The Commerce Commission has declined a request from Transpower that the Commission amend the administrative settlement it reached with Transpower last year.

Transpower sought an amendment to the settlement in order to remove its exposure to instantaneous reserve fees by allowing Transpower to pass through these costs to South Island generators, rather than being absorbed into Transpower's own operating costs.

Instantaneous reserve fees relate to the cost of back-up electricity generation (or load control, for example, distribution businesses switching off hot water heating) that remains on standby and is available within six seconds or 60 seconds (depending on whether the reserve is fast or sustained reserve) to inject electricity into the grid if required. Calling upon reserve generation covers loss of supply events, such as a line failing or a generator tripping out of service.

In May 2008 the Commission published its decision to accept an administrative settlement from Transpower in respect of breaches of the thresholds set under Part 4A of the Commerce Act 1986. In August 2008 Transpower sought the amendment to its settlement.

The situation causing Transpower to make the application arose due to a combination of Transpower's decision to remove Pole 1 of the HVDC link from service in September 2007 and high spot prices. This caused Transpower's instantaneous reserve fees to increase from a historic high of approximately $3 million, to $14.8 million in the 2007-08 financial year. The fee for the full 2008-09 year is forecast by Transpower to be $18.9 million.

"In declining the amendment the Commission is of the view that a significant increase in instantaneous reserve charges was foreseeable and did not result from exceptional circumstances. Transpower's Board was aware of the risk of instantaneous reserve fees increasing as a result of Pole 1 being removed from service. Having been advised that it would be required to absorb these types of costs within its operating expenditure, Transpower proposed a level of operating costs in its settlement significantly below its own forecast. The onus was on Transpower to accurately forecast and manage its risks and costs. The decision to remove Pole 1 whilst having no alternative capacity in place increased its exposure to reserves; a risk that was fully predictable," said Commission Chair Dr Mark Berry.

"The Commission also notes that settlements are carefully designed to balance incentives for efficiency, risks and rewards, and to ensure an appropriate level of accountability. In order to maintain the integrity of any settlement process, there should be limited ability to make future amendments unless for exceptional reasons."

"The charging methodology for instantaneous reserves has been designed to provide Transpower with the incentives to manage the risk caused by the services it provides. Allowing Transpower to pass these costs through would provide poor incentives for Transpower's future behaviour regarding investment decisions", added Dr Berry.

In addition to considering foreseeability, the Commission also considered the likely financial impact on Transpower of declining this request. In the Commission's opinion the likelihood of any downgrade to Transpower's credit rating as a result of this decision is low, as credit rating agencies take into account a much wider range of factors than just one element of an entity's costs. Exposure to instantaneous reserve fees is a short-term risk as the settlement agreement expires on 30 June 2011, and the HVDC upgrade is scheduled for completion in 2012.

Finally, in making this decision the Commission has also had regard to the Purpose Statement in section 52A of the Act, in particular whether amending the settlement would provide Transpower with incentives to innovate and invest in regulated services, including in replacement, upgraded and new assets. The Commission has decided that to treat instantaneous reserves as pass-through costs under the settlement would not be consistent with, nor better promote, the Purpose Statement.

The decision can be accessed on the Commission's website www.comcom.govt.nz under Targeted Control.

Background

In December 2005 the Commission announced its intention to declare control of transmission services supplied by Transpower for breaches[1] of the price-path thresholds set by the Commission under Part 4A of the Commerce Act 1986 (the Act).[2] Following this announcement, Transpower indicated its preference to resolve its breaches through an administrative settlement. After consultation, the Commission published in October 2007 its preliminary decision not to declare control of Transpower's transmission services and to accept the administrative settlement proposed by Transpower.[3]

After consultation with interested parties and further dialogue with Transpower, on 13 May 2008 the Commission published its decision to accept a revised settlement offer from Transpower.[4]

In accordance with the settlement, the Commission has replaced Transpower's existing price path threshold with three distinct thresholds[5] applying until 30 June 2011.[6] The quality threshold previously set by the Commission continues to apply to Transpower. The settlement has also been formally recorded in a Deed, which was executed on 24 June 2008.

On 28 August 2008, Transpower sought an amendment to the settlement to completely remove its future exposure to instantaneous reserve fees, by treating these as pass-through costs. The settlement constrains Transpower because the operating expenditure included in Transpower's revenue is limited by an amount set in the agreement (set at $199.61 million for 2006/07 (and indexed each subsequent year at CPI-0)).[7] If Transpower is able to make savings in other areas of its operating costs, then any loss resulting from higher than budgeted instantaneous reserve fees would be partially or fully offset. If not, the additional cost is unrecoverable, with this being a risk to Transpower.

On 26 September 2008, the Commission made a draft decision not to accept Transpower's proposed amendment. The Commission's preliminary view was that it would be more consistent with the objectives of section 57E of the Act for Transpower to remain within the thresholds agreed as part of the settlement than to allow Transpower to treat instantaneous reserve fees as pass-through costs.[8]

Having consulted on its draft decision, the Commission has now published its final decision.

[1] Under the Part 4A regime, a breach of the thresholds enabled the Commission to investigate the recent, current and future performance of an identified lines business. Should the performance of the identified business not be consistent with the objectives of the Purpose Statement in section 57E of the Act, the Commission must decide whether control would be necessary for the objectives of the regime to be achieved. Once the Commission accepts an administrative settlement, it closes its post-breach inquiry and makes a decision not to declare control.

[2] Commerce Commission, Commerce Act (Intention to Declare Control: Transpower New Zealand Limited) Notice 2005, New Zealand Gazette, 22 December 2005, Issue 210, p 5382.

[3] Commerce Commission, Draft Decision and Reasons for Not Declaring Control of Transpower New Zealand Limited & Draft Decision on Resetting Transpower's Thresholds, 5 October 2007.

[4] Commerce Commission, Decision and Reasons for Not Declaring Control of Transpower New Zealand Limited & Decision to Reset Transpower's Thresholds, 13 May 2008.

[5] The thresholds set in the administrative settlement between Transpower and the Commission are a transmission revenue requirement threshold, a transmission non-Part F capex threshold, and a system operator services threshold.

[6] Commerce Commission, Commerce Act (Transpower Thresholds) Notice 2008,New Zealand Gazette, 27 June 2008, Issue 106, p 2793.

[7] See definition of 'Indexed Opex' in clause 3 of the Notice.

[8] Commerce Commission, Draft Decision and Reasons for not amending Transpower's administrative settlement to include Instantaneous Reserves as Pass-Through costs, 26 September 2008.