Draft 2015 electricity distribution price-path reset Briefing for financial market analysts 4 July 2014 Sue Begg Commerce Commission

Overview 2 Introduction Today we published our reasons paper setting the default price-quality paths for 16 electricity distributors for the period The final decision will be released on 28 November 2014 The new price-quality paths apply from 1 April 2015

Overview 3 Electricity distributors subject to this reset Alpine EnergyAurora EnergyCentralinesEastland Electricity Ashburton Electricity Invercargill Horizon EnergyNelson Electricity Network TasmanOtagoNetPowerco The Lines Company Top EnergyUnisonVector Wellington Electricity Orion is currently on a customised price-quality path until 2019, after which it is intended that they will move on to the default path.

Overview 4 Process up to today 2010 Prices set based on previous Part 4A regime 2010 Input methodologies determined 2012 Prices reset based on input methodologies 2013 Orion customised price-quality path set 2013 High Court input methodologies merits review 2014Process and issues paper, draft model released

Overview 5 Contents Changes in the price limits Features of the decision Process from here to the final decision

Changes in the price limits 6 Price limits for this reset Impact of claw-back Alternative rates of change Reasons behind shifts in price limits

Changes in the price limits 7 Calculating the price limits We set price limits for each distributor across a five-year regulatory period Price limits are calculated using current and projected profitability They align revenues with forecast costs, and allow the expectation of a normal return The reset allows past improvements in efficiency and the benefits of updated forecasts to be passed on to consumers

Changes in the price limits 8 Calculating the price limits (cont) Adjustments are made for claw back A limit to increases can be applied to reduce price shocks Reduction of price shocks require alternative rates of change

Changes in price limit 9 Claw-back After the 2012 reset, a number of companies faced very large price increases to enable revenue to cover costs We limited increases to avoid price shocks for consumers As a result, these distributors’ prices did not cover their costs during the period These distributors need further price increases to ensure they recover their costs in the next period, as well as costs not recovered in the previous period

Changes in the price limits 10 Weighted average cost of capital (WACC) The WACC used for this draft decision is 7.60% The WACC used for the 2012 reset was 8.77% The WACC will be updated for our final decision based on changes to the input parameters we use, and our decision on whether to continue using the 75 th percentile of WACC A draft decision on the WACC review will be made on 22 July

Changes in the price limits 11 Forecast profitability if price limits were not reset* $ 62m Results in a reduction in prices with a net total impact of -$9.6m *Forecast revenues minus forecast costs for the whole of the period

Changes in the price limit 12 Price limit change 2014/15 to 2015/16 without claw-back

Changes in the price limit 13 Price limit change 2014/15 to 2015/16 with claw-back

Changes in the price limit 14 Change 2014/15 to 2015/16 with alternative rates of change 10% 6.0% 7.0% 3.5% 0.5% 2.0% 0% Rate change (CPI+X)

Changes in the price limit 15 Reasons behind increases Distributors facing increasing costs (opex and capex) Large changes are predominantly driven by claw-back We mitigate these large changes by applying alternative rates of change

Changes in the price limit 16 Reasons behind decreases Updated forecasts Sharing of benefits of increased operational efficiency with consumers Removing or reducing the impact of past inaccuracies

Changes in the price limit 17 Alternative rates of change and claw-back The Commission may cap large increases to avoid price shocks The balance of the increase is then spread over the regulatory period The alternative rates of change we have set allow full recovery between now and the next reset This will be likely to result in price reductions at the 2020 reset We are interested in views on alternative approaches

Changes in price limit 18 Claw-back and the need for alternative rates of change

Changes in the price limit 19 Reasons for differences between price limits for distributors and retail prices Electricity distribution accounts for approximately one third of an average customer’s electricity bill Some costs that are beyond distributors’ control are passed through to consumers Distributors choose how to structure their prices Distributors may price below the limit if they wish to

Overview 20 Contents Changes in the price-path Key features of the draft decision Process from here to the final decision

Key features 21 Key features of the draft decision Our low cost forecasting approaches Revenue linked quality incentive scheme Energy efficiency incentives Approach to catastrophic risk and other uncertainties

Key features 22 Low cost forecasting approaches Largely based on the approach that we used for the 2012 reset Operational expenditure forecast using econometric approach from 2013 base year Distributors’ capital expenditure forecast based on their asset management plans with a cap placed on overall expenditure increase Changes in revenue due to changes in demand forecast using an econometric approach

Key features 23 Operational expenditure base year We have chosen to use 2013 as the base year for opex This was due to large changes from 2013 actuals to Distributors estimates for 2014 We invite views on why either year would be atypical Estimated 2014 expenditure relative to 2013 actual expenditure (constant prices)

Key features 24 Capital expenditure increase with caps For network capital expenditure Either 110% or 120% of the historic average, depending on past reliability of distributor forecasts we relied on for last regulatory period For non-network capital expenditure A cap of 200% of the historic average Except where non-network expenditure is more than 5% of total expenditure

Key features 25 Quality incentive scheme Previous scheme was a pass/fail regime New scheme will link quality of service with revenue Performance target set based on the frequency and duration of power outages Rewards and penalties Caps and collars 1% of distributors’ revenue is ‘at risk’

Key features 26 Quality incentive scheme

Key features 27 Energy efficiency incentives We are proposing an incentive for distributors to increase energy efficiency Compensates distributors for revenue forgone as a result of decreases in volume due to energy efficiency measures Neutralises the incentive not to invest in assets with shorter lives Covers energy efficiency, demand management, and reduction of energy loss measures

Key features 28 Catastrophic risk Our proposed approach to catastrophic risk is consistent with the approach taken in the Orion customised price-quality path No allowance for ex-ante compensation Ex-post compensation for costs Forthcoming High Court decision on price path reopeners for catastrophic events

Overview 29 Contents Changes in the price path Key features of the draft decision Process from here to the final decision

Process from here 30 Indicative dates 18 July 2014Release of draft determination 22 July 2014Draft decision on cost of capital 25 July 2014Q&A session on models 2 August 2014Information gathering request (s53ZD) 15 August 2014Deadline for submissions of the draft decision 29 August 2014Deadline for cross-submissions on the draft decision Late 2014High Court direction on price-path reopeners 10 October 2014Release of revised draft determination 28 November 2014Release of the final decisions 1 April 2015New price-quality path takes effect

Process from here 31 Documents being released today Reasons Paper outlining and explaining the default price-quality path. Forecasting paper explaining our low cost forecasting approaches. Models used in determining the price path. Sector productivity report by Economic Insights. Econometrics report by Jeff Borland.

Process from here 32 Documents being released on Friday 18 July Draft determination text Quality targets paper with details of the quality scheme Compliance paper with details of what would be necessary to comply with the draft determination Draft input methodologies amendments redline drafting Input methodologies amendments reasons paper

Process from here 33 Related work Other Commission work will have an impact on the final price-path decision Incremental rolling incentive scheme Input methodology amendments Review of the weighted average cost of capital High Court decision on price-path reopeners

Process from here 34 Consultation process We welcome your views on this draft of the default price-quality path decision. You can provide feedback by to John McLaren (Chief Advisor, Regulation Branch) c/o Submissions are due by 5pm Friday 15 August Cross-submissions are due by 5pm Friday 29 August

Any questions? 35

Contact us 36 Call: Write:Contact Centre, PO Box 2351, Wellington 6140 Attn: John McLaren John McLaren, Chief Advisor c/o Website:comcom.govt.nz