1. Gas Transmission and Capacity Pricing Workshop 11 April 2013

2. Agenda 1.Reminder of what we set out to do ● Gas Transmission Investment Programme (GTIP) ● Transmission Access and Pricing project 2.First steps ● Preliminary advice from PEA to GIC, July 2012 ● Industry Submissions on PEA advice ● PEA response to submissions 3.Short-term improvements ● Demand management ● Nominations ● Transparency 4.Options for longer term change Gas Industry Co2 Workshop focus

3. Transmission contracts to Otahuhu and Southdown renegotiated o Aggregate reserved capacity reduced o Some capacity is now interruptible o Some capacity is now tradeable Better understanding of physical and commercial capacity o Vector has engaged with industry on its Capacity Determination process o Supply and Demand Outlook published Demand for firm capacity now less than supply o Less firm capacity dedicated to power stations o Economy depressed o All request for firm capacity in current year met Bulletin board market for transmission capacity introduced … more? Gas Industry Co3 Note on changed environment…

4. 1.REMINDER OF WHAT WE SET OUT TO DO Gas Industry Co4

5. Origins of GTIP Concerns (end-users, shippers, TSOs, regulators) that perhaps: Competition is reduced when a pipeline is constrained Capacity is not available to highest value use Capacity is not being fully utilised Investment will not occur when it is needed 5 GTIP launched with industry mandate to: ensure gas transmission assets are used efficiently establish the need for gas transmission investment develop an effective pathway for efficient investment

6. Governance of GTIP Gas Industry Co6

7. Projects relevant to today’s discussion Gas Industry Co7

8. 2.FIRST STEPS Gas Industry Co8

9. Timeline GTIP

10. PEA’s preliminary advice to GIC ChapterContent 1Introduction and background 2Economics of pipeline access 3Lessons from other jurisdictions 4Problem definition 5Straw man proposal 6Next steps and issues to be resolved App AInternational comparison Review of Transmission Access and Capacity Pricing Advice from the Panel of Expert Advisers July 2012 Gas Industry Co10

11. Essentially the PEA’s Straw Man proposed: Vector: Water down grandfather right (s5.3) If demand > supply, auction un-grandfathered capacity (s5.3) Make interruptible arrangements more transparent (s5.3) Rebalance tariffs: CRF ↑ TPF ↓ (s5.4) Confirm bulletin board and tradability of power station capacity (s5.5) Introduce a nominations regime (s5.6) GIC: discuss investment uncertainty and scarcity pricing with CC and MOBIE Gas Industry Co11

12. Main themes of submissions on PEA’s preliminary advice Gas Industry Co12 PEA failed to set-out a ‘vision’ for the future Dissatisfaction with the problem definition including a suggestion by Market Reform (Larry Ruff) that the fundamental problem is the point-to-point capacity definition and that a ‘Market Carriage’ type regime may be preferable – see BACK UP SLIDES Reflections on Market Reform submission PEA did not consider all the options in particular, the option of extending the MPOC regime to Vector pipelines should have been considered Support for greater transparency

13. PEA’s response to submissions and further work Gas Industry Co13 PEA’s response to submissions and further work

14. Respond to calls for long-term vision: Ideal gas transmission market characteristics 1.Overarching goal of dynamic efficiency ie the governance, rules and operation of the gas transmission market should be dynamically efficient: that is, produce outcomes that are justifiable in cost- benefit terms for the transmission market as a whole at all points in time. 2.Minimum costs (including transaction costs) of governing and operating efficient transport arrangements achieving an efficient level of cost, including the management of risk and avoiding inefficient duplication of operational and governance costs. 3.Maximum efficient use of physical capacity, particularly at times of capacity scarcity ie when pipeline capacity is scarce, competitive market mechanisms are used to facilitate its efficient use and signal its value. 4.Competition in related markets not distorted ie the transport arrangements do not distort competition in upstream and downstream gas trading markets. Gas Industry Co14

