Wins and Losses from IM Decision
A confidential memo to ENA members. Please do not circulate outside your company.
ENA members should overall be pleased with the outcome of the Commerce Commission’s input
methodologies review, announced today.
The IMs are the upfront rules, processes and requirements of Part 4 regulation and are important to
ENA’s 17 regulated members. *
The first IMs were determined in December 2010. The new IMs announced today will apply from 2020.
ENA members, through their membership association, put significant resources into the IM review
process for the benefit of members and, ultimately, their end consumers. It and its advisers prepared 23
separate submissions and expert reports through 2015 and 2016 ahead of today’s announcement.
Though the initial view is positive, the devil will be in the detail, which we will examine over time.
WINS
Form of Control – ENA members supported changing the form of control from a price cap to a revenue
cap. This change will reduce forecasting risk, incentivise efficient pricing, and encourage investment in
energy efficiency and demand-side management. The commission agreed.
WACC Asset Beta – ENA members pushed back firmly on potential downside risk to asset beta (currently
0.34), which is used to calculate regulated rate of return. This risk was exacerbated by a commission
proposal to remove a 10bp gas uplift. After providing strong evidence, and identifying an error in a
commission spreadsheet, the asset beta has in fact been increased to 0.35. This is a significant and
unexpected win.
Ringfencing – Retailers made a very strong push to convince the commission to adopt ‘ringfencing’ of
EDB investments in unregulated assets. Ringfencing would require EDBs to create separate businesses,
which would add unnecessary cost and complexity to trials of new technology and subsequent business
models. The commission agreed with the ENA’s view that ring-fencing would not provide long-term
benefits to consumers.
Accelerated write downs – ENA sought a faster write-down of the value of some assets whose
economic lives would be impacted by new technologies. The commission has today confirmed it will
allow accelerated write down of average remaining asset lives of up to 15 percent on average. This will
require commission approval.
Black’s Discounting Rule – The commission agreed with ENA’s view that Black’s Discounting Rule, a tool
supported by the Major Electricity Users Group to reduce cost of capital, should not be implemented.
Risk free rate – the commission agreed with the ENA to remove “on-the-day” or prevailing rate for
estimating the risk free-rate. The commission moved to three months averaged, which is less than ENA
sought.
Debt premium – the commission agreed with the ENA and moved to an historical averaging approach
for calculating debt premium. This will be estimated using a five-year historical average.
Split WACC – Early in the IM review process, there were suggestions of a two-tier WACC for EDBs. This
posed downside risk to WACC, and did not gain traction.
Removed separate WACC for Controlled Price Paths – supported by ENA, this change removed a
disincentive for EDBs to apply for a CPP. The commission also adopted approaches to reduce compliance
and complexity of CPPs, which will make them more cost effective and workable.
TCSD – the ENA corrected errors in the term credit spread differential calculations, and the commission
has agreed to simplify the methodology.
WACC overall – Taking everything into account, the commission estimates that based on constant risk
free and debt premium rates the WACC will remain relatively flat, easing to 5.18% from 5.23%. We will
review this estimate, which has upside improvement from the change to the new trailing average debt
estimation.
Stability – overall, the commission delivered stability, as most of the IMs do not change. ENA members
supported stability and predictability to help them run their businesses.
MISSES
ACAM gone – The commission has confirmed that it will remove the avoidable cost allocation
methodology, known as ACAM. This was not supported by ENA because removal would add a significant
administrative burden on EDBs for no benefit to consumers.
Debt Issuance Cost - The commission reduced the allowance for debt issuance costs from 0.35% to
0.20%.
Leverage Estimates – a win and a miss. The commission amended the estimate of leverage based on the
leverage of comparable companies from 44% to 42%. ENA had pushed back strongly on the
commission’s initial proposal, which was to reduce the estimate to as low as 40%.
WACC standard error – the commission changed the standard error calculation for WACC to take into
account a shift to 67th percentile. This has some downside.
Overall, the commission has delivered stability, predictability and, on average, improvement in its input
methodologies for EDBs. Yes, there has been some erosion, but overall the wins outnumber the misses,
and the sector has defended the status quo from attacks by other submitters, mainly retailers and
MEUG. It will be interesting to see the reaction from retailers, which some might say have struggled to
have their views and opinions accepted by the commission.
Finally, thank you to all individuals who supported and contributed to ENA submissions on the IM
review. Your collective brilliance has resulted in the provision of evidence that supported a positive
outcome or the status quo.
*Regulated EDBs
Alpine Energy Limited
Orion New Zealand Limited
Aurora Energy Limited
OtagoNet Joint Venture
Centralines Limited
Powerco Limited
Eastland Network Limited
The Lines Company Limited
Electricity Ashburton Limited
Top Energy Limited
Electricity Invercargill Limited
Unison Networks Limited
Horizon Energy Distribution Limited
Vector Limited
Nelson Electricity Limited
Wellington Electricity Lines Limited
Network Tasman Limited