New pricing limits for electricity distributors; Vector must cut its prices

BusinessDesk report by Pattrick Smellie
The Commerce Commission says Auckland electricity network monopoly Vector is wrong to claim it is being subjected to regulated costs of capital higher than its Australian counterparts.

Vector has repeatedly made the argument in its protracted argument with the competition regulator, saying Vector faces greater business risks than Australian networks and should be reflected in a higher weighted average cost of capital when regulated prices are being set.

Instead, Vector says it faces an 8.77 percent WACC while Australian peers face WACC’s of between 9.4 percent and 9.95 percent.

However, the commission’s deputy chair, Sue Begg, says in slides prepared for an analysts’ briefing in Wellington today that this is not a “like for like” comparison because Vector is not taking into account investor taxes, “notably dividend imputation.”

As a result, Australian network WACCs are in a range of 8.66 percent and 9.17 percent, falling to a range of between 7.08 percent and 7.49 percent on a post-tax basis, well below the 8.77 percent applying to Vector.

The comments were part of the commission’s confirmation of final default price-quality path pricing for 16 electricity distributors, which have been delayed by challenges to the commission’s methodology by Vector, which must cut its charges by 10 percent as a result of the commission’s ruling.

The decisions make only minor changes to the draft decisions already announced in August, and confirm the commission’s view that Vector would be “over-recovering” $121.6 million a year without the price changes.

Vector is also amongst a large group of monopoly operators including ports and airlines seeking a merits review in the High Court of the way the commission has set its final pricing. If successful, that could see today’s confirmed price paths being reopened.

Vector earlier this month lost a final appeal to the Supreme Court over the process the commission adopted to set the price paths.

The NZX-listed company’s chief executive Simon Mackenzie said today’s decision was “as expected”.

“Today’s decision requires a reduction in our electricity distribution prices by an average of 10 percent in 2013, with a further price adjustment in 2014.”

Mackenzie said the regime created “perverse incentives” which made Vector a “victim of its own success” for lowering its costs and improving operational efficiencies. Our focus remains on the merits appeal process, which is well under way, with a decision expected in the first half of next year,” he said.

The only changes of significance in today’s announcements are a decision, at the request of four community-owned lines companies to limit allowable increases in their tariffs to no more than 10 percent in one year, for fear that higher increases would be difficult for customers to afford. The affected lines companies are Alpine Energy, Centralines, The Lines Company, and Top Energy.

Network charges make up around one-third of the cost of electricity, so price rises and falls will not translate into electricity price cuts or increases for consumers of the same size.

Press Release – Commerce Commission
The Commerce Commission has today released its final decision to reset the default price-quality paths for 16 electricity distributors. Two of the distributors will have to reduce their prices, while the remainder will be able to increase their prices if they choose. The new price limits will take effect from 1 April 2013.

“The price limits on electricity distributors have been changed to better align their revenues with their costs. We aim to create an appropriate balance between providing incentives for these businesses to invest in their networks, while ensuring that consumers are being charged based on the cost of services provided in each region,” said Sue Begg, Deputy Chair of the Commerce Commission.

Individual adjustments for electricity distributors on 1 April 2013 vary in size, from a reduction of 10% to an increase of 10% before inflation.

“In those regions where we have determined that there needs to be a larger price increase to support network investment, we have smoothed the increases over a number of years. This has helped to avoid more significant price increases in 2013,” says Ms Begg. Today’s announcement has been able to proceed due to a recent Supreme Court decision. (See background)

The final limits on the total revenue that distributors will be allowed to earn are similar to those set out in the Commission’s draft decision. Changes to the price adjustments since the draft decision are mainly presentational. They result for the most part as a result of receiving better information on the prices that each supplier would have charged if there was no reset. This provides the comparison for the path reset.

“The price reset will eventually flow through to consumers, as either a price increase or decrease on their power bills depending on where they live. The Commission does not set how the distribution price is passed through. Businesses are free to decide how to spread the prices across their customer base, or indeed, in the case of increases may decide not to take up the full amount of the allowable increase,” said Ms Begg.

Distribution charges make up about a third of a customer’s bill. Example calculations of the changes consumers might experience in their electricity bill are attached. The extent of any price changes will depend on how retailers decide to pass on the price increases or decreases to their customers.

If the prices do not suit an electricity distributor’s particular circumstances, they can apply to the Commission for a customised price-quality path.

The Commission has not reset the default price-quality path for Orion New Zealand Limited, the Christchurch based electricity distribution business. Orion is currently assessing whether to apply for a customised price-quality path to deal with rebuild issues associated with the earthquakes. If Orion chooses not to apply for a customised path by early 2013, the Commission will review whether Orion’s default price-quality path should be reset.

You can read the final decision at www.comcom.govt.nz/2010-2015-default-price-quality-path

Background

Supreme Court decision

On 15 November 2012 the Supreme Court held that the Commission is not required to determine a starting price input methodology for electricity distribution and gas pipeline services. This confirmed the decision by the Court of Appeal in June 2012. Auckland-based distributor Vector Limited had argued that the Commission should not be allowed to carry out the price reset for electricity distributors without first setting this input methodology.

What is a default price-quality path?

A default price-quality path is a generic form of regulation that places a cap on prices and sets minimum standards for the quality of service provided to users. The default price-quality path usually applies for five years before it is reset to take account of new information on the performance of suppliers.

What are input methodologies?

Input methodologies are the upfront rules, processes and requirements for services regulated under Part 4 of the Commerce Act, and include default price-quality paths.

Which electricity distribution businesses are covered by this draft decision?
• Alpine Energy Limited
• Aurora Energy Limited
• Centralines Limited
• Eastland Networks Limited
• Electricity Ashburton Limited
• Electricity Invercargill Limited
• Horizon Energy Limited
• The Lines Company Limited
• Network Tasman Limited
• Nelson Electricity Limited
• OtagoNet Joint Venture
• Powerco Limited
• Top Energy Limited
• Unison Networks Limited
• Vector Limited
• Wellington Electricity Lines Limited

Why is the Commission resetting prices now?

The Commission is able to reset the default price-quality paths during the middle of the regulatory period if there is a material difference between the paths that came into effect in 2010, and the paths we would have set if the input methodologies for default price-quality paths had been available at that time.

The Commission previously proposed to reset the default price-quality paths in 2011, however due to a judicial review challenge from Vector, the High Court required the Commission to suspend the process until further input methodologies for the paths had been determined, which occurred in September 2012.

Which electricity distribution businesses are regulated under the Commerce Act?

Electricity distributors provide electricity lines services between Transpower and end-users. All electricity distribution businesses, except for those exempt on the basis of consumer ownership as defined in the Act, must comply with the default price-quality path set by the Commission. Consumer-owned electricity distributors are exempt on the basis that their consumers have input into their business to influence price and quality.

What is the purpose of regulating electricity distribution businesses?

The purpose of regulation under Part 4 of the Act is to promote the long-term benefit of consumers in regulated markets, by promoting outcomes that are consistent with outcomes produced in competitive markets. The outcomes are that suppliers of regulated services have incentives to innovate and invest, improve efficiency and provide services at a quality that reflects consumer demands, share efficiency gains with consumers, including through lower prices, and are limited in their ability to extract excessive profits.

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