15. …ideal gas transmission market (continued) 5.Efficient investment in related markets facilitated ie transparent transport arrangements provide sufficient price/quantity certainty not to distort upstream and downstream investment. 6.Investment in pipelines facilitated ie the transport arrangements signal the need for new investment, and promote efficient investment, in pipeline capacity. 7.Independence ie the ownership and management of open access gas pipeline businesses are independent of gas trading activities (other than for operational purposes). 8.Operational and commercial transparency ie the determination, holding and use of capacity, as well as the rules determining capacity allocation when congestion occurs, are transparent, and arrangements relating to the allocation of capacity on open access pipelines are transparent. 9.Able to evolve in a timely fashion ie gas transport arrangements and systems should be capable of continual evolution in response to changing market conditions. Gas Industry Co15

16. There are four broad styles of access arrangement: o Contract carriage o Common carriage o Entry-exit o Market carriage Each is best adapted for a particular environment, comprising: o Market conditions o Physical configurations o Institutional arrangements PEA attempted to find a match for NZ… Gas Industry Co16 Respond to calls for long-term vision: Which style of access is best suited?

17. Gas Industry Co17 Respond to calls for long-term vision: Which long term access arrangement? PEA concluded: o No clear best fit access regime for the future environment  significant environmental uncertainties including some ‘game changers’  the suitability of any ‘style’ of access arrangement is likely to depend as much on the detailed design of the arrangement, as on its broad features o Caution warranted because of substantial (sunk) costs in radical regime change o Many of the desirable characteristics of an ideal access arrangement appear to be achievable through an evolutionary approach

18. PEA’s response to submissions and further work Gas Industry Co18

19. Gas Industry Co19 CharacteristicCompariso n Concerns MauiVector 2. Minimum costs (including transaction costs) of governing and operating efficient transport arrangements High cost of operating two different access regimes 3. Maximum efficient use of physical capacity, particularly at times of capacity scarcity Inadequate mechanisms for allocating scarce capacity to its highest value use 4. Competition in related markets not distorted Competition in gas trading affected by grandfathering 5. Efficient Investment in related markets facilitated Inability to secure long term transport rights or assess risks of interruption may discourage investment Review problem definition

20. Gas Industry Co20 CharacteristicCompariso n Concerns MauiVector 6. Investment in pipelines facilitated Absence of short-term price signals (Economic regulation settings may not be optimal) 7. IndependenceTSO’s favouring affiliates 8. Operational and commercial transparency Lack of transparency of holding and use of capacity 9. Able to evolve in a timely fashion - Review problem definition

21. Revision to Problem Definition Access arrangements do not provide for:  efficient allocation of scarce capacity, both physical and commercial (ie as defined by contracts/codes);  price signals to facilitate efficient investment; or  transparency on physical state of the pipelines and contractual arrangements for use of the pipelines. Also:  grandfathering of capacity may reduce competition to supply downstream users;  unnecessary costs may arise from different Maui and Vector access arrangements;  end users do not secure long term capacity rights on the Maui pipeline; and  vertical integration demands special care that arrangements cannot favour affiliate businesses. Gas Industry Co21 original revised  the capacity product definition allows grandfathering, which inhibits the efficient primary allocation of transmission capacity;  there is no price signal for scarce capacity, either in the short- or long-run;  there is low uptake and opacity of interruptible capacity arrangements;  the effectiveness of the secondary market is still unclear but it is thinly traded and non-transparent;  there is a lack of transparency regarding the determination of the amount of commercial capacity; and  there is uncertainty about whether the regulatory incentives are adequate to encourage new pipeline capacity to be built when it is efficient to do so.

