8th Annual New Zealand Energy Summit 17 July 2006
Paula Rebstock
Chair, Commerce Commission
SLIDE 1
SLIDE 2
Introduction
1. Good morning and thank you for the opportunity to provide an update of Commerce Commission activity in the energy
sector.
2. Today I will focus on the Commission’s current enforcement and regulatory activities relating to energy.
3. In the enforcement area I will briefly touch on the Commission’s investigation into the electricity industry under
Part II of the Commerce Act.
4. Then I will comment on the joint marketing of gas and the Commission’s recent revocation of its authorisation for
joint marketing of gas from the Pohokura field.
5. Finally I will touch on the Commission’s two recent decisions under the Electricity Industry Reform Act.
6. On the regulatory front I will begin with an overview of electricity regulation under Part 4a, and consider how the
regime is working, and where the biggest gains have been made.
7. Then I will look in more detail at some aspects of the electricity regime including administrative settlements,
information disclosure, pricing issues and incentives for investment.
8. Finally I will provide a brief update on the Commission’s work in the gas control area.
9. I will be happy to answer any questions at the end of the presentation.
Enforcement activities
SLIDE 3
Retail investigation
10. The Commerce Act is one of the key pieces of legislation enforced by the Commission. Part II of the Act prohibits
understandings that substantially lessen competition; price fixing, and taking advantage of market power to deter entry
to a market.
11. At present, we are investigating whether breaches of Part II of the Commerce Act have occurred in New Zealand’s
wholesale and retail electricity markets.
12. In theory, effective competition in a market subjects prices to downward pressure. In an industry with multiple
suppliers, high prices may be due to numerous factors, one of which may be industry participants acting collectively to
increase prices. Alternatively, firms that enjoy a substantial degree of power in the market may have used that power to
prevent competition to keep prices high.
13. There is public debate about whether New Zealand electricity prices have been at workably competitive levels. The
Commission has received complaints from residential and business consumers, not only about prices, but also in relation
to other behaviour in the marketplace. On this basis the Commission opened its investigation.
14. To complete its investigation the Commission requires substantial amounts of complex data. This data has taken
considerable time and effort to obtain, and the quality and availability of industry data (particularly going back four
or five years) has, in many cases, been less than satisfactory.
15. Obtaining robust historic information has been a challenging task and despite the use of its information gathering
powers the Commission is finding that its timeframes are continually being pushed out.
16. While some may consider our requests for information are excessive, it is worth noting that, in many jurisdictions
around the world, much of the data we have gathered for this investigation would have to be disclosed either publicly or
to a regulator as a matter of course.
17. To assist with the analysis of the information the Commission has gathered from industry participants, we have
engaged the economist Professor Frank A. Wolak of Stanford University. Professor Wolak is also Chairman of the Market
Surveillance Committee of the California Independent System Operator for the electricity supply industry in California,
a visiting scholar at the University of California’s Energy Institute and a Research Associate of the US National Bureau
of Economic Research.
18. A major focus of Professor Wolak’s work over the past twenty years has been the empirical analysis of market power.
He will be constructing a measure of the ability of participants in both the retail and wholesale markets to raise
prices above competitive levels. Clearly, factors such as electricity demand, water availability and network
constraints, amongst others, will feed into this analysis.
19. By the end of the investigation, the Commission will have been able to analyse more information about the workings
of the electricity market than any other person or organisation in the past, and will hopefully be in a sound position
to draw robust conclusions about the operation of the market, the competitiveness of observed prices, and the behaviours
of the participants in the market.
20. The Commission is very clear that this investigation is not an inquiry to determine whether policy decisions need to
be made about the structure or design of the market. It is inevitable, however, that information relating to the
structure and design of the market will be thrown up during the investigation.
21. In deciding what information will be made public at the conclusion of its investigation, the Commission will strive
to strike a reasonable and legal balance between protecting the rights of the industry participants under investigation
and the rights of New Zealand electricity consumers and interested parties to transparent, fair and reasoned answers to
their concerns.
