key decisionmakers, the status of the latest events in New Zealand. Keywords:
New Zealand;
Electricity;
Competition Clark W. Gellings is Vice-President, Customer Systems Division, Electric Power Research Institute, 3412 Hillview Ave, PO Box 10412, Palo Alto, CA 94303, USA.
In the mid-1980s, the New Zealand government decided that protectionism was no longer an easy option for industries or for the government. They had evolved the belief that protectionism is expensive and promotes inefficiency. In government ownership, the market signals become confused and inaccurate and the protected industries lose the drive to improve productivity, and to respond to market changes. Protectionism also distorts the allocation of resources. According to John Luxton, New Zealand’s Minister of Energy: lower productivity,
a lower standard of living and lower real wages are all the result of protectionism built into our economy. Without competition, company directors and executives lose motivation. Industries become inefficient, complacent and stagnant. Eventually they fail. New Zealand is littered with their remains. Competition brings efficiency, productivthinking. A nation ity, and innovative benefits from free and open trade. Society does better when it concentrates its resources in their most productive uses. Protection directs subsidies to inefficient industries at the expense of efficient industries. Actions to begin to introduce competition into the electric utility industry began in 1986. In 1987, the Electricity Corporation of New Zealand was formed. The plan was to privatize the entire industry and allow open access to all transmission and distribution systems by January 1992. The Electricity Corporation of New Zealand Limited’s (ECNZ) origins can be traced back to the old Public
178
Works Department. In 1946, the hydroelectric branch of that department was separated off to become the State Hydro-Electric Department. In 1958, when its first thermal generating station was constructed at Meremere, the department changed its name to the New Zealand Electricity Department. A later reorganization saw it become the Electricity Division of the new Ministry of Energy. In August 1985, the government decided to place the Electricity Division on a more commercial footing by turning it into a limited liability company formed under new Zealand’s Companies Act, ECNZ was formed as a state-owned enterptise with its own Board of Directors on 1 April 1987. New Zealand reforms are aimed at: 0 0
0
Removing existing barriers to competition where possible; introducing more commercially oriented ownership structures; and, changing the regulatory environment to deal with natural monopolies in transmission and distribution through information disclosure.
ECNZ is expected to make a commercial return on its assets for its owner and quickly respond to the needs of its customers like any other commercial business. ECNZ is subjected to the general provisions of the Commerce Act, the law that promotes competition in New Zealand. The statutory barriers to entry into the electricity generating business by
UTILITIES
POLICY July 1992
In discussion
competing firms have been lifted. Previously anyone wishing to set up an electricity generation station had to seek specific approval from the government to do so. Now that is no longer so. When ECNZ was created, its assets, including 40 power stations, were valued at NZ$6.3 billion. It is a large business even by international standards and is the Crown’s largest single asset. Electricorp Production, the production division, operates and maintains the generating assets while Electricorp Marketing sells power to Electrical Supply Authorities and direct to the six largest consumers of electricity The six largest are an aluminum smelter at Tiwai Point, a steel mill at Glenbrook, New Zealand Rail, and three pulp and paper producers. These six clients consume 25% of the electricity sold in New Zealand. The corporation has two business divisions and two major subsidiary companies that are serviced by a corporate group based in Wellington.
Electricorp Production Electricorp Production is the division of the Corporation responsible for generating electricity on a profitable and cost-efficient basis. Currently it generates 96% of the country’s electricity. It operates 29 hydro driven power stations, seven thermal and two geothermal stations. Management responsibility is decentralized into four operating groups; a North Island Hydro Group based in Hamilton; South Island Hydro based in Dunedin, and, two thermal groups based in New Plymouth and Huntly. A Wellington Group provides support services to the General Manager.
Electricorp Marketing This division purchases electricity from Electricorp Production and sells electricity in bulk to local retailers and directly to some major commercial customers. Its primary objective is to profitably market electrical energy in New Zealand. Management responsibility is devolved to three regions centered in Auckland, Palmerston North and Christchurch. A Wellington
UTILITIES
POLICY July 1992
Group
provides
support
services.
Trans Power New Zealand Ltd This independent company operates the National Grid and controls all the high voltage bulk electricity distribution in New Zealand. To prevent natural monopolies the government recently decided to separate Trans Power from the Corporation. The exact composition of ownership is yet to be decided.
DesignPower Group Ltd
PowerBuild
This group incorporates two subsidiary companies of its own. DesignPower is its design consultancy arm and PowerBuild is its construction operation. The role of the Group is to sell professional, skilled and cost-effective design and construction services to the Electricity Corporation and any other clients both locally and overseas. The New Zealand government has made decisions on the electricity industry which they hope will provide a comprehensive and consistent framework for reforms to continue.