22. Revision to Purpose Statement The purpose of the Transmission Access and Capacity Pricing project is to ensure that transmission pipeline access arrangements are dynamically efficient. In particular, the arrangements should:  transparently provide for the efficient utilisation of physical transmission pipeline capacity;  enable and facilitate efficient investment;  be harmonised across both transmission systems, to the extent it is efficient; and  offer transport services that, to the extent that is efficient, meet the needs of users. Gas Industry Co22 The purpose is to ensure Vector’s arrangements for transmission access and capacity pricing allocate capacity efficiently and effectively signal the need for investment in additional capacity. original revised

23. 3.SHORT-TERM IMPROVEMENTS Gas Industry Co23

24. Gas Industry Co

26. PEA’s response to submissions and further work Gas Industry Co26

27. Demand management (also called ‘capacity rationing’) PEA has identified that: o there could be a common demand management regime across both pipelines using an ‘aggregator’ to provide interruptiblity services, but this is unlikely to be cost effective while interruptions are rare o For Vector, the evolutionary route to demand management is to:  further development of its interruptiblity arrangements, and/or  Introducing capacity buy-back arrangements o For MDL, the evolutionary route to demand management is to:  further develop its AQ arrangements Gas Industry Co27 Develop short term improvements: Demand Management

28. Full system nominations o Vector nominations trial on Frankley Road pipeline to be re-launched o Final design of nominations regime will depend on design of demand management option Gas Industry Co28 Develop short term improvements: Full system nominations

29. … proposed in straw man endorsed by submissions … a fundamental pre-requisite to a well-functioning gas market o Greater transparency generally leads to better decisions and more efficient markets, whereas confidential information creates information asymmetries that can provide unfair competitive advantages. … need is greater when pipeline owner competes with pipeline users in related markets Gas Industry Co29 Develop short term improvements: Improved transparency MauiVector In line with the standards of transparency in other jurisdictions  Sufficient for existing and prospective pipeline users to manage their commercial dealings with their customers and with the pipeline operator / 

30. Vector consulting on how it assesses the capacity of its pipelines o Explaining modelling assumptions and inputs o Providing transparency of Vector’s decision making; o Promoting wider understanding of availability of capacity on the North Pipeline Still in train, but GIC believes Vector has substantially raised awareness of: o Vector’s security of supply standard o The Reasonable and Prudent Operator (RPO) standard o Current status of Rotowaro-north pipeline Gas Industry Co30 Develop short term improvements: Improved transparency

31. GIC has requested that Vector provide o Accepted nominations for major plants (ie ‘scheduled quantities’ for system use) o Aggregate hourly receipt and delivery quantities at all transmission pipeline large stations to be available within 30 minutes after the end of each hour o Aggregate capacity reservation data, for each delivery point, for each day, to be available on that day o Aggregate quantities of interruptible capacity, for each delivery point, for each day, to be available on that day o All new contracts for use of the transmission system o Any existing contracts for use of the transmission system, where the counterparty agrees to disclosure Gas Industry Co31 Develop short term improvements: Improved transparency

32. GIC has requested that Vector provide (continued) o All material policies, procedures and notices relating to:  The physical status of the pipeline, including scheduled maintenance days  The physical and commercial operation of the pipeline  The issuing and trading of contractual capacity Also, GIC asked that confidentiality provisions are not offered by Vector in any future contracts for the use of the transmission system Gas Industry Co32 Develop short term improvements: Improved transparency

33. 4.OPTIONS FOR LONGER TERM CHANGE Gas Industry Co33

34. Focus of today’s workshop Gas Industry Co34  Longer term market reforms

35. Gas Industry Co Workshop focus

36. Longer term options for consideration Gas Industry Co36 1.Straw man o Auctioning some capacity when there is a shortage of commercial capacity 2.Maui style arrangement for Vector o Move away from point-to-point contract carriage towards common carriage 3.Victoria style arrangement for Vector and Maui o Integrate markets for transmission and gas

37. Longer term options: 1. Straw man Gas Industry Co37 Essential elements of straw man option o Auctioning some point-to-point capacity when there is a shortage of commercial capacity Sub-options could include: o Point-to-zone capacity o Entry-exit capacity o More automated capacity trading o Frequency of capacity trading