22. Critical to the outcome of this balancing exercise will be whether the Commission identifies any anti-competitive
behaviour which should be brought before the Courts. Should there be no basis for legal proceedings, the Commission will
need to consider what information should be publicly provided in the closing investigation report.
23. The Commission is seeking to finish its investigation as quickly as it can, without compromising the integrity of
its processes or the robustness of its analysis.
Joint Marketing of Gas
SLIDE 4
24. The Commission last month revoked an authorisation it had given to the Pohokura joint venture partners to jointly
market gas from the Pohokura field. For those not familiar with the case, in 2003 the Commission concluded that if the
parties in the joint venture (Shell, Todd and OMV) marketed and sold the gas in the field jointly, the gas production
market would be less competitive than it would be if each had sold their equity share of the gas separately. However,
the Commission authorised joint marketing because it was persuaded that joint marketing was necessary to achieve early
production from the field.
25. Things turned out somewhat differently from what had been anticipated. The joint venture parties who had previously
been adamant that separate marketing was extremely difficult and would cause delays in field development of perhaps
seven years, discovered that it was easier than joint marketing and proceeded to sell separately rights to perhaps half
the reserves of the field without it causing any obvious delay in field development. In other words the predominant
benefit claimed for joint marketing (and the one on which the Commission based its authorisation) was lost.
26. As a result the Commission considered it appropriate to revoke the authorisation. Any future variation from separate
marketing of Pohokura gas will put the parties at risk of breaching the Commerce Act.
27. One point to note from this case is that the Commission will have no compunction about revoking authorisations it
issues under the Commerce Act if it is demonstrated that they were based on false or misleading information, or if there
has been a material change in circumstance since the authorisation was granted.
28. The other comment I would make is that the Commission does not have a general objection to the joint development of
gas fields, or the joint marketing of gas from those fields. Each case is considered on its merits. The important
relevant feature of Pohokura is the significance of the field (accounting for something like 39% of New Zealand’s total
reserves) and of the significance of the joint venture parties (which between them have a substantial interest in fields
together accounting for around 77% of total reserves). Other parties with other fields are very unlikely to raise the
same competition concerns.
EIRA
SLIDE 5
29. In addition to our work under the Commerce Act, the Commission also has responsibility for enforcing the Electricity
Industry Reform Act. In 2001 the Act was amended to allow for lines companies to invest in unlimited new renewable
generation activities. However, these investments must still be made in accordance with the corporate separation and
arms-length provisions of the EIR Act.
30. Recently, the Commission considered the first two applications for exemption from these provisions: one from Unison
Networks and the other from Eastland Networks.
Unison exemption granted
31. Unison sought an exemption in respect of its proposed investment in a wind farm by way of a joint venture with Hydro
Tasmania. Unison sought exemption from the Arms Length Rules in the EIR Act and permission to enter into electricity
hedges. Unison did not propose to retail the electricity to customers connected to its own network.
32. The Commission granted a limited exemption to Unison in respect of certain Arms Length Rules relating to the
appointment of managers to the board of the joint venture company. The exemption required the other Arms Length Rules to
be observed. The exemption is also conditional on Unison not retailing the electricity to customers located on its own
network, and on the generation asset not being connected to Unison’s electricity lines networks.
Eastland exemption declined
33. The second wind farm application was from Eastland. Eastland also sought an exemption from the obligation to comply
with the Arms Length Rules and from the prohibition against trading in electricity hedges. Eastland, as part of its
proposal, intended to retail the electricity generated directly to customers on its own network.
34. Following an extensive investigation, the Commission determined that the granting of an exemption would be likely to
give Eastland the incentive and opportunity to inhibit competition in the electricity industry, particularly in those
areas where the distribution network is operated by Eastland.
35. The Commission considered that such incentives and opportunities would include the potential for the lines business
delaying or inhibiting access to its lines by its retail competitors and the lines business having information
advantages regarding customers on its network, to the disadvantage of other retail competitors.
Conclusion on EIRA
36. The Eastland and Unison applications had features in common, including that they were both proposing to build new
renewable generation.
