How an obscure regulation could save Tiwai Point

Over the past month and a half, the possibility of a bailout via the prudent discount mechanism has emerged as a compromise alternative to the Tiwai Point smelter shutting up shop. Marc Daalder reports.

An obscure regulatory mechanism could be retrofitted to save the Tiwai Point smelter. Called the prudent discount, it would allow the beleaguered smelter to receive a discount on its transmission prices based on the fact it would be cheaper for it to build its own power lines than pay for Transpower's.

With just 27 days to go until Rio Tinto decides whether to pull the plug on its local subsidiary, NZAS, all parties are rushing to hash out some sort of deal, while the Electricity Authority says the prudent discount will be implemented at the same time as the rest of its reforms. That timeline is still being considered by the regulator, but industry observers have picked a date of 2024 at the earliest.

Although the prudent discount mechanism has emerged as a potential stopgap to tide over Rio Tinto while the EA prepares to implement more wide-ranging transmission price reforms, the regulator insists it has no plans to introduce the measure early.

Rules for mechanism too strict

The prudent discount mechanism seems purpose-built for the situation NZAS and Transpower find themselves in.

According to the Electricity Code, the policy is intended "to help ensure that the transmission pricing methodology does not provide incentives for the uneconomic bypass of existing grid assets. The prudent discount policy aims to deter investment in alternative projects which would allow a customer to reduce its own transmission charges while increasing the total economic costs to the nation as a whole."

In other words, if a user finds themselves paying too much for transmission pricing - as NZAS says it is - they might choose to build their own power lines or pull out of the country. In such an event, the transmission costs they were paying would be redistributed to the rest of the country, leading to economic inefficiency.

As it stands, if a user can prove it would cost less to transmit the power themselves and then make a business case showing how they would do so, Transpower is able to offer that user a discount. However, NZAS has long maintained that while it would cost less to transmit the power, it can't make a business case because the consents for duplicate power lines across Southland wouldn't be approved by the relevant councils.

"We are a part of the backbone of the grid. There is no way on earth we could get permission to build a duplicate line through to Manapouri so that is just a nonsense," Rio Tinto's energy director Lesley Silverwood told Stuff in January.

Reform intended as a saviour

Shortly after NZAS raised the prospect of a reformed prudent discount mechanism, the EA proposed new rules in a document tagged on to its transmission pricing methodology (TPM) reforms. While a previous attempt at reform in 2016 would have allowed Transpower to offer a prudent discount if a user would be forced to pull out of the country by high transmission prices, that was later rolled back on the fear it could be gamed by companies threatening to leave in exchange for better deals.

The new reform would allow Transpower to grant prudent discounts to users whose "transmission charges would exceed the standalone cost of the transmission services [they] receive". This strips away the business case requirement and would cap transmission costs at the price of building its own power lines to Manapouri, including the costs of the consents but excluding the realistic chance of receiving them.

Meridian Energy was quick to jump on board the prudent discount lifeboat, with chief executive Neal Barclay endorsing the plan.

In its consultation paper, the EA indicated it was broadly in favour of the reform. "In our view, prudent discounts based on a real-world business case for bypass of the grid would effectively discourage inefficient disconnection in circumstances where the customer’s alternative is to disconnect in favour of alternative supply. This approach is consistent with the approach to prudent discounts that is followed in Australia."

Transpower doesn't want to call the shots

In its submission on the proposed reform, Transpower said it wanted an additional alteration: that the EA be the body to decide on prudent discount applications. "The Authority should decide whether to approve a SAC prudent discount," Rebecca Osborne, the national lines company's manager for regulatory affairs and pricing, wrote in the submission.

"Transpower’s role should be to act as “gate-keeper”, that is to assess the information provided by the applicant, decide whether the application has merit, and make a recommendation to the Authority. We do not consider it appropriate for Transpower to be the decision-maker for a form of prudent discount that is likely to have significant wealth transfer effects."

The EA's general manager for market design, Rob Bernau, said it had received Transpower's submission and that it was "considering submissions on all aspects of the proposed prudent discount policy under the proposed TPM guidelines, including responsibilities".

