Regulatory reform in the electricity industry: A new dawn or another false start?
By Nicholas Russell, principal, Chen Palmer New Zealand Public Law Specialists

In December 2009, the Government introduced the Electricity Industry Bill (Bill) in order to reform the governance arrangements and other aspects of the electricity market in New Zealand. The Bill follows, and adopts, recommendations made by a Ministerial Review of Electricity Market Performance conducted by the Ministry of Economic Development and an Electricity Technical Advisory Group (ETAG). As reported in NZLawyer last year (issue 119, 21 August 2009), these recommendations included the abolition of the Electricity Commission, the establishment of a new Electricity Authority with narrower regulatory responsibilities but more independence from Government, and the repeal of the Electricity Industry Reform Act 1998 (EIRA), amongst other things. 

During the Bill’s first reading in the House of Representatives, the Minister of Energy and Resources, the Honourable Gerry Brownlee, explained that the purpose of the Bill is “to improve competition in the electricity industry and to constrain price increases, to improve the security of supply and the management of dry years, and to improve governance arrangements in the sector” ((15 December 2009) 659 NZPD 8565).The Minister went on to note that, as the ETAG report found, there was too little competition amongst electricity retailers and evidence that energy generators had been earning excessive profits (Brownlee, ”Energy sector transformation to benefit customers”, 9 December 2009. Refer also Cabinet paper, Ministerial Review of Electricity Market Performance).

However, concerns about lack of competition in the electricity industry are not novel; the Bill is at least the fifth piece of legislation since 1998 to address concerns in this regard. The fact that these concerns persist demonstrates that previous reforms may not have achieved their purpose, and it is therefore timely to consider whether the Bill will deliver better outcomes than its predecessors.

A brief history lesson
Prior to 1998, New Zealand had little in the way of industry-specific regulation for the electricity industry. The Electricity Act 1992 provided for safety regulation, information disclosure, and property access (as it still does), but beyond this, the electricity industry was for the most part only subject to generic regulation, such as the Resource Management Act 1991 and the Commerce Act 1986.

Over the decade between 1998 and 2008, that approach changed fundamentally, as a series of reforms were introduced which gradually increased regulation across all aspects of the industry. Although each of these statutes had its own specific objectives, there is a broad theme underpinning all of them, namely a concern about inefficiency in the markets for the generation, transmission, and distribution of electricity. Over time, this concern has manifested itself in a variety of ways – including allegations of excessive profits, lack of competition, particularly at the retail level, and poor security of supply – but the common theme has always been that the regulatory environment was not delivering optimal outcomes for consumers.

EIRA was the first step of the regulatory programme. The fundamental concern about inefficiency in the electricity market is neatly encapsulated in its original purpose provision, section 2(1) (since amended by the Electricity Industry Reform Amendment Act 2008):

“2 Purpose

(1) The purpose of this Act is to reform the electricity industry to better ensure that—
(a) costs and prices in the electricity industry are subject to sustained downward pressure; and
(b) the benefits of efficient electricity pricing flow through to all classes of consumers—
by—
(c) effectively separating electricity distribution from generation and retail; and
(d) promoting effective competition in electricity generation and retail.”

The main reform introduced under EIRA was the separation of generation and retail from distribution: lines companies were essentially prohibited from owning generation or retail businesses (subject to limited exceptions under Part 2), thereby reducing lines companies’ ability to subsidise retail businesses by exploiting their monopoly position.

EIRA was followed in 2001 by the enactment of a new Part 4A of the Commerce Act, regulating electricity lines businesses, including Transpower, this time by introducing industry-specific price control provisions. Part 4A did not apply to generators or retailers, who remained subject only to the generic provisions under Parts 2 and 4 of the Commerce Act. 

This represented a concern that relying on the generic price control provisions under Part 4 of the Commerce Act had been ineffective (for analysis of the background to the enactment of Part 4A, refer Unison Networks Ltd v Commerce Commission (28 November 2005, High Court, Wellington CIV 2004-485-960, Justice Wild, [10] to [56])); concerns remained that electricity lines businesses were still making excessive profits, despite the reforms implemented under EIRA, but no electricity lines business had been brought under price control. (Two electricity lines businesses, Vector Limited and Powerco Limited, have been subjected to price control under Part 4 of the Commerce Act, but in each case the scope of the price control order is limited to gas distribution networks.) The purpose provision for the new Part 4A (since repealed by the Commerce Amendment Act 2008) made this concern explicit:

“57E  Purpose

The purpose of this subpart is to promote the efficient operation of markets directly related to electricity distribution and transmission services through targeted control for the long-term benefit of consumers by ensuring that suppliers—
(a) are limited in their ability to extract excessive profits; and
(b) face strong incentives to improve efficiency and provide services at a quality that reflects consumer demands; and
(c) share the benefits of efficiency gains with consumers, including through lower prices.”
 
