Part C: Distribution Reforms
Improved Information Disclosure
Objective
51. The measures described in this section are intended to increase the transparency of:
- excessive costs, profits and prices in distribution and the currently non-contestable component of electricity retailing;
- anti-competitive behaviour, in particular cross-subsidisation of electricity retailing (from distribution or non-contestable retail customers), thereby promoting retail competition; and
- cross-subsidies from distribution and non-contestable retail customers to generation.
Current Information Disclosure Regime
52. The current Electricity (Information Disclosure) Regulations 1994 and Handbook for Optimised Deprival Valuation of Electricity Lines Businesses:
- require disclosure of information on electricity companies' financial and non-financial performance. These include disclosure of line charges, access agreements and separate financial statements for distribution, retail and generation businesses; but
- are subject to various shortcomings, for example the financial separation and ODV rules are too open to interpretation These shortcomings undermine the transparency of electricity companies' performance.
Strengthened Disclosure Requirements
53. The Government has decided to amend the Electricity (Information Disclosure) Regulations 1994 and Handbook for Optimised Deprival Valuation of Electricity Line Businesses. The key changes are as follows:
- companies will be required to use a detailed methodology for allocating items among business activities for disclosure purposes, which will require:
- companies' line business financial statements to include only natural monopoly line activities; and
- costs, revenues, assets and liabilities to be allocated amongst companies' line and contestable activities on an "avoidable cost" basis (that is, the line business financial statements will include only those items or components of items which it would require if it were a stand-alone line business);
- electricity retailers will be required to disclose details of their wholesale electricity costs and the revenue obtained from specified electricity retailing customer groups; and
- companies will be precluded from exceeding the standard asset lives and values in the ODV Handbook (the standard lives of some assets are being increased in the new version of the Handbook).
54. Exposure drafts of these amendments were issued for public consultation in 1997. The new regulations are expected to be promulgated shortly and will take effect in 1998/99.
Government-Funded Analysis of Disclosed Information
55. The Government will fund increased analysis of disclosed information by (for example):
- preparing and publishing additional comparisons of companies' performance;
- analysing companies' application of the new allocation methodology;
- monitoring companies' application of the ODV methodology; and
- analysing companies' line charge methodologies.
56. It is expected that this increased analysis will enable ready public comparison of companies' performance.
User-Friendly Disclosures
57. The current information disclosure regime will be further enhanced by:
- requiring companies to disclose line charges on customers' bills; and
- requiring electricity supply companies to publish "user-friendly" summaries of their disclosures (in addition to their full disclosures).
Explanatory note:
Pressure on lines companies to minimise their costs and prices will be increased if their customers can more readily:
- identify and comment on a separate line charge which is comparable across line providers; and
- understand other key elements of the wider information disclosure regime by reviewing simplified summaries.
Impact of Ownership Separation on the Information Disclosure Regulations
58. The changes to the Electricity (Information Disclosure) Regulations 1994 referred to in paragraph 53 above will require further minor amendment in the light of ownership separation requirements described in paragraphs 66 and 67 below, including a requirement for distribution companies to disclose financial statements ring-fenced to lines and separated from any 'other' activities they undertake using an avoidable cost allocation methodology.
Explanatory note:
Ownership separation is not a substitute for information disclosure. The risk of excessive costs and margins in distribution will remain so long as lines are a natural monopoly function. Improved information disclosure regulations are therefore required.
Following ownership separation, electricity distribution companies will be permitted to operate both natural monopoly (distribution) activities and any other competitive services other than electricity retailing and generation. Financial separation will therefore still be required to assist in identifying whether the natural monopoly component of electricity distribution companies have excessive costs or profits (monopoly rents).
Low Cost Mechanisms for Changing Retailer
Objective
59. The measures described in this section are intended to address:
- the failure by the industry to provide low cost systems to enable customers to switch retailer, and
- the risk of anti-competitive restrictions to distribution lines for competing retailers.
