Part D: Policy Statements and Terms of Reference for the Transition Team
Government Policy Statement: Electricity Pricing and the Regulatory Regime
Objectives
The Government's overall energy policy objective is to ensure the continuing availability of energy services, at the lowest cost to the economy as a whole, consistent with sustainable development.
Electricity is a key input into the production and use of goods and services, in both industry and households. The achievement of the Government's overall energy policy objective is therefore important to both New Zealand's international competitiveness, and the quality and standard of living of New Zealand's population.
Mechanisms
Specific goals necessary for achieving this objective are that:
- Electricity prices should signal the full cost of providing each extra unit of electricity; and
- Electricity costs and prices should be subject to strong and sustained downward pressure.
The Government considers that the above objective and goals are best achieved by:
- Strong competition in all of the sectors of the electricity industry where competition is possible (electricity retailing and generation); and
- Robust regulation which replicates competitive pressures in the natural monopoly sectors of the electricity industry (electricity distribution and transmission).
Wholesale Prices
Under the new market structure, wholesale electricity prices are to be established by a process of vigorous competition between wholesale buyers and sellers, in particular:
- Competition in generation: multiple generators are to complete vigorously against each other in producing electricity and investing in any necessary further capacity;
- Demand-side alternatives: energy efficiency options are to compete actively as an alternative to buying additional more expensive power;
- Competition in contracts: buyers are to be offered a diversity of prices and other terms and conditions for purchasing electricity contracts; and
- Competition in spot market: prices for electricity in the spot market are to be disciplined by effective competition among buyers and sellers.
Transmission Prices
Consistent with its statement of corporate intent (SCI), Transpower is to provide the quality and quantity of transmission services demanded by its customers through a process of contractual agreement. Transpower is to price demanded services in a manner which is consistent with the Government's statement of economic policy issued under section 26 of the Commerce Act 1986. Customers are to make the trade-off between the level and quality of services and their price.
Distribution Prices
As for transmission services, the Government expects distribution companies to provide the quality and quantity of distribution services demanded by its customers through a process of contractual agreement. The Government also encourages distribution companies to enable customers to make trade-offs between the level and quality of services and their price. Before entering into contracts, customers should be invited by distribution companies to take into account the cost-benefit tradeoffs of alternative levels of service. An accompanying policy statement sets out the Government's policy principles in relation to a security on distribution lines.
The Government expects distribution companies to minimise costs while providing the level of service demanded by customers.
The price control provisions in Part IV of the Commerce Act have particular relevance to distribution companies given that they provide a natural monopoly service.
Retail Prices
The measures set out in the Government's reform package are intended to reduce substantially barriers to retail competition. Under the new industry structure, retail prices are expected, in due course, to be established by competition between competing retail suppliers.
Overview of Regulatory Regime
The regulatory regime for the electricity industry will now comprise four key components:
- The Commerce Act which is designed to prohibit and protect against anti-competitive behaviour and the acquisition or strengthening of market dominance;
- Ownership separation of natural monopoly (distribution and transmission) from competitive (retail and generation) electricity businesses;
- The Electricity (Information Disclosure) Regulations 1994 (to be enhanced by further amendments) which are intended to make transparent the operation of businesses in the electricity industry which have market dominance; and
- The threat of further regulation, including price control under Part IV of the Commerce Act, if market dominance is abused.
The Government has decided in principle to empower the Commerce Commission to impose price control within certain thresholds or criteria to be set by the Government. The Commission's decisions to impose price control may be subject to a Ministerial override. Further work on design and implementation for this empowering mechanism is to be completed before the Government makes final decisions on whether to proceed.
Parliament Buildings
WELLINGTON
7 April 1998
Government Policy Statement: Management of Electricity Supply Risk
Background
A key risk to the security of electricity supply in New Zealand is climatic uncertainty. We rely heavily on hydro generation and New Zealand has limited water storage capacity. Unusually low rainfall, or "dry years", can create electricity shortages. The economy will continue to face this risk for the foreseeable future. Its significance will reduce gradually if the proportion of non-hydro generation increases.
