Appendix 1: the Ministry's Response to the Key Issues Raised in Submissions on March 2005 Discussion Paper
1. Lines companies have, by and large, argued that an ability to trade in spot and hedge markets is a necessary but not in itself sufficient condition to remove barriers to their investment in generation. Many have stated that the current requirements for the corporate separation and arms length rules are by far much bigger barrier to their ability to investment, hence, if relaxed, would be sufficient to induce their entry into the generation market.
2. Some generators/retailers have expressed strong views against the proposal, viewing it as contrary to the original policy intent of EIRA, and therefore argued for a review of changes to the Act to ensure these are not made piecemeal.
3. Key issues raised in the submissions and the Ministry response to these issues are outlined below.
Policy Objectives
Submissions
4. The proposed amendment has been perceived as an incremental policy proposal, which contradicts the original policy intent of the Act. It was suggested that New Zealand's electricity sector will be better served by a first principles review of the policy objectives with respect to the role of lines companies in the sector, followed by an establishment of a clearer policy framework for the distribution sector.
The Ministry Response
5. The Ministry considers that merits and ramifications of the policy to relax the original cross ownership provisions of the Act to allow lines companies limited involvement in the generation and retail markets have been widely debated as part of the 2001 and 2004 Amendments of the Act.
6. The outcomes of this debate were decisions to relax the original cross ownership provisions of the Act. Since the passage of the recent legislative amendment, it has become clear that these relaxations have little practical effect without the ability of lines companies to manage the risks associated with selling the output from their generation. The Ministry therefore considers that the proposal to allow lines companies to trade in hedge and spot energy is simply a means of achieving effective implementation of the policy decisions taken as part of the 2004 Amendments.
Proposed Hedging Limits
Submissions
7. The proposed limits are too generous as they take no account of the generating plant's capacity factor and may result in lines companies being able to sell more electricity than they generate. Others suggested that the proposed limits are too restrictive and unnecessary as the risk of over or under hedging is better managed by investors rather than regulators.
The Ministry Response
8. The Ministry is of a view that the proposed limits strike a reasonable compromise, which allows a generation plant to be fully hedged while the simplicity of regulation is maintained.
Submissions
9. Lines companies should be allowed to trade in financial instruments to support planned generation plant of up to the current limits of 50 MW or 20% of peak load (and unlimited for renewables), provided that firm contracts with purchasers are in place for the quantities of energy being hedged.
10. This limit should be reviewed in 5 years time with a view of removing it completely if the Government's desired outcomes have been achieved.
The Ministry Response
11. The proposal aims to facilitate investment in new generation. The proposed modifications appear to be focused more on building a retail business. This is not the purpose of the proposal.
12. The proposed limits can be reviewed at any time, subject to the requirement for a specific review.
State of the Hedge Market
Submissions
13. The thinness of New Zealand's electricity hedge market makes it difficult to obtain hedges, and is therefore an impediment to an effective implementation of the proposed amendment.
The Ministry Response
14. The Ministry recognises that an effective hedge market is a key to effective implementation of the proposed amendment. The development of a liquid and transparent hedge market in New Zealand is one of the key priority areas in the Electricity Commission's work programme and is being worked on accordingly.
The Proposal Is Premature
Submissions
15. Consideration of the proposal should be deferred until the Electricity Commission completes its work programme on barriers to entry and the development of the hedge market and the Commerce Commission completes its study of competition in the market.
The Ministry Response
16. The Electricity Commission work programme is broad and designed to improve market conditions in general, whereas the proposal in question is a very specific initiative designed to remove specific barriers to the successful implementation of policy decisions taken as part of the 2004 Amendment Act.
Relevance to Other Investors
Submissions
17. Barriers to investment cited by lines companies are present for all potential entrants to the generation market. Hence the appropriateness of making lines companies a specific target for intervention was questioned.
The Ministry Response
18. The proposal focuses on barriers faced by lines companies because it aims to ensure that policy decisions taken as part of the 2001 and 2004 Amendments of the Act can be effectively implemented.
Clarifications Required
Submissions
19. The proposal seemed to be interpreted as requiring lines companies to wait for the generation to come on-line before a hedge contract could be negotiated and signed.
The Ministry Response
20. This was not the intention. The Ministry's view is that lines companies should be able to negotiate and sign hedge contracts on the basis of expected future generation capacity. The objective is to ensure that the contracts do not come into effect prior to the generation capacity becoming available.
Submissions
21. A question as to whether the proposed limits would apply to both selling and buying of hedges was raised in the context of the current legislative provisions not restricting lines companies' ability to buy hedges.
The Ministry Response
22. The focus of the proposal was on the trading activity, rather than on buying and selling of hedges per se. The current legislative restriction on selling (but not buying) of hedges was considered to be sufficient to prevent any trading activities. Any further amendment is likely to follow similar approach.
Submissions
23. A question as to whether the proposal would apply to both continuous generation and peak plant generation was raised.
The Ministry Response
24. The proposal is intended to apply to both continuous generation and peak plant generation.
Monitoring Arrangements
Submissions
25. It was recommended that the Ministry adopts a simple audited reconciliation from the lines companies confirming that the value of the financial instruments other than FTRs (as these are also called financial instruments) sold over a calendar year, do not (on average over the 12 months period) exceed the specified limits.
26.Another suggestion was to require monthly reports by lines companies.
The Ministry Response
27. The Ministry is in favour of a simple auditing mechanism and will work with the Commerce Commission to determine effective and efficient monitoring options.
28. It is likely that an annual audit would be sufficient. Such an audit would ensure that a lines company's net hedging position did not at any time exceed the specified limit. In other words, it is proposed that a contract portfolio would be seen as compliant with the limits provided that the net quantity sold over 12 months did not exceed the allowed limit during any trading interval over that period.
Back to Top