Final decision on Transpower allowances, quality standards

Commission releases final decision on Transpower’s allowances and quality standards

The Commerce Commission has released its final decision on the allowances for operating and base capital expenditure, quality standards, and reporting requirements that will be used to set Transpower’s price-quality path for the next five year regulatory period which begins in April 2015.

The price-quality path sets the maximum revenues Transpower can recover and will be finalised in late November this year when the cost of capital for the regulatory period has been set and other components of the path finalised.

The Commission has provided final operating and base capital expenditure of $1.29 billion and $1.13 billion for Transpower, which it estimates will allow Transpower to increase its total revenues by 4-5% over the regulatory period. The final expenditure allowances include the reinstatement of $76.9 million of base capital expenditure and $51.8 million of operating expenditure, including $19.7m of insurance costs removed in our draft decision.

Commerce Commission Deputy Chair, Sue Begg, said that this represents a significant narrowing of the gap between the numbers originally proposed by Transpower and the Commission’s draft decisions. “Transpower provided additional justification and evidence to support much of the expenditure removed in our draft decisions. Transpower also accepted the Commission’s view that some of the proposed expenditure was not required,” said Ms Begg.

An asset health incentive scheme will be implemented to incentivise Transpower to deliver the work programme it proposed to carry out with $34.2m of reinstated replacement and refurbishment expenditure. A further suite of incentives will be implemented to promote efficiency, including for the first time the introduction of quality performance measures that are linked to revenue.

Ms Begg said, “The allowances provide a clear direction for future development. We believe the package of allowances and incentives will allow Transpower to prudently manage its network and prioritise investment to achieve quality outcomes demanded by its customers.”

“Transpower has made significant progress since the setting of its first price-quality path in 2011. However there are a number of areas where further improvements could be made such as governance around development of its expenditure forecasts, targeting of expenditure, and performance measure development,” Ms Begg said. The Commission has suggested that Transpower address a number of specific areas before the process for the next regulatory cycle begins in 2018. The reinstatement of $9.4 million of investigations expenditure will assist the completion of these improvements.

All documents relating to this decision can be found on the Commission’s website - http://www.comcom.govt.nz/regulated-industries/electricity/electricity-transmission/transpower-individual-price-quality-regulation/transpowers-price-quality-path-from-2015-to-2020/

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Key changes from the draft decision to the final decision
1. Transpower included better support for its enhancement and development expenditure in its submission. That evidence was reviewed and $38.4 million was reinstated.
2. $34.2 million replacement and refurbishment grid expenditure has been reinstated pursuant to Transpower’s proposal of an asset health measure incentive scheme to address concerns around deliverability.
3. Flexibility has been increased around the reporting of non-revenue linked performance measures.This will enable the development of measures which best meet consumer demands.
4. A number of items of operational expenditure have been reinstated after consideration of submissions.

Background
Transpower New Zealand Limited is the owner and operator of the national grid. As system operator it also manages the real time coordination of the electricity market. Transpower is a State Owned Enterprise.

In markets where there is little or no competition, the Commerce Commission regulates the price and quality of goods and services to benefit consumers.
Individual price-quality regulation
Since April 2011, Transpower has been regulated under Part 4 of the Commerce Act 1986 by way of individual price-quality regulation. Under individual price-quality regulation, the Commission sets the maximum revenues that Transpower is allowed to earn from its customers and the quality standards it is required to meet for each year of a regulatory period.

A regulatory control period (RCP) typically lasts for five years. The first regulatory period (RCP1) under the Act ran from April 2011 to 31 March 2015. The second regulatory period (RCP2) will run from 1 April 2015 to 31 March 2020.

Price-quality path regulation is designed to mimic the outcomes of competitive markets so that consumers benefit in the long term. This includes making sure suppliers have incentives to innovate and invest in their infrastructure, and to deliver services efficiently and reliably at a quality that consumers expect, while limiting businesses’ ability to earn excessive profits.

Transpower's maximum allowable revenues are based on operating and base capital expenditure approved by the Commission before the start of the regulatory period, as well as the allowed rate of return on the existing asset base, and the additional capital expenditure approved during the regulatory period for major capital projects. Transpower also has a range of incentives mechanisms which encourage efficiency by providing Transpower the opportunity to earn additional revenue.

The Electricity Authority estimates that transmission charges make up about 7.5% of a typical household electricity bill.

Process for setting Transpower’s individual price-quality path
On 2 December 2013, Transpower proposed operating and base capital expenditure allowances and grid output measures for 2015 - 2020. The expenditure allowances are used to calculate maximum revenues, while quality standards comprise a subset of grid output measures.

On 10 February the Commission published an issues paper seeking submissions and cross-submissions on our initial view of the proposal. All papers, submissions and cross-submissions are available on the Commission’s website.

On 15 May the Commission published a draft decision and reasons paper on the expenditure allowances and quality standards for RCP2 as well as how Transpower’s maximum allowable revenue will be calculated for each year of RCP2. We received submissions and cross submissions on the decision which are also published on our website.

This final decision sets out the base capex and opex allowances, grid output measures and quality standards for RCP2. Transpower will be issued with an information gathering notice that will require it to apply the values to calculate a draft forecast maximum revenue for each year of the regulatory period.

We expect to publish our final determination that sets out Transpower’s maximum revenues, quality standards and grid output measures by 28 November 2014. The determination will take effect from 1 April 2015.

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