ELECTRICITY RESTRUCTURING AUSTRALIA AND CALIFORNIA

The Australian National Competition Policy

(NCP)

Brian Browne

Economist - Specializing in Water and Wastewater Studies

Fax 415-956-4628

h2oecon@@pacbell.net

Website http://www.hooked.net/users/bb2

October 20, 1997

The following slides are from my presentation to the EPRI conference on October 20,1997

• Consultant to EPRI on Water and Wastewater Issues and helped organize this conference
• Have been asked to give a quick overview of National Competition Policy in Australia and implementation of this policy as it impacts infrastructure (electricity) assets. Necessitated by unfortunate scheduling problem for original speakers.

• 1990 Premiers Conference Council of Australian Governments (COAG) -- Commissioned a study to create a National Electric Market (NEM)
• COAG --
• 1991 National Grid Management Council created to develop a protocol outlining objectives and principles
• 1991 COAG agrees to examine a national economic policy
• 1993 Hilmer Report presented ("micro" economic reform)
• 1995 Competition Policy Reform Act passed - formal implementation of National Competition Policy (NCP)

• Trade Practices Act amended -- All businesses subjected to competitive rules (government [some specified exclusions] and private enterprises)
• Shield of the Crown immunity for State and Territory businesses (GBE) removed
• Part IIIA Trade Practices Act "legal regime to facilitate access to certain facilities of national significance." (infrastructure)
• Abolition of Trade Practices Commission and Prices Surveillance Authority -- merged into Australian Competition and Consumer Commission (ACCC)
• Establishment of a pro-competition advisory body National Competition Council
• Incentive payment scheme implemented to ensure adherence
  - Reduce state debt
  - NSW unions see sale of electric assets as depriving state of a revenue source
  - States in Australia have limited taxing powers

• Built to encourage settlement -- e.g. RRs in US were of private enterprises often encouraged by land grants. Australia -- government infrastructure investments
• Closed monopolies
  - Vertical integration - generation, transmission, and distribution
  - Functions generally all performed within the company (planning, plumbing, R&D, etc., etc.)
• Exempted from Trade Practices legislation
• No formal regulation (i.e. PUC rate making)
• States appear to have greater power in these matter - hence - COAG's a priori agreements

• Corporatization
  - Emulate the private sector
  - Have government enterprises organized and performing like private sector industries (efficiency criteria)
  - Ensure competitive neutrality (NEC)
• Switch functional relationships from vertical to horizontal and break functions into separate corporatized entities
• Outsource
• Privatize -- sell assets -- A large percentage of the Victorian power system. Premier of NSW rebuffed by own party on attempt to sell NSW electric infrastructure.

n

NPV = S (R_i - C_i)/(1+r)ⁱ

i = 1

or to simulate a perpetual annuity n

NVP = NR/r

E.G., A $10 perpetual annuity with different discount rates

10 % = $10/.10 = $100

5% = $10/.05 = $200

Discount rates are important in planning and establishing reservation prices. Selling a used auto (capital good), one can obtain a base reservation price by asking a used auto dealer what they will pay for the vehicle. After that, it is a search process up to the time where the marginal value of the gain just equals the marginal value of holding the auto and conducting an additional increment of search. Power systems, surely require an even more exhaustive search process to determine their value in use to the seller.

Case Study:

NSW government owned electricity system has been valued at $A25 billion (newspaper quotations SMH et al). Inquiries have failed to produce a "planning discount rate" for establishing a reservation price, should the government sell. Buyers and sellers have different discount rates.
Quandary of NSW government - trade-offs - that may affect their imputed discount rate.

• Sell assets
  - reduce debt
  - incur dissatisfaction from (ALP case specific) parts of the electorate
  - give up a major source of income (states have limited taxing powers - rely on federal funding grants)
  - become more dependent on federal government funding
• Retain assets - face revenue fall-offs due to interstate (NEM) competition (guessing demand elasticities) - face primary (e.g. Powercorp sale to Sydney Water) and secondary (industries moving out-of-state) impacts.

Australian Power Industry Size by State/Territory

Recent Electric Supply Industry Structural Reforms

State and changes

Queensland Into three independent generation companies, three retail companies established, one transmission company, and seven distribution (wire) companies.

NSW 2 new generation and 25 distribution companies into 6 new distribution companies plus a separate transmission company

May 1997 - NEM1 (first stage toward National Electric Market - run by National Electric Marketing Company)

September Sydney Water Company (former Sydney Water Board - NSW Govt. entity) buys electricity from Powercor (Vic) Commonwealth Bank, Melbourne, Victoria contracts for electricity from NSW power station

Victoria Major reform market established. Corporatization and privatization (distributor companies and generators). Victorian Power Exchange (VPX) established 1994. Enters NEM1 May 1997. Dispatches under NEM1 administered by VPX (Victorian Power Exchange). PowerNet, Victorian transmission company privatized.

South Australia Utility corporatized - Further structural change under review -- Using Victorian VPX as model. Generation company separated and corporatized.