Electricity Supply Authorities Electricity Supply Authorities (ESAs) provide the supply of electricity to the final customer in all but the six cases cited above. In October 1990, there were 36 Electric Power Boards (EPBs), 14 Municipal Electricity Departments of Territorial Local Authorites, (MEDs), two private companies, two joint ventures and the Southland Electric Power Supply which is directly owned by central government. The ESAs are responsible for constructing and maintaining the vast distribution network of wires and cables that cover New Zealand, ensuring that in all but the most remote locations, customers have ready access to a supply of electricity. In all, there are approximately 165 000 km of ESA-owned distribution lines and some 119 000 substations. Electric Power Boards have undergone a recent change in make-up prior to the passing of new legislation which would convert them into power companies. While still operating under the
179
In discussion
Electrical Power Boards Act, they are a special purpose form of local government. In the past, boards of up to 12 members were elected every three years by the eligible voters of the constituent Territorial Local Authority districts which make up each Power Board District. But as at October 1990, under an amendment to the Act, directors were appointed to guide the power boards into true company status. The existing elected members have the option of becoming trustees. Electric Power Boards range in size from the Auckland EPB which has over 220 000 customers and sales in excess of 3 400 GWhs to the Wairoa Electric Power Board with 3 500 customers and sales of 39 GWhs. In all cases supply is purchased in bulk from ECNZ but 18 EPBs also own and operate their own generating plant which supplements their electricity purchases. The installed capacity of Electric Power Board’s generating exceeds 216 MW. The MEDs are trading arms of Territorial Local Authorities who operate under the provisions of the Local Government Act 1974. Councillors elected to the Territorial Local Authority may be appointed to an electricity or trading committee of the Local Authority and thereby become responsible for determining all matters relating to the supply of electricity in a Council’s area of supply. MEDs have in total about 85 MW of generation capacity. While government does not impose specific price regulation on the electricity industry, there is currently a legal requirement to supply similar customers at the same price. The ESAs atso have a legal obligation to supply all those who want electricity within their franchise area. In return the ESAs have each been granted a territorial monopoly. No one else may set up in business to supply electricity within their franchise area. On average about 50% of the price of electricity that consumers finally pay to an ESA is made up of generating costs, 20% of transmission costs, and 30% of distribution costs.
Distribution ~orporatization
180
of the
industry
will
proceed with the aim of improving the efficiency of the sector by allowing competition between retailers of electricity. Municipal Electricity Department and Electric Power Company corporate structures will be more closely aligned to allow for compatibility in performance monitoring, information disclosure and future amalgamations. The intention is that electric power companies should operate on a commercial basis. Shares in Electric Power Companies and Municipal Electricity Department companies are to be held by trusts in both cases with trustees appointed by elections in the case of Electric Power Companies and local authorities in the case of Municipal Electricity Departments. Electric Power Trustees have been asked to sign Trust Deeds. These Deeds form an agreement between these utilities and their boards. Trustees will be responsible for future appointments of Electric Power Company Directors and for reflecting the interests of the beneficial owners of the companies and the community. There will be a staged removal of area franchises and the statutory obligation to supply to allow for the controlled introduction of competition between supply authorities. From 1 January 1992, these were removed for consumers using less than 0.5 GWH a year. Full competition will apply for all other electricity consumers from 1 January 1993. This progressive approach will allow the new electric power companies some time to adjust to the new environment. It will ensure that there are no perverse incentives for supply authorities to increase prices above delivery costs to ordinary consumers to cross-subsidize prices to larger consumers. Government policy is to maintain current universal supply. The role of the Rural Electrical Reticulation Council will be reviewed, particularly in relation to alleviating possible adverse impacts of the reform on rural consumers. Distribution companies with generating capacity of more than 10 MW will be required to have an appropriate information disclosure arrangement.
UTILITIES
POLICY July 1992
In discussion
The Electricity Distribution Reform Unit was set up in May 1990 to implement distribution restructuring and monitor tariffs during the reform process.
tion in three 1.
Transmission An Establishment Board was appointed to oversee the change of ownership of Trans Power, which is responsible for the transmission of electricity under contract to any organization, from a wholly subsidiary to private ownership. On 1 July 1991, the government introduced a ‘light handed’ regulatory regime based on information disclosure. Under this scheme, the generation sector will be required to disclose prices, terms, and conditions of supply. The natural monopoly transmission sector will also be required to disclose costs, cost allocation policies, pricing policies and performance measures. Information disclosure will also facilitate action under New Zealand’s commerce act if there are anti-competitive practices. It is believed that price disclosure will facilitate new entry in generation and retailing. The line and retail functions of distribution will be separated in accounting terms and separate charges will be made for line services and energy. In the generation area, the corporatization of ECNZ is completed and has resulted in what are believed to be considerable efficiencies. The government is examining the possibility of spinning off stations to improve competition in generation. Trans Power is to be separated from ECNZ. Ownership options are currently under review. The Trans Power Establishment Board was asked to examine the ownership options and the valuation of Trans Power. The valuation of Trans Power is important because it will provide the basis for determining the value of the business at the time of any ownership change. It is also the main determinant of the level of transmission prices. The Establishment Board has been asked to arrive at a fully independent and transparently documented valuation of Trans Power. The Establishment Board has approached the valua-
UTILITIES
POLICY July 1992
2.
