New Zealand Legislation: Bills
Bills are proposed Acts
The purpose of this Bill is to implement 3 main policy changes.
The first is to make it easier for owners of lines businesses to sell the output of the generation they were permitted to own under the 2001 and 2004 amendments to the Electricity Industry Reform Act 1998 (EIRA). The objective here is to encourage the owners of lines businesses to invest in permitted generation, especially generation from renewable energy sources.
This policy objective is achieved by—
allowing sales of electricity of up to 100% of the nominal annual output capacity of permitted generation. (Previously, allowed sales were the actual output of the generating station, which could be very variable over time, especially in the case of generation from a renewable energy source, making it difficult to retail to customers):
allowing electricity generated from permitted generation to be traded via financial hedges (to manage spot market risks):
lowering the cost of corporate separation and compliance with arm’s-length rules by—
raising the threshold for requiring compliance to 10 MW (up from the higher of 5 MW or 2% of maximum demand):
allowing the same person to be a director of both lines and supply (generation and retailing) businesses, while requiring at least 1 independent director and not permitting executive directors:
allowing the same person to be a manager of both companies up to a threshold of 30 MW. (Joint staff and premises are permitted without limit.)
The second main change is to narrow the scope of ownership separation requirements to focus on the geographic areas where there is potential for the exercise of market power and anti-competitive practices, namely, where lines and supply are co-located.
This is achieved by allowing owners of lines businesses to be involved in generation and retailing without limits outside of their lines area. Requirements for corporate separation and compliance with arm’s-length rules are also repealed outside of their lines area.
At the same time, existing ownership separation rules are retained where lines and supply are co-located. This is because co-owned, co-located lines and supply businesses have both the incentive and ability to lessen competition in retailing and local generation. Ownership separation removes this incentive and ability.
Where co-located cross-ownership of lines and supply is permitted in order to encourage investment in permitted generation, corporate separation and the requirement to act on an arm’s-length basis is retained in order to reduce the risks of anti-competitive behaviour.
The third main change is to amend the definition of renewables. Currently, the owner of a lines business may only invest without quantity limitations in “new renewables”
, which are defined to exclude hydro and geothermal generation using traditional technologies. The new definition includes all renewables, to reflect the Government policy of encouraging the development of renewable energy.
The effect of the Bill is shown on the following table:
| Generation inside network (or connected to grid but deemed local by Commerce Commission) | Selling inside network | Generation/selling outside network | |||||
|---|---|---|---|---|---|---|---|
| Quantity | |||||||
Restricted to the larger of 50MW or 20% of maximum demand commissioned after 20 May 2003 | Can only sell up to nameplate capacity of qualifying generation | No limits | |||||
The following generation is not counted towards the limit:
| Generation can be deemed local for the purposes of the selling cap if connected to the grid, but only if—
| ||||||
| Governance | |||||||
If more than 10MW nameplate capacity, must—
But are allowed to have same directors on board of lines and supply businesses, provided there is at least one independent director. Above 30MW nameplate capacity—
|
| ||||||
For generation connected to grid, but deemed local—
| |||||||
| Exemptions | |||||||
| Commerce Commission may exempt companies from any or all rules if the purposes of the Act (separation of lines and energy and competition) would be facilitated | |||||||
Clauses 1 to 3 are the standard Title, commencement, and principal Act clauses.
Clause 4 amends the section that sets out the purpose of the Act, to better reflect current policy.
Clauses 5 to 7 relate to interpretation.
Clause 8 repeals section 17 and substitutes new sections 17 to 17F. The current section 17 is the main cross-ownership prohibition in EIRA, which is that no person involved in an electricity lines business may be involved in an electricity supply business, and vice versa. Section 17 is replaced by new rules that—
allow lines companies to invest in generation and retailing outside their local network area, without restriction:
retain the existing quantity restrictions on investment by lines companies in generation connected to their lines (namely, no limit on generation from renewable energy sources or reserve energy, and the higher of 50 MW or 20% of their load for other generation):
make it easier for lines companies to retail, within their local network area, the output of any generation they own within their local network area:
raise to 10 MW the threshold at which corporate separation and arm’s-length rules apply.
