Review of levy costs and allocations
Attachment A

Attachment A

Glossary of abbreviations and terms

Act / Electricity Industry Act 2010
Authority / Electricity Authority
CAP / Code Amendment Principle
Code / Electricity Industry Participation Code 2010
CRA / Charles River Associates
EECA / Energy Efficiency and Conservation Authority
EMS / Energy Market Services (a division of Transpower)
FTR / Financial Transmission Right
GIP / Grid Injection Point
GXP / Grid Exit Point
ICP / Installation Control Point
MBIE / Ministry of Business, Innovation and Employment
MCA / Ministry of Consumer Affairs
MED / Ministry of Economic Development (now part of MBIE)
Minister / Minister of Energy and Resources
NZX / New Zealand Securities Exchange
PPOs / Principal Performance Obligations of the System Operator
TASC / Technical Advisory Services Contract (between the Authority and the System Operator)
TPM / Transmission Pricing Methodology

Attachment A

Contents

Glossary of abbreviations and terms

1.Introduction and summary

1.1Introduction

1.2Summary of conclusions

2.Statutory framework

2.1Crown funds Authority activities via a levy

2.2Amending the Levy Regulations

2.3Authority needs to demonstrate efficiency gains

3.Current cost structure and allocation

3.1Levy regulations establish cost categories

3.2Levy Regulations determine cost allocation

4.Economic framework for levy design

4.1Levy design should facilitate economic efficiency

4.2Nature of costs to be recovered

4.3The principles applied in 2003 focussed on economic efficiency

4.4Key factors influencing current allocation

4.5Framework applied to TPM needs to be considered

4.6Proposed principles for Levy design

5.Industry Governance Costs

5.1Industry governance costs incurred for benefit of consumers

5.2Applying the principles

5.3Current allocation of industry governance costs

5.4Current allocation of industry governance costs may be efficient

6.Market operations costs

6.1Nature of the costs

6.2Applying the principles to market operations

6.3Wholesale market operations costs

6.4Registry costs

6.5FTR trading costs

7.System operations costs

7.1Nature of the costs

7.2System operation functions

7.3Applying the principles

7.4Current allocation of system operations costs

7.5Conclusion

Appendix A: Statutory framework

Overview

Levies under s128 of the Electricity Industry Act

Appendix B: Current cost structure and allocation

Cost structure

Current allocation under the Levy Regulations

Appendix C: Levy provisions under the Act

Appendix D: System Operator activities

Tables

Table 1: Expenditure categories in the existing Levy Regulations

Table 2: Allocation of costs of each activity

Table 3: Proposed principles for levy design

Table 4: Market operation service providers

Table 5: Market service provider functions

Table 6: Summary analysis of system operations activities

Table 7: Expenditure categories under the Levy Regulations

Table 8: Allocation of costs of each activity

Table 9: Levy Rates from recent 2013/14 Appropriations Consultation

Table 10: Operations Planning Functions

Table 11: Scheduling functions

Table 12: real time operations functions

Table 13: After the fact analysis functions

Table 14: Support functions

Figures

Figure 1: Levy allocation for 2013/14 under the existing levy Regulations

Figure 2: Annual costs – estimated 2013-14

Figure 3: Current allocation of industry governance costs

Figure 4: Annual market operating cost – estimated 2013-14

Figure 5: Overview of system operator functions

Figure 6: Breakdown of annual system operations costs

Figure 7: Current allocation of system operations costs

Figure 8: Overview of existing funding arrangements

Attachment A

  1. Introduction and summary
  2. Introduction
  3. The Authority has identified a number of issues with its current funding arrangements. Following a review of the issues and options for addressing them, the Authority concluded it should progress two key approaches in parallel:

(a)introduce the ability for the Authority to charge fees in certain circumstances through seeking an amendment to the Electricity Industry Act 2010 (Act) and the making of Fee Regulations pursuant to the amended Act; and

(b)operate in a modified way within the existing legislative framework including in particular reviewing the Levy activities identified in Table 1 of the Levy Regulations to identify areas where more specificity and/or granularity could deliver a better fit with the beneficiaries/users of particular services and then seeking appropriate amendments to the Levy Regulations.