0
stages:
They have sought to identify the best methodology for the valuation. This involved obtaining extensive input from the industry and having independent advisers carrying out a review of a variety of valuation methodologies; next they sought agreement from the industry and government for the use of the preferred methodology (the valuation methodology selected by the Board is that of optimized deprival value: what the user of a transmission asset would do if deprived of that asset); and, finally they will implement the methodology with the use of independent advisers under the Board’s direction.
An electricity user They can either:
0
0
has two options.
Ask Trans Power to rebuild the assets in the most efficient way possible taking into account the level of service required and today’s technology. This option is known as optimized replacement cost; or, build their own electricity generation facilities which is known as economic value.
Optimized deprival value takes which ever of the options is lower as the value of an asset. The value that finally goes into the books is adjusted to take into account the age of the existing asset. Taking account of alternative options to using the grid (the ‘economic value’) should ensure that no part of the transmission system is priced at a level which will result in users seeking to by-pass the grid. It is assumed that such an outcome would be inefficient given that the grid is a sunk cost and has a long life. According to Luxton, the government believes that the proposed methodology is fair. It enables adjustments to be made to take into account the various anomalies that have arisen in constructing the grid over the years. ‘Industry executives and major electricity users groups have expressed support for the use of the valuation method and it is being implemented.’
181
In discussion
The completion of a thorough and independent valuation is a key step in the separation process between Trans Power and Electricorp. In addition, it will also establish a fair and efficient basis for the pricing of transmission services. The second contentious issue to be addressed by the Trans Power Establishment Board is the ownership of Trans Power after the separation. Trans Power is a natural monopoly. Its separation from ECNZ, if done properly, should facilitate competition in the generation of electricity. In theory, monopolists can set their own price within reason and they are not subject to competitive pressures acting as a control on costs. Traditionally, this problem has been dealt with through either state ownership, heavy regulation on prices, or rate of return. New Zealand’s government is investigating the extent to which a degree of self-regulation can be applied to Trans Power. One method is by putting ownership in the hands of the industry. The government has several objectives for the transmission grid:
0
0
l 0
to ensure open access for the generation and trading of electricity. In other words, competition where competition is possible in the electricity sector; to provide a low cost and reliable transmission service; to promote efficient investment in the industry over time; and, to create transparency, thus minimizing the need for extensive government regulation.
There are five possible ship options: 1. 2. 3. 4. 5.
generic
owner-
generator owned (the current situation); distributor owned; market investor owned; government owned, as a new SOE; or, balanced ownership by the industry (the so-called club).
Ownership by the industry does have some advantages. As users, the industry has an incentive to minimize running costs and maintain reliability standards. Balanced ownership by
182
both sides of the industry may reduce the need for government involvement. According to Doug Kidd, New Zealand’s former Minister for StateOwned Enterprises, ‘the Government remains committed to Trans Power delivering low cost, reliable transmission services to all grid users.’ If competition is to be introduced into the electricity industry, there will also be a need to establish power pool to trade power in some form of electricity market. The Establishment Board is required to advise on how a mechanism for trading electricity in New Zealand might be structured.
Generation Consistent with its policy manifesto, the government will encourage competition in the electricity generation sector. A report, sought by the previous government from the Electricity Corporation on the issues involved in forming several generating companies is expected.
Information
disclosure
Natural monopolies and marketdominant firms will clearly continue to be a feature of the restructured electricity industry. In order to prevent any abuse of monopoly power and to encourage competition, the government will apply light-handed regulation, whereby information will be disclosed to consumers and actual and potential industry competitors. The generation and retailing sectors are regarded as potentially competitive and information disclosure details for them are to cover separation of line and energy charges, prices and terms and conditions of supply. The transmission and distribution sectors, which are natural monopolies, require more extensive information disclosure covering transmission and line charges, terms and conditions, costs, pricing and cost allocation policies, performance measures and financial statements. The disclosure regime is to be included in the energy sector reform legislation. Further discussions will be held with the industry on technical matters when the regulations are being prepared.
UTILITIES
POLICY July 1992
In discussion
Contestable
customers
Drew Stein, General Manager of Electricorp Marketing, is the real engine of change in the New Zealand scene. Drew views this time-scale as a real slow-down from the original January 1992 date. According to him: As I understand the position, the Government is proposing to gradually introduce competition over a three or four year period. From what I have heard, I believe that this move is based on the following assumption: ~~)mpetition introduced progressively will permit those electricity retailers who are not at present up to speed
with regard to adopting a true commercial attitude to their business, to catch up, so that when full competition does eventuate. there will be a rdasonabiy level playin; field. Also of concern is the com&e;ciai advantage/disadvantage associated with the wide disparity within the industry of
individual retailers’ financial eearine. ”
Y
Drew claims he cannot support above contention or reasoning.
the
The retail industry has known for a number of years that open competition was planned as part of the deregulation process. Indeed, a number of retailers have taken the lead and already geared themselves up for open competition. Yet it is these very innovative and commercially orientated leaders in the retail industry who are now going to be held back. In effect, the slowing-down process will favour those retailers who have sat on the fence and who have done nothing to change their way of doing business. These retailers have buried their heads in the sand regarding pending changes and commercialization of the industry: and those who foresaw that change was coming, took the appropriate action to change their way of doing business by preparing themselves for a truly commercial and competitive environment, are being penalized.
