Brian Fallow: TLC required - or grid your teeth

There was a time when providing an electricity supply was considered an essential service provided by a modern state.

Then in the 1990s that view was elbowed aside by the dogma that whatever the problem, the solution is a market. The electricity system was radically restructured on a market model.

It may well be that in the long run that approach keeps the lights on at a lower cost than the old centrally planned model. It is too soon to be confident about that.

But, in the meantime, the transition from one model to the other has left some loose ends in which we are still entangled to the point of risking strangulation.

What prompts these reflections is a decision by the High Court this week which bears on one of those loose ends: the vexed question of who pays for the high voltage direct current (HVDC) link, the 575km connection between the Waitaki and Hutt valleys which includes the Cook Strait cables.

More precisely the issue is how to decide who pays. More precisely still, the issue is whether the process the Electricity Commission used to decide the rules was acceptable.

Justice Alan MacKenzie found it was not. He has ordered the commission to consult further and reconsider the issue in the light of that consultation and the history of the matter.

This is a victory for state-owned Meridian Energy and investor-owned Contact Energy, the two generators which pay tens of millions of dollars a year for the HVDC link and which sought judicial review of the commission's plan to entrench that arrangement.

It may also be salutary for the commission, little more than a year old, to be slapped about judicially over the transparency and fairness of its processes and the quality of its analysis.

But why should the rest of us care?

It is because this is likely to add further delay and debilitating uncertainty to the process of upgrading a vital piece of infrastructure, the national grid, since the issue of who pays for what remains unsettled.

Not only that, the continuing indecision about transmission pricing going forward cannot be helpful for anyone contemplating investment in generation capacity.

The grid is on average 40 years old and in urgent need, its owner Transpower says, of about $1.5 billion in investment.

No serious money has been spent on it for years, at least partly because industry players have been unable to agree on how to decide what work should be done and who should pay for it (or rather, since inevitably the consumer will pay, who gets to present the bill).

Wrangling over this issue is one of the reasons attempts to get a self-regulating governance structure for the industry in place failed and the Government imposed the commission on it instead.

Justice MacKenzie accepted that there is urgency because of the need to make investment decisions and that further delay "should not lightly be countenanced".

He also saw force in the submission that reconsidering the guidelines on the pricing of the HVDC link could involve reconsidering the pricing methodology for the whole network.

But he did not consider these good enough grounds for denying Meridian and Contact the relief they sought.

Underlying these arcane issues of process lies the more fundamental question of how transmission of electricity should be priced.

Should charges reflect where generation is relative to load (the locational signal approach) or should charges be essentially uniform regardless of location (the "postage stamp" approach)?

Meridian chief executive Keith Turner has long argued for the latter. He says every power user benefits from the national grid.

It is only a national grid because of the HVDC link. It is a national asset, a public good, the cost of which should be spread as broadly and evenly as possible.

The other view, espoused by Brent Layton, director of the New Zealand Institute of Economic Research and a former Transpower director, is that economic efficiency requires that beneficiaries of assets like the HVDC link should pay.

Layton says the beneficiaries are clearly the South Island generators, who are able get a higher price for their power because they can export it to the North Island, and northern consumers who get cheaper power than they otherwise would if they could not draw on hydro power from the south.

He argues that, for that reason, the South Island generators should not only continue to pay for the existing link but should bear the cost of the coming upgrade as well.

Before the transmission function of ECNZ was hived off as Transpower, allocating transmission costs was an internal issue for ECNZ.

Since 1996, Transpower has sought to put the cost of the HVDC link entirely on the South Island generators, first ECNZ and Contact then, after ECNZ was further split up, Meridian and Contact.

Meridian objected and, in 2001, prevailed in the ensuing litigation.

The Government stepped in and legislated "transitional" pricing methodology for Transpower which included allocating the HVDC link costs to the South Island generators.

A year ago, the commission published an issues paper on transmission pricing in which it proposed to phase out a separate charge for the existing HVDC assets.

It also proposed that the cost of any upgrade should be recovered in the same way as any new investment in the core grid. That is significant because major capital expenditure on the Cook Strait link will be required before long as it is reaching capacity.

The proposal, in short, was to move to a "postage stamp" regime: a stamp to the same destination costs the same no matter where in the country you post it from. The cost is pooled.

But then just before Christmas, and after considering submissions on the issues paper, the Electricity Commission flip-flopped.

It amended the guidelines to say that the existing South Island generators should continue to pay for the existing link and only the cost of any upgrade should be meet via "postage stamp" charges on network users generally.

It explained the turnaround by invoking the spectre of regulatory risk. "The commission is concerned that adopting a new methodology for existing HVDC assets would undermine certainty because it signals to investors that the pricing methodology for existing grid assets may change after they have committed their investment."

This is ironic given that the court, in telling the commission to go back and do it again properly, has reopened the issue and arguably created just the kind of uncertainty the commission swerved to avoid.

But the court seems to have accepted the generators' argument that given the contentious and transitional nature of the existing arrangements for charging for the HVDC link, it is not a settled part of the status quo that investors are entitled to rely on.

The two generators claimed that they did not have the opportunity to respond to these concerns about regulatory stability.

Clearly, Meridian and Contact are behaving as commercial enterprises should in seeking to offload costs running to tens of millions of dollars a year.

Equally clearly this loose end should have been tidied up during the restructuring years ago.

Commission chairman Roy Hemmingway says he does not expect the commission will appeal. It would be better to get on with reconsulting.

"This suggests we have lost about a year in the process. It is likely Transpower will be operating under the old methodology for another year. After we go through the reconsultation we would expect them to have the new methodology in place by the end of next year."

The national grid

On average, it is 40 years old.
It's in urgent need of some TLC - $1.5 billion worth.
No serious money has been spent on it in years.
It is only a national grid because of the Cook Strait cables.
The high voltage direct current (HVDC) link runs 575km between the Waitaki and Hutt valleys.
Major capital expenditure will be required soon on the Cook Strait cables as they are reaching capacity.