Explanatory note:
Customers supplied by competing retailers are required to have half-hourly meters of certain minimum standards of accuracy installed, unless the incumbent company agrees to an alternative form of measurement. (Half-hourly metering is required because electricity is bought and sold on a half-hourly basis.) The costs of installing meters that meet these accuracy standards, and of handling the half-hourly data provided, tend to deter new entry. The current industry rules impose unnecessarily expensive compliance costs on competitive supply.
Lower cost alternatives could be developed to enable customers to switch supplier if they wish. This requires incumbent companies to agree on lower cost rules for assessing half-hourly consumption and data reconciliation. The problem is that incumbent electricity companies have limited incentives to agree on these cheaper alternatives as more of their customers could be competed away.
Measures
60. The Government expects industry participants to establish, by April 1999, a low cost system (or systems) which will enable consumers, if they wish, to switch retail suppliers.
61. The industry is expected to focus, in particular, on developing cheaper systems for assessing and reconciling electricity consumption by domestic and other small customers.
62. The Electricity Market Company Limited (EMCO) and the Electricity Supply Association of New Zealand (ESANZ) are expected to play key leadership roles in facilitating this industry initiative.
63. If the industry fails to make sufficient progress, or to achieve a workable outcome within twelve months, the Government will put in place by regulation a mandatory default system to enable consumers to switch between competing retailers.
64. To support the above, the Government will:
- set out the key policy objectives and principles it expects the industry to meet in developing a low cost switching system. (These are set out in a policy statement in the Part D);
- seek regular (monthly) reports from the industry on progress in developing this mechanism; and
- invite Parliament this year to amend the Electricity Act 1992 to empower the Executive to require the industry by regulation to use a 'default' switching system.
Separation of Distribution from Contestable Electricity Activities
Objective
65. The measures described in this section are intended to address the risks of:
- anti-competitive restrictions on access to distribution lines for competing retailers;
- cross-subsidisation of retail activities from distribution lines; and
- cross-subsidisation of generation activities from distribution lines.
Separation Concept
66. Legislation is to be introduced prohibiting common ownership of:
- electricity distribution; and
- electricity retailing and/or electricity generation.
Explanatory note:
The benefits of preventing vertical integration between competitive and monopoly services are as follows:
- it will eliminate the ability and incentives of a monopoly lines business to:
- restrict access to its network by competing retailers; and/or
- use monopoly rents from lines to cross-subsidise retail customers; and/or
- use monopoly rents from lines to cross-subsidise investments in generation;
- it will eliminate the risks of vertically integrated electricity companies failing to distinguish adequately between the business risks and requirements of:
- the monopoly lines business (on the one hand), where the focus should be on efficient asset management (including security of supply) and cost minimisation; and
- the competitive retail or generation businesses (on the other hand), where the focus should be on managing entrepreneurial risk;
- it will help to better expose the monopoly lines business to closer scrutiny by users and other market participants. The lines businesses will become stand-alone entities which will be more easily targeted for consumer comment, in the same way that Transpower has become more transparent since it was separated from ECNZ in 1994;
- it will encourage the amalgamation of retail businesses to achieve greater efficiencies and stronger competitive choice for consumers; and
- it will encourage the amalgamation of lines businesses to achieve lower costs and better service to users.
Unless integration of monopoly lines with retail and generation is prevented:
- it is likely that, over the next five to ten years, a small number of large regional vertically integrated monopolies will form, each operating within a de facto franchise area with the potential for limited competition and choice for consumers; and
- the Government's overall energy policy objectives of ensuring strong competitive disciplines on costs and prices in retail and generation, and efficiency drivers in distribution which proxy those competitive pressures are not likely to be achieved.
Specific Ownership Rules
67. Legislation will be introduced to implement the following rules (referred to in this section as 'the cross-ownership rules'):
- no person with an electricity distribution business may own more than 10 percent of a business that is involved in electricity retailing or generation in any part of the market, or vice versa;
- two or more persons with an electricity distribution business may not own more than 20 percent in aggregate of a business that is involved in electricity retailing or generation in any part of the market or vice versa; and
- similar rules will prohibit the exercise of material influence by a person involved in electricity distribution over a person involved in electricity retailing or generation and vice versa, whether by contract, arrangement or understanding.