38. Longer term options: 2. Maui style Gas Industry Co38 Essential elements of Maui style option o Achieving a common access regime across both pipelines o Each shipper would nominate its receipt and delivery quantities and be deemed to have received their nominated quantities of gas o Each shipper to a non-Welded Party gate would become a notional Welded Party responsible for its imbalance o Following month end reconciliations, any shipper who has an imbalance at a delivery point:  may receive balancing charges (where the shipper’s imbalance has contributed to a balancing action being taken); and  would receive penalty imbalance charges if its nomination had been scaled back in anticipation of congestion o Compulsory trading of imbalances at month end

39. Longer term options: 2. Victoria style Gas Industry Co39 Essential elements of Victoria style option o To avoid undue development cost, model on Victorian system

40. BACK-UP SLIDES Elements of ‘straw man’ proposal Gas Industry Co40

41. Change definition of TSO (s5.2) TSO could be independent party (common in regimes where vertical separation is mandated) However, until market grows or both transmission systems are under same governance regime, probably most efficient to leave as is PEA proposes two additional functions for Vector: o auctioning capacity products if demand exceeds supply; and o administering a nominations regime. Some consequential changes to the governance arrangements may be needed to minimise any potential conflicts of interest Gas Industry Co41

42. Change capacity product definitions (s5.3) Portfolio of contract terms considered… but too complex… so rejected Instead PEA proposes to water down grandfather right o Currently: if shipper buys 100 units of capacity, it gets option to buy up to 100 units next year o Proposal: if shipper buys 100 units of capacity, it gets option to buy up to, say, 80 units next year Also, if demand > supply, auction un-grandfathered capacity, say 20 units And, more transparency of interruptible arrangements Gas Industry Co42

43. Change primary allocation mechanism and the pricing structure (s5.4) PEA proposes that, if demand for capacity is more than supply, auction un-grandfathered capacity to: o allocate capacity to the highest value use o provide public signal of the value of scarce capacity The question of what happens to the auction revenue ‘is a complex issue that needs more thought’ Price for grandfathered capacity is still posted Capacity Reservation Fee, but… PEA proposes Vector should rebalance tariffs o Throughput Fee lowered to variable cost o Capacity Reservation Fee increased to cover all fixed cost Gas Industry Co43

44. Lower transaction costs of secondary trading (s5.5) PEA supports ‘Bridge Commitment’ initiatives to: o sell capacity on bulletin board and make price public in real time o make power station capacity tradable Also PEA discussed, but does not recommend: o shippers being required to publish binding bids and offers for a certain quantity of transmission capacity ‘thereby ensuring that genuine information on the value of transmission capacity becomes available to the market’ o Incentivising TSO to become a ‘market maker’, to buy back capacity, repackage it and re-sell it Gas Industry Co44

45. Improve short-run rationing of transmission capacity when constraint occurs (s5.6) Spot market for capacity in real time not warranted in NZ market Instead, PEA proposes Vector should introduce a nominations regime to help manage situations of short-term capacity constraint to: o incentivise short-term trading at times of constraint o facilitate the forecasting of peaks o provide valuable information for the market TSO ‘scales back’ Interruptible contracts when it judges nominations cannot be delivered Nominations regime also enable the introduction of some sort of use-it-or- lose-it mechanism (but not proposed at present) Gas Industry Co45

46. Suggestions to improve pipeline investment certainty (s5.7) PEA proposes that the next step should be to discuss investment uncertainty and scarcity pricing with the Commerce Commission and (possibly) the Economic Development Group of the Ministry of Business, Innovation & Employment Gas Industry Co46

47. Changes to the TSO governance arrangements (s5.8) Notes trend towards vertical separation in other jurisdictions But, net-benefit from separation might not be realised in small NZ market PEA proposes that there needs to be a significant increase in the transparency of Vector’s decision-making regarding its pipelines. The various proposals should achieve this Gas Industry Co47

48. BACK-UP SLIDES Submitter concerns Gas Industry Co48

49. Gas Industry Co49

50. BACK-UP SLIDES Outlook for the Rotowaro-north Pipeline Gas Industry Co50

51. Vector’s capacity determination Gas Industry Co51 Vector has called for feedback on its Rotowaro-North Capacity Determination as at 28 November 2012 (CD Report) o CD Report shows results of modelling a scenario involving:  Fixed demands: Otahuhu B and Southdown operating continuously at full firm contractual capacity entitlements  Variable demands: comprising demand between 15 and 19 August 2011(‘normalised’ for long term trends)