New section 17 provides that, if a person breaches the connected generation cap in new section 17A, or the connected customers selling cap in new section 17C, ownership separation is required. This is enforceable under Part 3 of EIRA, by a variety of means, including court action for pecuniary penalties or for an order for divestment of assets. This is enforceable against either the lines company or the generator/retailer or both, if they are already corporately separate.
The connected generation cap in new section 17A is that each person’s connected generation must be commissioned on or after 20 May 2003, and must not have a total annual nominal capacity that exceeds the greater of—
50 MW; or
20% of the maximum demand, in the immediately preceding 3 financial years, on the local network area.
New section 17B sets out other small or encouraged connected generation, including renewable energy, which is now redefined to include hydro and geothermal energy. This small or encouraged generation does not count towards the connected generation cap in new section 17A.
The connected customers selling cap in new section 17C is that no person may sell to connected customers within the local network area more, in total, in a financial year, than the equivalent of the person’s qualifying generation, as defined in that section, within that same local network area.
Selling financial hedges to a connected customer will not count towards the selling cap.
New section 17D sets the new threshold for corporate separation and arm’s-length rules for certain connected electricity businesses.
This section applies if a person is involved in more than 10 MW of connected generation or selling more than 87 600 MWh of electricity from qualifying generation to connected customers.
New section 17E provides that the rules are that—
the businesses must be carried on in different companies:
the arm’s-length rules must be complied with.
New section 17F continues an exemption for Transpower New Zealand Limited.
Clause 9 repeals section 18, which is the 20% aggregate cross-ownership rule. Currently, under section 18, several separate generator/retailers who compete in a lines area cannot buy more than 20% of the lines company (whether or not they are acting as a group or individually).
Clause 10 replaces a heading.
Clause 11 amends section 19, which lists other involvements that are disregarded under the Act. For example, geothermal generation, and generation of reserve energy in accordance with the terms and conditions for that reserve energy set by the Commission, are authorised by this section.
Clause 12 repeals sections 22 to 46C. Many of the provisions of EIRA are now spent, being mainly the provisions that provided for the transition from vertically integrated electricity businesses to separated businesses and other outdated concepts like mirror trusts. In addition, the current exemptions for renewable energy have been moved, in amended form, to new section 17B.
Clauses 13 to 15 are consequential amendments.
Clause 16 repeals Part 4, which provided for the taxation consequences of the separation of vertically integrated lines and supply businesses after 1998. It is now spent.
Clause 17 repeals section 70(1)(c) and is consequential on the repeal in 2001 of the rules relating to agencies.
Clause 18 inserts new section 70A, which requires disclosure of electricity sold to connected customers, and new section 70B, which requires directors to report on compliance with the arm’s-length rules.
Clauses 19 to 23 repeal other spent provisions or make consequential amendments.
Clause 24 amends the arm’s-length rules (which apply to companies that are subject to corporate separation). The amendments—
allow directors of a lines business to be directors of a supply business, in cases where the arm’s-length rules apply to companies, except that at least 1 director must be independent:
allow managers of a lines business to be managers of a supply business if the connected generation is 30 MW or less.
Currently, neither the directors nor managers can be common to both businesses.
Clauses 25 and 26 make consequential amendments to the control provisions of the Commerce Act 1986.
Clause 27 makes consequential amendments to the provision of the Electricity Act 1992 relating to declarations of electricity operator status.
Clause 28 is a transitional provision.
In November 2006 Cabinet agreed to amend the Electricity Industry Reform Act 1998 to encourage investment in generation by lines businesses. This is referred to as the primary November 2006 Cabinet paper. A Regulatory Impact Statement (RIS) was prepared for this Cabinet paper.
Subsequently, in June 2007, the Cabinet Economic Development Committee considered further proposals to address concerns that arose during the drafting of the legislation. This is referred to as the June 2007 Cabinet paper. A RIS was prepared for this Cabinet paper.
These subsequent changes were necessary in order to ensure consistency of the prior agreed changes with the objective of the Act and to guard against unintended behaviour that may arise as a consequence of these changes concerning market power and corporate governance.
This RIS consolidates these 2 prior separate RIS documents.