But others disagree. In speaking about progress, John Laxton believes that: we have gone a long wav down the track in our refo&. There% &I a way to go but I know we are making good progress on the
pathway of positive change to encourage a more competitive electricity industry. The more competitive environment is going to be advantageous to everyone. More importantly, I b&eve it will assist the economy in starting to grow again. It will remove many artificial ad hoc barriers and cross subsidies of the aast. A more efficient and competitive ele’ctricitv industrv will ensure that our industries and manufacturers can in effect compete on a far better level in the international arena. It wiil mean greater oroductivitv and. more importanzy, the bressurcs ii the system con-
tinue to improve productivity ..- a key to a
UTILITIES
POLICY July 1992
stronger and more positive economy. I am positive about the reforms and what they &II mean. Just as I am keen to implement
the legislation framework to allow this reform to take place. The electricity industry has a proud heritage and has shown real innovation in the past. What we want now is a new environment. To continue to encourage change to improve and to seek better and smarter ways to do yesterday’s chores. I believe a competitive electricity industry presents exciting opportunities for the future.
But things are changing even now. Wavne Greenstreet, Electricorp Maiketing’s Wholesale Manager Marketing, has spearheaded a major effort to bring a customer orientation to New Zealand’s system. The two largest arms of EiectrLity Corporation have formalized their relationship with the signing of a contract specifying the terms under which Electricorp Marketing buys electrical energy from Electricorr, Production. The agieement sets out the conditions of supply and price between the parties for the current financial year and allows. Electricorp Marketing to optimize the product mix purchased from Electricorp Production’s different manufacturing cost centres, thus providing the efficiencies needed to ensure a competitively priced product. Electricorp Production will benefit from the scale of economies and guaranteed demand levels provided by the contractual arrangement. The contract is a major step in the development of both these businesses. It has a number of major implications for the whole electricity industry and ultimately for electricity customers in general. It is intended that the Electricity Corporation of New Zealand will not seil its raw product direct from
the
source
to the
customer,
but
that it supplies a range of product options. These are not only deliberately designed to satisfy specific custamer re&irements. but are priced to reflect th;: diversity of those requirements and the prevailing circumstances of an increasingly competitive energv market. According to Doug Heffernan, Chief Executive of Waitemata Electricity ‘it is essential that Electricorp Marketing be in a position to pursue a marketing policy which allows it to L..
183
In discussion
utilize all the options for product mix in the light of demand, and that Electricorp Production applies the most efficient and direct test - customer demand - to its business. This will ensure that the company’s overall market position is retained and improved.’ One of Electricorp Marketing’s many initiatives has been to expand the concept of ‘going beyond the meter’. The realization that people do not buy kilowatthours but buy energy services which satisfy their more basic needs of warmth, comfort, and economy has slowly gained acceptance through Greenstreet’s encouragement. Accordingly, the themes of Electricarp Marketing’s advertising have consistently and progressively demonstrated by various messages the many ways in which electricity meets customer’s needs in a value for money way. Most recently they have moved towards a focus on the modern efficient electro-technologies that are available to meet the variety of different consumer needs in a manner which, when compared to the alternatives of the past and also those of New Zealand’s energy competitors is efficient, economic and effective. The purpose of this is to reinforce the effectiveness with which modern consumer products meet the different energy needs of consumers. Electricorp Marketing’s research confirms that their promotional objectives are being satisfied. According to Greenstreet: we have had a steady improvement in all our indicators; most importantly the perceptions of ‘value for money’ have shown a consistent improvement over the period since our promotions commenced.
184
The modernity and range of appliances has shown a similar consistent improvement, at the same time the positive gap to gas appliances has increased. The perception of convenience of electricity appliances has also improved whilst at the same time the indicators for gas appliances have made no improvement, thus increasing the relative satisfaction for electricity.
An interesting point, no doubt influenced by the preponderance of the press and many in the industry to continue to talk about cost rather than value, is that cost-consciousness has not changed at the same rate as that at which perceptions of value have increased. Perhaps this represents the fact that New Zealand has still to break away from its old cost-plus culture, and to embrace an economy which focuses on enhancing values. Electricorp Marketing’s strategies are being influenced by another important factor as they enter a decade of increasing environmental awareness: the need to ensure that the unique qualities of electricity are reflected in customer attitudes. Their research shows that the overwhelming majority of consumers regard electricity more positively than any other energy form in relation to its cleanliness, its long-term security of supplv i (significantly better than gas or coal) and is impact on the environment (again rating significantly above gas (50/50 rating) with coal having a negative overall rating). Their marketing programmes will build on these positive factors in order to demonstrate how the unique qualities of electricity can be utilized to futher decrease energy intensity levels, increase the renewables share of the energy market (perhaps resulting in increasing electicity intensity) but at the same time to power economic growth.
