Part 3: Our audits of electricity distribution businesses

Energy sector: Results of the 2014/15 audits.

3.1
There are 29 electricity distribution businesses in New Zealand. As at 31 March 2015, 20 of them were public entities and within the Auditor-General's mandate. They vary greatly in size. Orion New Zealand Limited is the largest, with around 191,000 customers,12 and Buller Electricity Limited is the smallest, with about 4500 customer connections.13

3.2
In this Part, we comment on matters arising from our 2014/15 audits of electricity distribution businesses. We focus on the trends found in our audits of these companies, covering:

The regulatory environment

3.3
Electricity distribution businesses are natural monopolies, regulated by the Commerce Commission and, to a lesser extent, the Electricity Authority.

3.4
The electricity distribution businesses must comply with the reporting and information requirements of the Commerce Commission. The regulation of electricity distribution businesses' pricing is in the public interest. However, the regulations are complex and some are difficult for electricity distribution businesses to comply with. Many companies expressed concern in their annual reports about the substantial, complex, multiple disclosure requirements. One company remarked:

In recent years regulation … has become more and more complex. Keeping abreast of these regulations requires significant resources and the costs of compliance continue to increase. … disclosures are intended to enable ‘an interested person' to gain understanding of the company's operations. However, the detail required to meet disclosure requirements is exceedingly complex, and in some cases not easy to interpret.

3.5
The Electricity Authority is responsible for the efficient operation of the entire electricity market under the Electricity Industry Act 2010. The Authority monitors the operation and effectiveness of the market.

3.6
Ensuring reliable, secure, and safe electricity supplies is foremost in electricity distribution businesses' and regulators' minds. Relevant, up-to-date information on technical, financial and service performance information is essential for electricity distribution businesses, and regulators, to plan for and deliver on these objectives. It is not for us to comment on the merits of the regulations or structures of the electricity market. However, we note it is important that electricity distribution businesses have the capability and capacity to understand and respond to regulatory requirements. Otherwise, the potential regulatory benefits to consumers might not be realised.

3.7
A number of electricity distribution businesses' 2014/15 annual reports commented on the way the nature of the sector and the regulatory environment influenced their approach to doing business. One company said that compliance with regulatory quality targets, "… significantly influences the extent of planned outages on the network"; and that, together with more stringent health and safety requirements that limit their work on live lines, this could mean that its quality targets are ultimately not sustainable. Another company remarked that, if it had not diversified and grown, it "… would have remained a small provincial electricity lines company with few, if any, options for profitable growth".

3.8
We comment on some of the approaches that electricity distribution businesses are taking to expand their investments in paragraphs 3.18 to 3.34.

Governance of electricity distribution businesses

3.9
The make-up of and skills on governing bodies are always important considerations. Electricity distribution businesses are commercial entities and, in our experience, can attract directors with appropriate experience and skills. With the relative stability of electricity line companies' boards, they have the experience and skills to manage the core electricity distribution business.

3.10
Given the increasing diversity of company operations, the complexity of the regulatory settings, and the often large investments at stake, we encourage electricity distribution businesses to continue to be vigilant in maintaining their standards of governance.

3.11
For electricity distribution businesses making an investment, particularly outside of their core operations, the governing bodies must be careful to apply appropriate judgements based on good business cases. Also, as investments diversify away from the core business, governing bodies might need to reassess whether they maintain the appropriate mix of skills.

Investments by electricity distribution businesses

3.12
We have noted an increasing trend for electricity distribution businesses to diversify into other kinds of business, including investments seeking new revenue streams and geographical reach beyond their network location.

3.13
In doing so, electricity distribution businesses have sought to increase their unregulated revenue sources. One reason for companies to increase "non-core" operations is to seek increased profitability.

Investments in core network

3.14
Electricity distribution businesses continued to invest in their networks, upgrading and replacing assets and bearing the cost of unplanned repairs. Unplanned spending or large spikes in spending can affect the companies' operating positions and strategies.

