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Efficiency Of Gas Sector Under Scrutiny

Minister of Energy Pete Hodgson announced today a review of the New Zealand gas sector.

"Having reviewed the electricity industry and introduced the Power Package reforms, it is now time to put the gas industry under scrutiny," Mr Hodgson said.

"The Government's energy policy objective is to ensure that energy is delivered in an efficient, fair, reliable and sustainable manner to existing and potential users. This must include gas as well as electricity."

Labour's pre-election energy policy noted that the gas market may not have developed enough to ensure the most efficient use of this non-renewable resource.

"The key issues for the review include the overall efficiency of the gas sector and the current regulatory environment," said Mr Hodgson. "Factors affecting consumer choice, such as pricing and fixed charges, will be examined. The review will also cover issues relating to gas take-or-pay contracts ¡V including their effect on the efficiency of gas use, and whether they result in gas-fired electricity generation displacing hydro, causing unnecessary water spill."

The review does not include transport gas, such as LPG. The use of gas in transport is covered in the Government's draft National Energy Efficiency and Conservation Strategy, due for release later this month. The management and regulatory regime for exploration is the subject of a separate review.

A detailed discussion paper will be prepared by an independent consultancy, to be chosen by competitive tender in early April. A draft is due from the consultants by the end of June 2001.

Submissions on the discussion paper will be sought from the public and interested parties. Following this consultation, policy options are expected to be considered by the Government later in 2001.

Terms Of Reference
Review Of The New Zealand Gas Sector


To assist in providing advice to the Minister of Energy, the Ministry of Economic Development proposes to commission a wide-ranging review of the performance of the natural gas sector. The objective is to form a view about the degree to which the sector is meeting the Government¡¦s energy policy objective.

The Government¡¦s energy policy objective is to ensure that energy, including natural gas, is delivered in an efficient, fair, reliable and sustainable manner to existing and potential users.

For the purpose of this study, groups of users can be distinguished in the gas market:
(i) tariff customers, that is all domestic/residential customers and those commercial or industrial customers not on individual contracts;
(ii) industrial / commercial users with individual contracts with gas suppliers; and
(iii) large users, in particular those which purchase gas under the Maui contracts. This latter group consists of Methanex, Petrochem and electricity generation.

The study is to cover natural gas sold to these consumers (transport fuels and LPG are excluded).

The study shall
Review the overall efficiency of the gas sector
a review the efficiency of the gas sector in terms of productive, allocative and dynamic efficiency in each of the different parts of the market (production , wholesale, transmission, distribution and retail);
b in conducting the review in ¡¥a¡¦, make particular comment on:
„h whether, and if so to what extent, inter-fuel competition places a restraint on the price of gas for gas users identified as group (i) and (ii) above. Please refer to the attached background paper which includes additional questions relating to inter-fuel competition;
„h whether the prices faced by gas users identified as group (i) and (ii) above are efficient; and
„h whether any barriers exist to the efficient use of gas.

In carrying out ¡¥a¡¦ and ¡¥b¡¦ above, comment should be included on the extent to which pricing environmental externalities would alter the conclusions.

Review the current regulatory regime for gas companies
In light of the conclusions on ¡¥a¡¦ and ¡¥b¡¦ above:
c consider the appropriate methodology for valuation of gas system fixed assets (see attached background note on ODVs);
d consider the impact on efficient outcomes of common ownership of gas businesses by companies operating other network businesses (ie multi-utilities);
e review the regulatory regime for gas , and assess the costs and benefits of any changes. In proposing any changes to the regulatory regime, advice should be provided on:
(i) opportunities for self-regulation by the industry vis-a-vis government regulation;
(ii) distributional effects;
(iii) safety implications; and
(iv) implications for the efficiency of gas use.
Take-or-pay contracts
f review the advantages and disadvantages of take-or-pay contracts;
g assess whether, and the extent to which, existing take-or-pay contracts result in incentives:
(i) to extract gas inefficiently;
(ii) to use gas inefficiently;
(iii) for gas-fired electricity generation to displace renewable resources such as hydro (resulting in unnecessary water spill and leading to unnecessary or excessive greenhouse gas emissions);
h assess the costs and benefits of seeking to renegotiate the existing Maui take-or-pay contracts and provide advice on the feasibility of any renegotiation.