The Ministry of Economic Development (MED) confirms that the Code of Good Regulatory Practice and the regulatory impact analysis (RIA) requirements, including the consultation RIA requirements, have been complied with. A RIS was prepared and MED considers the RIS and the RIA analysis undertaken to be adequate. A draft RIS was circulated with the Cabinet paper for departmental consultation purposes.
The Electricity Industry Reform Act 1998 (the Act) required full ownership separation between electricity lines (distribution and transmission) and electricity supply (retail and generation) businesses.
The Act has been amended twice. In 2001 the Act was amended to enable lines companies to invest in new renewable generation without limit, and to own any generation up to the higher of 5 MW or 2% of lines peak load, in order to encourage investment in renewable generation and allow lines companies to use generation to support lines functions where that is efficient. A 2004 amendment allowed lines companies to own generation up to 50 MW or 20% of peak load and unlimited reserve generation contracted to the Electricity Commission to improve security of supply.
In addition, changes made to the regulatory regime and market structure since 1998 collectively go some way toward safeguarding against potential abuse of market power. These include targeted price control and information disclosure requirements under Part 4A of the Commerce Act 1986, use-of-system agreements with retailers, and powers to regulate terms and conditions for access to lines by generators (regulations are still under development and should be in place at the end of 2006).
Currently, the Act allows lines companies to invest in unlimited quantities of new renewable generation and in new non-renewable generation up to 50 MW or 20% of lines peak load. Below a threshold of 5 MW or 2% of lines peak load, there are no requirements for line companies owning generation, but above this threshold lines companies must comply with corporate separation and arm’s-length rules.
Corporate separation requires lines companies to set up a separate legal entity for any cross-owned electricity supply business. Arm’s-length rules outline permitted governance arrangements for the 2 entities, including requirements for separate directorship and management, duties not to discriminate in favour of companies in common ownership, prohibitions on sharing information, and requirements for financial separation.
Lines companies also cannot currently hedge the output of their generation for risks related to electricity prices and trade in spot energy.
Lines companies may seek an exemption from any or all of these restrictions from the Commerce Commission. The criterion for approval of exemptions by the Commission is that the purposes of the Act (primarily to ensure effective separation of lines and generation/retailing and to promote competition in generation and retailing) would be facilitated.
Lines businesses have invested very little in generation since 1998, despite amendments to the Act to encourage investment. Lines businesses argue that this is because the corporate separation and arm’s-length rules are difficult to comply with, an inability to trade in hedges and financial instruments makes selling the output of their plant difficult, and seeking exemptions from the provisions of the Act is too challenging because of time taken and the uncertainty involved.
To facilitate investment in generation by lines companies, it is necessary to examine the legislative issues that lines companies state are barriers to their investment to see if current settings are appropriate or if there are unnecessary impediments to investment.
The second June 2007 Cabinet paper addressed issues that have arisen during the drafting of legislation to implement these prior decisions where those issues have the effect of extending the scope of the prior decisions and thereby require further Cabinet decision. The substantive issues to be considered included proposals to—
modify the decision to allow the same person to be a director of cross-owned lines and supply companies in order to maintain the integrity of corporate separation; and
allow the same person to be a manager of cross-owned lines and supply companies up to a threshold of 30 MW generation; and
allow generation connected to the grid to count towards the level of permitted retailing; and
amend the definition of new renewable energy source by removing the restriction on hydro and geothermal generation energy sources and aligning the definition with that in the Resource Management Act 1991.
To facilitate lines companies investing in electricity generation by removing unnecessary barriers to investment without creating opportunities for unwarranted market power to arise.
This option would completely remove the quantity restrictions on lines companies investing in generation and retail. (In effect the Act would be repealed). This option is not preferred, because removal of ownership separation requirements will not only increase investment in generation but will also increase the ability of lines companies to engage in anti-competitive behaviour, including cross-subsidies between line and supply businesses, may allow regional monopolies in the electricity market to emerge, and may lead to lines companies making risky or non-commercial investments.