37. While the amendments to the Act allow a lines company to retail electricity from renewable generation, it requires
those companies meet the Arm’s Length Provisions in the Act to limit the extent to which they can favour their own
retail business over others.
38. In its case Eastland was proposing to retail the electricity it generated to users connected to its network, and
this meant that it may be able to inhibit other electricity retailers from competing with its retail business.
39. The important distinction with Unison was that Unison was not proposing to retail its renewable generation on its
network Therefore, Unison would not have an incentive to inhibit retail competition. Accordingly the Commission decided
to give a partial exemption from the arms-length rule to Unison, but found it was unable to give a similar exemption to
Eastland.
Regulatory Activities
Part 4A introduction
SLIDE 6
40. I will now move on to our regulatory activities for electricity and gas lines businesses.
41. Part 4A of the Commerce Act, relating to electricity lines businesses, came into effect on 8 August 2001.
42. Part 4A encompasses a targeted control regime, and also an information disclosure regime, for the 28 distribution
businesses plus Transpower.
43. None of the electricity lines businesses are automatically subject to control of their prices, revenues, and/or
quality of service. The Commission cannot make a declaration of control, and then authorise prices, revenues or quality,
unless a lines business has breached one or more performance thresholds set by the Commission.
44. The Commission has established two such performance thresholds to assess the lines businesses:
a price path threshold; and
a quality threshold.
45. These two thresholds are in effect until March 2009, at which time they will be reset following consultation with
interested parties. I will comment more on the 2009 threshold reset later.
46. First, I would like to make a few observations about the impact to date of the targeted control regime, which has
now been in place since June 2003.
What the regime has achieved
SLIDE 7
47. The price path threshold provides incentives for lines businesses to improve efficiency, share efficiency gains with
consumers, and limit their ability to extract excessive profits.
48. The quality threshold encourages lines business to supply electricity transmission and distribution services at a
quality that reflects consumer demands, and to not let that quality reduce in pursuit of lower costs and higher profits.
49. To comply with the current CPI minus X price path threshold, around two-thirds of lines businesses have had to
reduce their average prices in real terms over the last three years and they face further reductions over the next two
years. Given current inflation rates, all businesses have been able to increase prices in nominal terms. However,
limiting price increases to be less than inflation provides incentives for businesses to make efficiency gains and, over
time, to share those gains with consumers.
50. A small number of businesses can increase their average prices at a greater rate than inflation without the prospect
of further scrutiny from the Commission. This is because the Commission has found that some companies, while they appear
to be relatively efficient, have been setting prices at a level that is not sufficient for re-investment in their
networks over the longer term. The price path threshold is flexible enough to allow for companies in very different
situations.
51. So while the perception may be that New Zealand is moving closer to other jurisdictions’ approaches to regulating
electricity sector monopolies, the targeted control regime is still light handed by international standards. It allows
companies to make their own business decisions about price, quality and investment within broad boundaries of behaviour
and is flexible enough to allow workable solutions to be developed without necessarily moving to control.
What happens when companies breach?
SLIDE 8
52. A breach of a threshold is not necessarily a breach of the law. A threshold breach simply alerts the Commission to
take a look at the circumstances and, if necessary, investigate in more depth the current and future performance of the
business.
53. The Commission must strike a balance. On one hand, we must assure New Zealand consumers that these companies, which
are natural monopolies, are not exploiting their market power.
54. On the other hand we must ensure that the companies are able to run their businesses efficiently and have incentives
to make appropriate investments.
55. To allow us to balance those imperatives, there are a number of options available to the Commission in responding to
a breach of the thresholds.
56. First, the Commission may decide that, following a breach, there is no need to take further action, because the
business may be performing in a manner consistent with the long-term benefits of consumers.
57. Secondly, the Commission may consider it possible to resolve the breach through an administrative settlement between
the Commission and the business concerned.
58. Finally, should the Commission be concerned about the performance of the business, but be unable to reach an
agreement with that business, it cannot automatically impose control. The Commission must first publish its intention to
declare control and then consult with interested parties. It is worth noting that the Commission can enter into an
administrative settlement at any stage of this process.