 [Emphasis added]

In principle, the new “targeted” price control scheme was straightforward: the Commerce Commission was required to set “thresholds for the declaration of control” under section 57G, and then assess the performance of each lines business against those thresholds. Under section 57H, the Commerce Commission was required to investigate any lines business which breached the thresholds, and then determine whether to impose price control. But underlying this apparent simplicity was an almost total absence of provisions to guide or assist the Commerce Commission or the industry for the purposes of setting and/or complying with the regulatory regime. By way of illustration, although the thresholds were the key feature of the regulatory regime, Part 4A contained virtually no provisions specifying their substance; section 57G(2) merely stated that the thresholds “can be expressed in quantitative or qualitative terms”. 

The result was that the Commerce Commission enjoyed very wide discretion in terms of setting thresholds, assessing performance, investigating breaches, and declaring control. Moreover, the Act made no provision for appeals against the merits or substance of decisions made by the Commerce Commission during this process; the only means for disputing the Commerce Commission’s decisions was by application to the High Court for judicial review.

The Electricity Act was also amended in 2001 to allow for industry self-regulation, but the attempt ultimately failed due to a lack of consensus amongst the industry (see D Caygill, ‘Why Did Electricity Self-Regulation Fail?’ (2004) 7 NZ Yearbook of Jurisprudence 20. Note however that self-regulation of the gas industry by the Gas Industry Company under the Gas Act 1992 has been far more successful). Accordingly, the Electricity Commission was established under Part 15 of the Electricity Act to perform a range of regulatory functions. Since 2004, the functions and objectives of the Electricity Commission have been set out in sections 172N and 172O of the Electricity Act.

The functions of the Electricity Commission are extremely wide-ranging, encompassing almost every aspect of the industry, and requiring it to undertake both broad policy objectives, and to perform detailed regulatory functions with respect to making governance rules for the market for the generation and supply of electricity. Notably, these regulatory functions include approving investments by Transpower in the national grid.

The Electricity Commission’s objectives conflict in some respects: for example, section 172N(1)(b) requires it to promote and facilitate the efficient use of electricity, but this is qualified by the principal objectives in section 172N(1)(a), which require the Electricity Commission to ensure that “electricity is produced and delivered to all classes of consumers in an efficient, fair, reliable, and environmentally sustainable manner”.

The Electricity Commission is also required to give effect to Government policies under section 172O(1)(j). This reflects its status as Crown agent under Schedule 1 of the Crown Entities Act 2004. By contrast, the Commerce Commission is an independent Crown entity, required only to have regard to Government policy statements: refer sections 103 and 105 of the Crown Entities Act 2004 and section 26 of the Commerce Act.

This combination of broad (and in some cases conflicting) statutory policy objectives, wide-ranging statutory functions, and a lack of independence from central Government has caused difficulty. These tensions came to a head in 2006 when the Government decided not to renew the appointment of then-Chairman Roy Hemmingway after the Electricity Commission decided not to approve Transpower’s original application to upgrade the transmission network between Waikato and Auckland (see, for example “I’m sorry I took the job, says Roy Hemmingway”, The New Zealand Herald, 10 November 2006).

The final major statutory reform during this period was the enactment of the Commerce Amendment Act 2008. In substance (at least in so far as the electricity industry is concerned), this reform is a refinement of the previous targeted regulatory regime for electricity lines companies under Part 4A, which addresses concerns about the extent of the Commerce Commission’s discretion, and the lack of adequate means for challenging the exercise of that discretion. The new Part 4 replaced these broad discretionary powers with a far more prescriptive regime, including merits reviews for substantive decisions on input methodologies (section 52Z). The new purpose provision, section 52A, is substantially identical to the old section 57E, apart from a new subsection (1)(a) which provides that suppliers of regulated services (such as lines companies) must have “incentives to innovate and to invest, including in replacement, upgraded, and new assets”.

Will the Bill work?
As noted above, the Bill had its origins in two very basic concerns about New Zealand’s electricity market; despite the existing regulatory regime, there were still grounds for concern about security of supply and rising prices. But can the Bill address these concerns when they have proved so elusive to date? There are grounds for optimism, for example:

• First, by clarifying the role of the new Electricity Authority and making it an independent Crown entity, the Bill reduces the potential for a repeat of the difficulties which arose in the Electricity Commission in 2006.
• Secondly, the Bill contains reforms which pragmatically address the constraints within which the market operates. For example, by allowing lines companies to re-enter the retail market, and reallocating generation assets to give (for example) Genesis Energy a presence in the South Island in the form of the Tekapo A and B stations (currently owned by Meridian), the Bill seeks to improve competition, particularly in the South Island, in a way which is intended to work within existing transmission and geographic constraints.
• Similarly, by requiring consumers to be compensated during conservation campaigns, the Bill creates a new financial incentive for the efficient management of resources during dry winters. 

But against this, it has to be said that the problems facing consumers, in particular, are not new, and that previous attempts at addressing those concerns have not been entirely successful. More fundamentally, the pattern of introducing new reforms every two or three years has a cost in and of itself in the form of regulatory uncertainty; investments in electricity generation, transmission, and distribution infrastructure have to pay for themselves over an asset life measured in decades. Chopping and changing the regulatory environment only makes those investment decisions more difficult. The acid test is therefore whether the Bill will break that pattern of uncertainty and usher in a new era of regulatory stability.