Brian Fallow: Users should pay but not that early

Hold your horses, Transpower.

You are not entitled to pass on costs you have yet to incur. Today's electricity consumers should not have to pay for tomorrow's upgrade of the national grid.

And when you are subject to a regime that (conditionally) limits your price rises to less than the rate of inflation, it is a bit arrogant, isn't it, to announce a 19 per cent rise and the prospect of five more years of double-digit increases beyond that.

That at least is the message the Commerce Commission has just delivered to the national grid operator in spelling out the reasons for its intention, announced late last year, to impose control on it.

The decision is not yet final and the commission has not indicated what form such control would take.

But it is likely to put a stop to what the commission regards as excess profits which have enriched Transpower to the tune of around $50 million over the past two years, and it would be surprising and messy if the announced 19 per cent hike in transmission charges scheduled for April 1, which the commission believes is unjustified, went ahead.

Above all, one would expect it to seek to ensure a better alignment of the timing of approved investments on the one hand and the price increases to fund those investments on the other.

Transpower has yet to respond. When it does it is likely to emphasise the urgent need to spend serious money on its antiquated transmission network.

It will express the frustrations involved in planning for that while it waits for one regulator, the Electricity Commission, to approve its investment plans while another, the Commerce Commission, hobbles its ability to build up its balance sheet for a huge increase in capital expenditure.

Its business plan includes nearly $3 billion of capex over the next six years, including the controversial new line from Taupo to Auckland and a new inter-island link.

It will make the point that there is more to it than compensating landowners, ordering cable, erecting pylons and building substations.

Ahead of that it has had to build up its human resources, depleted during long years of little or no investment in the grid.

Should we care about all this?

After all, Transpower's charges represent less than 10 per cent of most residential consumers' power bills. The 19 per cent increase planned for this year, it says, would add only about $2 a month to their power bills.

But at the same time it announced that increase, it foreshadowed further rises of 13 per cent a year for the next five years. Combined with 2004's increase that would amount to a cumulative doubling of transmission charges over eight years.

The Commerce Commission accuses the company of seeking to prefund investments which the Electricity Commission has yet to approve as the most efficient option.

Before giving its blessing, the Electricity Commission has to consider alternatives such as the prospects of additional generation downstream of a transmission bottleneck as well as being vigilant for any tendency to gold-plate.

The Commerce Commission objects to prefunding on equity and efficiency grounds.

Today's electricity consumers are a different set of people from the future consumers who will benefit from the investment. This is why long-lived infrastructure investments are often funded by long-dated debt, to smooth the cost increase to users and reduce the inter-generational transfer.

If Transpower is allowed to "save up" for its planned investment there is an opportunity cost involved. The consumers whose money it is sitting on might have made better use of it.

The commission says prefunding means there is less incentive on Transpower to minimise costs and it may transfer risk from the company to consumers.

The sums involved are not trivial. If the quest for maximum efficiency, via the Electricity Commission's scrutiny, were to trim 10 per cent from the cost of Transpower's plans, the net present value of that saving would be $234 million, the Commerce Commission calculates.

If the investment programme ended up occurring a year later than Transpower envisages - not beyond the realms of possibility - that would save a further $148 million.

Transpower's statement of corporate intent shows that over the current financial year and next year it expects to increase its shareholders' funds through retained earnings by $157 million or around 14 per cent.

Of that, $60 million would come from cutting the Government's dividend to $10 million a year, from $40 million last year.

But the lion's share, nearly $100 million, would come from consumers as transmission costs rose by an eighth from an average 1.37c a kilowatt/hour to 1.54c.

Over the same period, it expects to ramp up its debt by $500 million.

A tidy sum, to be sure, but it hardly represents a major increase in gearing for an enterprise of this size. It would reduce the ratio of equity to total funds employed from 42 per cent last June to 40 per cent in June next year.

That is not exactly a balance sheet lying perilously low in the water. Transpower is a state-owned enterprise and a natural monopoly whose commercial risk - the possibility of expensive transmission lines being stranded by some unexpected shift of load or generation - is not very high.

It ought not to have much trouble borrowing money cheaply.

One of the reasons Transpower likes to adduce for ramping up its prices now is to avoid the need for an injection of capital from the Government.

It is a red herring. The Government would be able to borrow that money even more cheaply than Transpower.

Ultimately, of course, the electricity consumer will bear the cost of upgrading the national grid.

But Transpower's directors and shareholding ministers would appear to have plenty of options about over what period the inevitable price increases are spread.

It was unwise to expect the Commerce Commission to allow it to start early, especially when the economy is slowing, business profits are squeezed and consumers have been hit by a string of power price rises already.

Electricity prices, as measured by the consumers price index, have risen relentlessly by a cumulative 31 per cent over the past four years.

Most of that increase has gone to the generators rather than Transpower and the local lines companies which transport the energy.

The generators, too, are great ones for getting today's consumers to pay for investment which has yet to occur.

This is a structural feature of the wholesale electricity market.

Spot prices fluctuate wildly but the trend line they oscillate around is supposed to climb towards the long-run marginal cost - that is, the price at which the next dollop of generation capacity would be commercially viable.

The theory that that is the price signal the market should be giving is fine.

But the practice in New Zealand's case, being a small country, is that large new power stations are built only infrequently.

The response to the price signal can be a long time coming.