DAVID CAYGILL: A COST-BENEFIT APPROACH
27 November 2008Last week Neil Anderson cast doubt on the Electricity Commission's approach to its ``supervision'' (actually one-off review) of Transpower's transmission investments. He described this as ``a classic case of striving to prove that an investment is optimal''. A straight-forward cost-benefit analysis would be a more accurate description of the commission's approach.
The commission is charged under the Electricity Governance Rules with ensuring that a ``proposed (transmission) investment maximises the expected net market benefit or minimises the expected net market costs compared with a number of alternative projects''. In simpler language, we're charged with making sure that what is proposed is a fair impost on consumers - compared to other ways of reaching the same objective whilst still delivering the appropriate standard of security. The fundamental principle behind this is that we all have other things to do with our resources. In other words, that there is an opportunity cost to capital.
To suggest that Sir Julius Vogel didn't need to satisfy a similar test 130 years ago doesn't, I suggest, justify just ``going for it'' today. Electricity transmission and for that matter generation aren't ends in themselves - any more than is the consumption of electricity. These are all means to wider objectives - and means that are paid for by consumers, not taxpayers. A rigorous, but open, examination of transmission investment, on behalf of consumers, seems a worthwhile public service. Anderson is certainly correct to say that there are also risks associated with under-investment. He implied that the commission gave them less weight than we should when he suggested ``we're desperately trying to avoid the cardinal sin of gold- plating''. I appreciate that his ``we'' wasn't just the commission. But only the week before, Rob Cameron said in your paper ``A lot of the [regulatory] settings are geared towards excess capacity in key elements of infrastructure - I'm talking about electricity generation and transmission''. So which is it? Are ``we'' under or over-investing?
The commission is neither the grid owner nor the grid planner. Rather it reviews monopoly grid investments on behalf of consumers to ensure that capital isn't wasted nor security ignored. To discharge this task we use open models that others can replicate and challenge.
To dismiss economic models as "just a forecast - a fancy word for a guess'', as Anderson did, is to disparage both engineering and economics for the sake of being glib.
The key imperative for any regulator - actually for all of us - is to make sound, that is principled, decisions. In the last two years the Electricity Commission has approved $2 billion of transmission investment.
We currently have just one large proposal - relating to Auckland - in front of us. We are almost certain to address that before Christmas. Transpower is clearly and rightly in ``build mode''. There is no regulatory bottleneck holding it back. The ``action'' Anderson called for is already under way.
On the other hand, Transpower recently estimated that transmission prices (ie the transmission component of the cost of electricity), will nearly double over the next seven years, reflecting the increasing volume of transmission investment. So it seems only sensible to make sure that in each case the proposed investments meet the commission's grid investment test, ie that they maximise net benefits or minimise net costs compared to reasonable alternatives. Abandoning such a test would risk squandering scarce resources and ultimately paying more for electricity than we need.
David Caygill
Chairman
Electricity Commission
(c) 2008 The Independent Business Weekly
The Independent Financial Review
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