Australia constrained interstate interconnections - 3 percent - marginal interstate flows - National order of merit (least marginal cost) sequencing not currently a reality

Electricity Market Structure

Milestones

• 1990 Special Premiers Conference - commissioned a study to create a National Electricity Market (NEM)
• 1991 National Grid Management Council (NMC) creates and issues draft protocol outlining objectives and principles
  - the market should be competitive
  - customers-choice of supplier
  - open access to transmission and distribution network
  - equal treatment of existing and potential market participants
  - no discrimination between fuels and technologies
  - no discrimination between intra and interstate trading
• National grid developed as eight separate state and territory based systems in addition to the Snowy Mountains Scheme
• NEM to remove barriers between eastern States - Western Australia and Northern Territory are not involved at this time
• March 1997 - National Electricity Market Management Company takes over responsibilities of National Grid Management Council (NGMC)
• May 1997 - interstate trading in electricity (NSW/Victoria) authorized
• September 1997 -- Powercor, Victoria and Sydney Water, NSW sign deal

• National Electricity Grid - amalgamation of the various networks of electric poles, wires, and cables within Queensland, NSW, Australian Capital Territory (ACT), Victoria, Tasmania, and South Australia.
• National Electric Market Management Company (NEMMCO)
  - Operate a spot market (the pool) for wholesale trading of electricity
  - Facilitate a short-term forward market for participants
  - Provide the facilities for inter-regional hedging contracts
• Energy is traded through a conceptual pool. Pool rules/disputes are specified in National Electric Code (NEC) are administered by the national Electric Code Administrator (NECA)
• A computerized system The Settlement System -Metering Data Provider- is used to calculate prices and gathers other data under NEC codes. The Meter Providers are responsible for providing the metering devices.
• Market Participants are persons registered with NEMMCO under one of the following categories
  - Market generator - Must sell all energy at spot price
  - Market customer (1) retailers (DC) or Non-franchise (large) customer (apply to NEMMCO)
  - Trade - Support NEMMCO in financial contracts
  - Franchised customers must trade retailers
• Network Service Provider (NSP) - own or operate transmission or distribution system - Registered with NEMMCO and agrees with Australian Competition and Consumer Commission to ensure open access in accordance with provisions of NEC.
• Network Operator - operate the system - currently a "ring-fenced" entity inside TransGrid in NSW and VPX in Victoria. NEMMCO likely will establish regional control centers in Sydney and Brisbane.
• NEMMCO Business Accounting Function will provide an Electronic Funds Transfer Facility (EFT) for authorized pool Settlement amounts
• NEMMCO and NECA will be non-profit organizations. NEMMA will collect charges from participants to fund itself and make payments to NECA.

Clarifying letter -- October 1997

National Competition Council

Thank you for your letter. Hopefully I can answer your questions articulately.

Q. In NEM1 and then NEM will power stations be sequenced in order (lowest marginal cost to highest marginal cost) on a nation-wide basis?

A. In general, yes the power station's bids are sequenced in order on a nation-wide basis. Under the NEM1 arrangements, only the states of NSW and Victoria are covered, and dispatch is administered by the respective State authorities, VPX (in Victoria) and TransGrid (in New South Wales). However, under the NEM, South Australia will also be included and the National Electricity Market Management Company (NEMMCO) will take over that role of system operation.

Queensland currently has an interim market running along side NEM1, but will join the NEM once it is physically interconnected with NSW - expected around 2001.

However, I would like to point out that electricity supply has traditionally been provided by State utilities meeting the needs of the individual States, and until recent years the grid connections between States have been relatively weak or non-existent. In fact, interstate trade in electricity represents on average around 3% of total electricity consumed within the States. So, in reality there are going to be constrained interconnectors and differing spot prices will occur in regions where there are constrained interconnectors. So, the real answer is yes, national basis subject to constrained interconnectors.

Q In California, there is a definite time period during which the major utility power stations have to sell into the pool. Does such a time constraint exist in Australia? As I understand it, NEM requires that all Australian power stations sell into the pool regardless ad infinitum.

A. All generators with a name plating of more than 30 MW (check) are required to generate all their energy through the pool. Generators can sign contracts with customers to supply them electricity. However, there is no guarantee that they will be dispatched.

Generators will bid into the pool, 24 hours ahead to supply electricity over particular half-hour periods. Generators are not required to submit bids for a particular half-hour period - so it is self-commitment. However, if the planners expect demand to exceed planned supply, then all generators will asked to bid extra quantities. The only time a generator is required to generate is for ancillary services or in the case of an emergency.

Q As I understand it, the price charged is the price at which the demand price equates to the marginal price of the last station supply to offer an amount to meet the quantity demanded.

A. In general, this is the case - your diagram is correct. However, as I said previously because of weak interconnectors between jurisdictions, it is likely that there will be constraints, leading to differing pool prices. So in this case, the price charged is for the last unconstrained generator bid. For example, demand for Victoria could be 1000 MW and NSW 1500 MW over a particular half-hour period. However, according to the bids, the cheapest bids for 2500 MW could all be by Victorian generators. If the interconnector can only take 500 MW at a time, that means that there is still 1000 MW needed to meet NSW's demand. No more can be received from Victoria, so it will have to come from NSW generators - the pool price in NSW will therefore be higher than in Victoria. There are financial instruments to hedge against these problems!!!