68. The detail of the cross-ownership rules, including definitions of key terms, will be set out in the legislation.
Explanatory note:
In the Government's view clear and strict rules are required for separation between lines and contestable electricity activities to be effective. The formulation of the above rules has taken into account the following key factors:
- the 10 and 20 per cent thresholds recognise that companies with disparate ownership can be disproportionately influenced by concentrated small holdings, which could be used to frustrate the objectives;
- the rules need to minimise incentives to create artificial avoidance arrangements and/or use litigation for tactical purposes;
- the rules need to provide for straightforward enforcement and strong penalties, supplementing Commerce Act remedies; and
- the rules need to minimise opportunities and incentives to maintain indirect control.
Overview of Options
69. All electricity supply companies, however currently owned, must elect either to:
- Option 1: by 1 April 1999, set up a separate trust-owned company for their distribution or electricity retailing/generation activities; or
- Option 2: by 31 December 2003, sell their distribution or electricity retailing/ generation activities and, between 1 April 1999 and the time of sale, operate these activities as separate companies on an arms-length basis.
Option 1: Trust Separation
70. Under this option, electricity supply companies must, by 1 April 1999, sell all or part of their distribution or electricity retailing/generation undertaking to a separate ratepayer, community, customer or charitable trust, or customer co-operative.
71. Where an undertaking is transferred to a new trust pursuant to paragraph 70 above, the cross-ownership rules set out in paragraph 67 above will not apply to the extent that:
- the beneficiaries of the new trust are the same as the beneficiaries of an existing trust; and
- the beneficial interest in the trust is widely held in the community.
72. Where an undertaking is transferred to a new co-operative pursuant to paragraph 70 above, the cross-ownership rules set out in paragraph 67 above will not apply to the extent that:
- the beneficiaries of the new co-operative are the same as an existing co-operative or existing trust; and
- the co-operative is widely held in the community.
73. The exemptions in paragraphs 71 and 72 above from the cross-ownership rules only apply to cases of common trust beneficiaries and common co-operative membership. For the avoidance of doubt, the exemption does not cover:
- the trust-owned companies or co-operative companies themselves (e.g. trust-owned distribution company A cannot purchase more than ten percent of the retail or generation company B);
- other shareholders in the trust-owned company or members of the co-operative company (e.g. non-trust owners are subject to the cross-ownership rules); or
- the trust or co-operative itself (e.g. trusts are subject to the cross-ownership rules where they purchase other businesses).
74. Separated trust-owned or co-operative companies will be required to comply with arms-length principles and rules, which will be set out in detailed legislation.
Explanatory note:
The arms-length principles and rules will require companies to operate as if they had no common ownership. Examples of the arms length principles and rules include:
- no person can be a director of both companies or a trustee of both shareholding trusts;
- the directors or board of one company must act in the best interests of that company (this rule is intended to overcome the provisions in the Companies Act that enable, in particular circumstances, directors of a subsidiary company to act in the best interests of the holding company); and
- in allocating dividends or rebates, the distribution (lines) company must not discriminate among beneficiaries on the basis of whether or not the beneficiary is a customer of the retail or generation company.
The rules will also restrict the information which can be provided by either company (or its directors) to the other company (or its directors), and the uses which can be made of such information.
75. By 1 April 1999, companies will need to have:
- reached a complete and unconditional agreement to transfer their distribution assets and liabilities, or the assets and liabilities of the electricity retailing/generation businesses, to a company in which the new trust or co-operative is a shareholder; and
- ensured that any other shareholdings comply with the ownership separation rules.
76. The conclusive agreement referred to in paragraph 75 above should include:
- an agreed description of the assets and liabilities to be transferred to the trust-owned company;
- details of the way in which the existing contracts of the electricity supply company are to be assigned between the distribution and electricity retail/generation companies;
- details of the procedures to be followed in resolving any outstanding issues; and
- the price or consideration which the trust will make for the assets and liabilities to be transferred.
