Reasons: intent to declare control of Transpower

Media Release

Issued 31 January 2006/093

Commerce Commission’s reasons for intention to declare control of Transpower’s transmission services

The Commerce Commission today published its reasons for its intention to declare control of the electricity transmission services supplied by Transpower New Zealand Limited, the owner and operator of the national grid. Transpower is a monopoly and is subject to Government regulation administered by the Commerce Commission and Electricity Commission.

In December 2005 the Commission announced its intention to declare control of Transpower’s transmission services. The move followed an inquiry after the company breached regulatory thresholds.

Imposing control can be considered if Transpower breaches its regulatory thresholds and the Commerce Commission is satisfied that control would result in long term benefits for consumers.

The Commission opened its inquiry after Transpower reported breaches of the price path threshold of $2.3m in the pricing year 2003/2004, $67.9m in the pricing year 2004/2005 and $43.2m in the pricing year 2005/2006. In April 2004 Transpower implemented a major price increase (13% for HVAC customers and 16% for HVDC customers). More recently, Transpower has announced further price increases, including an increase of 19% from April 2006, to be followed by a 13% increase in each of the subsequent five years.

“The Commerce Commission has analysed information provided by Transpower about its breaches and given Transpower ample opportunity to explain them,” said Commerce Commission Chair Paula Rebstock.

The Commerce Commission also commissioned analysis of the breaches by the New Zealand Institute of Economic Research. This analysis shows that even after allowing for volume and other adjustments in favour of Transpower the company breached its thresholds by $14.3 million in 2004/05 and a $35.8 million in the 2005/06 pricing year.

“After rigorous analysis undertaken by the Commission and NZIER the Commission is still not satisfied that Transpower’s past breaches can be justified,” Ms Rebstock said. “Therefore, the Commission’s preliminary view is that Transpower’s April 2004 price increase was not justified and the company is likely to have been earning excess profits from the 2004/05 year onward.”

When deciding whether to impose control, the Commission not only considers past threshold breaches, but must also be satisfied that control of Transpower can be justified in terms of ensuring the efficient operation of markets related to electricity distribution and transmission services, as required by the Commerce Act.

The Commerce Commission considers there to be evidence that:

- Transpower approach to the Electricity Commission investment approval processes is likely to result in investment outcomes inconsistent with the objectives of the regulatory regime;

- Transpower’s planned price increases would allow it to recover the cost of investments that have not yet been approved or made; and

- The planned timing of Transpower’s price increases is not consistent with the company’s forecast capital expenditure, and its planned April 2006 price increase is not justified.

“When the regulatory regime was put in place, Parliament and Government envisioned that the Electricity Commission would scrutinise Transpower’s investments to ensure they are efficient and in the long-term interest of consumers. This process also allows alternatives to be scrutinised and debated by the public,” Ms Rebstock said.

“Transpower’s planned investments total $3.4 billion, of which only a small proportion has been approved by the Electricity Commission.”

“The Commerce Commission considers Transpower is effectively seeking to pre-fund substantial investments that have not yet been approved by the Electricity Commission. This could result in today’s consumers paying disproportionately for investments that will benefit consumers well into the future. It could also limit the scope for alternative investments. Even more significantly, the additional revenue Transpower will gain means that there is less incentive for the company to minimise costs, and this may inappropriately transfer risk associated with the investments from the company to consumers.”

“Transpower’s planned investments may ultimately be found to be prudent and be approved by the Electricity Commission,” Ms Rebstock said. “But even if the investments were approved, the Commerce Commission would continue to have concerns about the timing of price rises to cover the cost of those investments.”

In estimating the net benefits to consumers of control the Commission has considered Transpower’s planned price increases; the extent of any excess returns Transpower is likely to earn in the future; and the likely efficiency of Transpower’s future investment plans, including the timing of the investments and the timing of price increases.

Taking these factors into account the Commerce Commission has found that imposing control would result in benefits, which could include:

- Transpower being limited from earning excess profits in the future, including up to an estimated $36 million of excess profits in 2006/2007;

- significant savings due to investment efficiency gains through ensuring that the full application of the Grid Investment Test impacts on Transpower’s investment decisions. These savings are estimated to be between $117 million and $234 million of reduced costs through more efficient investment over the 2006/07 - 2014/2015 period;

- more efficient timing of investments resulting in estimated savings of $31 million to $405 million;

- more appropriate timing of price increases; and

- lower cost implementation of investments.

The Commission estimates the incremental direct costs of control at $3 million, with little additional indirect costs of control.

“Transpower must operate in a manner consistent with the Government Policy Statement, the Electricity Governance Rules and Part 4A of the Commerce Act,” Ms Rebstock said. “The Commerce Commission considers that Transpower is not currently operating in such a manner, and the Commission’s preliminary view is that control would result in significant long-term benefits for consumers.”

After having regard to the views of interested persons, the Commerce Commission will decide whether to proceed with making a declaration of control. Submissions on this paper are due on 27 February 2006, and cross-submissions are due on 13 March 2006.

The Commission intends to make a final decision and publish its decision paper by 5pm Friday 31 March 2006.

The Commission is still consulting with Transpower about the future status of information in the paper currently being treated as confidential.

The Commission’s reasons for its intention to declare control of Transpower can be viewed on the Commission’s website http://www.comcom.govt.nz. Select Industry Regulation/Electricity/Electricity Lines Businesses/Targeted Control.

Background

Part 4A of the Commerce Act came into effect on 8 August 2001 and, among other things, requires the Commission to implement a targeted control regime for the regulation of 28 electricity distribution businesses and the state-owned transmission company, Transpower.
The purpose of the targeted control regime is:
to promote the efficient operation of markets directly related to electricity distribution and transmission services through targeted control for the long-term benefit of consumers by ensuring that suppliers–
(a) are limited in their ability to extract excessive profits; and
(b) face strong incentives to improve efficiency and provide services at a quality that reflects consumer demands; and
(c) share the benefits of efficiency gains with consumers, including through lower prices.

The targeted control regime comprises a number of distinct elements: setting thresholds; assessment and identification; post-breach inquiries (and administrative settlements); and control.

Since the regime was implemented the Commission has twice published its intention to declare control, of Unison Networks’ electricity distribution services in September 2005 and of Transpower’s transmission services in December 2005.

If the Commission makes a declaration of control it can relate to all or some of the services provided by the controlled business. The Commission can then set rules—termed an "authorisation"—governing the prices and revenue of those controlled services for up to five years.

While the business may face penalties if it does not comply with those rules, it can otherwise continue to operate normally.

Furthermore, control is not intended to compensate consumers for any past overcharging that may have taken place. Rather, it is intended to put in place constraints on the controlled business’s future performance.

ENDS

Commission media releases can be viewed on its web site www.comcom.govt.nz

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