1.1.2The focus of this paper is on approach (b) - to review the Authority’s cost structures and the allocation to participants, to establish whether the current allocation is efficient and whether amendments to the Levy Regulations should be proposed.

1.1.3This paper follows from, and draws on material from, a report prepared by Concept Consulting Group (the Concept Report[1]) and considered by the Board at its 29 June 2012 meeting.

1.2Summary of conclusions

1.2.1Application of efficient levy design principles suggests that:

(a)the industry governance costsshould be allocated to participants that have a strong connection with end-use consumers, through a mechanism that spreads costs as widely as possible;

(b)the wholesale market operations costs (pricing, reconciliation, information and clearing) should be predominantly allocated to generators and purchasers in the wholesale electricity market based on a charge per MWh traded;

(c)the registry costs should be predominantly allocated to retailers and distributors via a charge per ICP;

(d)the FTR Manager costs should be recovered through a broad based charge, similar to that used for wholesale market operations costs, pending further development of, and more information on the level of activity in, FTR trading; and

(e)there is a case for a range of efficient user-pays charges covering factors that exacerbate costs (including the provision of late or inaccurate data, prudential problems, consumer switching, non-compliant and unreliable assets, and requests for extensive systems analysis made to the system operator), but these charges would be complex to implement within Levy Regulations.

1.2.2The current arrangements for the recovery of costs through the Levy Regulations are reasonably consistent with efficient levy design principles. Any improvements that are feasible within the framework of the Levy Regulations are unlikely to lead to material efficiency gains.

1.2.3If the Act is amended to allow the Authority to charge fees for its market operations activities, further consideration should be given to a range of supplementary user-pays charges within a fees framework.

Attachment A

  1. Statutory framework
  2. Crown funds Authority activities via a levy
  3. The Act sets out the Authority's functions. These fall into two broad categories:
  • Industry governance – the Authority makes, administers, and enforces the rules governing the New Zealand electricity market - the Electricity Industry Participation Code 2010 (Code)
  • Market operation – the Authority is responsible for running the central systems and processes to operate the New Zealand electricity system and market in accordance with the Code. In practice, the Authority contracts most of these functions to a range of external service providers.
  • Section 128 of the Act provides for the Crown (via appropriations in Parliament) to be the sole funder of all the Authority’s statutory functions. Appendix A outlines the key features of section 128 including how levies are established and the process for amending levies. The key points are that the empowering provisions in the Act:

(a)require the Crown to fully recover its actual costs via a levy on industry participants;

(b)allow for the making of Levy Regulations which specify the amount of the levy or method of calculating or ascertaining the amount of the levy; and

(c)provide for different levies for different classes of industry participants.

2.1.3Although the Authority could charge a fee for activities outside those set out in the Act, it is unclear what such activities might be. However, they could include, for instance, the Authority providing assistance and advice to other countries about electricity market design and hosting international visitors. As stated by the Controller and Auditor-General in the Good Practice Guide – Charging fees for public sector goods and services, “Public entities do not need statutory authority to enter into contracts for commercial transactions. Such transactions are voluntary for both parties rather than being a matter of statutory duty. An example of a normal commercial transaction is the Department of Internal Affairs’ provision of professional translation services to businesses, central and local government, and private individuals. The Department is not obliged to provide these services. The amount charged by the Translation Service is a contractual payment agreed to by the recipient, and not a fee within the scope of this guide”.

2.1.4Although section 115 of the Act authorises regulations to be made relating to fees, the requirement under section 128 that the Authority’s costs are fully met from the levy renders this inoperable for recovery of any costs that relate to the Authority's statutory functions. It is a general regulation-making power for fees or charges relating to any matter under the Act (i.e. wider than just the Authority’s statutory functions) and makes no specific reference of the Authority or the Minister.

2.2Amending the Levy Regulations

2.2.1The Governor-General may, by Order in Council made on the recommendation of the Minister, make or amend regulations providing for the levy.

