Part B: Generation Reforms
Restructuring of ECNZ
Objective
1. The objective is to promote effective competition in the New Zealand generation market by restructuring ECNZ into three competing State-owned enterprises (SOEs) which are -
- commercially viable entities; and
- effective competitors.
Implementation Principles
2. The restructuring of ECNZ outlined below is to be implemented in a manner which best achieves the objective in paragraph 1 above.
3. Subject to paragraph 2, implementation is to be planned and executed in a manner which:
- is consistent with the financial parameters set out in paragraphs 27-36 below;
- minimises implementation costs;
- enables the new SOEs to be fully independent as soon as possible; and
- avoids any unnecessary adverse impacts on the financial statements of the Crown.
4. For the avoidance of doubt, implementation is to be consistent with:
- the State-Owned Enterprises Act 1986 and any directions issued by the shareholding Ministers under section 13 of that Act; and
- any other relevant law, including the Resource Management Act 1991.
5. A Transition Team, acting as an advisor to the Government and working in consultation with ECNZ, is to prepare an implementation plan for approval by ECNZ's shareholding Ministers. If possible, the implementation plan is to be agreed with ECNZ. SOE Development Groups for each new SOE are to establish detailed contracts for the transfer of assets and liabilities, within the framework of the Government-approved implementation plan. Further details on this process are set out in paragraphs 22-26.
Allocation of Major Assets
6. The three SOEs are to be based on the following key asset groups:
- the Waikato hydro system (SOE 1);
- the Huntly thermal station, the Te Awamutu station and the Tongariro system (SOE 2); and
- Manapouri and the Waitaki hydro systems (SOE 3).
7. The remaining small hydro stations are to continue to be sold pursuant to Memorandum of Understanding between the Government and ECNZ dated 8 June 1995, except that any which are not sold before the completion of the ECNZ split are to be allocated as follows:
- SOE 1: Matahina
- SOE 2: Waikaremoana
- SOE 3: Cobb, Coleridge, Highbank
Explanatory note:
Based on current forecasts, this should give rise to a generation market with the following market shares (MW in 2002)
| SOE 1: | 13% |
| SOE 2: | 17% |
| SOE 3: | 30% |
| Contact: | 25% |
| Private: | 15% |
Under this structure, interdependent hydro stations are held within the same SOE. The main hydro reserves - Lake Pukaki - would be held by SOE 3. To minimise transition costs, the current ECNZ is likely to become SOE 3.Even though ECNZ would not be a new SOE in legal terms, it is intended, nevertheless, that an SOE Development Group would prepare detailed business, financial and organisation-build plans for it as if it was a new SOE.
Related Assets
8. The generation portfolios referred to above are to include all rights, interests and privileges (including intellectual property (subject to paragraph 9-11 below), resource consents, fuel contracts and development sites) required by, or most efficiently associated with, the relevant portfolios.
Intellectual Property
9. During the period between the date of announcing these measures and completing the transfer of assets to the new SOEs, ECNZ will provide to the new SOEs access to all intellectual property required to achieve the objective set out in paragraph 1 above.
10. On transfer of the assets to the new SOEs, ECNZ will provide the new SOEs with duplicates of all intellectual property required to achieve the objective set out in paragraph 1 above, and the new SOEs will pay for any reasonable duplication costs.
11. For the avoidance of doubt, a duplicate copy of strategic models will be provided by ECNZ to the new SOEs.
Transfer of Staff
12. It is intended that ECNZ staff associated with the power stations referred to in paragraph 6 above will be transferred to the relevant SOE.
13. If any redundancies or severances occur after the date of transfer of the power station staff, the employer in each case shall bear the costs.
14. ECNZ and the Transition Team will agree on an appropriate process to allow some or all of ECNZ s existing head office personnel staff to transfer to the new SOEs. ECNZ and the new SOEs will endeavour to avoid redundancies or severances arising from this process. If any such redundancies or severances do occur, the costs will be shared between ECNZ and the new SOEs in proportion to the book value of their assets on the date of transfer. The new SOEs will pay their shares of any such costs to the residual ECNZ entity after the separation is completed.
Explanatory note:
The approach outlined above is intended to avoid redundancies and severances in the separation process. The agreed cost-sharing agreement will create strong incentives for ECNZ and the new SOEs to put in place a process that ensures a smooth staff transition.