On 8 June 1995, when announcing the creation of Contact Energy Limited as an SOE, the Government issued a policy statement concerning the management of "dry year risk". The Government wishes to re-emphasise the principles underlying that statement and to see the electricity industry explicitly take responsibility for managing "dry year" and other supply risks.
Objectives
The Government's objective is to provide a framework which will ensure that "dry year" and other supply risks are managed prudently at least cost to the economy as a whole.
In New Zealand's predominantly hydro system, a key outcome should also be to minimise any wasting (or spilling) of water.
Before 1995
- "Dry year" risk was managed on a central basis;
- ECNZ operated the system to cope with a "1 in 60 dry year" event;
- Wholesale buyers of electricity paid ECNZ a fixed charge of about 1.5c/kWh; and
- The spot price was managed by ECNZ and could not rise above a certain cap.
1995 Reforms
Since October 1996, with the implementation of the reforms announced in June 1995:
- ECNZ's implicit obligation to manage the system to cope with a "1 in 60 dry year" event ceased;
- Responsibility for "dry year" risk shifted to all buyers and sellers in the wholesale electricity market;
- The Government advised that it would not step in to protect buyers or sellers with inadequate risk management strategies;
- Spot prices are determined by supply and demand. Spot prices are no longer capped;
- Better information has become available from the wholesale market process on changing hydrology conditions;
- Buyers are expected to manage their exposure to the risks of shortage, in particular the extremely high spot prices that can be expected in a shortage;
- Sellers (mainly generators) are expected to sell contracts to protect their revenue stream, and to ensure that they have adequate generation available, even in a dry year, to back their contractual commitments.
1998 reforms
Under the restructuring package announced today:
- Responsibility for managing "dry year" and other supply risks will continue to rest with all buyers and sellers in the wholesale electricity market;
- The Government confirms that it will not step in to protect buyers or sellers with inadequate protection;
- Buyers and sellers are likely to employ a range of risk management strategies, including:
- establishing electricity hedge contracts;
- contracting between generators for back up generation;
- contracting with customers for interruptible load (reduced consumption) in the event of a shortage;
- self-generation; and
- self-insurance.
- Other low costs risk management strategies are likely to develop as a fully competitive market becomes established;
- Generators will continue to be expected to provide "dry year" protection only at a quality and quantity that is demanded through a process of agreement with buyers of those services;
- Each wholesale buyer will continue to be expected to make the trade-off between risk and price through the contractual arrangements they agree with generators;
- Spot prices for electricity will continue to be set by competing buyers and sellers responding to changing supply and demand;
- Increased competition in the generation market is expected to cause spot prices to better reflect, among other things, the projected risk of electricity shortage and the value of electricity to buyers in a shortage;
- The market for hedge contracts, and secondary trading of hedge contracts, is expected to become more active and provide more efficient price signals of possible shortages; and
- These developments are expected to improve the quality of information and signals available to buyers and sellers on the risk of a future electricity shortage.
Acceptance of Responsibility
Wholesale buyers and sellers should take a prudent approach to management of their exposure to "dry year" and other supply risks. As noted above, the Government will not step in to protect wholesale buyers who fail to provide adequate protection. Such action by a government would in fact increase the likelihood of future supply shortages by undermining the incentives on buyers and sellers of electricity to arrange put in place appropriate risk management strategies.
One of the guiding principles in the constitution of the New Zealand Electricity Market (NZEM) is:
"To foster markets for electricity which ... allow market participants to identify and take responsibility for managing risk."
Before making final decisions on generation restructuring the Government wishes to see the wholesale buyers and sellers of electricity explicitly accept responsibility for managing their exposure in relation to "dry year" and other supply risks.