UTILITIES
POLICY July 1992
Competition in New Zealand’s electricity business Clark W. Gellings
The utilities in New Zealand are well on their way toward privatization and open competition. Using the venue of New Zealand’s third annual customer convention as a forum, Utilities Policy asked one of the convention’s keynote speakers, Clark Gellings to report through discussions with key decisionmakers, the status of the latest events in New Zealand. Keywords:
New Zealand;
Electricity;
Competition Clark W. Gellings is Vice-President, Customer Systems Division, Electric Power Research Institute, 3412 Hillview Ave, PO Box 10412, Palo Alto, CA 94303, USA.
In the mid-1980s, the New Zealand government decided that protectionism was no longer an easy option for industries or for the government. They had evolved the belief that protectionism is expensive and promotes inefficiency. In government ownership, the market signals become confused and inaccurate and the protected industries lose the drive to improve productivity, and to respond to market changes. Protectionism also distorts the allocation of resources. According to John Luxton, New Zealand’s Minister of Energy: lower productivity,
a lower standard of living and lower real wages are all the result of protectionism built into our economy. Without competition, company directors and executives lose motivation. Industries become inefficient, complacent and stagnant. Eventually they fail. New Zealand is littered with their remains. Competition brings efficiency, productivthinking. A nation ity, and innovative benefits from free and open trade. Society does better when it concentrates its resources in their most productive uses. Protection directs subsidies to inefficient industries at the expense of efficient industries. Actions to begin to introduce competition into the electric utility industry began in 1986. In 1987, the Electricity Corporation of New Zealand was formed. The plan was to privatize the entire industry and allow open access to all transmission and distribution systems by January 1992. The Electricity Corporation of New Zealand Limited’s (ECNZ) origins can be traced back to the old Public
178
Works Department. In 1946, the hydroelectric branch of that department was separated off to become the State Hydro-Electric Department. In 1958, when its first thermal generating station was constructed at Meremere, the department changed its name to the New Zealand Electricity Department. A later reorganization saw it become the Electricity Division of the new Ministry of Energy. In August 1985, the government decided to place the Electricity Division on a more commercial footing by turning it into a limited liability company formed under new Zealand’s Companies Act, ECNZ was formed as a state-owned enterptise with its own Board of Directors on 1 April 1987. New Zealand reforms are aimed at: 0 0
0
Removing existing barriers to competition where possible; introducing more commercially oriented ownership structures; and, changing the regulatory environment to deal with natural monopolies in transmission and distribution through information disclosure.
ECNZ is expected to make a commercial return on its assets for its owner and quickly respond to the needs of its customers like any other commercial business. ECNZ is subjected to the general provisions of the Commerce Act, the law that promotes competition in New Zealand. The statutory barriers to entry into the electricity generating business by
UTILITIES
POLICY July 1992
In discussion
competing firms have been lifted. Previously anyone wishing to set up an electricity generation station had to seek specific approval from the government to do so. Now that is no longer so. When ECNZ was created, its assets, including 40 power stations, were valued at NZ$6.3 billion. It is a large business even by international standards and is the Crown’s largest single asset. Electricorp Production, the production division, operates and maintains the generating assets while Electricorp Marketing sells power to Electrical Supply Authorities and direct to the six largest consumers of electricity The six largest are an aluminum smelter at Tiwai Point, a steel mill at Glenbrook, New Zealand Rail, and three pulp and paper producers. These six clients consume 25% of the electricity sold in New Zealand. The corporation has two business divisions and two major subsidiary companies that are serviced by a corporate group based in Wellington.
Electricorp Production Electricorp Production is the division of the Corporation responsible for generating electricity on a profitable and cost-efficient basis. Currently it generates 96% of the country’s electricity. It operates 29 hydro driven power stations, seven thermal and two geothermal stations. Management responsibility is decentralized into four operating groups; a North Island Hydro Group based in Hamilton; South Island Hydro based in Dunedin, and, two thermal groups based in New Plymouth and Huntly. A Wellington Group provides support services to the General Manager.
Electricorp Marketing This division purchases electricity from Electricorp Production and sells electricity in bulk to local retailers and directly to some major commercial customers. Its primary objective is to profitably market electrical energy in New Zealand. Management responsibility is devolved to three regions centered in Auckland, Palmerston North and Christchurch. A Wellington
UTILITIES
POLICY July 1992
Group
provides
support
services.
Trans Power New Zealand Ltd This independent company operates the National Grid and controls all the high voltage bulk electricity distribution in New Zealand. To prevent natural monopolies the government recently decided to separate Trans Power from the Corporation. The exact composition of ownership is yet to be decided.
DesignPower Group Ltd
PowerBuild
This group incorporates two subsidiary companies of its own. DesignPower is its design consultancy arm and PowerBuild is its construction operation. The role of the Group is to sell professional, skilled and cost-effective design and construction services to the Electricity Corporation and any other clients both locally and overseas. The New Zealand government has made decisions on the electricity industry which they hope will provide a comprehensive and consistent framework for reforms to continue.