There are a number of ways (sub-options) in which provisions of the Act could be relaxed (short of removing all restrictions) to facilitate lines companies investment in electricity generation. These are—
(a) removing the requirements for corporate separation and/or the arm’s-length rules, and/or removing all restrictions on retailing. It is not recommended that these restrictions be fully removed as the risks involved are similar to the risks of removing ownership separation as under option 1:
(b) introducing a net public-benefit test for exemptions. A net public-benefit test would be very time consuming and resource intensive, both for companies and for the Commerce Commission. It is not clear that the benefits of introducing such a test would exceed the significant increase in costs required to implement it:
(c) setting a time limit of 60 working days (or longer if agreed with the applicant) for consideration of exemption applications by the Commerce Commission. This would be consistent with time limits for similar exemption processes considered by the Commission and would reduce uncertainty and costs for applicants. However, the indicative cost of this proposal to the Commerce Commission is estimated at $300,000 to $500,000 and, given that few exemption requests are likely to be received, this additional cost is not merited. In addition, if other proposals are implemented, there are likely to be fewer exemptions sought anyway:
(d) allowing generation/retail companies owned by lines companies to trade in financial instruments (hedges) and spot energy. This would enable companies to better manage revenue flows from generation outputs and make generation projects easier and less costly to finance:
(e) raising the threshold at which corporate separation and arm’s-length rules apply to 10 MW generation. If this was the case, lines companies would only incur the substantial costs involved in corporate separation for relatively substantial investments:
(f) allowing cross-owned lines and supply businesses to appoint the same persons to their separate boards of directors. This proposal would reduce transaction and overhead costs and enable lines companies’ directors to maintain an overview of investment across all businesses:
(g) allowing lines companies to invest in generation and retail to customers outside their local lines region without limit without complying with corporate separation and arm’s-length rules (except accounting separation). This would allow lines companies to invest in generation where there was no conflict of interest with other generation in the local network, and where the lines company did not have access to privileged information about customers. A monitoring regime would be put in place to ensure cross-owned supply businesses only retail within their lines region the output of any generation owned within that lines region (that is, connected to local lines). This would likely be in the form of an audited statement to the Commerce Commission annually confirming that the quantity of electricity sold over a calendar year to customers connected to its lines does not exceed the limit of nominal generation capacity owned by the lines company and connected to its lines.
The decision to amend the Act was taken by Cabinet in November 2006 (EDC Min (06) 20/18 refers). The options considered in this paper are extensions to the prior decisions that are necessary in order to ensure the policy is efficiently implemented.
For the recommended options, apart from the status quo, the following alternatives were considered:
directors: an option would be to require more than 1 independent director. However, given the small size of many businesses, it was felt that this would be too onerous and that precluding executive directors would prove sufficient:
managers: options were considered to set the threshold at levels above 30 MW generation, or at a percentage of network demand. Levels above 30 MW were judged to be too large, creating too great an opportunity for inappropriate information sharing. A change from a simple, fixed MW generation threshold to a percentage of demand would significantly increase the compliance and monitoring costs of the Commerce Commission:
grid connection: an option was considered to extend this rule to cover generation connected to adjacent lines businesses. Such an extension would not be warranted because it would weaken the Act’s objective of controlling activities within a lines area.
Officials recommend that some of the rules relating to investment in generation (see paragraphs (d), (e), (f), and (g) as outlined above in Option 2) are relaxed.
The preferred options are—
to maintain the integrity of corporate separation by requiring at least one independent director and by not allowing common executive directors:
to allow the same person to be a manager of both companies, but only up to a generation threshold of 30 MW:
to allow generation connected to the transmission grid to count towards the level of permitted retailing where the generation is clearly local:
to amend the definition of new renewables by removing the restriction on hydro and geothermal generation energy sources and aligning it with the Resource Management Act 1991 definition.
Facilitating lines companies’ investment in generation would help to achieve Government’s objectives as outlined in the Government Policy Statement. In particular, increased generation investment should enhance security of energy supply, and put downward pressure on electricity prices, through increasing competition.
There would be a small increase in costs for the Commerce Commission associated with monitoring cross-owned supply businesses retailing within the local lines region and annual certification of directors’ compliance with arm’s-length rules, which would be met within baselines.
The Commerce Commission has also indicated that it may seek additional funding through the Ministry of Economic Development in order to undertake its existing functions under the Act. Any request will be considered within the budget process.
