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• 2. Assumptions

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21. This section sets out the Ministry's assumptions and proposes criteria for evaluating the outcomes of each option.

Assumptions

2.1 Urban and rural cross-subsidy

22. Current government policy is to peg changes in line charges to rural areas to changes in line charges to urban areas, as set out in the Government Policy Statement on Electricity Governance (GPS, October 2006, paragraph 99):

"The Government expects distribution companies keep any changes to rural line charges in line with urban line charges. The Electricity Commission should monitor developments in rural charges."

23. The statement reflects the importance of affordable electricity access in rural areas, but its implications are that remote rural consumers are likely to pay line charges that are lower than they would be if they paid the full cost of supply. Hence there is an explicit degree of cross-subsidy from other users of the network. This review is undertaken on the assumption that this government policy will continue, and the review therefore does not examine in detail the prices paid by consumers for their electricity supply.

24. Some consumers do not, and likely will not, face the full costs of supply by lines so the impacts for lines companies and consumers need to be considered in this context. For example, even if the costs of alternative supply were lower than the true costs of line supply, consumers in remote areas would be likely to face increased costs if they were to switch from supply by lines to alternatives.

2.2 The economics of line supply

25. Supplying electricity by lines could be considered uneconomic for two main reasons:

1. When the revenue generated from the consumers connected to the line is insufficient to meet the costs of maintaining the line, including asset renewal. In a business sense, this means the asset (the line) generates a negative return and network assets used elsewhere must generate a higher return to cover the full cost of supply across the line company's network.
2. When it would be a lower cost to supply the same area by an alternative means (i.e. not by long distribution lines). This concept of "uneconomic" is used by the Commerce Commission in its direction to lines companies on how to value their network assets.

2.3 Lines companies' asset valuations

26. A lines company values its network assets using a valuation methodology called Optimised Deprival Valuation (ODV). One part of the method requires that a lines company consider its network as comprising many segments and evaluate whether, for each segment, it is possible to provide the same service, at lower cost to users of the network, by an alternative means. If so, then that portion of the network is deemed uneconomic. This is called the Economic Valuation (EV) test and its result is to reduce the asset value of the network. A company does not have to undertake an EV test if it is thought that the reduction in value would be less than 1% of the total network value.

27. The line companies' disclosure statements show that none have made any Economic Valuation adjustments. This implies that any portion of their network deemed to be uneconomic cannot be more than 1% of each company's total asset valuation. This may change (become greater than 1%) as lines become due for replacement and investment is required.

2.4 What is alternative supply (alternatives)?

28. Alternative supply (alternatives) can mean two things:

1. Any method to generate and supply electricity to an area that is not connected to a line company's network. These are broadly termed "remote area power systems" or "off-grid generation" and can include supply to individual households or to a local "islanded" network.
2. Any method by which electricity use can be reduced to better enable alternative supply; for example, by substitution with another energy source (such as using gas bottles for heating and cooking, or wood burners for space and water heating) and/or by using electricity more efficiently.

29. Technologies available for generating electricity off-grid include micro-hydro, geothermal, solar photovoltaic, micro-wind and diesel/petrol generators. These technologies and their relative economics are discussed further in section 6. In addition to these more established technologies, pilot research is underway that examines newer technologies; for example, fuel cells and hydrogen storage.

30. Also being considered, but outside the scope of this paper, is the potential for on-farm/in–forest generation of electricity using bioenergy for both off-grid use and national distribution.

31. A May 2006 study by East Harbour Management Services (EHMS) on the potential for small-scale generation (the alternatives) in New Zealand¹ assumed that the expiry of section 62 would influence uptake. One reason given for a fixed continuance of supply period (1993 – 2013) was that further development and cost reduction in alternatives to lines would occur during that time.

32. Alternative systems that supply electricity will also have ongoing maintenance costs and need to be understood in terms of their capacity, quality, reliability and complexity.

• Capacity relates to the maximum power that can be drawn - which determines what appliances can be used together.
• Quality relates to the voltage stability of supply – sudden spikes, for example, can damage computer equipment.
• Reliability means the ability to switch appliances on when required – noting the ability of a distribution company to switch off hot-water or other facilities for certain time periods.
• Complexity means the ease with which such systems can be maintained / repaired, and the level of expertise required to do so.

33. Alternative energy sources such as gas bottles or wood burners will also have ongoing maintenance requirements. For example, gas bottles need to be filled periodically, which raises issues of whether the consumer is responsible for that (and hence needs transport and a nearby supplier) or a company delivers (but at what cost); and whether the fuel for a wood burner may be collected (essentially free but takes time) or must be bought.

2.5 Proposed assessment criteria

34. The government's objective is for all classes of consumer to have access to electricity that is delivered in an efficient, fair, reliable and environmentally sustainable manner.²

35. The following assessment criteria, applied to the consideration of the outcomes for each option, are proposed:

• Efficient (e.g. assess whether lines business have incentives to maintain and invest in supply infrastructure; assess whether the resources for maintaining access to electricity are being used in the best way).
• Fair (e.g. assess whether remote, rural users will continue to have access to electricity at reasonable prices, comparable with supply to other users;
• Reliable (e.g. assess whether the option leads to enabling sufficient, reliable supply; assess the change in level of involvement required of the consumer);
• Environmentally sustainable (e.g. assess whether the outcome is consistent with climate change considerations).

36. The New Zealand Energy Strategy, proposing the future direction for energy policy in New Zealand, is expected to be finalised in October 2007. This review of the 2013 obligation takes that strategy work into account.

37. This review does not discuss any other element of the electricity regulatory framework, but it takes into account proposed changes to the Electricity Industry Reform Act 1998.