Next Comcom Reset to Hammer Prices?

Trust Matters

Issue 14, February 2017

This informal newsletter for ETNZ members is designed to provide periodic brief updates of issues of current interest to trustees and asset owners.

Next ComCom reset to hammer prices?

The Electricity Authority’s current ‘Issues Paper’ on the Transmission Pricing Methodology (TPM) review uses an assumed major downward adjustment in the critical ‘weighted cost of capital’ (WACC) input methodology applying from 2020, resulting in a drop in regulated electricity distributor’s maximum allowable revenue of 10.7%. This assumption is based on the EA’s views on current WACC trends (views presumably formed in consultation with the Commerce Commission, which is responsible for WACC reviews).

Under the Commerce Act’s ‘no price shocks’ to suppliers or consumers requirement, the Commission could be expected to cap any such reduction at 10% or less.

To put this in perspective, a 10% reduction in regulated electricity distributors’ revenue would amount to about $190 million annually. If – as the EA assumes - it were applied across the board to all distributors (i.e. the 11 exempt trust-owned companies as well as the 17 regulated ones) then the total annual reduction would be close to $230 million.

ComCom’s Input Methodologies decisions

On 20 December 2016 the Commerce Commission released its final decisions on its review of input methodologies (IMs) – the rules, requirements and processes that apply to the sectors it regulates under Part 4 of the Commerce Act.

Deputy Chair Sue Begg said the IMs had held up well on review and the Commission’s approach to make a small number of targeted changes had been well supported. However (reflecting pressure from the Electricity Authority as well as gentailer submissions) she said that “There have been a range of views on the impacts new technologies will have in the energy sector and this is an ongoing conversation, with the Ministry of Business, Innovation and Employment now taking the lead on this topic from a policy perspective.” It’s becoming increasingly clear that there will be a policy debate and intensive lobbying in 2017 on whether or not distributors’ involvements in frontier technology provision will be regulated.

Otherwise, the key outcomes of the IMs review are:

·  Longer term risks that distribution assets will become redundant sooner are recognised with an average 15% reduction in their regulatory lives.

·  From 2020, price control of electricity distributors will be via a revenue cap, rather than a price cap. This will reduce the disincentives EDBs face for investment in demand-side activities and load reduction, caused by resultant falls in volumes of delivered electricity.

·  There will be a small reduction in the all-important post-tax WACC Input Methodology, down from 5.23% to 5.18%.

·  Cost allocation rules have been tightened with the removal of the ‘avoidable cost allocation’ provision, meaning that distributors’ ability to gain slightly more regulatory income is reduced.

Still to come is a detailed consultation/decision process on ‘related party transactions’, with the Commission’s final word on these scheduled for Q4 2017.

The Commission’s views on whether or not distributors should be allowed to participate in the emerging technologies market are reasonably forthright:

.  Our review of emerging technologies has highlighted concerns from some stakeholders (mainly energy retailers and the Electricity Authority) that EDBs may have a significant competitive advantage in emerging energy markets. Their key concern is that EDBs’ status as regulated monopoly providers may give them an undue competitive advantage in, or otherwise distort, competitive emerging energy-related markets (either existing or new), and that our cost allocation rules would not adequately deal with this.

.  The cost allocation IM is intended to ensure that consumers of regulated services benefit over time from any efficiency gains achieved by EDBs supplying regulated and unregulated services together. We consider the cost allocation IM is largely fit for purpose except that we have decided to remove the avoidable cost allocation methodology (ACAM) as a stand-alone option from the cost allocation IM for EDBs [and gas distributors]. The potential benefits from sharing efficiency gains are just as relevant for any regulated and unregulated service. Therefore, our decision to remove ACAM applies to all regulated EDBs and GPBs, and makes no distinction in respect of certain types of unregulated services.

New Trusts Bill taking shape

Over the past two years the Ministry of Justice has been developing a new Trusts Bill that will replace the Trustees Act 1956 and the Perpetuities Act 1964, along with section 59(2) of the Property Law Act 2007. While it is mainly focussed on family trusts and trusts involved in financial management, it applies to all ‘express trusts’ – i.e. any that are created for an express purpose, and – as noted by various legal commentators:

…, the proposed statutory provisions could have significant and unintended implications for a range of commercial trusts, and the process of amending commercial trust deeds to limit the effect of the new law would involve substantial resource and cost for no, or very limited, benefit. In addition to having a major impact on statutory and corporate trustees, the bill has the potential to affect the rights of creditors by affecting the allocation of risk and reward, which are carefully negotiated by the parties to commercial trust deeds.

In addition, the bill does not appear to deal with the requirements of other applicable legislation, including the Companies Act 1993 (for trading trusts)…. This could result in duplication of reporting and record-keeping and retention requirements. [1]

As set out in the initial consultation draft, the purpose of the bill is:

(1) … to restate and reform New Zealand trust law by—

1.  (a) setting out the core principles of the law relating to trusts; and

2.  (b) providing for default administrative rules for express trusts; and

3.  (c) providing for mechanisms to resolve trust-related disputes; and

4.  (d) enhancing access to the law of trusts.

(2) However, this Act is not an exhaustive code of the law relating to trusts.

(3) This Act is informed by and complements the rules of common law and equity relating to trusts (except where otherwise indicated or where those rules are in- consistent with the provisions of this Act).

Justice Minister Amy Adams says that ‘improvements’ to trustee law will include:

·  clear mandatory and default trustee duties, so people know what their obligations are if they’re involved in managing a trust,

·  requirements for trustees to manage and provide information to beneficiaries,

·  flexible trustee powers and updated rules,

·  clear rules for when people make changes to a trust or wind them up, and

·  more options for removing and appointing trustees without having to go to court.