2.2.2Historically, Levy Regulation amendments have been developed and consulted on by either the Ministry of Economic Development (MED) or by the Electricity Commission, prior to a recommendation being made to the Minister.

2.2.3Although the Act specifiesneither process nor principles for developing and consulting on an amendment to the Levy Regulations, for consistency with undertaking its functions under the Act more generally, the Authority should look to its statutory objective and Consultation Charter.

2.2.4Section 15 of the Act provides that the Authority's statutory objective is:

…to promote competition in, reliable supply by, and the efficient operation of, the electricity industry for the long-term benefit of consumers.

2.2.5The Authority interprets its statutory objective[2] as requiring it to exercise its functions in ways that, for the long-term benefit of electricity consumers:

  • facilitate or encourage increased competition in the markets for electricity and electricity-related services, taking into account long-term opportunities and incentives for efficient entry, exit, investment and innovation in those markets;
  • encourage industry participants to efficiently develop and operate the electricity system to manage security and reliability in ways that minimise total costs whilst being robust to adverse events; and
  • increase the efficiency of the electricity industry, taking into account the transaction costs of market arrangements and the administration and compliance costs of regulation, and taking into account Commerce Act implications for the non-competitive parts of the electricity industry, particularly in regard to preserving efficient incentives for investment and innovation.
  • The Authority’s Consultation Charter December 2010 (the Charter) sets out guidelines relating to the processes for amending the Code and for consulting on proposed amendments. In particular it sets out the Authority’s Code Amendment Principles (CAPs), and obliges the Authority to have regard to these principles, to the extent that the Authority considers that they are applicable.
  • Although amending the Levy Regulations is not a Code amendment, the Charter and the CAPs are nevertheless relevant. The Charter notes that there are other matters on which the Authority may seek feedback from interested parties, but for which the Authority is not required to consult under the Act. In such instances, the Authority may adopt the general principles and processes described within the Charter having regard to the materiality of the matter being considered, the particular feedback sought, and other related factors.
  • The CAPs include three key high-level principles that Authority should apply to any proposal to amend the Levy Regulations:
  • CAP 1 – any change must be lawful;
  • CAP 2 - any change must demonstrate a clear efficiency gain or resolve a market or regulatory failure; and
  • CAP 3 – a quantitative cost-benefit assessment must be applied with a particular focus on dynamic efficiency impacts.
  • Authority needs to demonstrate efficiency gains
  • Although an amendment to the Levy Regulations is not a Code amendment, the Authority should adopt an approach that is consistent with the Consultation Charter and CAPs.
  • When proposing an amendment to the Levy Regulations, the Authority should consult with stakeholders, and any amendment should demonstrate a clear net efficiency gain.

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Attachment A

  1. Current cost structure and allocation
  2. Levy regulations establish cost categories
  3. The existing Levy Regulations define a number of expenditure categories or “activities”, generally with reference to carrying out functions in relation to various parts of the Code. The current categories are set out in Table 1, and Appendix B describes in more detail how these categoriesare used as the basis for the existing cost allocation.

Table 1: Expenditure categories in the existing Levy Regulations

Category / Description of activities as set out in the Code
Common quality operations / Activities relating to Part 7 (system operator) and Part 8(common quality).
Market operations / Activities relating to Part 5 (undesirable trading situations), Part 10 (metering), Part 13 (trading), Part 14(clearing and settlement), and Part 15(reconciliation).
Registry and consumer operations / Activities relating to Part 11 (registry) and other consumer-related activities.
Supply reliability operations / Activities relating to Part 9 (security of supply), and sections of Part 7(system operator) relating to security of supply, including the Security and Reliability Council and the functions of the Authority under section 136 of the Act.
Transmission operations / Activities that relate to Part 12 (transport) and any costs incurred by the Crown in preparing electricity supply and demand forecasts and scenarios.
Electricity Efficiency / Certain activities of the Energy Efficiency and Conservation Authority (EECA) relating to the encouragement, promotion, and support of electricity efficiency.
Customer switching fund / The costs of the customer switching fund.
Other activities / Any activities not covered by other categories, including the monitoring and enforcement of the Code.

