Part 3: Deciding on sole source procurement

Electricity Commission: Contracting with service providers.

3.1
In this part of the report, we focus on the events leading to the decision to use sole source procurement in the appointment of the service providers. We exclude details of the negotiations that the Ministry and the Commission went through to reach these points.

The Electricity Commission Establishment Unit

3.2
The proposal to establish the Commission was first advanced in Cabinet Economic Development Committee Minute EDC (03) 86 (13 May 2003). In relation to service provider contracts, the Cabinet paper noted -

Services to the electricity market are presently provided through eight contestable contracts. New contracts (or extensions of existing contracts) will need to be negotiated. Provision for service contract negotiations has been included in the budget proposal, but there is a risk that negotiations could become more complex and more expensive than budgeted…Delays in completing service contract negotiations also have the potential to cause a delay to the proposed 1 August start up. A further financial risk exists with the costs of converting the industry rulebook into statutory regulations or rules.

3.3
The first meeting of the ECEU Steering Group took place on 23 May 2003, but not until its fifth meeting on 4 July was the issue of service provider contracts substantially discussed.

3.4
A paper discussed at that meeting noted¹⁰ -

One of the key requirements of successfully establishing the Electricity Commission (EC) and launching the Electricity Governance Regulations and Rules (EGRs) is the negotiation and execution of Service Provider Contracts (SPCs). The deadline for achieving this is tight, given the number of contracts, the relative complexity of the contracts, the cautious outlook of existing service providers, and the limited amount of time available. However, to our advantage, progress has already been made negotiating similar contracts under the EGEC [Electricity Governance Establishment Committee] rule set. It is our intention to use these contracts as a template that will be updated and then used as the starting point for negotiation on behalf of the EC.

3.5
The paper went on -

While the service provider roles are contestable (except for the System Operator role in the initial stages), it has been decided, given the time constraints and the specialist knowledge and systems required to perform the service provider roles, that only the current Service Providers under the NZEM [New Zealand Electricity Market] and MARIA [Metering and Reconciliation Information Agreement] rules will be approached to provide these services.¹¹

3.6
Based on the documentation we saw, this was the first point at which it was decided that only existing providers would be contracted to deliver services to the Commission.

3.7
The subject of service provider contracts came up at subsequent meetings of the ECEU Steering Group, but it was the 4 July meeting that determined that the ECEU would approach existing service providers (and opt for sole source procurement) rather than make these contracts contestable.

The Electricity Commission

3.8
By the time the Commission was formally established on 15 September 2003, negotiations with service providers were well advanced. The regulated market was scheduled to come into being on 1 December 2003, with the Electricity Governance Rules gazetted and the service provider contracts signed some time before that.¹²

The Electricity Commission’s first informal meeting

3.9
The Commission’s first informal meeting was held on 19 September 2003. At this meeting, the Commission was briefed on the progress of the negotiations for service provider contracts, and the decisions already made by the ECEU.

3.10
The briefing notes recorded the following -

Terms of Reference
Use the contracts template developed under the industry process
Don’t lock the EC [Electricity Commission] into long term contracts
Deal with current industry Service Providers
Complete by 19th September
Negotiating Mandate
Develop a key term sheet with the Service Providers
Provide for a term which doesn’t expose the Board to risk (i.e. neither too long nor too short) or inhibit structural preferences
Require pricing or fee base to be transparent
Recognise interdependence between Service Provider Contracts and EGRs [Electricity Governance Rules]
Ensure that a robust process has taken place to enable EC [Electricity Commission] to sign off
Strive to maintain good relations with Service Providers

3.11
The briefing notes show the ECEU’s clear intention to negotiate with existing service providers to the electricity industry, and also to give the Commission the flexibility to restructure service provider contracts when they came up for renewal.

The Electricity Commission’s first official meeting

3.12
The Commission’s first official meeting occurred on 7 October 2003, and considered:

a paper by the ECEU, Service Provider Contract Negotiation Update, dated 29 September 2003; and
a paper by the ECEU, Service Provider Contract Recommendations, dated 3 October 2003.

3.13
The first of these papers provided an update on the status of the contract negotiations with existing service providers. The second recommended that the Board approve the main terms of the service provider contracts and the associated negotiation limits. The minutes simply noted -

The Board approved in principal the key terms of the Service Provider Contracts (SPCs) and associated negotiation limits as set out in Schedule 1 [as set out in the second of the papers referred to above] subject to the guidance provided by the Commissioners.

3.14
While not explicitly stated in the minutes, it is clear that the Commission approved the method for contracting with service providers at that meeting on 7 October. This was the second point at which it was decided that contracts for the delivery of services to the Commission would be negotiated with existing service providers, rather than contested.

3.15
The Commission told us that the decision reflected:

an earlier Government decision to base the Electricity Governance Rules as closely as possible on the New Zealand Electricity Market rules. The existing service providers had been closely involved with that self-reform and were therefore better placed than other parties to commit to new contracts based on those rules; and
a concern to ensure the “safe” operation of the electricity market through the transition period – that is, without disruption or interruption. Existing service providers were considered to be familiar with their roles in that market, and to have systems in place that worked.

3.16
The Commission said it was aware that it needed to make its own decision on the approach to contracting, but it was also aware that that decision would be considerably influenced by the earlier decisions of the Government and its advisers. Taking account of all relevant factors, the Commission concluded that it would be prudent and responsible to confirm the approach to the service provider contracts recommended to it by the ECEU on 7 October.

NZX Limited

3.17
On 17 September 2003, NZX Limited (NZX, formerly the NZ Stock Exchange) wrote to the ECEU expressing interest in several of the service provider functions to be managed by the Commission. Specifically, it proposed taking responsibility for the market administrator, pricing manager, clearing manager, information services provider, and registry manager functions.

