Appendix 1: The regulatory framework

In November 2010, the Electricity Industry Act 2010 (the Act) took effect. The Act repealed and replaced significant sections of the Electricity Act 1992. The new Act provides a new framework for regulation of the electricity industry.

Under the Electricity Act 1992, the Electricity Commission was responsible for regulating the operation of the electricity industry in accordance with the Act, Electricity Governance Regulations, the Electricity Governance Rules (the rules), and the Government Policy Statement. The Commerce Commission was (and continues to be) responsible for regulating Transpower's revenue.

The 2010 Act disestablished the Electricity Commission and replaced it with the Electricity Authority (the authority). The authority is required to make and administer the Electricity Industry Participation Code (the code) and monitor compliance with the Act.

On 1 November 2010, the code came into force. It incorporated large parts of the 2003 Electricity Governance Regulations and rules that it replaced.

The 2010 Act also established sections 54R and 54S of the Commerce Act 1986. These sections transferred the Electricity Commission's role in requesting and approving grid upgrade plans to the Commerce Commission. The 2010 Act also gave the Commerce Commission the power to determine input methods for Transpower's capital spending policies.

Under the terms of the 2008 administrative settlement between the Commerce Commission and Transpower, the Commerce Commission was required to set a non-part F capital expenditure threshold. The threshold sets the process and constraints by which an annual level of capital spending will be approved in advance. Spending on existing asset replacement, asset refurbishment, asset enhancement and development, and operational network information technology services were considered non-Part F capital expenditure. The non-part F capital expenditure threshold was set each year.

In December 2010, the Commerce Commission finalised a new regulatory regime that required Transpower to submit quality performance targets, and plans for operating expenditure and minor capital expenditure for a three-year period from 1 July 2012 to 30 June 2015. This is a change from the previous annual approval process.

At the time of our audit, the Commerce Commission had considered the threeyear proposal and produced a draft decision.

Grid upgrade plans

Section 54E of the Commerce Act declares electricity lines services to be regulated under Part 4 of the Act. Transpower is further subject to individual price-quality path regulation under section 53ZC of the Commerce Act 1986. Transpower is required to get Commerce Commission approval for investment in the grid. This was previously the role of the Electricity Commission. Transpower is required to prepare and submit grid upgrade plans (the plans) to the Commission.

Part F, section 3, of the rules required the plans submitted to the Electricity Commission to contain, among other things:

• a comprehensive plan for managing assets and operating the grid;
• information on investment contracts (contracts for grid investments that are agreed between Transpower and one of its customers); and
• different treatment of economic and reliability investments.

Section 54S of the Commerce Act 1986 requires the Commerce Commission to prepare an input methodology for capital expenditure projects. It has until 1 November 2011 to do so. The Minister can extend this deadline for a further three months. Until the new input methodology is completed, section 54R of the Commerce Act 1986 requires Transpower to comply with Part F of the Electricity Governance Rules (the rules) when considering grid upgrade plan proposals.

Section 54S states that the new input methodology prepared by the Commerce Commission must include requirements that Transpower must meet, including the scope and specificity of information required, the extent of independent verification and audit, and the extent of consultation and agreement with consumers.

Grid investment test

Until the Commerce Commission determines the capital spending input methodology, the grid investment test in Part F of the Electricity Governance Rules continues to be applied to Transpower's investments.

Under Part F of the rules, the Electricity Commission and subsequently the Commerce Commission checked that Transpower's investment proposals met the grid investment test. The grid investment test is essentially a net benefits test. A proposed grid investment satisfies the test if it is determined to maximise net market benefits (or minimise net costs) relative to alternatives.

The objectives of the grid investment test include achieving economic efficiency, looking after the interests of end users, balancing costs of various levels of reliability against expected value of unused energy and selecting transmission options that maximise net benefits to producers, distributors, and customers.

Under the code there is no requirement for a grid investment test, but section 54S of the Commerce Act does require the Commerce Commission to determine an input methodology for Transpower's capital expenditure, which will replace the grid investment test. The Commerce Act (Transpower Input Methodologies) (Capital Expenditure) Determination 2011, produced by the Commerce Commission contains a similar net electricity market benefit test for major capital expenditure.