Administrative settlements
SLIDE 9
59. To date, the Commission has published an intention to declare control for only two lines businesses: Transpower and
Unison Networks. In response, both companies have sought to settle with the Commission. We are also considering
administrative settlement offers from a number of other businesses.
60. The Commission considers that administrative settlements may, in principle and in certain circumstances, produce
better outcomes for consumers. They may allow for greater flexibility, should involve lower administrative and
compliance costs, and are likely to be less intrusive.
61. Each individual settlement would, however, need to result in long-term net benefits to consumers than are
demonstrably equal to or greater than the net benefits of control. This suggests that settlements may need to last for a
number of years, and address as many of the Commission’s concerns as is appropriate at that time.
62. If the Commission decides that an administrative settlement is acceptable in principle, then it will consult
publicly on the terms of that settlement, and whether a settlement is appropriate. Apart from permitting feedback on the
specific settlement terms, any public consultation process would also allow interested parties to provide their views on
the Commission’s proposed broader framework and processes relating to the evaluation of settlements.
63. It is important to make the point that that what might be acceptable to the Commission as part of a settlement
cannot be seen as a proxy for the terms on which control might subsequently be imposed, if a settlement is not able to
be reached.
64. If the Commission is unable to reach an agreement, and it decides that a declaration of control is appropriate, then
further consultation may also take place. This may be the case where there is a sufficient amount of new or updated
information to warrant feedback prior to a final decision on control.
65. One area of concern however, is that the settlement process has in some circumstances been used to relitigate
industry-wide matters, for instance, the Commission’s ODV Handbook. The settlement process should be used to discuss
business-specific matters, and relitigation of past decisions is not an appropriate use of the administrative settlement
process.
66. I should also stress that resolution of significant breaches is not intended to be a lengthy process. While it is
good that some businesses have deferred or reversed price increases in order to work through a settlement, the
Commission will become concerned if the settlement process is too drawn out.
67. If the settlement process does take a long time, it suggests that there are complex issues involved that require a
full “bottom up” analysis of the company to come to an informed view. In those circumstances control may be a more
suitable option than a settlement.
68. Furthermore, the Commission may consider moving much more quickly to announce whether it intends publishing a
declaration of control on the basis of information before it, rather than waiting to see whether a settlement offer
emerges.
Information Disclosure
SLIDE 10
69. Let me now turn to the information disclosure regime.
70. Information disclosure is intended to ensure that businesses make information about their operation and behaviour
publicly available. Timely and reliable public disclosure is a vital part of the regulatory regime.
71. The information disclosure regime promotes a greater understanding of the relative performance of lines businesses
over time, provides information for assessing threshold compliance, and aids in the resetting of thresholds.
72. The Commission is currently undertaking a far-reaching review of the Electricity Information Disclosure
Requirements. This considers the fundamental question of what regulatory performance accounts should look like in the
context of Part 4A, while at the same time assessing the compliance costs to lines businesses of producing disclosure
information.
Asset management plans
73. A key priority for the Commission in this review has been to improve the disclosure of asset management plans, and
the new requirements for these plans were released in March this year.
74. In the Commission’s view, sound asset management planning is an integral part of ensuring that distribution
businesses improve efficiency and provide quality services. The new requirements will see businesses reporting back on
actual versus planned investment and maintenance expenditure, and explaining any differences.
Pricing methodologies and line charges
SLIDE 11
75. The Commission is currently consulting on revisions to the disclosure requirements for lines business pricing
methodologies and line charges. Past compliance against the existing requirements has been a particular concern with all
businesses having been required to re-disclose their 2004 and 2005 pricing methodology information.
76. In the Commission’s view, the disclosure of pricing methodology and line charges is essential for helping different
consumer groups understand the costs and share of profits to which they are contributing when they pay their electricity
bill. Such disclosures also keep industry players informed about pricing and cost allocation policies, thereby
encouraging lines businesses to evaluate the factors which drive their costs and therefore the extent to which their
line charges are cost-reflective.