The Bill is expected to be introduced shortly. Consultation documents are at https://consultations.justice.govt.nz/policy/trusts-bill-exposure-draft/

Some easing of restraints on trustees’ and directors’ supposed conflicts of interest likely
On 17 November 2016 Revenue Minister Michael Woodhouse announced that the forthcoming Taxation Bill will include an easing of the restraints on trustees’ “voting interest test”[2]:

“Two recent High Court cases on the application of the voting interest test for corporate trustees could result in overreach when it comes to measuring the ownership of companies including their association.

This overreach is a particular problem for professional firms including accountants who are acting as independent trustees for their clients’ companies.

We are proposing to reinstate the previous policy position to ensure these companies are not associated.

Officials are planning to consult with stakeholders shortly on these proposals.”

A couple of years ago IRD published new guidelines on how transactions between or among ‘associated persons’ must be treated in financial disclosures. This move was paralleled by a legal decision making it clear that all the corporate and private activities of trustees and others were intertwined when it comes to corporate responsibilities. As noted by PwC last February:

The High Court’s decision for the Commissioner in its judgment inStaithes Drive Development Limited v Commissioner of Inland Revenue[2015] NZHC 2593 (Staithes)1results in a significant shift in how the associated person tests have previously been applied to corporate trustees. Prior to this and the earlier decision inConcepts 124 v CIR2(Concepts 124), it was accepted that a trustee has both a trustee capacity and a personal capacity and that it is therefore not appropriate to look through a corporate trustee to its shareholders when considering association. The decisions in these two recent cases reject that approach by finding that voting interests for control purposes are held by the legal owner of shares regardless of the capacity in which those shares are held.

As a consequence of these decisions, in the extreme, two otherwise unrelated companies may be associated if the same solicitor nominee company holds shares in both or if a public trustee company holds shares in two separate companies for trusts with unrelated beneficiaries.

Contact Energy repositioning to compete as platform provider?

Contact CE Dennis Barnes got quite a lot of media exposure with his comment that households of the future will have a mix of smart appliances, electric vehicles, energy storage and perhaps solar power, and “Contact would eventually become a technology company that sells energy.”

Noting that Contact have suddenly started splitting their financial reporting into separate ‘generation’ and ‘customer’ accounts, after years of promoting its ‘integrated energy model’, business journalist Patrick Smellie reported:

The new approach represents a profound shift.

….The 'integrated' logic of the previous decade need not apply, while the explosion of digital technology in homes and businesses offers new opportunities managing the apps and gadgets that will run our lighting, heating, cars, telecommunications, entertainment and daily chores in the near future.

….Add in the likelihood that solar photo-voltaicand localised wind generation could render the national grid redundant within a generation, and the logic becomes inescapable – traditional electricity retailers risk becoming like any industry facing massive disruption thanks to digital technology.

A company like Contact may not want to own power stations quite soon – just customer relationships with various kinds of energy-managing devices.[3]

Growing demand peaks indicate Waikato and Upper North Island voltage management will be needed

The Commerce Commission has acknowledged that closure of Southdown and Otahuhu Power stations in Auckland and the proposed closure of the Huntly Power Station in Waikato are likely to cause voltage management issues in the Auckland and Waikato regions as peak electricity demand increases. To manage voltages in these regions,Transpower may need to invest in the grid or procure non-transmission solutions from third parties.

Transpower and the Commission have agreed on a consultation programme aimed at producing “non-Transpower solutions”, beginning around July this year. A request for proposals to deliver those solutions is expected in October, with a view to having new voltage management options available from some time in 1919.

There are a couple of significant messages in this. First, the Commission has been slow to recognise the significance of peak load growth (as opposed to overall annual growth in delivered electricity) to networks, and acknowledging that it is becoming an issue for Transpower suggests that some recognition will be given to it at the 2020 reset of distribution regulation. Second, how ‘non-Transpower solutions’ are sourced could reflect how accepting the regulator is to distributors continuing to lead the way in delivering demand-side options. It would be concerning if, e.g. retailers emerged as the favoured middlemen contracted to aggregate alternatives such as demand restraint and storage management.

South Australia’s power shortages

After the closure of South Australia’s last coal-fired generators last year, wind power supposedly accounted for around a third of electricity supply in the State. However, the main cause of the serious peak time supply problems there this month, seems to have been the failure of gas-fired back-up plant to come on stream, rather than over-reliance on renewables.

According to ‘Engineers Australia’s’ Chris Stoltz “Under the predominately market-driven reform of the last two decades, overlaid with more recent regulations, electricity has become increasingly expensive, unreliable and inflexible.” Other critics claim that the need for imposed power cuts could have been avoided if big electricity companies hadn’t blocked a rule change last November that would have alloowed demand-side participation in the market.

Nevertheless, Aussie Prime Minister Malcolm Turnbull has seized the opportunity to lay the blame on the SA Labour government’s pursuance of renewable energy generation through wind farms.

“Of course they (the SA Government) want to blame it on everybody else. Well, I suppose they can blame it on the wind because it wasn’t blowing yesterday. But you know something, in SA which does have a history of heatwaves, when they have the biggest heatwave there’s no wind. And when there’s no wind, all their windmills are not generating electricity and they haven’t planned for that.”

Notably the PM didn’t mention the very significant contribution that SA’s 25% roof-top solar penetration made to help households through the supply crisis.

2

[1] Bell Gully Financial Services Quarterly: 2/12/16

[2] https://www.beehive.govt.nz/speech/opening-address-chartered-accountants-australia-and-new-zealand-annual-conference

[3] http://www.stuff.co.nz/manawatu-standard/business/89440116/Pattrick-Smellie-Electricity-s-internet-moment-becoming-visible