Existing ECNZ Contracts
Principles
15. Legal rights and obligations in existing contracts between ECNZ and its customers, suppliers and lenders are to be protected as far as possible.
16. Consistent with paragraph 3 above, the costs to the Crown and ECNZ of assigning, amending or renegotiating any of ECNZ's existing contracts are to be minimised.
Process
17. In its implementation plan, the Transition Team is to outline a framework for addressing each of ECNZ's major existing contracts, including ECNZ's existing debt obligations, the Comalco contracts, the Fletcher Challenge Energy heads of agreement relating to gas, the Contact gas supply contract and ECNZ's existing hedge or bilateral contracts relating to electricity supply or pricing.
Debt Contracts
18. ECNZ's existing debt contracts will remain in force. The Transition Team will advise the Government on options for continuing to satisfy any security and other prudential covenants within these contracts.
Explanatory note:
The mechanisms used for separating Contact and Transpower are examples of how this can be achieved. In time, the new SOEs will approach the debt markets on their own account.
Transmission Contracts
19. ECNZ's existing contracts with Transpower will, at some stage in the restructuring process, have to be renegotiated. It is expected that Transpower will cooperate fully in this process.
Comalco Contracts
20. The restructuring is to be implemented in a manner which does not require any material change to the existing Comalco contracts.
Explanatory note:
The Transition Team's implementation plan will need to work within this parameter. Initial indications are this would be achieved by leaving the Comalco contracts with ECNZ as SOE 3 (which is to control the Manapouri and Waitaki systems).
Fletcher Challenge Energy Heads of Agreement for Gas
21. Options for managing this arrangement are to be explored by the Transition Team and addressed in its implementation plan. This will take into account SOE 2's need to ensure fuel contracts for Huntly.
Implementation Process
22. Implementation of this restructuring will be carried out in three stages:
- Stage one (about two months): preparing an implementation plan to provide a more detailed framework for stage two negotiations between ECNZ and the proposed new SOEs;
- Stage two (about six months): negotiation of detailed arrangements for the possible transfer of assets and liabilities; development of detailed business plans for each proposed SOE, including operating strategies, human resources, financial structures and organisation-build; and certification to Government as to financial viability and competitiveness based on the parameters set out in this document;
- Stage three (up to three months): subject to final decisions by Government on whether to proceed with the restructuring, actual implementation of the ECNZ separation and establishing the new SOEs.
23. Stage one is to be carried out by a Transition Team, in consultation with ECNZ. The Transition Team will be appointed by, and make recommendations to, the Government. Detailed terms of reference on the Transition Team's role are set out as in Part D.
24. Stage two is to be carried out by SOE Development Groups, in consultation with ECNZ. The SOE Development Groups will also be appointed by the Government. Detailed terms of reference on their role will be provided closer to the appointment of the SOE Development Groups.
Explanatory note:
If ECNZ becomes SOE 3 (as is likely), it is intended, nevertheless, that ECNZ would still go through the SOE development process for strategic, financial and organisational planning purposes.
25. During stage two, the Transition Team will remain in place with the primary role of monitoring progress against the implementation plan, providing advice on the resolution of any disputes between ECNZ and the SOE Development Groups, and driving the process to achieve the target timetable.
26. At stage three, if the Government decides to proceed, the SOE Development Groups are likely to become SOE Establishment Boards and actual implementation and organisation-build would proceed.
Financial Parameters
Valuation and Financial Structure
27. Issues relating to the valuation of assets, and any liabilities to be transferred from ECNZ to the new SOEs are to be agreed between the Transition Team and ECNZ, subject to the approval of ECNZ's shareholding Ministers.
28. The financial structures of the SOEs are to be agreed by the SOE Development Groups respectively with their shareholding Ministers, in consultation with the Transition Team.
29. To facilitate the separation process, the objective is to transfer assets to the new SOEs at book value. This approach will be followed provided that the shareholding Ministers are satisfied that it is consistent with the overall objective set out in paragraph 1 above.
30. The SOEs will undertake to review their asset valuations and capital structures within 12 months of the separation date (or other such date as agreed between each company and its shareholding Ministers).
31. The purpose of such reviews is to provide an opportunity to adjust the financial structure of the companies to reflect the establishment of long term contracts, and to ensure the companies have asset values suitable for their future operation.
