Watchdog pulls its punches

By BRIAN FALLOW

Electricity lines companies are breathing sighs of relief at the Commerce Commission's decision to drop a profit cap from its new regulatory regime.

Listed lines company Powerco's shares rose 8.7 per cent to $1.38 on the news.

The commission's decision includes two other victories for the companies:

* The commission will take another year to quantify a cap on line companies' price increases.

* And it has accepted their argument that any increases in transmission charges from national grid operator Transpower or local body rates can be passed through to consumers.

The commission is designing a regulatory regime for the electricity distributors, which are natural monopolies, that limits their ability to extract excessive profits and gives them strong incentives to improve efficiency, provide the quality of service customers demand and share the benefits of efficiency gains with their customers, for example through lower prices.

The draft rules the commission put up just before Christmas embodied a belt and braces approach: it imposed a limit on increases in line charges in any year to general inflation (CPI) minus a factor, X, intended to give the companies an incentive to improve efficiency.

That was to be backed up by a profit cap that would debar them from earning a return greater than the cost of capital on their assets, on average over a five-year period.

The profit cap was vehemently opposed by the companies as a deterrent to innovation and investment.

It would create perverse incentives, Vector chief executive Mark Franklin argued. "If we met their price and quality thresholds but because of efficiency gains threatened to breach the profit cap my incentive would be just to spend the extra money," he said.

"They have done the right thing."

The commission had already accepted another industry contention, that a one-size-fits-all value for X would be inappropriate.

Commission chairman John Belgrave said yesterday the difficulty with an across-the-board value for X was that it would not have been fair to those companies which needed to invest heavily to increase the capacity of their networks.

The commission said it expected lines companies that had been performing relatively poorly to face a higher X, requiring greater price reductions and/or quality improvements than other companies to avoid breaching the threshold.

The better performing lines businesses would face a lower X but, importantly, would still be required to make efficiency improvements each year to avoid breaching the threshold.

Belgrave said: "Provided we can get a satisfactory resolution to the variable Xs and get them in force, they will have an ongoing impact on excessive profits ... and we shouldn't have to use the profit threshold."

The threat of a profit cap remained if the commission and the industry failed to agree on a basis for setting the values of X.

"We haven't thrown it right away but it is very much a fallback position. There should be sufficient incentive to get on and set those Xs."

Speaking to a utilities conference in Auckland yesterday, commission deputy chairwoman Paula Rebstock said the thresholds were not controls, but she acknowledged they would have an impact on the behaviour of the lines companies.

Until April 1 next year the companies cannot increase their prices above the level when the legislation was enacted in August 2001.

With inflation running at around 2.5 per cent a year that is a real price fall of that order.

Rebstock said there would be ongoing, real reductions in lines company prices from April 1 next year.

The executive director of the Electricity Networks Association, Alan Jenkins, welcomed the fact that the commission had taken away "that awful profit cap uncertainty, the risk that a different personality at the top of the commission could come in and completely destroy the companies".

The delay in setting up the variable CPI-X regime was desperately needed, Jenkins said, in light of all the other upheavals facing the wider electricity industry.

The new regime

The Commerce Commission has imposed controls on electricity lines companies such as Vector and Powerco. Line charges make up about half of a residential consumer's electricity bill.

The new rules are:

* A freeze on prices until April 1 next year.

* Then price rises will be limited by a formula that ensures they fall in real terms every year.

* The price limits will vary from company to company.

* Lines companies' profits will not be regulated.

* The companies will have to meet reliability standards.

- additional reporting by Chris Daniels

Herald Feature: Electricity

Energy Efficiency and Conservation Authority