Part 1: Background

• The establishment of the Electricity Commission
• What the Electricity Commission does
• The Electricity Commission Establishment Unit
• Service provider contracts
• The scope of our inquiry
• How we carried out our inquiry

The establishment of the Electricity Commission

1.1
In December 2000, after a Ministerial inquiry into the electricity industry¹, the Government released a policy statement² setting out its plans for a new governance structure to manage the electricity market. The industry then set up an Electricity Governance Establishment Committee (EGEC).

1.2
The task of the EGEC was to rationalise the industry’s existing structures³; establish rules governing wholesale and retail prices, security of supply, and transmission and distribution, and get the industry to agree to those rules. In April 2003, the EGEC proposed a new set of rules to govern the industry.

1.3
About this time, inflows to hydro lakes were low and the country was dealing with a potential energy shortage for the second time in 3 years. This prompted the Target 10% advertising campaign, which called for a 10% voluntary reduction in power usage. Issues around the continuity of supply, supply and demand management, and the need for backup reserves in a dry year were widely debated.

1.4
The first stage in implementing the proposed new rules was a referendum to gauge the level of support for the rules. Votes were allocated equally to each of 3 classes: consumers, traders (generators and retailers), and transporters (lines companies and Transpower New Zealand).

1.5
As widely expected, the referendum (in April and May 2003) failed to achieve the support needed to allow the new rules to proceed, and the Government moved quickly to establish its own governance arrangements for the electricity industry. The Electricity Amendment Act 2001 empowered the Government to set up, without consultation, a Crown entity to manage the industry if the Minister considered it necessary, or desirable, in the public interest that such an entity be established. The Government decided it was, and the Electricity Commission (the Commission) was formally established on 15 September 2003.

1.6
In setting up the Commission, the Government was moving away from a voluntary model based on industry contracts to a statutory, regulation-based model. As well, rather than creating a new organisation from an already established unit within an existing public sector agency, an entirely new entity was being established, with functions not previously performed by such an agency.

What the Electricity Commission does

1.7
The principal objectives of the Commission are –

• to ensure that electricity is produced and delivered to all classes of consumers in an efficient, fair, reliable, and environmentally sustainable manner; and
• to promote and facilitate the efficient use of electricity⁴.

1.8
The specific functions of the Commission are to –

1. formulate and make recommendations concerning electricity governance regulations and rules in accordance with [the Electricity Act 1992]:
2. administer, monitor compliance with, investigate, enforce, and apply penalties or other remedies for contraventions of electricity governance regulations and rules:
3. establish, operate, and facilitate the operation of markets for industry participants or consumers, or both:
4. use reasonable endeavours to ensure security of supply (including contracting for reserve energy), without assuming any reduction in demand from emergency conservation campaigns, while minimising distortions to the normal operation of the market:
5. undertake forecasting and modelling of future electricity supply and demand:
6. promote and facilitate the efficient use and conservation of electricity (including funding programmes that provide incentives for cost-effective energy efficiency and conservation):
7. manage emergency conservation campaigns to avoid material risk of supply shortages:
8. approve 1 or more complaints resolution system for the purpose of section 158G:
9. develop best practice methodologies and other standards and model agreements for use by industry participants:
10. give effect to [Government Policy Statement on Electricity Governance] objectives and outcomes:
11. provide advice to the Minister [of Energy] on matters concerning the electricity industry.⁵

1.9
The Commission’s functions may be performed “by contracting with other parties, entering into a joint venture or contractual arrangement in respect of reserve energy and other things, or by other means.”⁶

1.10
The Commission’s task is to oversee the operation of the electricity market in line with specific regulations and rules. The rules set out the various responsibilities of the market participants, the Commission’s duties and responsibilities, and a number of decisions relating to Transpower and the transmission grid. The regulations are the mechanism by which those rules are enforced. The electricity market began operating under these regulations and rules on 1 March 2004.

The Electricity Commission Establishment Unit

1.11
The Electricity Commission Establishment Unit (ECEU) was set up on 1 May 2003 to bring the new Commission into being. It was part of the Ministry of Economic Development (the Ministry), and its functions included writing statutory regulations or rules, negotiating service contracts, obtaining premises, and appointing staff.⁷

1.12
The ECEU reported to a steering group (the ECEU Steering Group), which consisted of Ministry staff. The ECEU Steering Group met 2 or 3 times a month, and service provider contracts were an agenda item at most meetings. The ECEU Steering Group continued to meet regularly (until just after the Electricity Commission was set up), and was then disestablished.

Service provider contracts

1.13
The Electricity Commission contracts 7 service providers under the Electricity Governance Regulations 2003. Regulation 30 states –

Appointment of service providers

(1) The Board must appoint a person or persons to act as the following service providers:

(a) a system operator:

(b) a registry:

(c) a reconciliation manager:

(d) a pricing manager:

(e) a clearing manager:

(f) a market administrator.

(2) The Board must appoint Transpower as the system operator.