To this end, the Government has asked the administrator of the NZEM and MARIA Rules to facilitate a process to enable the principles set out in Part D of this policy statement to be adopted in substance by the parties to those rules. This process is to be completed no later than 1 December 1998.
The Chairperson of the Electricity Market Company (EMCO) has been asked to report to the Minister of Energy every two months on progress in this regard.
Parliament Buildings
WELLINGTON
7 April 1998
Appendix: Principles for Managing Electricity Supply Risks
- Dry year and other supply risks should be managed in such a way as to minimise overall costs to the economy.
- Responsibility for managing risks relating to supply rests with wholesale buyers of electricity and their consumers.
- Generators are responsible for providing protection against supply risk at a quality and quantity that is demanded by their customers and established in contracts .
- Spot and contract prices in the wholesale market should signal the changing risks of a dry year event.
- A range of mechanisms are available to market participants to manage dry year and other supply risks, within and outside the wholesale market.
- The trade-off between the costs of supply and protection measures should be made by those at risk.
- The wholesale market rules should not be biased against any particular protection mechanism.
- The Government is not expected to step in to protect wholesale buyers who fail to put in place adequate protection arrangements.
Government Policy Statement: Security of Electricity Lines
Background
Lines businesses own and operate the equipment (lines, cables and transformers) which connect the transmission grid and/or local generation to individual customer premises. The quality and security of electricity supply depends in part on the age and condition of equipment, the availability of backup and the way in which the lines business manages its network.
Customers generally want a high level of supply security. However there is a trade-off between the level of supply security and cost. Absolute security would normally be prohibitively expensive (except for some industrial processes where uninterrupted supply is critical). Cheaper alternatives may be available, such as insurance, backup generation and self-insurance.
Security standards for the distribution network have traditionally been set by lines businesses often with engineering considerations taking primacy. Consultations with customers have been limited.
Objectives
The risks of failure of the distribution network need to be managed in a way which minimises overall costs to the economy.
Mechanisms
This is best ensured through contractual negotiations between the lines business and the party or parties, such as individual customers, customer groups or retailers, paying for the lines service.
This provides the right incentives for users, informed by the lines business and other interested parties, to make trade-offs between security standards, risks, costs, and alternatives.
Smaller Customers
It may appear that smaller customers, which have few if any alternatives to full reliance on the lines business, are vulnerable to unilateral decisions on security standards and costs by the lines business. These unilateral decisions can be reflected in contracts which have been imposed in circumstances where consumers (either individually or through representative groups) have had little or no input into the terms of the contract. Where that occurs, the courts are likely to review critically the terms of such contacts, particularly exclusion clauses that purport to eliminate, or greatly reduce, the liability of lines businesses for failure to provide reasonable security of supply.
The development of competition in retailing, which will be accelerated by the separation of lines and retail/generation businesses and the other measures being taken by the Government, is likely to improve the negotiating position of consumers. Retailers are likely to become the intermediaries between lines businesses and end customers. Retailers will want to contract with lines businesses for the provision of lines services to their customers, and retailers which are able to offer the best trade-off between price and supply security will have a competitive advantage. This will help ensure customers are well informed on price and security trade-offs.
Lines businesses and retailers are expected to provide information so that all consumers can evaluate the cost-price trade-offs of alternative security arrangements before entering into contracts for line services.
Retailers
Retailers, after they have been separated from lines, are also expected to ensure on behalf of their customers, that contracts with lines businesses include appropriate liability provisions for failure to provide reasonable security of supply.
Principles
The following principles should be taken into account in establishing contractual arrangements for line services:
- The risk of failure of lines should be managed in such a way as to minimise overall costs to the economy;
- Minimising costs requires a trade-off to be made between security standards and costs in comparison with alternatives such as insurance, self-insurance and back-up generation;
- The trade-off between security standards and costs is best made by users after full consideration of alternatives;
- Lines businesses should ensure that users are adequately informed and consulted about options when developing contracts and considering major investments or changes in network management practices; and
- Decisions on security standards along with penalties for non-performance should be incorporated in contracts between lines businesses and users.