77. By 1 April 1999, companies will also need to have put in place separate accounting procedures for the two companies.
78. By 1 April 2000, companies choosing Option 1 must have completed the transfer of assets and liabilities to the new trust-owned company, including resolving all outstanding issues.
Option 2: Non-Trust Separation
79. Under this option, an electricity supply company must:
- by 31 December 2003, divest either its distribution or electricity retail/generation activities to any person or entity, except a trust or co-operative under paragraph 70 above, to a level that satisfies the cross-ownership rules set out in paragraph 67 above; and
- from 1 April 1999 until the completion of the divestment required above, operate their distribution and electricity retail/generation activities as separate companies on an arms-length basis. Legislation will set out arms-length principles and rules. These are likely to be similar to those rules set out in paragraph 67 above.
80. By 31 December 2003, companies must have reached a complete and unconditional agreement to transfer their distribution assets and liabilities, or the assets and liabilities of the electricity retailing/generation businesses, to a person (other than a trust or co-operative) consistent with the cross-ownership rules in paragraph 74 above.
Allocation of Customer Meters
81. Under either Option 1 or 2 outlined above, customer meters could be owned by either the distribution or electricity retailing/generation companies. However, financial disclosure rules will require that any customer meters which are owned by distribution companies are to be excluded from the financial statements of the lines business.
Explanatory note:
Meters are a contestable service, likely to be subject to further innovation in the relatively short term. However the Government would be concerned if metering was used anti-competitively. If problems emerge, the Government will review the financial separation requirements mentioned above with a view to imposing stronger regulatory or structural safeguards.
Enforcement, Penalties and Remedies
82. Penalties and remedies will be court-based and set at levels which should effectively deter contraventions. Enforcement will be available to any person.
Explanatory note:
A law has limited effect unless it is effectively enforced. Penalties and remedies under the ownership separation legislation will support the goals of the legislation. This requires that the penalties and remedies are set at a level which means that companies expect in advance that it will be costly to breach the legislation. Enforcement by any person will also sharpen incentives to comply.
The legislation will specify offences, which will include breach of the cross-ownership threshold rules, failure to divest by 1 December 2003, and failure to implement corporate separation or set up a trust by 1 April 1999.
Penalties and remedies could include divestiture of assets, fines, civil damages, injunctions and other orders (for example, corporate probation/supervision, and behavioural undertakings).
Application of Commerce Act
83. Changes are being considered to the Commerce Act such that the distribution and retail/generation companies will not be treated as interconnected bodies corporate.
84. Arms-length arrangements between the companies will therefore become subject to the Commerce Act.
Increased Threat of Price Control
Objective
85. The measures described in this section are intended to reduce the risk excessive (monopoly) costs and margins in monopoly lines businesses.
Measures
86. The credibility of the threat of price control on the monopoly distribution businesses needs to be enhanced.
87. The Government has decided, in principle, to:
- empower the Commerce Commission to apply price control within Government set criteria or thresholds (subject to Ministerial override). The Commission would police compliance by electricity supply companies with the overall objectives of minimising distribution costs and prices while maintaining reasonable levels of quality and service; and
- amend the Commerce Act to enable the Government to obtain advice from the Commerce Commission on thresholds or criteria for the application of price control.
88. Final decisions on these proposals will be made following further work on design and implementation issues.
Explanatory note:
The distribution of electricity is a natural monopoly service. Consumers are not likely to have alternatives to using distribution networks in the foreseeable future (except in limited cases such as where bypass is viable). Distribution businesses therefore face weak downward pressures on costs, profits and prices.
The separation of distribution from retail/generation businesses does not affect this situation. Price control or an increased threat of price control which replicates competitive pressures is therefore needed.
Related Issues
Privatisation Not Necessary
89. Electricity supply companies are not required by the rules outlined above to privatise any part of their business. The rules provide options which enable publicly owned assets to remain in publicly owned hands.
Security of Distribution Lines
90. The Government has issued a policy statement on security of lines which is set out in the Part D.
Implementation
91. The measures outlined in this section will require legislation. The Government intends to introduce an electricity distribution reform bill this year.
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