Intention to declare control of Vector Limited published

The Commerce Commission has published its intention to declare control of the electricity distribution services supplied by Vector Limited.

The Commission has found that Vector is overcharging industrial and commercial customers across its networks. Vector is also undercharging some residential customers, particularly the Auckland residential consumers who are the beneficiaries of Auckland Energy Consumer Trust, Vector's principal shareholder. By being undercharged, beneficiaries of the Trust are receiving an implicit dividend in addition to the normal shareholder dividend.

The Commission considers that the disparity between customer classes is inefficient and can not be justified. The Commission also found that Vector is earning excessive revenues overall.

Commerce Commission Chair Paula Rebstock says that the Commission's view is that:

• Vector is overcharging some customers and undercharging others. The company is making different rates of return from its 21 different customer classes and these differences can not be justified. For example, during the 2006/2007 year, Vector will earn a 54.4% rate of return on investment from one group of Northern business customers, while it earns only a 4.6% rate of return from Auckland residential customers.
• Vector is earning excess revenues. The Commission's preliminary estimate is that, during the next two years, Vector will earn between $13 million and $75 million in excess revenue per annum. To bring its returns to a normal level, the Commission estimates Vector would need to reduce its charges between 2% and 11% for each of the next two years. (Vector's distribution charges comprise around 20 to 40% of the customer's power bill.)

Ms Rebstock says that the Commission has given full regard to the Government Policy Statement issued on Monday.

"The Commission is committed to ensuring that there is effective investment in New Zealand's basic infrastructure and our regulatory approach takes full account of appropriate infrastructure investment incentives for lines businesses," says Ms Rebstock.

"The Commission considers that Vector's actions are not consistent with the purpose of Part 4A of the Commerce Act, nor with the objectives of the Government Policy Statement.

"Vector is focusing on the short term interests of particular classes of customers who are also beneficiaries of its major shareholder, the Auckland Electricity Consumers Trust. Such customers receive a direct dividend and an additional implicit dividend by being undercharged themselves.

"The Commission's view at this time is that a declaration of control would be in the long-term interest of consumers.

"Overcharging and undercharging are both inefficient - that is, they are harmful to the New Zealand economy," Ms Rebstock says.

"Vector is aware of the imbalances across its customer classes and has had ample opportunity to improve the situation. Instead, during the time that Vector has been aware of the imbalances, the situation has deteriorated further for many groups of consumers.

"Vector is not making sufficient progress in redressing the overcharging of some customers and reducing its excessive revenues, and as a result the Commission has moved to this intention to declare control.

"These are very serious issues," says Ms Rebstock. "Vector is only able to overcharge some customers and undercharge others by abusing its monopoly power."

Ms Rebstock said that Vector was in discussions with the Commission about an administrative settlement, which is an alternative to control. She said the release of the Commission's paper will assist Vector to focus on the long term interest of all its consumers, and will add transparency to the process of removing overcharging.

Background and explanatory tables

The following table shows the rates of return being earned from each of Vector's 21 customer types and the price reductions that would be required for each class to move Vector's returns to a normal level.

Vector's Estimated Return on Investment (%)

Earned across its Customer Groups

Estimated Annual Distribution Charge Reductions

(based on Vector's Target Returns)

Vector. Vector is listed on the New Zealand Stock Exchange. 75.1% of Vector is owned by the Auckland Electricity Consumer Trust. The Trust's beneficiaries are Auckland electricity consumers who are Vector's customers. The remaining 24.9% of Vector's shares are publicly traded on the Stock Exchange.

Electricity distribution services. New Zealand's electricity industry has four parts: generation, transmission, distribution and retail. Distribution services take electricity from the national grid and distribute it to homes and businesses. Vector's electricity distribution charges comprise around 20 to 40% of the average power bill.

The regime. The Commerce Commission administers regulation of 28 electricity distribution companies and Transpower under Part 4A of the Commerce Act. The companies are regulated because they face limited competition, and without regulation could charge too much for their services and earn excess profits.

The companies are regulated by having thresholds set for them that govern the quality of services they deliver and/or how much they can raise their prices by each year. The price thresholds are linked to the Consumer Price Index rate of inflation. The thresholds are a screening mechanism the Commission uses to identify distribution businesses whose performance may warrant further examination, and, if necessary, control of their prices, revenues and/or service standards.

Intention to declare control. Since the targeted thresholds regime was implemented in 2001, the Commission published its intention to declare control three times: of Unison Networks' electricity distribution services in September 2005, of Transpower's transmission services in December 2005, and now of Vector's electricity distribution services. The Commission is now considering administrative settlement offers from both Unison and Transpower. If agreed, these administrative settlements would remove the need for control to be imposed.

Control. If companies breach price or quality thresholds set for them, the Commission can consider imposing control on their electricity services. If the Commission makes a declaration of control it can then set rules termed an "authorisation" governing the prices, revenue and/or quality of those controlled services for up to five years. While the company may face penalties if it does not comply with those rules, the operation of the company will continue to be undertaken by its management and Board of Directors as normal. Control is not intended to compensate consumers for any past overcharging but to put in place constraints on the controlled business's future performance.

Administrative settlement. As an alternative to control being imposed, the company can reach an administrative settlement with the Commission. This usually involves the Commission and the company agreeing to pricing levels and quality measures for a period of up to five years. The result is that prices and quality are maintained at levels the Commission considers appropriate for the long term interests of consumers, without the need to impose control, which can be intrusive and costly.