3.15
Orion New Zealand Limited operates in greater Christchurch and central Canterbury. It has been making large investments in concurrently upgrading and restoring its network after the 2010 and 2011 earthquakes, installing new 66kV underground lines across the north of Christchurch, and building a new substation in Waimakariri. In 2014/15, the company reported that it had invested more than $80 million in each of the last two years on its network, $30 million each year above normal annual levels.

3.16
Waipa Networks Limited has committed to funding several big new capital projects, including $25 million for the construction of a second 110kV line to Te Awamutu.

3.17
Some electricity distribution businesses also faced repair costs after extreme weather events. Northpower Limited noted unplanned repair expenses of $1.1 million resulting from storms. Other natural hazards, such as earthquakes or flooding, and incidents such as fire and accidents, resulted in unplanned expenses. Alpine Energy Limited noted its purchase of back-up diesel generation capacity.

Network expansion and diversification

3.18
Some electricity distribution businesses have invested beyond the local networks, acquiring other companies' networks or transmission assets disposed of by Transpower.

3.19
In one of the larger transactions, Marlborough Lines Limited sold its 51% interest in the OtagoNet Joint Venture (OtagoNet) to The Power Company Limited and Electricity Invercargill Limited in September 2014.

3.20
We noted that electricity distribution businesses also acquired assets previously operated by Transpower. Transpower currently has a policy of divesting certain assets, particularly lower-voltage and spur lines, to lines companies.

3.21
Eastland Network Limited acquired Transpower assets worth $12.5 million that supplied Gisborne and Tokomaru Bay, Wairoa, and Tuai. As a result of the transfer of these Transpower assets, the large area supplied by Eastland Network Limited will be connected to the national grid only at Transpower's exit point at Tuai. Network Tasman Limited also acquired Transpower assets in 2014/15. Northpower Limited acquired Transpower assets in April 2015.

Construction/contracting companies

3.22
About a quarter of electricity distribution businesses have subsidiaries to carry out the network maintenance, construction, and development operations. A number of these construction/contracting companies also subcontract to Transpower and do contract jobs for other networks. Competition can be fierce. Retaining staff, particularly engineers and technicians, can be difficult for smaller or more remote companies. There can be a high demand for operational and planning expertise in the main centres and, to a lesser extent, further afield.

Generation

3.23
Since the energy sector was restructured in 2010, regulations have restricted electricity distribution businesses to electricity generation activities up to a maximum capacity. A number of companies have interests in generation. Westpower Limited commissioned hydro generation on the West Coast on the South Island in June 2013, through its subsidiary Amethyst Hydro Limited. Westpower Limited is also investigating a second hydro scheme. Westpower Limited reasoned that its hydro dam investment was desirable for continuity of supply.

Telecommunications fibre networks

3.24
A few electricity distribution businesses are involved directly or indirectly in installing and operating telecommunications fibre. Network Tasman Limited has been laying fibre for several years. Northpower Limited has built an ultrafast broadband network in the upper North Island, through its associate Whangarei Local Fibre Company Limited. Unison Networks Limited (Unison) is involved in fibre through its subsidiary, Unison Fibre Limited. Others, such as Westpower Limited, are less directly involved – it has part of the contract to roll out fibre on the West Coast, on behalf of Chorus Limited.

3.25
Electricity distribution businesses have noted that developing fibre networks share similar techniques and processes with lines networks, and often follow the same infrastructure corridors or adjacent trenches, allowing opportunities for co-operation.

Offshore business

3.26
Some electricity distribution businesses undertook offshore business. Alpine Energy Limited's core lines business is situated in South Canterbury, up to the edge of the Southern Alps and Aoraki/Mount Cook. Alpine Energy Limited subcontracted to the Ministry of Foreign Affairs and Trade through one of its subsidiaries (Infratec Renewables Limited) and installed an off-grid solar array in Rarotonga. Infratec was also involved in a similar scheme in Afghanistan (the Bamyan Renewable Energy Project) again subcontracting to the Ministry.