Electricity Supply Authorities Electricity Supply Authorities (ESAs) provide the supply of electricity to the final customer in all but the six cases cited above. In October 1990, there were 36 Electric Power Boards (EPBs), 14 Municipal Electricity Departments of Territorial Local Authorites, (MEDs), two private companies, two joint ventures and the Southland Electric Power Supply which is directly owned by central government. The ESAs are responsible for constructing and maintaining the vast distribution network of wires and cables that cover New Zealand, ensuring that in all but the most remote locations, customers have ready access to a supply of electricity. In all, there are approximately 165 000 km of ESA-owned distribution lines and some 119 000 substations. Electric Power Boards have undergone a recent change in make-up prior to the passing of new legislation which would convert them into power companies. While still operating under the
179
In discussion
Electrical Power Boards Act, they are a special purpose form of local government. In the past, boards of up to 12 members were elected every three years by the eligible voters of the constituent Territorial Local Authority districts which make up each Power Board District. But as at October 1990, under an amendment to the Act, directors were appointed to guide the power boards into true company status. The existing elected members have the option of becoming trustees. Electric Power Boards range in size from the Auckland EPB which has over 220 000 customers and sales in excess of 3 400 GWhs to the Wairoa Electric Power Board with 3 500 customers and sales of 39 GWhs. In all cases supply is purchased in bulk from ECNZ but 18 EPBs also own and operate their own generating plant which supplements their electricity purchases. The installed capacity of Electric Power Board’s generating exceeds 216 MW. The MEDs are trading arms of Territorial Local Authorities who operate under the provisions of the Local Government Act 1974. Councillors elected to the Territorial Local Authority may be appointed to an electricity or trading committee of the Local Authority and thereby become responsible for determining all matters relating to the supply of electricity in a Council’s area of supply. MEDs have in total about 85 MW of generation capacity. While government does not impose specific price regulation on the electricity industry, there is currently a legal requirement to supply similar customers at the same price. The ESAs atso have a legal obligation to supply all those who want electricity within their franchise area. In return the ESAs have each been granted a territorial monopoly. No one else may set up in business to supply electricity within their franchise area. On average about 50% of the price of electricity that consumers finally pay to an ESA is made up of generating costs, 20% of transmission costs, and 30% of distribution costs.
Distribution ~orporatization
180
of the
industry
will
proceed with the aim of improving the efficiency of the sector by allowing competition between retailers of electricity. Municipal Electricity Department and Electric Power Company corporate structures will be more closely aligned to allow for compatibility in performance monitoring, information disclosure and future amalgamations. The intention is that electric power companies should operate on a commercial basis. Shares in Electric Power Companies and Municipal Electricity Department companies are to be held by trusts in both cases with trustees appointed by elections in the case of Electric Power Companies and local authorities in the case of Municipal Electricity Departments. Electric Power Trustees have been asked to sign Trust Deeds. These Deeds form an agreement between these utilities and their boards. Trustees will be responsible for future appointments of Electric Power Company Directors and for reflecting the interests of the beneficial owners of the companies and the community. There will be a staged removal of area franchises and the statutory obligation to supply to allow for the controlled introduction of competition between supply authorities. From 1 January 1992, these were removed for consumers using less than 0.5 GWH a year. Full competition will apply for all other electricity consumers from 1 January 1993. This progressive approach will allow the new electric power companies some time to adjust to the new environment. It will ensure that there are no perverse incentives for supply authorities to increase prices above delivery costs to ordinary consumers to cross-subsidize prices to larger consumers. Government policy is to maintain current universal supply. The role of the Rural Electrical Reticulation Council will be reviewed, particularly in relation to alleviating possible adverse impacts of the reform on rural consumers. Distribution companies with generating capacity of more than 10 MW will be required to have an appropriate information disclosure arrangement.
UTILITIES
POLICY July 1992
In discussion
The Electricity Distribution Reform Unit was set up in May 1990 to implement distribution restructuring and monitor tariffs during the reform process.
tion in three 1.
Transmission An Establishment Board was appointed to oversee the change of ownership of Trans Power, which is responsible for the transmission of electricity under contract to any organization, from a wholly subsidiary to private ownership. On 1 July 1991, the government introduced a ‘light handed’ regulatory regime based on information disclosure. Under this scheme, the generation sector will be required to disclose prices, terms, and conditions of supply. The natural monopoly transmission sector will also be required to disclose costs, cost allocation policies, pricing policies and performance measures. Information disclosure will also facilitate action under New Zealand’s commerce act if there are anti-competitive practices. It is believed that price disclosure will facilitate new entry in generation and retailing. The line and retail functions of distribution will be separated in accounting terms and separate charges will be made for line services and energy. In the generation area, the corporatization of ECNZ is completed and has resulted in what are believed to be considerable efficiencies. The government is examining the possibility of spinning off stations to improve competition in generation. Trans Power is to be separated from ECNZ. Ownership options are currently under review. The Trans Power Establishment Board was asked to examine the ownership options and the valuation of Trans Power. The valuation of Trans Power is important because it will provide the basis for determining the value of the business at the time of any ownership change. It is also the main determinant of the level of transmission prices. The Establishment Board has been asked to arrive at a fully independent and transparently documented valuation of Trans Power. The Establishment Board has approached the valua-
UTILITIES
POLICY July 1992
2.