Parliament Buildings
WELLINGTON
7 April 1998
Government Policy Statement: Choice of Retail Supplier for All Consumers
Objectives
The Government considers that all consumers should have choice of electricity retail suppliers. Electricity retailing is not a natural monopoly. Competition should be able to develop for all consumers (including domestic and small consumers) in all parts of the retail market.
Background
Competition in electricity retailing requires that competing retailers each use the same distribution network for transport of electricity. This requirement is analogous to Clear and BellSouth requiring use of Telecom's communications network in order to provide national calling and cellular services, respectively.
Competition requires that the incumbent and new entrant retailers agree on a way to reconcile the amount of electricity (transmitted through the distribution network) that each purchased from the wholesale electricity market. As electricity is sold on the wholesale market on a half-hourly basis, this reconciliation needs to take place for each half-hour.
The Metering and Reconciliation Information Agreement ("MARIA") sets out the current basis on which this is done:
- The consumption of consumers supplied by entrant retailers is measured using half-hourly time-of-use meters (unless the incumbent retailer agrees to an alternative form of metering) and this data is supplied to the National Reconciliation Manager ("NRM");
- The network losses are allocated amongst the incumbent and entrant retailers by the distribution network and this information is supplied to the NRM; and
- The difference between the total electricity sold to entrant retailers (including the losses allocated to each entrant retailer) and the bulk supply meter reading (which measures electricity transmitted into the distribution network) is calculated in order to determine the incumbent retailer's wholesale electricity cost.
Problem
These metering and reconciliation requirements impose substantial costs on entrant retailers which incumbent retailers do not incur. These costs are higher than the gross margins for most retail consumers at present, particularly domestic and other small consumers (current technology means that the cost of half-hourly meters, including meter reading, is expensive).
Incumbent retailers have little incentive to develop cheaper alternatives that would overcome this barrier to retail competition.
Measures
The Government intends to facilitate the development by the electricity industry of a cheaper system for measuring and reconciling electricity consumption. To this end:
- The Government expects the industry to develop by 1 April 1999 a low cost metering and reconciliation system, which will enable all consumers (including domestic and other small consumers) to switch retailers if they wish;
- The industry's low cost metering and reconciliation system should:
- be kept simple to minimise costs. (For example, serious consideration should be given to arrangements in which a 'profile' for half-hourly consumption by consumers without half hourly meters is derived by deducting the amount of electricity used by consumers who have half hourly meters from the total amount supplied through a grid exit point. Alternatively, given the large numbers of smaller consumers without half hourly meters, profiles could be established using statistical sampling techniques);
- not preclude or discourage the development of time of use meters. (Half-hourly meters have the advantage of accurately conveying price signals to consumers. Their cost is falling rapidly. Progress is required however in lowering the cost of data management and reconciliation to facilitate the use of half-hourly meters); and
- comply with the Commerce Act. (The industry's process should provide for the possibility of having to obtain an authorisation from the Commerce Commission);
- The Government will seek monthly reports from the industry on its progress in developing this low cost metering and reconciliation system;
- If the industry fails to establish a low cost metering and reconciliation system by 1 April 1999 the Government will introduce a mandatory 'default' system by regulation; and
- To this end, the Government will invite Parliament this year to amend the Electricity Act 1992 to empower the Government to make the regulations referred to above.
Parliament Buildings
WELLINGTON
7 April 1998
Terms of Reference for the Transition Team
Purpose
The document outlines the key tasks of the Transition Team which is to oversee the implementation of the proposed restructuring of ECNZ. It is addressed to the chairman and members of the board of the Transition Team.
Objectives
The Government's 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.