A Rio Tinto spokesperson said the priority should be on fixing its transmission costs, not arguing over the details. "Rio Tinto believes the regulatory regime of a country is the business of that country’s regulators and Parliament to decide. We would support a pathway which would mean we could stop paying tens of millions of dollars every year for transmission grid assets we don’t use."

EA could put damper on plans

The bigger issue is the regulator's unwillingness to bump up the timeline for implementing any potential reform. Bernau told Newsroom that "The Authority’s proposal indicated that most aspects of the guidelines, including the prudent discount policy, would apply from the date the guidelines were implemented. The Authority is considering implementation timeframes."

As it stands, the new TPM guidelines are likely to be implemented in 2024 at the earliest. Since the prudent discount measure has been seen by NZAS and its allies as a stopgap until the new guidelines kick in, this position from the EA neutralises much of the reason for the flurry of activity around the mechanism.

"Rio Tinto’s understanding is that reform is expected to be implemented in 2024 if the process goes well and is unchallenged. This means any relief from unfair transmission costs would be too late to inform the strategic review," a Rio Tinto spokesperson said.

In recent weeks, energy companies have gone on the attack against the EA, asking for it to move the timeline forward. "The prudent discount mechanism does not need to wait till 2024 when Transpower can deliver a billing solution for the rest of the reform. It could be done immediately," Barclay said.

Contact Energy also called on the regulator to push forward the prudent discount reform timeline.

Energy Minister Megan Woods said she would not get involved. "I have repeatedly made it crystal clear to NZAS in several meetings that I will not be intervening on their behalf and the right course of action is to speak to the relevant authorities who are the decision-makers," she said.

This leaves the distinct possibility that Rio Tinto will pull the plug on Tiwai Point because of the EA's reticence.

NZAS paying too much for transmission

The core of the Tiwai Point dispute is transmission pricing. As it stands, the cost of operating and maintaining the national grid - as well as constructing new add-ons - is roughly evenly distributed across the country, based on how much power a consumer uses.

NZAS consumes about 12 percent of the country's electricity and therefore pays around 7 percent of the transmission charges, despite only using 2 percent of the country's electricity grid. This is despite the fact that almost all of Tiwai's power comes from Meridian Energy's Manapouri power station in Fiordland, through lines purpose-built to supply the smelter.

Take, for example, recent upgrades to grid infrastructure in Auckland and Northland. Although Tiwai Point receives no benefit from these investments, it has subsidised them to the tune of tens of millions of dollars.

"There are very few people - if any - who argue that NZAS are not paying too much for transmission. In reality, NZAS have been subsidising New Zealand homes and businesses for years," Barclay said last week.

NZAS chief executive Stewart Hamilton has previously said that the charges for infrastructure the smelter doesn't use amount to almost $200 million over the past decade. In 2017, the smelter estimated it would pay $72 million in transmission pricing for the year. By 2019, that figure had fallen slightly to $64.5 million.

TPM reform "too little and too late"

Since its formation in 2010, the Electricity Authority has seen reforming the transmission pricing methodology (TPM) as one of its key missions. An early proposal for TPM reform, released in 2016, was lambasted by Winston Peters for hiking power prices for Aucklanders and regional New Zealand while giving NZAS relief to the tune of $21 million a year.

After returning to the drawing board, the EA produced its current proposal in mid-2019. Although it bears a strong resemblance to the 2016 draft - keeping the high-level idea of a user-pays system in which people pay for the grid upgrades that benefit them - it softened the blow for consumers and lowered Tiwai's discount. Under the new plan, the smelter would pay $11 million less for transmission pricing each year.

While that could make a difference, NZAS says the crucial problem is that the new TPM will kick in far too late - some time in 2024. "Rio Tinto continues to encourage the Authority to progress its TPM review with the utmost urgency, though Rio Tinto can no longer rely on the review to deliver appropriate and timely relief from very high transmission charges for NZAS," the smelter's owners wrote in an October submission to the EA.

"Over the decade Rio Tinto has been part of the TPM review process NZAS has paid a total of nearly $656 million in transmission costs; hundreds of millions of which have been and are used to fund grid upgrades to take power from the hydro-rich south to the north of the North Island and which do not benefit NZAS at all," a Rio Tinto spokesperson said.

"For us, that's too little and too late," Hamilton told Newsroom in October.

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