The following questions should be considered regarding inter-fuel competition. This list should not be considered exhaustive.
Relative Prices
„h How does the price of gas compare with other relevant fuels on an energy efficiency equivalent basis in various uses (ie for a range of technologies)?
„h What differential between gas and other energy prices is required, in the short term and long term, to encourage switching?
Decision to Switch
„h In undertaking the work on relative price issues above, comment is sought on the decision-making process involved when assets specific to gas or electricity use are purchased. The factors that may contribute to this decision may be different for the groups of users (domestic, commercial, industrial). Issues include:
„³ what is the major determinant of the decision by consumers to invest in gas relative to electricity: relative energy prices (current and prospective), relative capital costs (including relative length of life of assets), relative reliability of energy delivery, other factors? It would be useful to rank these factors.
„³ is the decision to invest in gas made only when the life of the existing asset expires? What is the life of the key assets in question?
„³ is the necessary information readily available to make an informed choice between gas and other fuels?
„³ do suppliers lock users into supply contracts / prices?
„³ what is the impact of fixed (connection) charges (for gas and electricity) on the decision to invest in gas assets?
„³ do any uncertainties in the regulatory environment impact on decisions to invest in gas?

Market Structure Issues
„h What has been or is likely to be the impact of recent moves to common ownership of gas and electricity retailing / networks on the outlook for inter-fuel competition?
„h To what extent is any restraint on gas prices arising from competition from electricity offset by the impact of gas wholesale prices on wholesale electricity prices, given that gas-fired electricity generation plant can be the marginal plant which therefore determines the spot price of electricity?


The following issues and questions should be considered in relation to asset valuation. This list should not be considered exhaustive.
Why Use Asset Valuations?
„h Asset valuation provides a reference point for a regulatory regime to measure reasonable prices/profits. Are concerns about excessive prices/profits in gas transport markets justified?
Use of ODVs in Gas and Electricity
„h ODVs were chosen for use in the electricity information disclosure regulations for the following reasons:
„³ there was a lack of a good set of book values as the start-point for any form of historical cost based valuation;
„³ to facilitate cross-company comparisons;
„³ ODV mimics asset values in a perfectly contestable market; and
„³ the constraints imposed by the maximum asset values/lives, optimisation and economic valuation rules substitute for a regulator overseeing investment decisions.
„h Pipeline owners have adapted ODVs for use in the gas industry. However, since the Government has not specified an ODV methodology for gas pipelines, there is no assurance of the quality of the valuations. On 1 May 2000, Cabinet authorised drafting to begin on an amendment to the gas information disclosure regulations to incorporate a standardised ODV methodology. Work on promulgating the new regulations is in abeyance.
„h There are alternatives to using ODV to value sunk assets. These include depreciated historical cost, indexed depreciated historical cost, depreciated replacement cost, optimised depreciated replacement cost, or the market value of the assets if line charges were held constant in real terms.
„h The costs and benefits of using ODVs for utility industries has been the subject of some recent reviews . The efficiency and wealth transfer effects of any changes in asset valuation methodologies should be considered.
„h Some specific questions to be considered are:
„³ What criteria should be used in determining an appropriate valuation methodology for gas networks?
„³ What are the pros and cons of each alternative methodology in meeting these criteria?
„³ What is the history of valuations of gas pipeline businesses (focussing particularly on ¡§privatisation¡¨ price and subsequent movements)? Were the privatisation prices determined at arms length?
„³ What are the practicalities of adoption of historic cost valuation approaches using the ¡§privatisation¡¨ price?

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