Outline
Major assets are to be allocated among the three SOEs as follows:
- SOE 1: Waikato system
- SOE 2: Huntly station, Te Awamutu station + Tongariro system
- SOE 3: Manapouri + Waitaki systems
Final decisions by Cabinet on whether to proceed are subject to:
- appropriate consultation with Maori on Treaty issues;
- certifications on the financial viability of each new SOE;
- certifications that each new SOE will compete vigorously against all other market participants;
- 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.
General Tasks
The Transition Team's tasks are to carry out the tasks referred to in Part B of this document, in particular -
- to develop, within around two months, in consultation and (if possible) agreement with ECNZ, an implementation plan with the key steps and strategies for achieving the split of ECNZ, and
- to drive the preparation and implementation processes -
in both cases, within the principles and parameters set out in Part B above. The implementation plan is to be approved by ECNZ's shareholding Ministers.
Treaty of Waitangi
The Government will consult Maori on Treaty issues relating to the proposed split of ECNZ. The Government's final decision on whether to proceed is subject to this consultation.
Security of Supply
The administrator (EMCO) of the New Zealand Electricity Market Company (NZEM) has agreed to facilitate a process to clarify how electricity supply risks are to be managed in the proposed market structure. Key elements of this process are as follows:
- As part of the reform package, the Government has issued a policy statement on managing the risks of energy shortages. A set of principles are attached to that statement.
- EMCO will facilitate a process by which market participants can vote to adopt these principles as part of the New Zealand Electricity Market (NZEM) and Metering and Reconciliation Industry Agreement (MARIA) constitutions. This would provide positive affirmation that market participants, in particular buyers, accept the responsibility for insuring against dry year risks, and that neither the Government nor its SOEs will step in to insulate any parties which failed to protect themselves adequately against supply risk.
- The NZEM and MARIA rule change processes need to be completed before the Government makes final decisions on whether to proceed with the split of ECNZ.
- The Chairman of EMCO has been asked to report to the Minister of Energy every two months on progress in this matter.
Implementation Principles
The Transition Team's role is to assist in preparing and (subject to final decisions by Cabinet) establishing the new SOEs in a way that meets the Government's objectives as set out above, in accordance with the implementation principles set out in Part B. In addition:
- preparation and implementation should meet the timetable set out below;
- the Transition Team's expenses are not to exceed the amounts appropriated for that purpose.
Specific Tasks
The Transition Team will develop a detailed framework for implementing the restructuring, including any contracts:
- for the transfer of stations to the SOEs as follows:
- SOE 1: Waikato stations
- SOE 2: Huntly + Tongariro stations
- SOE 3: Manapouri + Waitaki stations
- for the transfer to the SOEs of all related assets rights as described in Part B;
- for the transfer to each new entity of:
- staff associated with the relevant power stations; and
- ECNZ's current head office staff, as agreed with the Interim Development Group for each entity.
- to provide the new entities with duplicates of all intellectual property required to achieve the Government's objective set out above. (The new entities will pay for any reasonable duplication costs);
- to address, in accordance with Part B, ECNZ's existing major contracts, including its debt obligations, the Comalco contracts, the Fletcher Challenge Energy heads of agreement relating to gas, the gas supply contract with Contact Energy, and ECNZ's existing hedge and bilateral contracts relating to electricity supply or pricing;
- to address such other agreements as are necessary for the SOEs to commence operations as fully separate companies on 1 April 1999; and
- for capitalising each SOE in accordance with the financial parameters set out in Part B and below.
The Transition Team is also to carry out such other actions as are necessary to achieve the Transition Team's objectives and tasks, as may be agreed between the Transition Team and ECNZ's shareholding Ministers.