3.1.2In some areas one entity (for example, the Authority or the system operator) undertakes functions that span more than one expenditure category. The Levy Regulations allow for the Authority to exercise judgment in determining the split of actual costs across the relevant expenditure categories.

3.2Levy Regulations determine cost allocation

3.2.1The Levy Regulations describe the methodology for calculating each participant’s share of the total costs. The expenditure categories described in the previous section are a key building block in this methodology.

3.2.2Table 1 of the Levy Regulations sets out the allocation of each expenditure category to participant class. It is reproduced as Table 2 in this paper.

Table 2: Allocation of costs of each activity

Activity / Classes of industry participants to whom costs are allocated
Generators / Purchasers / Distributors
Common quality operations / One-third / One-third to purchasers / One-third
Market operations / One-half / One-half to purchasers / -
Registry and consumer operations / - / One-half to retailers / One-half to distributors other than Transpower
Supply reliability operations / - / All to purchasers / -
Transmission operations / - / - / All to Transpower
Customer switching fund / - / All to retailers / -
Other activities / One-third / One-third to purchasers / One-third
Establishment costs relating to transition of functions to Commerce Commission / - / - / All to Transpower
Establishment costs relating to Energy Efficiency and Conservation Authority / - / All to purchasers / -
All other establishment costs / One-third / One-third to purchasers / One-third

3.2.3Charts illustrating how costs are currently allocated across different activities and recovered from each participant class are shown inFigure 1.

Figure 1: Levy allocation for 2013/14 under the existing levy Regulations

3.2.4The charts in Figure 1 highlight that:

(a)the largest part of the costs is currently allocated to the “market” activity;

(b)a significant portion of costs is currently allocated to the “common quality” activity;

(c)the costs allocated to other activities are relatively small apart from the “electricity efficiency” costs(which are excluded from consideration in this paper as a special case);

(d)purchasers in the wholesale electricity market fund the largest proportion of total costs;

(e)generators supplying the wholesale electricity market fund a significant proportion of the total costs; and

(f)other participant classes (retailers and line businesses) fund relatively small proportions of the total cost.

  1. Economic framework for levy design
  2. Levy design should facilitate economic efficiency
  3. Efficient funding arrangements for the Authority (and associated Levy Regulations) should exhibit the following broad characteristics:
  • allocative efficiency - arrangements should provide incentives to encourage the most useful mix, volume, and standard of services. This generally means that where costs can be clearly attributed to causers and/or beneficiaries, those parties should pay for the service in proportion to their relative contribution to costs/benefits. In cases where it is not possible to clearly identify specific causers/beneficiaries, the aim should be to recover costs in the way that causes the least amount of distortion to decisions and minimises so-called deadweight losses.
  • productive efficiency -arrangements should provide incentives to minimise the cost of the services being provided. For example, where costs vary with the level of output, the charge should generally reflect this rather than being fixed, and there would ideally be opportunities for payers to interact with the Authority on service provision decisions.
  • dynamic efficiency - arrangements should provide incentives to look for new ways to provide services, to increase benefits or to lower costs over time. For example it may be important in this context to provideopportunities for users/beneficiaries and the Authority to alter the shape of services that are provided over time.
  • To apply these characteristics it is important to understand the nature of the costs to be recovered under the levy.
  1. Nature of costs to be recovered
  2. For the purpose of this paper the costs have been considered withinthe following four broad categories, illustratedfor the 2013/14 appropriation in Figure 2:
  • Industry Governancecosts – these are costs incurred through making, administering, and enforcing the rules governing the electricity market (the Code);
  • Market Operation costs – these are costs incurred through a range of external service providers supplying the systems and market operations necessary to operate the market in accordance with the Code;
  • System Operation costs – these are costs incurred by the System Operator supplying the systems and coordinating the power system in real-time to match supply and demand, in accordance with the Code; and
  • Electricity Efficiency costs – these are a portion of the costs of the Electricity Efficiency and Conservation Authority (EECA) in relation to the encouragement, promotion, and support for electricity efficiency.

Figure 2: Annual costs – estimated 2013-14