3.18
When the Ministry and the Commission became aware of the NZX proposal, no contract decisions had been made. It may then have been appropriate to revisit the contract method that the 2 agencies had chosen—that is, sole source procurement.

3.19
The ECEU’s project manager replied to NZX on 25 September -

Given the timetable we are dealing with, our current thinking is to contract with existing Service Providers for the initial phase of the EC [Electricity Commission]. However, as the EC moves beyond the establishment phase I believe it is likely that it will favour a more contestable approach to the appointment of Service Providers.
I suggest that we leave matters on this basis for the time being.

3.20
On 7 October, NZX formally advised the Commission of its interest in being a service provider to the New Zealand electricity market, and during the next 2 months met the Commission and various other parties in the electricity industry. Prompted by NZX’s interest, the Commission sought legal advice from the Ministry on the approach it should follow in appointing service providers.

3.21
The Ministry’s advice was that -

… the Commission should be following processes that meet the standards set in the Statement of Good Practice¹³. They should be demonstrably acting fairly and reasonably, and they need to be in a position to justify a “selective procurement” strategy for their service providers.
This process should include a fair and reasonable assessment of the NZX proposal, considered in the context of the statutory functions of the Commission. The government’s requirement that the Commission take responsibility for the operation of the electricity market, and the timing of the establishment of the Commission and the making of the EGRs [Electricity Governance Rules] are obviously critical factors for the Commission to take into account. The risk inherent in the proposal from any new provider at this time is also clearly a critical issue for the Commission.

3.22
On 27 November, NZX presented a formal application to the Commission for the 5 service provider functions it had nominated on 17 September.

The final decision

3.23
On 15 December, the ECEU put a paper to the Commission. The paper, Recommendations To Enter Into Service Provider Agreements, noted -

Public sector guidelines and commercial good practice both suggest that the Commission should choose service providers through a contestable tender process (i.e. not just one involving parties known at the time). Contestable processes have the potential to offer similar services for lower prices and/or to offer improved service standards that benefit participants and the Commission.
However, using tender processes during the Commission’s establishment phase would have:
a Meant that it was not possible to introduce the EGRs [Electricity Governance Rules]in accordance with the Minister’s timetable. That is because only a limited, or “pseudo-contestable”, process could have been conducted in the time available. A full tender process could have taken at least 9 months to complete. A contestable process would involve the following steps
i announcement of a contestable process (including; [this point is incomplete in the paper];
ii development of service specifications (including consultation) and standardised contracts (without incumbent service provider input);
iii development of requests for proposals;
iv responses to and evaluation of proposals; and
v negotiating a contract with the chosen provider.
If a new service provider were chosen, it is likely that the timeframe for negotiation, developing and testing the systems needed for the role would also have to be agreed to. This would further extend the timeframe. All of the above would have led to a complex and new phase in the appointment of service providers.
b Created significant risks to the operation of the market, and the Commission’s credibility, if new service providers did not have sufficient time to develop, implement and test their systems and procedures.
Given these constraints, the Commission decided in October 2003 that the only practical approach during the Commission’s establishment phase was to use the service providers who are currently contracted to MARIA [Metering and Reconciliation Information Agreement] and NZEM [New Zealand Electricity Market](and who would have continued to provide services if the EGEC [Electricity Governance Establishment Committee]proposals had been implemented). These service providers are known in the market, have demonstrated expertise and are familiar with existing rules, the majority of which are continued.

3.24
On the NZX proposal the paper noted -

The 27 November NZX proposal is not of itself a fully developed proposal that could have been used as a base to make a decision to choose NZX. Rather, it required that the Board undertake a contestable process. Therefore, the decision that needs to be taken is whether the Board should stop the current process and instigate a contestable process.
We expect that a range of organisations would participate in a thorough process. These organisations could include the existing service providers, other organisations that have shown interest to date (including NZX and others), and a wider group that would likely respond once a process were made public (e.g. Australian companies with relevant expertise).
The process could only be undertaken once a thoroughly developed service specification was drawn up and agreed by the Commission. Given the significance of the service providers to the successful operation of the market, it would be desirable if the specifications were consulted on prior to the Commission agreeing to them.
The choice for the Commission is either to use existing service providers (as is currently proposed) or to introduce a contestable process that would significantly delay the start date for the EGRs [Electricity Governance Rules].
We believe that the Commission should introduce a thorough contestable process once the EGRs are fully operational. Overall, there is little downside for market participants from contestable processes being initiated after the EGRs are implemented. There would be significant costs and risks as a result of delays to the EGRs if contestable processes were initiated at this stage.

3.25
The ECEU paper recommended that the Commission reconfirm its “resolution” of 7 October 2003 that it would be impractical to initiate a contestable selection of service providers at this time. It also recommended that, once the Electricity Governance Regulations and Rules were in place, the Commission negotiate agreements with its service providers under existing contract arrangements.

3.26
In our view, the paper provided a reasoned argument for why the Commission should proceed with sole source procurement, and at its meetings on 16 and 17 December it confirmed its decision to do so.¹⁴

10: Discussion Paper: Service Provider Contract Issues and Plan.

11: Discussion Paper: Service Provider Contract Issues and Plan, page 2.

12: There were a number of delays to the establishment of the regulated market. The Electricity Governance Rules eventually took effect from 1 March 2004.

13: Procurement – A Statement of Good Practice, June 2001, Office of the Controller and Auditor-General.

14: Minutes of board meeting of the Electricity Commission, held on 16 and 17 December 2003.

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