Q. Do the power stations offer their supplies on an ad hoc half-hourly basis? Do they offer them on a half-hourly basis but at the beginning of a planning week? In other words, do they pre-submit their offers? How and when do they determine the amount of supply and the supply price (marginal cost/ marginal supply price) at which to offer the electricity supplies?

A. Generators put their bids in the day before for a particular half-hour period. The merit order of dispatch is based on the bids, but the spot price is determined when it is known the demand for each half-hour unit. Over a half-hour period, generators may be called to be dispatched for a five-minute period and then switched off again. The ex-post spot price calculated for the half-hour is the average of six 5 minute SMPs.

Q. The NEMMCO diagram shows a System Operator and a Network Provider, appointed by NEMMCO. Are these functions carried out by VPX and TransGrid, or will NEMMCO become the actual operator? Will they continue to be carried out by TransGrid and VPX?

A. Currently, VPX is responsible for system operation in Victoria, and a ring-fenced unit within TransGrid is responsible for system operation in NSW. Upon commencement of the NEM, NEMMCO will take responsibility for this role (although I believe that VPX will retain some Victorian specific functions). I have been reliably informed that it has been a recent decision to go down the direction of NEMMCO establishing 2 national system control centres - one in NSW and one in Queensland (Queensland is not currently interconnected to the south-east grid, but intends to be by 2001). This is supposed to be based on the Californian experience.

My understanding is that the network providers are the transmission and distribution businesses. TransGrid and VPX are the transmission network providers for NSW and Victoria respectively. There are six distribution network providers in NSW and five in Victoria.

Q. In this context, who will unbundle the charges for generation, transmission and distribution? The Metering Data Provider? Now? In the future?

A. There are no vertically integrated entities in NEM1 market. As part of the (Council of Australian Governments) COAG reforms in electricity, all participating governments were required to structurally separate generation from transmission, and ring-fence the distribution wires business from retail activities.

So a large customer that has entered the wholesale market will either bid in the spot market for purchasing electricity (and pays NEMMCO) or signs a contract with a generator to receive energy at particular prices. The large customer will also be required to pay for transmission charges and distribution charges to the respective companies. So because of the structural separation, the charges are already unbundled.

It is my understanding that for retail companies that supply to households and small businesses, the bill will be itemised to show the transmission, distribution and energy usage charges.

Q. The Independent System Operator in California and the Exchange Operator will be non-profit entities. My reading of corporatization means that every entity will be treated as a profit making entity under Australian tax law - true or false?

A. Both NEMMCO and NECA will be non-profit organisations. NEMMCO will collect charges from participants in the market to support itself and make payments to NECA.

Q. Do you have a diagram explaining the relationships between providers, the regulators and the ACCC?

A. No I don't.
The national electricity market will be subject to a mix of national and State based regulation which includes a national regulator and industry code of conduct.
the Australian Competition and Consumer Commission (ACCC) will be responsible for the economic regulation for transmission services. It may also, at a jurisdiction's request, become the economic regulator for distribution services of that jurisdiction. At present, IPART (Independent Pricing and Regulatory Tribunal) and the Regulator General are responsible for economic regulation for transmission services in NSW and Victoria respectively.
-The ACCC also has the role of approving the access arrangements provided by the network service providers and authorisation of the market trading arrangements within the Code. Approval of the access arrangements means that access terms and conditions are known and cannot be overturned by someone seeking to have the network services declared under Part IIIA of the Trade Practices Act.
Authorisation of the market arrangements means that any anti-competitive behavior (such as price fixing as all dispatched generators receive the same price) that would normally be in breach of the Trade Practices Act is now outside of the ambit of the Trade Practices Act. The ACCC has released their draft determinations on approval of the access arrangements and authorisation of the Code, and final determinations are expected soon.
franchise customer pricing, environmental matters, distribution network pricing, distribution and retail licence conditions, and health and safety will remain State based responsibilities. Again, IPART (Independent Pricing and Regulatory Tribunal) and the Regulator General are responsible for economic regulation for distribution services in NSW and Victoria respectively.
Market operations (market rules, network connection and access, operation, system control and security, network pricing principles, and metering) will be covered by a mandatory industry Code, which will be administered by the National Electricity Code Administrator (NECA). NECA will monitor and report compliance with the Code; enforce the code; resolve disputes through the code; and manage change to the Code.
NEMMCO will be responsible for the day to day management of the security of the power system, national merit order dispatch of generation and controllable load; and operation of the spot and forward trading markets; and settlements system.

If you have any problems with these answer, do not hesitate to give me a call. I am not the expert of the national electricity market, but hopefully can assist you. If you have very technical questions, the best person to speak to may be Don Williams of the Department of Primary Industries and Energy. His number is 61-2-6272-4886.

All the best with your conference. Let me know how it went.

Yours sincerely