2. Current Legislative Provisions
7. Submissions showed that there is a range of understandings of the current legal framework and the ability of lines companies to invest in generation. This section outlines the current legislative provisions, relevant policy objectives and policy settings designed to achieve the objectives.
2.1 Electricity Industry Reform Act
8. Table 1 below summarises the current regulatory settings and the policy objectives of the Electricity Industry Reforms Act 1998 and its subsequent amendments. More detailed consideration is outlined below.
2.1.1 Electricity Industry Reform Act 1998
9. The Government's concern at the time was that local electricity companies, being vertically integrated natural monopolies, had both the ability and incentive to use their market power in distribution to discourage competition in retail and generation. The Government accepted the view that companies in this position can and do use their market power to benefit their owners to the detriment of consumers. Structural regulation (i.e. ownership separation) was preferred over conduct regulation as the means to deliver the best outcomes to consumers.
10. To this end, the Electricity Industry Reform Act (EIRA) was introduced in 1998. The Act required full ownership separation between lines (distribution and transmission), and energy supply (generation and retail) businesses.
11. The key provisions of the Act prohibiting cross-ownership are:
- section 17 prevents persons that are involved in an electricity lines business from being involved in an electricity supply business and vice versa;
- section 18 provides that persons involved in one type of electricity business (e.g. lines business) may not acquire an interest in the other type of electricity business (e.g. generation) if it would result in a 20% aggregate of control rights or equity return rights in the generation business by persons involved in the lines business, and vice versa;
- section 20 applies cross-ownership prohibitions, similar to those found in sections 17 and 18, to trust-like entities.1
12. At the time the Act came into effect, owners of the power companies, which were to be separated, were also given an option (as an alternative to full divestiture of generation and retail businesses) to set up mirror trusts, which, if chosen, required full corporate separation (i.e. creation of a separate legal entity) and arms length management, as per sections 24 and 25 of the Act.
Table 1: Electricity Industry Reform Act 1998 | Electricity Industry Reform Act 1998 | Electricity Industry Reform Amendment Act 2001 | Electricity Industry Reform Amendment Act 2004 |
|---|
Policy Objectives | Minimise opportunity and incentive to lessen competition in retail and generation markets | - Retain original objectives
- Facilitate efficient use of distributed generation to support line function services and promote new renewables
| - Retain original objectives
- Promote increased security of supply and competition in generation market
|
|---|
Policy Settings | - Prohibition on cross involvement of supply and energy
- Prohibition on trading in financial instruments
- Requirement for arms-length corporate separation of cross-owned line and energy businesses
- Case by case exemptions available
| - Exception to own distributed generation up to the higher of 5 MW or 2% of lines' peak load
- Exception to own unlimited distributed generation from new renewable sources
- Exception for selling the output of cross-owned generation
- Prohibition on trading in financial instruments
- Exception for up to 5 MW or 2 percent of peak demand
- Case by case exemptions available
| - Exception to own generation up to the higher of 50 MW or 20% of lines' peak load capacity limits and unlimited reserve energy, commissioned after 20 May 2003
- Exception to own unlimited generation from new renewable sources
- Exception for selling the output of cross-owned generation
- Prohibition on trading in financial instruments
- Exception for up to 5 MW or 2 percent of peak demand
- Case by case exemptions available
|
|---|
13. The arms-length rules require companies in common ownership to act independently and as if they were in separate ownership, thus prohibiting any person to have material influence on both kinds of business. The rules, as specified in section 25 and Schedule 1 of the Act, include, among other things:
- requirement for separate and independent management and directorship;
- duties not to discriminate in favour of the other company in common ownership or to make any arrangements that unrelated parties would not have made;
- prohibition on sharing information unless it is also available to other parties; and
- requirement for records to be kept of all transactions between the companies in common ownership.
14. Section 81 of the Act provides the Commerce Commission with a wide range of powers to exempt businesses and persons from the provisions of the Act, if the Commission finds that an exemption will be consistent with the purpose of the Act. In the majority of cases, the Commerce Commission has granted exemptions subject to a range of conditions intended to ensure that benefits to consumers are realised.
2.1.2 Electricity Industry Reform Amendment Act 2001
15. The purpose of the Electricity Industry Reform Amendment Act 2001 (2001 Amendment) was to facilitate investment in distributed generation to support line function services. It was considered lines companies should have an option of developing distributed generation facilities instead of undertaking upgrades to their networks where it is economically efficient to do so. Lines companies were recognised as having, in principle, a strong incentive to undertake such investment, but were prevented from doing so under EIRA.
16. The 2001 Amendment Act relaxed the ownership restriction on the basis that it would not seriously threaten the underlying objective of the Act to lessen competition. The Amendment allowed lines businesses to own distributed generation up to the higher of 5 MW or 2% of their maximum demand and sell their output, without having to comply with the original cross-ownership requirements (including corporate separation and arms length requirements).
17. Lines businesses were also permitted to own and sell (in unlimited quantities) the output of generation from new renewable energy sources, such as wind, connected to their network. However, companies taking this option were still required to comply with the corporate separation and arms-length rules, if the capacity of their renewable generation plant exceeded 5 MW or 2% of their peak load.
