Amendments to the Electricity Industry Reform Act 1998

Friday 26 September 2008

A decade ago, the electricity industry went through fundamental reform as a result of restrictions on the ownership or operation of both a line network business and a generation retail business. The amendments to the Electricity Industry Reform Act further water down the strict rules on separation. A lines company can now own and operate new renewable generation and sell the output to consumers connected to its network. Certain other combinations of line businesses and generation retail businesses are also now permitted. In this article, partner Garry Downs, senior associate Louise Hill and solicitor Sukhdeep Johal outline the latest amendments and describe their impact.

Introduction

The Electricity Industry Reform Amendment Act 2008 comes into force on 14 October 2008.

As previously reported in the Summer 2008 issue of Commercial Quarterly, the amendments are intended to further relax the ownership separation rules and restrictions for lines companies and generation/supply companies. The Amendment Act seeks to encourage lines companies to invest in permitted generation, particularly renewable generation. It proposes to achieve this by:

• allowing line companies to invest in new renewable generation within its network and sell the output to consumers connected to its network;

• relaxing some of the corporate separation and arm's length rules relating to generation and retailing;

• allowing electricity lines businesses to sell to consumers on their network more of the electricity they are permitted to generate;

• allowing electricity lines businesses to hedge the output of their generation; and

• allowing electricity lines businesses to invest in generation and retail without limit outside their own line network areas.

The key changes brought about by the Amendment Act are:

• replacing the old (fairly strict) rules on prohibited cross involvements with more relaxed provisions which will now prohibit a person being involved in both line and in generation or supply only if those investments breach that person's connected generation cap and/or that person's connected customers selling cap (essentially owning, operating or selling new thermal generation or thermal produced output of greater than 50MW within the line Company's local area network);

• making it clear that only the proportion of generation that is owned by the lines business is counted towards its connected generation (for example if a lines company owns 10 percent of a 200MW generator, then it is attributed with 20MW of generation to count towards its connected generation cap). The selling cap does not change in proportion to the extent of the lines company's interest in the business selling the electricity;

• making it clear that generation disregarded for the purpose of calculating the connected generation cap rule (such as renewable electricity generation) would nevertheless be counted towards the threshold for corporate separation and arm's length rules. The effect of this is that although a lines company may invest in renewable generation without such generation counting towards the lines company's connected generation cap, the lines company must still comply with the arm's length rules and corporate separation rules;

• inserting a new provision providing that a lines business that is involved in 5MW of connected generation and selling more than 5GWh per annum of electricity to connected customers must have a comprehensive, written use of systems agreement with its retail arm. This agreement should not discriminate in favour of the generation business and must be published on the generator's internet site; and

• inserting a new Schedule 1 in replace of the existing Schedule 1 of the Act. Schedule 1 sets out the arm's length rules. The effect of the new schedule is that businesses must not discriminate in favour of their sister business or the customers, suppliers or members of their sister business. They must also not enter into a transaction in which its sister business is interested if the terms of the transaction are such that unrelated parties in the position of the parties to the transaction, each acting independently and in its own best interests, would not have agreed to. Each business must have at least one independent director that is not a director or manager of the other business and must not share any executive directors. If the generation business is involved in more than 30MW of connected generation, including any renewable generation or other generation which is not counted towards the connected generation cap, then the managers of the lines company must be separate from the managers of the generation company (this applies only to managers and not to directors).

What can a lines company do?

What exactly can a lines company do in relation to ownership or operation of generation activities? We set out below a quick guide to the main activities that a lines company can be involved in.

• A lines company may invest in thermal or renewable generation and sell the results of that generation in any region outside of its lines area, without restriction. It need not comply with the arm's length separation rules provided that the generation is not connected to its lines.

• A lines company may invest in "new" (ie. generation commissioned after 8 August 2001) renewable generation which is connected to its lines, of any size. This renewable generation does not count towards the lines company's connected generation cap. This also applies to generators that are partly renewable and partly fossil fuel based, provided that fossil fuels provide no more than 20 percent of the fuel for the generator in any 12 month period. The lines company may sell this electricity to consumers within its lines area.

If the renewable generation is over 5MW the lines company must have a comprehensive, written use of systems agreement that provides for the supply of lines services to the business that is involved in selling electricity. The use of systems agreement must not discriminate in favour of one business and must contain arrangements that include elements that the business usually omits or omit elements that the business usually includes in use of systems agreements with independent parties. The use of systems agreement must be published on the internet. In addition, the directors of the electricity business must publish on an internet site a certificate signed by the directors stating whether or not, in the preceding calendar year, the terms of the use of system agreement are a true and fair view of the terms on which line services were supplied during that year.

The lines company must also comply with the arm's length rules if the lines company is involved in more than 10MW of connected generation. In that case, the business involving the relevant line must be carried on in a different company from the company that carries on the business involving the qualifying generation or the selling to connected customers. The businesses must then comply with the requirements of Schedule 1, which are outlined in general terms above.

• A lines company may invest in thermal generation up to 50MW (or 20 percent of the average of the maximum demand, in the immediately preceding three financial years) on the local network area. Again, if over 5MW the lines company must comply with the requirements in relation to the use of systems agreement described above, and if over 10MW, the lines company must comply with the arm's length rules described above. The lines company may sell this generation to its customers within its lines business area.

• A lines company may be involved in the generation of reserve energy that is in accordance with the terms and conditions for that reserve energy set by the Commission, and this is not included in the connected generation cap of the lines company.

• A generator can own lines which are not connected directly or indirectly, to the national grid.

• A generator can own lines which convey electricity only from a generator to the national grid or from the national grid to a generator.

• A generator can own lines which convey electricity mostly in competition with another line or lines operated by another electricity business that is not an associate of the generator, provided that the competition is actual competition and not potential competition.

Bell Gully comment We consider that these amendments are sensible as far as they go. Among other things they allow a line company to invest in a new wind farm or other renewable project and obtain a natural hedge to the project economics by selling the output to consumers on their network should they wish to. However, if you stand back from the Amendment Act it is really saying that the market issues that originally drove the 1998 reforms are, for a variety of reasons not so relevant in 2008. If you accept this, then there is a strong case to be made for repealing the Electricity Industry Reform Act in its entirety and retaining only the now – sensible arm's-length separation rules. This could drive further simplicity and efficiency in the electricity industry while retaining appropriate protections for consumers via the other regulatory mechanisms which currently exist.

 

For further information, please contact:

Garry Downs
Partner

Louise Hill
Senior Associate

To access the Commerce Select Committee's report on the Electricity Industry Reform Amendment Bill visit parliament's website at www.parliament.nz/en-NZ/SC/Reports/.