Design of Financial Transactions
Implementation of a three-way split will involve a relatively complex set of commercial transactions involving ECNZ, the Crown and the SOEs. In summary, the Crown's objectives for the Transition Team in designing the financial transactions will be to:
- split the Crown's existing shareholding in ECNZ into equivalent holdings in the three SOEs;
- achieve the split without a net capital injection. (New capital would only be injected if it is absolutely and if it is approved by Cabinet on the recommendation of Shareholding Ministers, in consultation with the Transition Team. The Crown seeks to minimise new equity while providing for commercial viability);
- issue debt to the SOEs at such time as they can arrange their own debt raised from financial markets. (This is likely to match an equivalent loan to the Crown from ECNZ);
- protect the position of ECNZ's existing debt-holders. (This could involve a Government guarantee of some or all of ECNZ's existing debt. There would be no Government guarantee of debt raised by the new entities); and
- minimise the Crown's residual risks and obligations to third parties during the transition phase.
ECNZ's Legal Form
The Transition Team's implementation plan is to address the questions relating to how ECNZ's existing legal form should be treated in the restructuring, having regard to the implementation principles referred to above. If ECNZ becomes SOE 3, it is intended, nevertheless, that ECNZ should still go through the SOE development process referred to below for strategic, financial and organisational planning purposes.
Executive Support for Transition Team
The Transition Team is expected to engage executive staff to assist in carrying out its tasks. The executive staff will be accountable to the Transition Team board.
Certification by Transition Team
Before the Government makes final decisions on whether to proceed with the separation, the Transition Team will be invited to provide written certification to the Government that the overall arrangements which have been established ensure that, in the opinion of the Transition Team members, the Government's objectives and principles referred to in these terms of reference are likely to be achieved. The Government will have regard to the certification report in making decisions on whether to proceed with the split.
Interim Development Groups (IDGs) for Each SOE
Subject to satisfactory progress by the Transition Team, ECNZ's Shareholding Ministers will appoint an IDG for each SOE. Each IDG would have its own terms of reference and will be responsible to shareholding Ministers.
Each IDG will represent the interests of a proposed SOE until that SOE is formally established with its own board and management.
The IDGs will be required to:
- establish detailed arrangements for the proposed transfer of assets and liabilities within the Government - approved implementation plan; and
- develop detailed business plans covering human resource, financial structuring and organisation-build.
Before making final decisions, the Government will consider certification reports from each IDG on viability and competitiveness issues. The certification reports also should address factors relevant to those issues, including:
- projections of expected financial performance;
- gas supply arrangements;
- arrangements for dispatch and scheduling;
- arrangements for sharing any non-duplicable strategic resources (e.g. modelling staff or hardware);
- the division or sharing of intellectual property;
- environmental issues; and
- any other critical success factors.
Role of the Transition Team Once the IDGs are Established
Once the IDGs are established, 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.
In relation to dispute resolution, the Transition Team is to identify areas of dispute, whether between IDGs, or between an IDG and ECNZ. Where possible, the Transition Team should seek to resolve each issue. Where this is not possible, the Transition Team is to refer the issue to shareholding Ministers for resolution, along with its recommendations for how Ministers should proceed.
Timeline
The target dates for the Transition Team's work are:
- 15 April 1998: Transition Team commences work
- 31 May 1998: Transition Team makes progress report
- 30 June 1998: Transition Team makes progress report
- 30 June 1998: Interim Development Groups appointed
- 15 December 1998: Government considers advice from the Transition Team and the outcome of Treaty consultations and security of supply issues and decides whether to confirm its decision-in-principle.
If the Government decides to proceed
- By 1 April 1999: Settlement of financial arrangements and separation of staff. Three SOEs commence operations as stand-alone companies
Any changes to this timetable are to be agreed by shareholding Ministers and the Transition Team.
Accountability
The Transition Team will be accountable to the Minister of Finance and the Minister for State-Owned Enterprises for the delivery of its outputs within the specific times and budgets agreed with the Ministers. In this context, the Transition Team will be required to provide a detailed work programme, budget and business plan prior to 15 May 1998.
In respect of matters relating to energy policy issues, Shareholding Ministers will consult with the Minister of Energy.
Back to Top