0
stages:
They have sought to identify the best methodology for the valuation. This involved obtaining extensive input from the industry and having independent advisers carrying out a review of a variety of valuation methodologies; next they sought agreement from the industry and government for the use of the preferred methodology (the valuation methodology selected by the Board is that of optimized deprival value: what the user of a transmission asset would do if deprived of that asset); and, finally they will implement the methodology with the use of independent advisers under the Board’s direction.
An electricity user They can either:
0
0
has two options.
Ask Trans Power to rebuild the assets in the most efficient way possible taking into account the level of service required and today’s technology. This option is known as optimized replacement cost; or, build their own electricity generation facilities which is known as economic value.
Optimized deprival value takes which ever of the options is lower as the value of an asset. The value that finally goes into the books is adjusted to take into account the age of the existing asset. Taking account of alternative options to using the grid (the ‘economic value’) should ensure that no part of the transmission system is priced at a level which will result in users seeking to by-pass the grid. It is assumed that such an outcome would be inefficient given that the grid is a sunk cost and has a long life. According to Luxton, the government believes that the proposed methodology is fair. It enables adjustments to be made to take into account the various anomalies that have arisen in constructing the grid over the years. ‘Industry executives and major electricity users groups have expressed support for the use of the valuation method and it is being implemented.’
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In discussion
The completion of a thorough and independent valuation is a key step in the separation process between Trans Power and Electricorp. In addition, it will also establish a fair and efficient basis for the pricing of transmission services. The second contentious issue to be addressed by the Trans Power Establishment Board is the ownership of Trans Power after the separation. Trans Power is a natural monopoly. Its separation from ECNZ, if done properly, should facilitate competition in the generation of electricity. In theory, monopolists can set their own price within reason and they are not subject to competitive pressures acting as a control on costs. Traditionally, this problem has been dealt with through either state ownership, heavy regulation on prices, or rate of return. New Zealand’s government is investigating the extent to which a degree of self-regulation can be applied to Trans Power. One method is by putting ownership in the hands of the industry. The government has several objectives for the transmission grid:
0
0
l 0
to ensure open access for the generation and trading of electricity. In other words, competition where competition is possible in the electricity sector; to provide a low cost and reliable transmission service; to promote efficient investment in the industry over time; and, to create transparency, thus minimizing the need for extensive government regulation.
There are five possible ship options: 1. 2. 3. 4. 5.
generic
owner-
generator owned (the current situation); distributor owned; market investor owned; government owned, as a new SOE; or, balanced ownership by the industry (the so-called club).
Ownership by the industry does have some advantages. As users, the industry has an incentive to minimize running costs and maintain reliability standards. Balanced ownership by
182
both sides of the industry may reduce the need for government involvement. According to Doug Kidd, New Zealand’s former Minister for StateOwned Enterprises, ‘the Government remains committed to Trans Power delivering low cost, reliable transmission services to all grid users.’ If competition is to be introduced into the electricity industry, there will also be a need to establish power pool to trade power in some form of electricity market. The Establishment Board is required to advise on how a mechanism for trading electricity in New Zealand might be structured.
Generation Consistent with its policy manifesto, the government will encourage competition in the electricity generation sector. A report, sought by the previous government from the Electricity Corporation on the issues involved in forming several generating companies is expected.
Information
disclosure
Natural monopolies and marketdominant firms will clearly continue to be a feature of the restructured electricity industry. In order to prevent any abuse of monopoly power and to encourage competition, the government will apply light-handed regulation, whereby information will be disclosed to consumers and actual and potential industry competitors. The generation and retailing sectors are regarded as potentially competitive and information disclosure details for them are to cover separation of line and energy charges, prices and terms and conditions of supply. The transmission and distribution sectors, which are natural monopolies, require more extensive information disclosure covering transmission and line charges, terms and conditions, costs, pricing and cost allocation policies, performance measures and financial statements. The disclosure regime is to be included in the energy sector reform legislation. Further discussions will be held with the industry on technical matters when the regulations are being prepared.
UTILITIES
POLICY July 1992
In discussion
Contestable
customers
Drew Stein, General Manager of Electricorp Marketing, is the real engine of change in the New Zealand scene. Drew views this time-scale as a real slow-down from the original January 1992 date. According to him: As I understand the position, the Government is proposing to gradually introduce competition over a three or four year period. From what I have heard, I believe that this move is based on the following assumption: ~~)mpetition introduced progressively will permit those electricity retailers who are not at present up to speed
with regard to adopting a true commercial attitude to their business, to catch up, so that when full competition does eventuate. there will be a rdasonabiy level playin; field. Also of concern is the com&e;ciai advantage/disadvantage associated with the wide disparity within the industry of
individual retailers’ financial eearine. ”
Y
Drew claims he cannot support above contention or reasoning.
the
The retail industry has known for a number of years that open competition was planned as part of the deregulation process. Indeed, a number of retailers have taken the lead and already geared themselves up for open competition. Yet it is these very innovative and commercially orientated leaders in the retail industry who are now going to be held back. In effect, the slowing-down process will favour those retailers who have sat on the fence and who have done nothing to change their way of doing business. These retailers have buried their heads in the sand regarding pending changes and commercialization of the industry: and those who foresaw that change was coming, took the appropriate action to change their way of doing business by preparing themselves for a truly commercial and competitive environment, are being penalized.
