$200m at stake as SOEs locked in power struggle

By RICHARD BRADDELL

WELLINGTON - Parliament's Commerce select committee has more than a point. It is ironic and undesirable, it says, that two state-owned enterprises should go to court at the expense of the taxpayer when the true winners will be the teams of legal experts who will collect a mountain of fees.

The enterprises are Transpower, the owner/operator of the national electricity grid, and South Island based Meridian Energy, the country's largest electricity generator and one of three state-owned enterprises created by the split of ECNZ last year.

As in any good commercial dispute, there is a lot of money at stake, about $200 million over two years, and enough already to force Transpower to slash its interim dividend to the Government after Meridian withheld $32 million in the second half of 1999.

The gist of Meridian's complaint is one of unfair discrimination. It alleges that Transpower charges its rival Contact Energy much less for access to the national grid and for the costs of the Cook Strait cable in particular.

The dispute arises from the contract Transpower signed with Contact more than three years ago. At the time Transpower was trying to provide contracts that were aligned to customers' needs, says Transpower's general manger of sales, Bill Heaps.

But the electricity landscape has changed completely. Since the contract was signed, the electricity lines companies have been separated from energy retailing, and while there were few generators of consequence back then, now there are many.

Furthermore, Transpower's statement of corporate intent has changed, as has the pricing methodology it dictates.

The dispute is buried within the complexities of electricity pricing. Essentially, when Transpower delivers electricity, it buys it from the generators and resells it at the delivery point at a price that reflects distribution and transmission losses.

According to Mr Heaps, there are two components in the price. The first is what is paid for the electricity. Transpower in effect buys the power from the generators at the prices offered in the wholesale electricity market. Those prices vary among generators, and Transpower pays at the offer prices until retail demand is satisfied.

So Transpower could pay 5 cents per kWh for half a given demand for electricity, and 10 cents for the rest. In an interesting twist, it sells back to the retailers at the top (i.e. marginal) price, giving it a profit.

Obviously, Transpower is hardly deserving of this windfall profit, and it has to do something with it. As it happens, it distributes those gains among the electricity lines companies, who should then pass it back to consumers through lower lines charges.

There is an important reason for managing energy prices in such a convoluted way -- it's so that the true cost of energy, including its transmission, is accurately represented at the nodes or distribution points where electricity is passed to the local lines companies.

The marginal price signal, as Mr Heaps calls it, is important because mammoth generation projects such as the Clyde dam are no longer regarded as the last word in electricity.

Today the buzz words are distributed generation. By that, the industry means smaller projects, perhaps only 5 or 10 MW, that are close to localities where the electricity is used. Such projects may be sufficient to meet peak loads when transmission lines are stretched, thus avoiding the need to build new ones.

Fuel cells are a developing new technology with great promise for that. There are two types: one generates electricity by converting chemical energy into power; the second stores offpeak energy for use during busy times. Either way, they may be a more efficient local substitute to building transmission lines.

For Transpower, giving pricing signals that encourage distributed generation is vital because it may save it from investing hundreds of millions of dollars in additional transmission facilities.

``The only party that's really got an incentive to facilitate that kind of development is Transpower,'' says Mr Heaps. ``We don't want to spend $300 million if it's the wrong decision because fuel cells will come in five years later and strand those assets.''

But for the fact that it is barred by law under the energy/lines split, Transpower would be the ideal party to build smallscale localised generation.

But there is another component to electricity pricing - the sunk cost or the non-avoidable cost of maintaining a network, whether it is used or not.

``We've got around $500 million in those charges to recover, represented by the assets and the cost of maintenance,'' Mr Heaps says.

``We have to have a pricing methodology, and the methodology is geared to present the least distortion possible to the nodal price. That's why we don't have a variable price -- if it was variable, they would all try to avoid it.''

And that's where the disputes with Transpower arise. A court action with Auckland lines company Vector, which Transpower won, was about the allocation methodology, and that is what lies behind the battle with Meridian.

Meridian's complaint is that it is paying an unfair share for the Cook Strait cable. But while it argues that Contact got a much better deal, Mr Heaps says it was not better, simply different.

The reason is that Contact assumed certain risks under the contract, although it also gives Transpower what Mr Heaps describes as perverse incentives to constrain capacity on the cable so it can extract profits on electricity transmission.

Meanwhile, while they complain, Meridian and TransAlta get the benefits of the Cook Strait cable which exposes the two South Island generators to higher North Island prices.

So the Contact contract was not perfect. But it expires in 2002 and to negotiate new bilateral contracts is simply to perpetuate the problem.

Instead, the economic allocation formula required under the statement of corporate intent has to be applied equally on all players, Mr Heaps says.

He also rejects Meridian's suggestion that the dispute should go to arbitration. The problem is that the arbitrator will have to decide not on the dispute but on the allocation process.

``How can you have an arbitrator who sits between us and Meridian and says Meridian should pay only half the DC link. Who pays the other half, and shouldn't they be at arbitration?''

Suddenly everybody will want to be involved, North and South Island generators, and at that point the arbitrator ceases to be that and becomes a regulator instead.

As it happens, that's precisely the role that Mr Heaps sees as being ordained for Transpower in administering the economic allocation formula under its statement of corporate intent.