3.27
Unison also completed business in Fiji and Australia through its subsidiary, ETEL Limited. Unison operates in Hawke's Bay and central North Island districts. ETEL Limited worked with the Fiji Electricity Authority on the installation of back-up diesel generators, and provided transformers for a wind farm at Boco Rock in New South Wales, Australia.

3.28
Electricity distribution businesses have also engaged in construction and maintenance subcontracting overseas (for example, in Australia and the Pacific islands). Northpower Limited and Unison (together with Top Energy Limited) sent crews to Fiji in support of the Ministry of Foreign Affairs and Trade's efforts to help restore Fiji's distribution network after Tropical Cyclone Winston in March 2016.

Other ventures

3.29
We also found instances of electricity distribution businesses that were involved in commercial ventures with no direct links to their core business.

3.30
Scanpower Limited noted that in 2014/15 its revenue from sources other than the network exceeded its revenue from the network (by 55%) for the first time. Scanpower Limited operates in the Tararua and southern Hawke's Bay regions, and has extensive investments in distribution-related activities and non-core interests. Non-core interests include commercial property leases, such as cold-store facilities. Scanpower Limited also has a 33% joint-venture holding in the Kiwi Sock Company Limited.

3.31
Marlborough Lines Limited disposed of its 51% share in OtagoNet. Marlborough Lines Limited recognised a $71.5 million gain on the sale, before tax. Since that sale, and after its 31 March 2015 balance date, Marlborough Lines Limited purchased an 80% share of Yealand's winery, which is in the Marlborough region.

3.32
Other electricity distribution businesses have a variety of interests, including farming and security guard services.

3.33
Any investment can create risk for an entity. However, investments outside of an entity's core business are inherently riskier, because the board and management might not have the relevant skills and experience to enter into and manage the new investments.

3.34
Given that electricity distribution businesses are investing more in non-core operations, we encourage them to pay particular attention to the oversight of investment decisions and to risk management. This will include actively ensuring that:

  • corporate governance and management arrangements are appropriate and robust, taking into account their increasing diversity of investments, the management of conflicts of interest, and the geographical distance of some such investments and activities from parent companies;
  • specific decisions about investments and activities, especially non-core investments or remote activities, include consideration by directors and managers with appropriate experience and expertise;
  • project management of capital expenditure be maintained and enhanced; and
  • appropriate consideration be given to the time it can take to implement projects and initiatives, and then to see returns on them.

Emerging technologies

3.35
In their annual reports, electricity distribution businesses noted their interest in emerging technologies, such as consumer solar generation and network technologies (such as smart meters). Several are investing in research and development and in pilot schemes. Centralines Limited and Unison are contributing to research and development on solar generation and storage in rural environments. Northpower Limited is one of a small number of companies that have invested in establishing an electric vehicle fast-charge station, and is also promoting the use of electric vehicles in the community.

3.36
Companies also remarked on their concern about the effects of disruptive technologies, particularly consumer solar generation, on their activities and especially on their revenue and operating costs. In particular, they noted that the costs of maintaining connections to on-site solar generation users are greater than those for regular connections, because the overall network electricity usage of on-site consumers was lower.

3.37
Network Waitaki Limited is investing in upgrading its asset management and geographic information system software, which includes a provision for better communication with staff in the field.

3.38
Unison is investing heavily in advanced technologies. It reported that it is the first company in the world to install a Silver Springs Networks Generation Four Distributed Automation mesh radio network for communicating with its smart meters and integrating them with other systems.

3.39
We plan to look at electricity distribution businesses' asset management practices to understand how they are driving the businesses' operations and distribution capacity. The case studies we produce will consider how these entities intend to accommodate emerging technologies as part of their asset management.

12: Orion New Zealand Limited, Annual Report 2015, page 1.

13: Buller Electricity, Asset Management Plan 1st April 2015-31st March 2025, page 123.