Financial performance measures
77. The Commission is preparing new financial information disclosure requirements including key performance measure such
as the return on investment. The release of these has been delayed and the Commission will be updating businesses
further on the likely release date. The due date provisions will be amended to allow businesses five months from the
release date in order to complete and audit their disclosures.
78. The Commission will be requiring disclosure under the new financial requirements for the year ended March 2006 to
enable at least two years’ worth of information to be used as an input into the 2009 threshold reset. Lines businesses
will need to cooperate with the Commission on information disclosure if they wish key factors to be taken into account
in the 2009 reset.
79. The Commission is intending to hold a workshop with businesses and auditors to assist with understanding the new
information disclosure requirements once they have been released. The new requirements, together with the targeted
control regime, will constitute the twin pillars of a coordinated and effective regulatory framework.
Key issues going forward
80. I would now like to share with you a number of key issues for the Commission in respect of both the targeted control
and information disclosure regimes going forward.
Threshold compliance
SLIDE 12
81. The Commission has yet to resolve a number of threshold breaches, particularly where the quality thresholds have
been breached due to increases in network outages. Clearance of these breaches has been delayed while the Commission
finalises its criteria for determining whether weather or other events that impact system reliability can be considered
“extreme”.
82. Clearance of price path breaches occurring during the same assessment period has also been held up, as the
Commission considers these breaches together. We intend resolving these over the next few months, as well as those
post-breach inquiries into businesses that have not approached the Commission with a settlement offer.
83. On the subject of threshold compliance, I do also need to express the Commission’s disappointment concerning the
quality of the certifications of threshold compliance statements by some auditors. Should this continue, we may need to
consider introducing a process for certifying the auditors themselves, as is the case in many international
jurisdictions.
Investment incentives
SLIDE 13
84. The Commission is beginning to gear up for initial rounds of consultation on key issues relating to the 2009 reset.
We will be canvassing the views of interested parties as to what extent a number of issues that have arisen in
implementing the regime to date should and could be taken into account in the revised thresholds from April 2009.
85. Possible incentives or disincentives provided by the regime will be a key area of focus, with possible topics
including any impact of the regime on increased distributed generation and changes in the transmission/distribution
boundary.
86. More generally, however, the Commission is particularly interested in views on investment incentives. Much anecdotal
evidence exists regarding the burgeoning capital expenditure needs of the electricity lines sector—the so-called “wall
of wire”.
87. As I mentioned earlier, the recent changes to the disclosure requirements for Asset Management Plans will help the
Commission monitor the need for increased investment on a business-specific and industry-wide basis.
88. These changes, particularly the requirement for businesses to explain discrepancies between planned and actual
investment, will also allow the Commission to monitor whether planned investments actually proceed. Recent experience
from overseas jurisdictions suggests that utilities do not always deliver on their forecast capital expenditures. The
Commission intends exploring the application of possible investment incentive and accountability mechanisms in either
the thresholds, or in other regulatory instruments under the targeted control regime.
89. The Commission is also interested whether the governance arrangements of trust-owned lines businesses might result
in too great a focus on providing short-term rebates to consumers rather than on meeting long-term investment needs. The
Commission would also be concerned if it found that trust-owned lines businesses weighted their investment or pricing
decisions in favour of their consumer owners.
Cost-reflective pricing
SLIDE 14
90. More generally, the Commission has concerns about the level of cross-subsidies between different customer groups.
This has now become a major point of focus for us given evidence that we have uncovered during some post-breach
inquiries to date, as well as through the pricing methodology disclosures. The Commission is very clear that businesses
must not have economically unjustifiable differentials between customers, either by region or by customer class.
91. Companies that do not meet this requirement for any reason need to fix that problem now, as the Commission will take
action to ensure that one group of consumers is not subsidising another. Certainly such imbalances must be corrected
before the 2009 reset, subject of course to relevant constraints that government policy places on pricing.