18. There are no legal restrictions on lines companies selling the output of their generation to anyone, including to end-consumers, by whatever contractual arrangements they wish (subject to only selling their own output). Lines businesses are, however, prohibited by the legislation from trading in financial instruments to hedge risks (other than financial transmission rights).
2.1.3 Electricity Industry Reform Amendment Act 2004
19. The purpose of the Electricity Industry Reform Amendment Act 2004 (2004 Amendment) was to promote security of supply and greater competition in the generation market.
20. The 2004 Amendment relaxed the restrictions on new non-renewable generation by allowing cross-ownership of up to the higher of 50 MW or 20% of lines' peak demand and unlimited reserve generation contracted to the Electricity Commission. The Amendment also retained lines companies' ability to invest in new renewable generation in unlimited quantities. However, any generation capacity above 5 MW or 2% of peak demand remained subject to corporate separation and the arms-length rules.
21. The requirement for generation to be connected to the lines company's network (i.e. to be "distributed generation") was removed. It was considered to be unnecessarily restrictive and prevented, for example, a remote wind project being connected to the grid or another company's network even where it would be more efficient to do so.
2.1.4 The Electricity Industry Reform Act Today
22. The current provisions of the Act make a clear distinction between new and existing generation. Generation capacity producing electricity from renewable sources is considered to be "new" if it was commissioned after 7 August 2001. Generation capacity producing electricity from non-renewable sources, is considered to be "new" if commissioned after 20 May 2003. Generation plants commissioned prior to these dates are considered to be "existing generation". The cross ownership restrictions, introduced by the original 1998 legislation and described in paragraphs 9 to 14 above, are still relevant for the purposes of cross involvement in existing generation capacity.
23. However, different rules apply to businesses and individuals wishing to be involved in cross-ownership of new generation capacity. These are briefly summarised below:
- Investment in new renewable2 and reserve energy (without quantity limits): Lines companies are permitted by the legislation to invest in unlimited quantities of renewable energy and reserve generation contracted to the Electricity Commission. They are also no longer restricted by the legislation to have these generation facilities connected to their local networks.
- Investment in non-renewable energy (up to certain quantity limits): Lines companies' investment in generation of up to the higher of 50 MW or 20% of lines' maximum demand has been exempted from the requirements of the original cross ownership provisions. As with renewables and reserve energy, there is no requirement for the generation to be connected to the local network.
- Investment in diversified portfolios of generation (up to certain quantity limits): The current legislative provisions do not restrict a lines company from owning (wholly or partially) more than one generating plant, as long as the total capacity of the lines companies generation portfolio is within the limits specified. For example, a lines company could invest in three generating plants (commissioned on or after 20 May 2003) of 25 MW, 15 MW and 10 MW each.
- Selling generation output: The current legislation provides for lines companies' ability to sell the output of their own generation by whatever contractual arrangements they wish (subject to selling only their own output). Lines companies are, however, prohibited from trading in financial instruments (other than financial transmission rights).
- Governance requirements: Generation capacity above 5 MW or 2 per cent of lines' maximum demand is required to be operated by a separate corporate entity and subject to arms length rules. The arms-length rules require companies in common ownership to act independently and as if they were in separate ownership, thus prohibiting any person to have material influence on both kinds of business.
- Exemption Regime: Section 81 of the Act provides the Commerce Commission with a wide range of powers to exempt businesses and persons from the provisions of the Act, if in any particular case the Commission finds that an exemption will be consistent with the purpose of the Act.
2.2 Other Relevant Provisions
2.2.1 Targeted Control of Lines Businesses and Information Disclosure Regulations
24. In 2001 the Commerce Act 1986 was amended to provide a targeted control and information disclosure regime for electricity lines businesses. It was considered that while EIRA separated the ownership structure to remove potentially anti-competitive cross subsidisation and remove barriers to competition in generation and retail markets, a remaining issue was the risk of monopoly pricing by distribution companies.
25. The purpose of the targeted control regime, as set out in section 57E of the Commerce Act, is to promote the efficient operation of markets directly related to electricity distribution and transmission services through targeted control for the long-term benefit of consumers. This purpose is to be achieved by ensuring that suppliers:
- are limited in their ability to extract excessive profits; and
- face strong incentives to improve efficiency and provide services at a quality that reflects consumer demands; and
- share the benefits of efficiency gains with consumers, including through lower prices.
26. Under the regime, businesses are only potentially subject to control if they cross the set thresholds of performance. The regime is "targeted" because only businesses that cross the thresholds trigger further examination by the Commerce Commission. If the Commerce Commission considers it to be necessary it can introduce control of prices, revenues and/or quality of lines businesses services.
27. The purpose of the information disclosure regime, as set out in section 57T of the Commerce Act, is to promote the efficient operation of markets directly related to electricity distribution (and transmission) services. The regime aims to ensure that large line owners and large electricity distributors make publicly available reliable and timely information about the operation and behaviour of those businesses, so that a wide range of people are informed about such factors as profits, costs, asset values, price (including terms and conditions of supply), quality, security, and reliability of supply of those businesses.
2.2.2 Distributed Generation Regulations
28. Powers to regulate terms and conditions of access to distribution lines by generators were introduced in the 2001 Amendment to the Electricity Act 1992. Draft regulations are currently being developed. The purpose of these regulations is to mitigate barriers (price or non-price related) that distributors might erect against generators.
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