Grid reliability standards

The rules required investments to be justified against the grid reliability standards (the standards). The standards set by the Electricity Commission consisted of:

• an economic (probabilistic) standard for the whole grid and the associated assessment of the costs and benefits for reliability; and
• a "safety net" minimum reliability standard of N-1 of the core grid. N-1 security means that at any particular point location in the core grid, the loss of one system component can be tolerated without loss of service. This means that if an equipment loss occurs, the system has enough back up capacity to keep transmitting. It also means that maintenance can often be done on one component without the need to restrict supply.

The standards required Transpower to enter a process to upgrade the assets or amend the transmission agreement or service levels when it reasonably expected the existing connection or interconnection assets to be unlikely to continue to meet the standards at the relevant grid exit point over the next five years. This requirement is contained in the new code and is discussed below.

With the change in legislation, new standards were included in Schedule 12.2 of the code. The standards are set by the Electricity Authority. The purpose of the standards is to provide a basis for Transpower and other parties to appraise opportunities for transmission investments and alternatives.

The grid satisfies the standards if:

• the power system is reasonably expected to achieve a level of reliability at or above the level that would be achieved if all economic reliability investments were to be implemented; and
• with all assets that are reasonably expected to be in service, the power system would remain in a satisfactory state during and after a single credible contingency event occurring on the core grid.

A single credible contingency event means an event comprising any of the following:

• a single transmission circuit interruption;
• the failure or removal from operational service of a single generating unit;
• an HVDC link single pole interruption;
• the failure or removal from service of a single bus section;
• a single interconnecting transformer interruption; or
• the failure or removal from service of a single shunt connected reactive component.

The Commerce Commission's Commerce Act (Transpower input Methodologies) (Capital expenditure) Determination 2011, requires Transpower to assess how well the grid meets the grid reliability standards for investments.

Grid reliability reporting

Under the rules, Transpower was required to publish a grid reliability report within six months of the statement of opportunities being published.²⁷ The report was required to set out:

• a forecast of demand at each grid exit point during the next 10 years;
• a forecast of supply at each grid injection point during the next 10 years;
• whether the power system is reasonably expected to meet the N-1 criterion, including in particular whether the power system would be in a secure state at each grid exit point, at all times over the next 10 years, having regard to the possible future scenarios set out in the statement of opportunities; and
• planning proposals for addressing any matters identified in the previous item.

The forecasts of demand at each grid exit point and the supply at any grid exit point supply included in the report had to be consistent with the forecasts of demand and supply set out in the statement of opportunities.

When there was a material change in the forecast demand at any grid exit point or in the forecast supply at any grid injection point, Transpower was required to publish a revised report as soon as reasonably practicable.

The code requires Transpower to publish a grid reliability report. The requirements for the content of the report have been carried over from the rules and included in Part 12 of the code. A change has occurred to the timing of the publication of the report. Transpower must now publish the report no later than two years after the date on which it published the previous report, or as determined by the Electricity Authority. The requirement remains for the report to be revised and published if there is a change in forecast demand at a grid exit point or change in forecast supply at a grid injection point.

If the report identifies that the power system is not reasonably expected to meet the N-1 criterion at the grid exit point at all times during the five years after the publishing date of the report, and that this is because of an interconnection asset, the code requires Transpower to act. Transpower must investigate whether the interconnection asset meets the grid reliability standards. If the asset does not meet the standard, Transpower must consider its options with respect to the standards. Transpower must submit an investment proposal to the Commerce Commission if it considers that one or more investments are required in respect of that interconnection asset to meet the standards.

27: The statement of opportunities was required under the rules. The Electricity Commission was required to publish the statement to enable identification of potential opportunities for efficient management of the grid, including investment in upgrades and investment in transmission alternatives. The Government Policy Statement required that the statement of opportunities be prepared every two years. The statement of opportunities was not included in the code. There is provision for the Electricity Authority to carry out a core grid determination to provide a basis for the Authority to determine the grid reliability standards, and for Transpower and other parties to appraise opportunities for transmission investment and transmission alternatives. Interested parties may request a core grid determination.