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3. Why Consider Further Amendments to the Electricity Industry Reform Act?


Investment in Electricity Generation by Lines Companies: Discussion Paper 2006

Resources and Networks Branch
[ Last Updated 26 April 2006 ]


Within this section…

29. The previous section summarises the constraints that EIRA places on cross-involvement between line and supply businesses and explains the policy reasons for those constraints. This section discusses why further changes to EIRA may be considered. It begins by postulating some benefits from lines companies investing which are not being realised owing to the legislative barriers placed on their activities by EIRA, which if accepted, would support a case for relaxing the current constraints on cross-involvement.

3.1 Propositions

30. There are potential efficiency gains obtainable from close coordination of lines and distributed generation operations. For example, the benefits of co-optimising investment between line upgrades and new generation. However the statutory restrictions in EIRA prevent these gains being realised.

31. Distributors are well-placed to enter generation (and retail) markets because they:

  • are more likely than national generators to identify and develop local generation options because they have strong relationships with local communities and good knowledge of local energy resources;
  • have existing knowledge and involvement in the electricity industry
  • can readily identify opportunities and exploit synergies with coordination between line and generation and demand-side operations (e.g. using generation and/or demand management to avoid network investment); and
  • can realise economies of scope by making use of common resources (operations staff, control centres, etc).

32. Reducing barriers to entry for distribution companies may increase the level of competition in generation markets, which should place downward pressure on prices for consumers (provided lines companies do not have incentives to cross-subsidise or use regional market power to reduce competition.)

33. Although distributors are technically permitted to enter the generation market with unlimited quantities of new renewable and limited quantities of other generation, some potential projects may have difficulty being commercially viable because, under EIRA:

  • lines companies cannot hedge the financial risks of selling energy at spot prices which may make potential generation projects costly. Lines companies are limited to selling their output either on the spot market, or to other parties able to manage variations in output from lines companies' generation. In practice, such parties are likely to be restricted to the existing vertically integrated generators/retailers and some end-consumers who are willing to organise their own supply at the time of outages and trade on the spot market. This presents lines companies with several difficulties:
    1. Selling on the spot market results in volatile and unpredictable revenue streams, making a project difficult to finance;
    2. Selling to other retailers may not be an attractive business proposition because these retailers are also likely to be major generators, and are therefore lines companies' competitors in generation;
    3. Retailing to end-consumers, although permitted by the legislation, may not be feasible due to lines companies' inability to meet typical customer requirements, such as fixed prices and an ability to draw variable quantities of electricity.
  • compliance costs associated with corporate separation and arms length operation (applicable to projects above 5 MW or 2% of system peak) may be too high for smaller projects. Arms length rules require generation to be held by a separate company with a separate board and management structures.3 Some potential generation projects are not being progressed as a result of the extra costs arms length rules create and the loss of control over investment capital by the board.

34. If the propositions above were accepted, there would be a case for amending EIRA to allow the hedging of financial risks and/or reducing the compliance costs associated with corporate separation and arms length rules in order to:

  • capture the efficiency gains obtainable from more integrated operation of lines and distributed generation; and
  • put downward pressure on prices in the generation and/or retail markets by facilitating new entry and increased competition in those markets.

35. However, these potential (or hypothesised) benefits need to be weighed against the potential detriments that EIRA is designed to mitigate, namely, the potential for cross-involved firms to use their market power in the distribution market to lessen competition in the generation and retail markets.

36. Any amount of cross-involvement provides an incentive to lessen competition, but a firm's opportunity to lessen competition is limited by the extent of cross-involvement relative to the size of the relevant market (e.g. cross-involvement in a 10 MW generation plant is unlikely to provide much opportunity to lessen competition materially in a 10,000 MW market).

37. The Ministry considers that the proposals described in this paper would result in relatively small changes in the extent of cross-involvement between lines and supply businesses. The central question is whether the benefits arising from relatively limited changes in the amount of cross-involvement would outweigh the costs.

3.2 Options for Addressing Legislative Barriers

38. The Ministry considers the regulatory framework under EIRA is still necessary and therefore is not considering a high level review of the purpose of the Act at this stage. Moreover, the issues of competition levels in electricity market are currently being investigated by the Commerce Commission and also being looked at by the Electricity Commission. Any potential review of the purpose of EIRA would be a consequence to the outcomes of these studies.

39. However, it is appropriate to look at several possible changes within the parameters of the current framework with a view of removing unnecessary barriers to lines companies' ability to investment in generation.

40. Following consideration of the submissions in April 2005, the Ministry has considered the following possible changes to the current policy setting in EIRA. These are to:

  1. Allow Trading in financial instruments
    • Allow the generation entity, owned by a line company's owners, to trade in financial instruments up to the nominal generation capacity of their permitted generating plant.
  2. Changes to the Arms Length Rules
    • Raise the threshold for arms-length separation above current minimum level (5 MW or 2%)
    • Raise the threshold for arms-length separation up to the current cross-ownership limits (50 MW or 20%)4.
    • Introduce less onerous arms-length requirements for generation projects between the thresholds of 5 MW or 2% and 50 MW or 20%. For example, accounting and information separation could be required, but staff, managers and/or directors may be able to provide services for both the lines and generation parts of the distribution company.
    • Provide lines companies with more flexibility to decide how they will meet arms length obligations. For example, in the United Kingdom (UK) electricity distributors develop their own proposals outlining how they will comply with conditions and submit these to the regulator for approval. In Australia, the regulator provides an option where if a distributor considers that they have a better method of ring-fencing that meets the high level objectives, they can seek the regulator's permission to implement it.
    • Remove the requirement for lines companies to comply with arms length rules when generation owned by a lines company is connected to a different distribution network or the transmission grid, and retail customers (if any) are outside the lines company's network. In this situation, it is suggested the lines company has no conflict of interest with other generation proposals on the local network, and no insider information about customers' energy usage, and therefore that there is no need to impose constraints on lines company involvement in energy supply.
  3. Reducing legislative uncertainty
    • Provide criteria in legislation to guide the Commerce Commission and distribution companies in applications for exemptions from the provisions of EIRA. Both the process and the substance of the exemptions regime are currently determined by the Commerce Commission rather then being explicit in the legislation. Some lines companies argue that in order to be in a position to satisfy Commerce Commission questions, a project need to be a long way into its development plan and that guidelines would enable the Commerce Commission to obtain relevant information for decision-making and provide clarity earlier in the exemptions process.
    • Redraft the provisions relating to arms length rules to make the rules more detailed and specific, reducing uncertainty. Some lines companies suggest that the wording of schedule 1 of EIRA is too open to interpretation, and legislation is not clear in terms of prohibitions on staff working for both companies. They suggest there is a need to spell out exactly what is and is not permitted, and include a description of activities and functions rather than titles of individuals performing functions.

3 The arms-length rules required companies in common ownership to act independently and as if they were in separate ownership. The rules specified, inter alia:

  • Separate management
  • 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 was also available to other parties, and
  • Records to be kept of all transactions between the companies in common ownership.

4 Once companies own generation above 50 MW or 20% full corporate separation would still be required.


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