The proposals will facilitate lines companies’ investment in generation. There will be benefits for lines companies that choose to invest in generation in terms of reducing transaction costs and providing greater certainty for investment by allowing directors to retain an overview of investments, reducing overhead costs for smaller levels of investment by raising the corporate separation generation threshold to 10 MW, better managing returns from investment through being able to use financial instruments such as hedges, enabling investment in situations where there are no incentives on lines companies to behave anti-competitively, and improving the synergies available through co-optimisation of investment between lines and generation. It should be noted that some lines companies would be worse off as a result of the removal of the 2% threshold. However, corporate separation costs will be similar for all lines businesses regardless of the size of the lines business.
For lines companies that choose not to invest in electricity generation, or which invest in electricity generation below the 5 MW generation threshold or 2% peak load threshold (to be raised to a 10 MW threshold), there will be no change in compliance costs. Those lines companies that choose to invest above the threshold will incur increased compliance costs. These are discussed in the business compliance cost statement. However, the benefit to lines companies of being able to invest in and sell generation is likely to be greater than the cost of compliance with requirements that enable them to do so.
There are risks that lines companies investing in generation may engage in anti-competitive practices, disadvantaging generator/retailers competing in the same markets, for example, through cross-subsidisation from their lines business to their supply business, or through concealing costs within their monopoly line charges. However, these risks are substantially reduced by the Commerce Commission monitoring the price threshold regime and information disclosure requirements set out in Part 4A of the Commerce Act 1986 and, therefore, will be able to be managed within existing regulatory frameworks, which have changed substantially since 1998.
It is unlikely that the proposals in this paper will impact significantly on the transmission sector. If lines companies invest in electricity generation, it is likely to be within their own lines networks, or other distributed generation, and may lead to a reduced need for investment in the national grid.
The proposal is likely to result in a net benefit for consumers. Increased investment in electricity generation will enhance security of electricity supply and increase supply and competition, which can act to ensure that delivered electricity costs and prices are subject to sustained downward pressure. In particular, there may be benefits for communities in remote areas, where local generation could contribute to economic development (eg, wood processing), and in cases where the cost of distributed generation is significantly lower than the costs of upgrading transmission, the proposal may lead to lower prices. Costs and risks of cross-subsidy and anti-competitive practices to consumers will be managed within existing regulatory frameworks.
An amendment to the Electricity Industry Reform Act 1998 is category 4 on the legislative programme for 2007. The amendment is expected to be passed in early 2008.
The following government departments/agencies have been consulted on these proposals: the Treasury, Commerce Commission, Electricity Commission, Department of Prime Minister and Cabinet, Ministry for the Environment, Ministry of Consumer Affairs, and Energy Efficiency and the Conservation Authority.
Feedback received has not indicated any significant concerns with the proposals.
This paper was prepared in consultation with the Treasury, the Energy Efficiency and Conservation Authority, and the Commerce Commission.
There was consultation with interested parties in the electricity sector for a period of 3 weeks on the draft Bill.
For any lines companies investing in generation above the 5 MW or 2% peak load threshold (to be raised to a 10 MW threshold), there will be a compliance cost associated with a monitoring regime to ensure that their affiliated supply businesses are complying with requirements to retail within their local lines region only the output of any generation owned within that lines region (that is, connected to local lines). Lines companies would be required to provide an audited statement to the Commerce Commission each year confirming that the quantity of electricity sold over a calendar year to customers connected to its lines does not (on average over the 12-month period) exceed the limit of nominal generation capacity owned by the lines company and connected to its lines. The costs to lines companies would include the cost of keeping records of the quantity of electricity sold to customers connected to its lines, the cost of completing a statement, and the cost of obtaining an independent auditor to have that statement audited.
Compliance costs from the requirement for directors to certify on an annual basis that they are complying with arm’s-length rules will only be incurred if companies choose to share directors across the boards of lines and supply companies. If companies continue to maintain entirely separate boards, costs will remain the same. The compliance cost from certification will be small—directors will be required to sign a statement each year certifying that they will comply with arm’s-length rules and send this to the Commerce Commission. The Commerce Commission will work with lines companies to ensure that they understand how to comply with these new requirements.