Procedure for ECNZ to Repay Equity Capital to the Crown
32. Following the transfer of assets to the new SOEs, ECNZ will have surplus equity capital.
33. ECNZ will pay the Crown, subject to the Companies Act 1993, the surplus shareholders funds arising from the transfer of assets to the new SOEs.
Expected Financial Flows
34. The timing and amounts of financial flows will be determined by shareholding Ministers on the advice of ECNZ and the Transition Team. Provided the Transition Team and the shareholding Ministers are satisfied that the proposed flows are consistent with the objectives set out in paragraph 1 above, the expected set of transactions to occur on settlement date is as follows:
- the Crown supplies appropriate capital to the new SOEs on the basis of a proposal from the Transition Team that is approved by the Government;
- the new SOEs use these funds for working capital and to purchase a portfolio of assets and liabilities, or shares in a subsidiary company, from ECNZ for cash;
- ECNZ transfers a portfolio of assets and liabilities, or shares in a subsidiary company, for cash to the new SOEs, and uses all of the proceeds to reduce its capital and, if appropriate, make a loan to the Crown. The amount and terms of any loan or any debt finance the Crown supplies to the new SOEs (under the sub-paragraph above) is expected to be identical to the amount and terms of the loan from ECNZ to the Crown.
35. It may be appropriate for ECNZ to use a portion of any loan to the Crown as security for an in-substance debt defeasance transaction. Such a defeasance could assist in protecting the position of ECNZ's creditors, as was the case in the separation of Contract Energy. This is an issue for the Transition Team to address in its implementation plan.
36. The question of whether the separation is implemented by a transfer of assets or shares in a subsidiary is an issue for the Transition Team to address in its implementation plan.
Target Dates
37. The target date for the completion of stage two is 15 December 1998.
38. The target date for completion of implementation is 1 April 1999.
Dispute Resolution
39. If agreement cannot be reached for the purposes of valuation and financial structure (paragraphs 27 and 28 above refer) by a date set by ECNZ's shareholding Ministers, the matters not agreed will be determined by shareholding Ministers.
40. Subject to paragraph 39 above, if a difference arises between during stage two among ECNZ and any of the SOE Development Groups, which prevents agreement being reached between them on a matter referred to in this document by a date determined by the Transition Team or the shareholding Ministers, then, unless the shareholding Ministers determine otherwise, ECNZ and the SOE Development Groups will be bound by the decision of the Transition Team to be given within 14 days of the date referred to above.
Shareholder Directions
41. Shareholding Ministers may issue directions under section 13 of the State-Owned Enterprises Act 1986 in relation to the separation of key asset groups.
42. The Government will consider the option of inviting Parliament to make a minor amendment to the State-Owned Enterprises Act 1986 to clarify that ECNZ's shareholding Ministers may issue directions under section 13 of that Act on key implementation issues. If necessary, the Government will also consider the option of inviting Parliament to empower shareholding Ministers to decide the terms and conditions on which the transfer of assets and liabilities are to take place.
Related Issues
Existing Restraints on SOE Generators
43. In early 1996, shareholding Ministers issued directions under section 13 of the State-Owned Enterprises Act 1986 which:
- prohibit ECNZ and Contact from purchasing any energy company or any significant share in an energy company;
- requires ECNZ to sell eight small hydro stations;
- prohibit ECNZ from building more than 50% of all new capacity (with exclusions for co-generation and renewable technologies such as wind power);
- require ECNZ to 'ringfence' any investment additional capacity;
- require ECNZ to offer specified volumes of longer term financial contracts.
44. These requirements are to be addressed as follows:
- When the transfer of assets from ECNZ to the new SOEs has been completed, the shareholders' restriction on Contact and ECNZ buying energy companies are to be lifted and the SOE generators are to be subject to the same regulatory rules as may apply from time to time on any other market participant;
- The sale of small hydros is to continue in accordance with the provisions of the Memorandum of Understand dated 8 June 1995 between ECNZ and the Government ('the MOU'), except that the MOU will be amended to confirm that the selection of eligible energy companies as potential bidders will also be subject to the restrictions set out in Part C below on lines businesses owning generation businesses.
Explanatory note:
Under the distribution reforms set out below, lines businesses will not be eligible to buy the small hydros. The MOU preference to sell small hydros to "energy companies within the general region of the hydro station" will apply to the former retail part of those companies. It is possible, therefore, that the size of the "general region" for eligible bidders will need to be enlarged to ensure reasonable contestability.This will continue to be considered by Ministers on a case-by-case basis.