But others disagree. In speaking about progress, John Laxton believes that: we have gone a long wav down the track in our refo&. There% &I a way to go but I know we are making good progress on the
pathway of positive change to encourage a more competitive electricity industry. The more competitive environment is going to be advantageous to everyone. More importantly, I b&eve it will assist the economy in starting to grow again. It will remove many artificial ad hoc barriers and cross subsidies of the aast. A more efficient and competitive ele’ctricitv industrv will ensure that our industries and manufacturers can in effect compete on a far better level in the international arena. It wiil mean greater oroductivitv and. more importanzy, the bressurcs ii the system con-
tinue to improve productivity ..- a key to a
UTILITIES
POLICY July 1992
stronger and more positive economy. I am positive about the reforms and what they &II mean. Just as I am keen to implement
the legislation framework to allow this reform to take place. The electricity industry has a proud heritage and has shown real innovation in the past. What we want now is a new environment. To continue to encourage change to improve and to seek better and smarter ways to do yesterday’s chores. I believe a competitive electricity industry presents exciting opportunities for the future.
But things are changing even now. Wavne Greenstreet, Electricorp Maiketing’s Wholesale Manager Marketing, has spearheaded a major effort to bring a customer orientation to New Zealand’s system. The two largest arms of EiectrLity Corporation have formalized their relationship with the signing of a contract specifying the terms under which Electricorp Marketing buys electrical energy from Electricorr, Production. The agieement sets out the conditions of supply and price between the parties for the current financial year and allows. Electricorp Marketing to optimize the product mix purchased from Electricorp Production’s different manufacturing cost centres, thus providing the efficiencies needed to ensure a competitively priced product. Electricorp Production will benefit from the scale of economies and guaranteed demand levels provided by the contractual arrangement. The contract is a major step in the development of both these businesses. It has a number of major implications for the whole electricity industry and ultimately for electricity customers in general. It is intended that the Electricity Corporation of New Zealand will not seil its raw product direct from
the
source
to the
customer,
but
that it supplies a range of product options. These are not only deliberately designed to satisfy specific custamer re&irements. but are priced to reflect th;: diversity of those requirements and the prevailing circumstances of an increasingly competitive energv market. According to Doug Heffernan, Chief Executive of Waitemata Electricity ‘it is essential that Electricorp Marketing be in a position to pursue a marketing policy which allows it to L..
183
In discussion
utilize all the options for product mix in the light of demand, and that Electricorp Production applies the most efficient and direct test - customer demand - to its business. This will ensure that the company’s overall market position is retained and improved.’ One of Electricorp Marketing’s many initiatives has been to expand the concept of ‘going beyond the meter’. The realization that people do not buy kilowatthours but buy energy services which satisfy their more basic needs of warmth, comfort, and economy has slowly gained acceptance through Greenstreet’s encouragement. Accordingly, the themes of Electricarp Marketing’s advertising have consistently and progressively demonstrated by various messages the many ways in which electricity meets customer’s needs in a value for money way. Most recently they have moved towards a focus on the modern efficient electro-technologies that are available to meet the variety of different consumer needs in a manner which, when compared to the alternatives of the past and also those of New Zealand’s energy competitors is efficient, economic and effective. The purpose of this is to reinforce the effectiveness with which modern consumer products meet the different energy needs of consumers. Electricorp Marketing’s research confirms that their promotional objectives are being satisfied. According to Greenstreet: we have had a steady improvement in all our indicators; most importantly the perceptions of ‘value for money’ have shown a consistent improvement over the period since our promotions commenced.
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The modernity and range of appliances has shown a similar consistent improvement, at the same time the positive gap to gas appliances has increased. The perception of convenience of electricity appliances has also improved whilst at the same time the indicators for gas appliances have made no improvement, thus increasing the relative satisfaction for electricity.
An interesting point, no doubt influenced by the preponderance of the press and many in the industry to continue to talk about cost rather than value, is that cost-consciousness has not changed at the same rate as that at which perceptions of value have increased. Perhaps this represents the fact that New Zealand has still to break away from its old cost-plus culture, and to embrace an economy which focuses on enhancing values. Electricorp Marketing’s strategies are being influenced by another important factor as they enter a decade of increasing environmental awareness: the need to ensure that the unique qualities of electricity are reflected in customer attitudes. Their research shows that the overwhelming majority of consumers regard electricity more positively than any other energy form in relation to its cleanliness, its long-term security of supplv i (significantly better than gas or coal) and is impact on the environment (again rating significantly above gas (50/50 rating) with coal having a negative overall rating). Their marketing programmes will build on these positive factors in order to demonstrate how the unique qualities of electricity can be utilized to futher decrease energy intensity levels, increase the renewables share of the energy market (perhaps resulting in increasing electicity intensity) but at the same time to power economic growth.
UTILITIES
POLICY July 1992