(3) The Board may also appoint a person or persons to act as any other type of service provider.

1.14
These services are essential to the efficient delivery of electricity to its end consumers:

• The system operator is responsible for scheduling and dispatching electricity, to avoid fluctuations in frequency or disruption of supply.
• The registry is a database that identifies every point of electricity connection, enabling energy flows between retailers to be reconciled. The registry also tells retailers when a customer switches to another electricity supplier.
• The reconciliation manager facilitates the monthly reconciliation process and is responsible for reconciling metering data against a register of contracts.
• The pricing manager calculates and publishes final electricity prices.
• The clearing manager is responsible for monitoring security, invoicing, and setting electricity and ancillary service payments.
• The market administrator provides operational administration under the rules, rule change administration and analysis, education and advisory services, and enforcement.

1.15
The seventh service contract awarded was an information system contract.

1.16
Our inquiry specifically excluded the system operator contract because Regulation 30 requires Transpower New Zealand to perform this function. Figure 1 shows the value and term of each contract for the service providers appointed through the Commission’s sole source procurement process.

Figure 1
Service provider contracts

* From Recommendations to enter into service provider agreements, paper to Electricity Commission Board, 15 December 2003.

** With The Marketplace Company Limited as guarantor. Energy Clearing House Limited is a 100% owned subsidiary of The Marketplace Company Limited.

*** The Market Administrator Service Provider Agreement expired on 1 December 2004. The Commission reviewed the services provided under this agreement and decided to seek tenders in 2 areas:

• market governance and operational support services in relation to the Commission’s 5 key work streams (retail, wholesale, system operation/common quality, transmission, and security of supply); and
• membership of a preferred consultants’ panel to ensure that the Commission has access to specialist consulting support as and when required so that it can operate efficiently and achieve its key objectives.

The Commission also decided to bring in-house some of the services previously provided under the Market Administrator Service Provider Agreement.

**** The Information system function is not a specified service provider under the Regulations, but the agreement with The Marketplace Company Limited for this function was structured as a service provider contract under Regulation 30(3).

The scope of our inquiry

1.17
Under the original terms of reference for our inquiry (see Appendix 1), we examined the actions of the Commission and Ministry that led to the Commission’s decision in December 2003 to contract with 4 of its service providers.

1.18
Our inquiry set out to determine whether any act or omission had occurred that showed, or appeared to show:

• that the Ministry or the Commission had not complied with its statutory obligations; and
• a lack of probity or financial prudence by the Ministry or the Commission.

1.19
We did not examine whether the service provider contracts should have been contestable. That decision was for the Commission to make. The focus of our inquiry was on the procedures followed by the Ministry and the Commission in deciding to use sole source procurement. If a public entity decides upon sole source procurement, we would expect that decision to be made very carefully, based on sound analysis and due consideration of all the alternatives.

1.20
One service provider was concerned that our inquiry was not focusing on all of the Commission’s service provider contracts. Because of those concerns, we expanded our terms of reference to include 2 other contracts awarded by the Commission in December 2003. The expanded terms of reference are set out in Appendix 2.

1.21
We use the term “sole source procurement” to describe the steps that the Commission followed in contracting with its service providers. Under sole source procurement, the purchaser of the services negotiates a contract with only one party. This is a legitimate form of procurement in certain circumstances, and we discuss it further in Part 2.

1.22
Our inquiry considered good public sector procurement practice. We did not examine the merits or otherwise of the appointed service providers.

How we carried out our inquiry

1.23
We conducted our inquiry by:

• interviewing staff and members of the Commission, and staff from the Ministry;
• reviewing all documentation requested by us from the Commission, the Ministry, and the complainant; and
• meeting the Commission’s current service providers.

1.24
We circulated a draft of this report to all affected parties for comment.

1: The inquiry was set up by the Government to examine whether the regulatory arrangements for the transmission, distribution, wholesale and retail sectors were best suited to ensuring that electricity was delivered in an efficient, reliable, and environmentally sustainable manner to all classes of consumer. Its recommendations included strengthening and making mandatory the governance framework for the electricity industry, and replacing the existing governance bodies with a new single market structure.

2: Government Policy Statement: Further Development of New Zealand’s Electricity Industry, December 2000. A revised statement was released in February 2002, after a review of the way the electricity system functioned during the winter of 2001. A new statement was published in October 2004.

3: NZEM (New Zealand Electricity Market), MARIA (Metering and Reconciliation Information Agreement), and MACQS (Multilateral Agreement on Common Quality Standards, which deals with the security and quality of the electricity transported by the national grid).

4: Section 172N of the Electricity Act 1992 (as amended by the Electricity Amendment Act 2004).

5: Section 172O(1) of the Electricity Act 1992 (as amended by the Electricity Amendment Act 2004).

6: Section 172O(2) of the Electricity Act 1992 (as amended by the Electricity Amendment Act 2004).

7: Report to Cabinet Economic Development Committee, Proposal to Establish an Electricity Commission, 13 May 2003, page 9.