- The remaining three shareholder restraints referred to above are to be removed when the transfer of assets from ECNZ to the new SOEs has been completed.
Security of Energy Supply
45. The Government has issued a policy statement on managing the risk of dry years (insufficient rainfall or snow melt into the hydro catchments) and other supply risks, which is set out in the Part D of this document.
46. Final decisions by Cabinet on whether to proceed with the restructuring is subject to obtaining positive affirmation from market participants, especially wholesale buyers, that they accept full responsibility for security of supply risks.
Explanatory note:
In a well-functioning wholesale market with effective competition:
- Responsibility for effectively managing the risks of non-supply should rest with buyers and sellers;
- The Government should not step in to protect players which fail to arrange adequate protection. (To step in would increase the likelihood of future supply shortages by undermining the incentives on buyers and sellers to put in place proper risk management strategies);
- The risk of non-supply can be managed using a variety of mechanisms, including back up generation, load reduction (buying power back), self-generation and hedge contracts;
- Each buyer and seller needs to assess their exposure and determine the most cost-effective risk-management strategy for them. There is no single best strategy for all; and
- The key point is that security of supply risks will not increase as a result of this restructuring so long as each wholesale buyer and seller accepts full responsibility for protecting themselves against the risks. In fact, the Government's advice is that security of supply risks should, over time, be managed more efficiently, with a lower risk of wasting valuable water;
This is why the Government is inviting EMCO to facilitate the process set out above in which wholesale buyers and sellers confirm their acceptance of this responsibility.
The risk of shortage will be reduced during the transition period by the significant surplus of new capacity which is due to come on-stream over the next five years or so.
Environmental Issues
47. The existing processes, protections and penalties under the Resource Management Act apply to the new SOEs.
48. Final decisions by Cabinet on whether to proceed with the restructuring are subject to advice from the SOE Development Groups and officials where appropriate that they have identified any likely changes to station usage and made suitable arrangements to address any environmental issues.
Explanatory note:
In developing this generation reform package, government officials analysed the likely environmental impacts and obtained independent expert review of that analysis by Eden Resources Limited. A copy is available from the Ministry for the Environment.
In summary, breaking ECNZ into three competing SOEs is expected to have little adverse environmental impact and may confer benefits in the short to medium term. Longer term impacts are expected to be positive for the environment compared with maintaining the status quo.
Amongst other things, the reforms encourage retail competition and require that generators and retailers accept responsibility for managing security of supply risks. This should provide incentives for retailers to offer energy services with the least cost combinations of energy efficiency measures and supply to suit customers' individual price, service and security of supply preferences.
The recent experience with supply to the Auckland CBD is one example where the energy retailer and consumers put in place a range of demand side techniques that were cheaper than supply side options.
Demand-side measures help reduce peak power demands and hence the need for new generation capacity. This is significantly less harmful to the environment in the longer term.
Treaty Issues
49. Final decisions by Cabinet on whether to proceed with the restructuring are subject to appropriate consultation with Maori on Treaty issues.
Explanatory note:
The process of consultation is likely to be similar to that followed for the separation of Contact Energy.
Crown representatives will inform each of the relevant Maori groups of the proposals and invite Maori to inform the Crown of any Treaty implications. The Crown will then consider those views with an open mind, in particular the extent to which existing mechanisms protect Treaty claims, before making a final decision on whether to proceed with the proposed split of ECNZ.
For the avoidance of doubt, the Government notes that existing Treaty protection mechanisms, including the system of memorials and powers of resumption in relation to SOE land, will remain in place and apply to the new electricity SOEs.
Next Steps in Cabinet Decision Process
50. Final decisions by Cabinet on whether to proceed with the generation restructuring are subject to:
- Appropriate consultation with Maori on Treaty issues;
- Certification by Transition Team and SOE Development Groups on financial viability;
- Certifications by SOE Development Groups that each new SOE is structured to compete vigorously;
- Obtaining positive affirmation from market participants, especially wholesale buyers, that they accept full responsibility for security of supply risks; and
- Advice from the SOE Development Groups and officials where appropriate, that they have identified any likely changes to station usage and made suitable arrangements to address any environmental issues. Existing protections and penalties under the Resource Management Act are to remain in force.
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