92. If such businesses breach in the meantime, then this is an issue we may look at closely. If a lack of
cost-reflective pricing appears to remain an industry-wide concern by the time of the reset then we may need to consider
whether the reset thresholds are specifically re-designed to address this issue.
93. On a more positive note, as experience with the regime is gained over the next few years, it may be possible for the
Commission to exercise its discretion not to assess all businesses every year where it is clear that businesses are
achieving efficiencies and quality improvements, and cost savings are being passed on to consumers. This may help to
further reduce compliance costs across the industry.
Gas Control
SLIDE 15
94. I would like to finish the regulatory update with an overview of the Commission’s progress on implementing gas
control.
95. Since the Commission issued the provisional authorisation, we have been working towards issuing a final
authorisation for Powerco’s and Vector’s gas distribution businesses. A Discussion Paper on the form of control was
released last week. It sets out the range of options for form of control and the Commission's initial proposals as to
the appropriate form of control for the controlled services.
96. The Commission proposes using a hybrid form of control with different forms of price control for three separate
groups. For standard consumers the form of control proposed is a weighted average price cap. For non-standard consumers
and for metering consumers a total revenue cap is proposed.
97. For the regulation of quality, the Commission is proposing a form of control that provides financial incentives for
the businesses to maintain quality at the standards that are set by the Commission.
98. Details of the proposed form of control can be found in the Commission’s Discussion Paper on forms of control, and
submissions on this Paper are due by the 7 August. Following this the Commission will hold a conference on the form of
control on 5 and 6 September.
99. The Commission plans to issue the final authorisation in May 2007. It is expected that the pricing impact of the
final authorisation will be felt by consumers through the annual price changes which occur each 1 October.
100. The Commission recognises the importance of giving both the businesses and retailers sufficient time to implement
the final authorisation. However, it is important that there are not unacceptable delays to the process. All parties,
including the retailers, are expected to fully pass the effect of the final authorisation through to consumers in a
timely manner. The Commission will closely monitor the market to ensure that the intention of the Authorisation is
carried through.
101. While the Commission is working towards issuing the Final Authorisation, the 9% and 9.5% price cuts required by the
Provisional Authorisation will remain in effect.
102. The Commission has decided not to amend the provisional authorisation, but if any further price reductions are
found to be necessary when the final authorisation is reached, these can be backdated.
Conclusion
103. In closing, the energy sector continues to be a priority for the Commission, as the effective operation of the
electricity and gas markets are essential to New Zealand’s economic performance.
104. The most important issue for the Commission in the energy sector is investment. Regulatory regimes must facilitate
investment, and consumers must be confident that investment is being planned and carried out efficiently, is priced
fairly, and is subject to public scrutiny.
105. Regulation is often criticised as a barrier to investment, but it is important to note that unregulated businesses
will not always choose to make necessary investments. In New Zealand’s electricity sector we now have a pent up need for
investment, because necessary investment did not occur in the past.
106. An effective regulator will not be swayed by unsubstantiated claims about barriers to investment. Any claims that
regulation is discouraging investment must be substantiated. The Commission is planning substantial work in this area to
consider what the investment needs in the sector are, before the threshold reset in 2009.
107. The Commission is very aware that as a regulator it is our role to ensure that investment does occur, and that it
is efficient, transparent, and meets the long term needs of consumers. We will continue to work with industry to refine
the regime so that the best outcomes can be achieved. And we will continue to maintain our independence, and require
that submissions on investment incentives be substantiated with robust analysis.
108. Of course there is more to the Commission’s role than industry-specific regulation. As I noted at the beginning of
this presentation, we have other tools at our disposal to address market issues that are not covered by regulation, and
where there are competition or market structure issues, the Commission will undertake Commerce Act investigations.
109. And if consumers are not receiving accurate or reliable information to make informed choices, the Commission will
investigate under the Fair Trading Act.
110. Through applying the appropriate tools the Commission can help ensure that New Zealand energy markets are dynamic,
competitive and deliver the energy that is so vital to the welfare of New Zealand’s industrial, commercial and
residential consumers.
111. Thank you for your time today.
ENDS