1. Review of the Market Reform report Presentation to PEA Wellington 2 November 2012 James Mellsop Director

2. 1  Submission on PEA paper by Larry Ruff of Market Reform (“MR”) (dated 31 August 2012)  These slides summarise my written review (dated 26 October 2012) of that paper Introduction

3. The MR problem definition

4. 3  MR report argues that a point-to-point contract carriage regime will be inefficient when –There are multiple injection and withdrawal points on a pipeline –The value of injecting/withdrawing at those points changes over time  Point-to-point contracts will be too rigid to allocate physical capacity properly –Lack of reconfiguration Conceptual problem definition (1)

5. 4  At least at a conceptual level, MR critique of a point-to-point contract regime on a pipeline with dynamic loads seems to be a fair one –Indeed, grandfathering rights would make the problem even worse  Note that other submissions were also concerned that current point-to-point contract carriage regime does not allocate physical capacity efficiently –Albeit they did not (explicitly) use the same argument as MR report Conceptual problem definition (2)

6. 5  But is the conceptual problem a practical/real problem on the Vector system? –The MR report does not demonstrate a practical problem –How variable are the loads at the various locations? –Interesting to compare the Vector system to the Victorian one Practical problem definition?

7. 6 VectorVictoria Annual withdrawals120PJ230 PJ Injection points89 Withdrawal points>130>120 Length2,287km~2,000km Major Pipelines65 Vector versus Victoria

8. 7 Victorian system

9. 8 Vector system

10. 9 Vector injection points Rotowaro comp Kanpuni comp MokoiaKGTPPokuru 1 Pokuru 2 Frankley Rd Kupe Rd North√ South√√ Central (North) √ Central (South) √ BOP√√ Frankley Rd √√

11. 10  If area of interest is just northern pipeline, there is only a single injection point, and issues appear less complicated than in Victoria –i.e., single injection point with multiple withdrawal points vs. multiple injection and withdrawal points  This is just a preliminary analysis –Not seeking to draw any strong conclusions –Main point is that it is not clear at this stage that conceptual problem identified by MR report is in fact a real problem for Vector pipeline system Vector less complicated?

12. 11  Even if problem identified by MR report turns out to be a practical one, still issue of whether solution proposed by MR report is most cost effective one Most cost effective solution?

13. The MR solution

14. 13  Effectively the Victorian system  Price and allocate physical capacity on a daily market operated by TSO –Bids for selling/injecting at each location, and buying/withdrawing –If no congestion, only pay for daily imbalances –If (physical) congestion, there will be a congestion price  Would still require throughput and fixed fees to recover pipeline costs Victorian-style system

15. 14 Efficacy (1)  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 FTRs have not developed

16. 15 Efficacy (2)  Too early to provide a definitive view on efficacy of Victorian market –But not a solution without difficulties  Even if there is a practical problem, is the MR solution the most cost effective one? –Common carriage? –MR report supports common carriage when supply/demand weak and growing slowly

17. 16 Cost benefit analysis  Need to carry out CBA for the Vector system of –Victorian-style regime –Common carriage  But Victorian-style regime would entail more radical change –Integrated gas/transmission market –New set of market arrangements –Market-clearing model

18. The MR critiques of PEA report

19. 18 Grandfathering (1)  PEA’s proposal to water down grandfathering rights “would require even more trading without doing anything to improve it, is unnecessary given the companion recommendation for an annual RC XY auction, and would be counterproductive in its effect on long-term contracting”

20. 19 Grandfathering (2)  But –Objective of watering down grandfathering rights is to assign more of the allocation role to the primary market, reducing reliance on secondary market –Reduction in certainty in exchange for improved allocative efficiency

21. 20 Bespoke contracts  MR report critical of PEA’s idea that capacity tied up under long-term contracts with generators should be transferred to the general pool as those contracts expire  Critique relies on speculation about profile of that capacity, i.e., that it is “profiled for a load with a strong summer peak”  But –Profiles are confidential –Surely there would be a winter peak, if any?

22. 21 Lack of investment certainty  MR report asserts that PEA paper –Regards scarcity rents “as a regulatory issue and problem” –Misses point that “scarcity rents … have important roles to play”  But misunderstands PEA paper –Scarcity rents have an important economic role –PEA’s concern has been how to deal with those rents, given the price control of Vector

23. 22 Transmission charges (1)  MR report argues CRF should be higher on northern pipeline than on other pipelines, because of the relative scarcity on the northern pipeline  This argument has merit

24. 23 Transmission charges (2)  But tension between “second-best” regulatory pricing and forward-looking, “economic” pricing –Under PEA model, purpose of CRF is to recover sunk costs While scarcity pricing operates either through the primary market auction or secondary trading  If CRF on underutilized pipeline is lowered to below level required to recover sunk costs, to break even Vector would need to increase CRF on northern pipeline to above sunk cost levels, regardless of whether there is actually scarcity on that pipeline

25. 24 Auction  MR report’s critique of PEA’s auction proposal is effectively that the proposed auction would not reconfigure property rights –In other words, MR report’s critique is effectively that PEA is proposing to stick with a point-to-point contract carriage regime

26. 25 Interruptible capacity  MR report appears to have impression that the PEA does not see a role for the TSO to issue interruptible capacity –But not correct – PEA sees important role for formalisation of interruptible capacity

27. Contact Us James Mellsop Director NERA—Auckland +64 9 928 3290 james.mellsop@nera.com © Copyright 2012 NERA Economic Consulting Limited All rights reserved.