52. Vector’s capacity determination Gas Industry Co52

53. Vector’s capacity determination Gas Industry Co53 Results of modelling: o Normalised Peak Demand at Greater Auckland is 47 TJ/day o Unused Operational Capacity is between 8.8 and 23.6 TJ/day (for gas delivered into Greater Auckland through the Henderson Delivery Point or Papakura Delivery Point, respectively) o ie, demand at Greater Auckland could increase from the Normalised Peak Demand by 19% to 50%

54. Outlook for the Rotowaro-north Pipeline Gas Industry Co54 In summary, outlook for the Rotowaro-north Pipeline is: o Although flows (both firm and interruptible) on Rotowaro-north Pipeline can reach the limit of available physical capacity:  Some existing pipeline users are already on interruptible agreements  Renegotiation of Otahuhu Supplementary Agreement resulted in a significant proportion of firm capacity becoming interruptible capacity o Therefore:  Vector has more interruptible capacity to call on to manage congestion  ‘headroom’ created can allow more non-interruptible (firm) demand to develop (eg between 19% and 50% of Greater Auckland demand)

55. BACK-UP SLIDES Reflections on Market Reform submission Gas Industry Co55

56. … which can suggest how complex the market design should be Less complex More complex Market carriage Common carriage Contract carriage Market carriage may be justified in a complex system requiring frequent reconfiguration of capacity between receipt/delivery points If frequent reconfiguration not needed, then simpler options may be more suitable Gas Industry Co56

57. Each pipeline has only one or two injection points o For example, on the North pipeline, there is only a single injection point o Victoria is a meshed system with multiple injection and withdrawal points including interconnections with other states So… it’s not clear that conceptual problem identified by MR report is in fact a real problem for Vector pipeline system Even if problem identified by MR report turns out to be a practical one, the solution proposed by MR report may not be most cost effective one Vector’s system is not very complex Gas Industry Co57

58. Victorian model is no panacea MR claim – Victorian market “most competitive, liquid and transparent … in Australia” But efficacy of Victorian market is actually quite controversial ○Complex ○Investment difficulties ○No firm capacity at fixed price: Financial Transmission Rights (FTRs) have not developed Gas Industry Co58

59. BACK-UP SLIDES Overseas regimes Gas Industry Co59

60. Gas Industry Co Market influences Global influences ● 1980s on… transport/trading separation, privatization and deregulation Regime specific influences ● Supply characteristics (1960s on… LNG) ● Demand characteristics ● Regulatory arrangements ● Ownership arrangements ● Political

61. USA Gas Industry Co Characteristics ● Private ownership (since 19 th century) ● Common interstate regulation (FERC created 1930) ● Vertical structural separation (began 1992, complete 2000) ● Full transparency (since 2000) ● System length – 345,000Km (interstate)

62. EU Gas Industry Co Characteristics ● Mix of public/private ownership ● Regulation by country and EU ● Vertical structural separation ● Mix of carriage regimes (tending towards entry-exit?) ● System length 150,000Km

63. UK Gas Industry Co Characteristics ● Private ownership (since 1986) ● Vertical structural separation (began 1986, complete 1990) ● Entry-Exit access regime ● System length 7,000Km

64. Australia Gas Industry Co Characteristics ● Private ownership ● Regulation of ‘covered’ pipelines ● Contract carriage except in Victoria ● System length 7,000Km

65. Gas Industry Co Transmission market trends ● Open access ● Structural separation of transmission ● Transparency ● Private ownership ● Regulatory objective: efficiency/competition ● Clear definition/allocation of regulatory roles

66. USA Gas Industry Co Point-to-point contract carriage Summary of Access Regimes EU Entry-exit UK Aus Vic: Market carriage Others: Point-to-point contract carriage