Brian Fallow: Keeping Transpower honest

For the second year in a row Transpower, the operator of the national grid, has raked in more revenue than the Commerce Commission says it is allowed.

Over the two years, the breaches exceed $100 million. In that period, power prices for household consumers have risen 18.5 per cent and commercial ones are paying 17.7 per cent more.

Even if most of that inflation is down to generation rather than transmission costs, it is tempting to see Transpower, the archetype of a monopoly, as greedy and arrogant and to wonder what use the regulators are.

But it is not that simple.

Everything about Transpower, including the roles of its two regulators, the Electricity Commission and the Commerce Commission, is overshadowed by the question of upgrading the grid.

Most of the grid, it likes to point out, dates from an era when television was either unknown or consisted of a single black-and-white channel.

About $1.5 billion of investment is required, and soon, if security of supply is not to be compromised, it says. That includes the controversial planned new line across the Waikato into Auckland and upgrading the interisland link.

It portrays itself as beset on one side by an empire-building and intrusive Electricity Commission second-guessing every decision it makes, and on the other by a Commerce Commission whose approach to regulation would tether its revenues to those in the days when it was spending little on the grid and hobble its ability to undertake the investment it needs to.

But again it is not that simple.

The Electricity Commission, after all, has just approved $158 million of "tactical" upgrades for the grid.

The Commerce Commission, it is true, has set a short-term price path threshold of CPI minus 1, which allows Transpower to increase its transmission charges by the rate of inflation minus 1 percentage point.

But that threshold only acts as a tripwire turning on the searchlights, as it were. A breach triggers an inquiry into whether the breach is warranted.

Transpower argues that to allow for the investment it needs to do, it should be allowed CPI plus 7 or even plus 10.

In confirming its CPI minus 1 threshold for another year last June, the Commerce Commission made it clear that, for its part, the appropriate treatment of new investment was still an open question.

In short, the regulatory environment Transpower operates in is still in a state of flux.

But the emerging trends are troubling, says a report by Alex Sundakov of economic consultants Castalia, commissioned by Transpower.

"The Electricity Commission is heading in the direction of becoming more of a central planner than a regulator," Sundakov says.

Its approach to approving investment proposals focuses on the commission's view of what an optimal generation and transmission system should look like, rather than Transpower's assessment of real-world market needs and risks.

The risk is that the Electricity Commission's theoretical model will take precedence over Transpower's commercial judgment.

The Electricity Commission appears to want to specify the assumptions for system planning.

"Since in many areas the Electricity Commission is not an independent decision-maker but an adviser to the minister [of energy], this may introduce a risk of planning assumptions being set to reflect political objectives or beliefs rather than market realities."

Sundakov, like Transpower, is critical of the unwieldy division of labour between the two commissions, whereby one is responsible for approving grid investments but the other is responsible for regulating how much revenue it can earn.

Seeking to regulate prices through a price threshold based on historic revenues, when historically there has been underinvestment in the grid, means Transpower will have to breach the threshold to fund necessary investment, Sundakov says.

The ultimate sanction for unwarranted breaches of the threshold is for the commission to control prices directly.

But exactly how it would do that in Transpower's case is not clear, which Sundakov says only increases the regulatory risk for investors.

And the relevant investors are not just Transpower.

Clarity about the physical capacity of the grid and transmission pricing is vital information for people planning generation investments.

This creates a problem.

"In order to review whether a particular transmission investment is necessary and efficient, the regulator needs to know about investors' plans with respect to generation.

"In turn, investors cannot finalise their plans with regard to generation without knowing what transmission in generation would be undertaken."

Sundakov rejects the notion that transmission and generation investment can be seen simply as competing ways of addressing the same problem.

Rather, transmission sets the platform for and defines the geographical scope of competition among generators.

Blurring the distinction between a regulated monopoly and a competitive market is a bad idea, which gets worse if the regulator ends up subsidising generation investment (from some sort of levy) on the grounds that it is still cheaper than a major transmission investment.

Ralph Matthes, of the Major Electricity Users Group, sees this as a slippery slope towards the Electricity Commission taking over investment on the energy and investment sides.

"We are trying to find a way for the commission to facilitate others investing in transmission alternatives before we actually have to do the transmission investment. At one extreme, this could be the commission writing out a cheque to someone to build a power station in Auckland.

"We would say no to that."

Matthes believes the Electricity Commission will be risk averse.

"They will canvass the options and if it looks absolutely clear that the generators are highly incentivised to get generation into Auckland, and the only question is which of the generators will do it first, [the commission may] decide it can defer Transpower's upgrade."

But if there is any doubt, the upgrade will be approved, Matthes believes.

In regulating bodies like Transpower, or the local lines companies, a fine line must be walked. Get it wrong in one direction and we all get ripped off through excess monopoly profits.

Get it wrong in the other direction and the risk is underinvestment and the lights eventually going out.

With infrastructure as vital as the national grid those risks are asymmetrical.

A recent Electricity Commission study found a power failure or series of failures would only have to cause 72 gigawatt hours of lost electricity consumption to justify the $1.5 billion upgrade plan Transpower believes is necessary. That is less than one day's average consumption.

Sundakov sees a danger that we end up with a worst of both worlds outcome, with the Electricity Commission trying to impose a central planner model on top of an industry structure that is decentralised and market-based.

Matthes says: "Everyone is watching the commission like a hawk to make sure we don't go down that road, including us. It's far to early to conclude that's happening."

He believes Transpower has yet to make the mental adjustment to a higher level of accountability than before, instead of "we know best and here's the bill".