2006 Report. of the. Optimised Deprival Valuation of Transpower s System Fixed Assets. as at 30 June 2006

Transcription

1 T R A N S P O W E R N E W Z E A L A N D L I M I T E D 2006 Report of the Optimised Deprival Valuation of Transpower s System Fixed Assets as at 30 June 2006 Prepared by Transpower New Zealand Limited Reviewed by PricewaterhouseCoopers Issued: November 2006

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3 Contents 1. Executive Summary Valuation Results 1.2 Valuation Drivers Page 2. Director s Certification and External Reviewer s Letters 5 3. Compliance with Information Disclosure Regulations Background Valuation Process Overview Background ODV methodology The Assets Being Valued Transpower s Valuation Process Other Aspects of Transpower's Valuation Process Easements Scope of the ODV Use of the ODV Basis of Load Forecasts Background and Summary Valuation of the AC Transmission System AC Assets Summary System Boundaries Modern Equivalent Assets Replacement Costs Technical Optimisations Depreciation/Assessed Remaining Life Economic Value Assessments Valuation of the HVDC Link Assets HVDC Valuation Summary Background HVDC Link Capacity Optimised Depreciated Replacement Cost Assessment Economic Valuation of the HVDC Link Assets Valuation of Other System Fixed Assets Background and Summary Communications System Assets ODV Summary Summary Concluding Remarks i

4 Appendices Page 1 AC Modern Equivalent Assets and Replacement Costs Detailed Design Assumptions Building Block Costs 92 2 AC Asset ODRC Calculation and Standing Data Calculation of ODRC Values Interest During Construction Factors Terrain Factors Seismic Zones Asset Lives Security Criteria and Quality of Supply Criteria for 112 Technical Optimisation 3.1 General Load Forecast Generation Scenarios Time Frame for Analysis Supply Transformer Optimisation Criteria Optimisation Cases Single Line Diagrams Refurbished Assets Detailed Schedule Specific Asset Values by Location Existing and Forecast Load Glossary of Terms and Abbreviations Location Codes Glossary of Abbreviations 159 ii

5 Tables Table Page 1 Summary of Optimised Deprival Valuation as at 30 June Movement in Valuation of Fixed Assets from 2005 to Comparison of ORC/RC between 2006 and Econometric Forecast Data 34 5 Price Elasticities of Demand 34 6 Range of Total Electricity Consumption Forecast 35 7 Expected Forecast of Total Electricity Consumption by Island 36 8 Current Best Case Cost Frontier of Delivered Energy via a Distributed Generation Technology Alternative in Best Case Cost Frontier for Delivered Energy via a Distributed Generation Technology Alternative in Projected Potential for Distributed Generation Uptake by Regional Peak Demands from Grid Summary of AC Assets as at 30 June Alternative Costs Used in Economic Value Assessments HVDC Valuation Summary HVDC Link Component Ratings x 540 MW Mercury Arc Converters (Pole 1) x 700 MW Thyristor Converters (Pole 2) x 100 MVAR Synchronous Condensers kv Overhead Transmission Line x 350 kv Submarine Cables Cable Termination Stations Electrodes and Electrode Lines Book Value of Communications System Assets Summary of Asset Valuation as at 30 June A1.1 Panel Widths 78 A1.2 Transformer Infrastructure Building Blocks 79 A1.3 Oil Containment Building Block Sizes 81 A1.4 Environmental Assumptions 83 A1.5 Switchgear Electrical Performance Characteristics 83 A1.6 Representative Lines 87 A1.7 Establishment Building Block Costs 92 A1.8 Buildings Building Block Costs 92 A1.9 Substation Control Room Buildings 93 A1.10 Substation Switchgear Room Buildings 93 A1.11 Power Transformer Building Block Costs 94 A1.12 Oil Containment Building Block Costs 97 A1.13 Switchgear Metering and Bus Zone Protection Building Block Costs 98 A1.14 Miscellaneous Plant Building Block Costs 103 A1.15 Transmission Line Building Block Costs 104 A2.1 AC Transmission Lines Terrain Factors 106 A2.2 Application of Terrain Factors 106 A2.3 Seismic Zones 108 A2.4 Substation Assets Class Lives 111 A2.5 Transmission Line Assets Class Lives 111 A3.1 Security Guidelines for Transmission Equipment Planning 113 A5.1 Refurbished Assets 143 A6.1 AC Transmission Lines Asset Values by Location 145 A6.2 AC Substations - Asset Values by Location 150 A6.3 HVDC Link - Asset Values by Location 153 A7.1 Peak MW by Bus Projected to A8.1 Location Codes 158 iii

6 Figures Figure Page 1 ORC Valuation and ODV Valuation Transpower North Island Transmission System Transpower South Island Transmission System Overview of the Valuation Process and Outputs 27 5 Quantifying Economic Distributed Generation Uptake 39 A2.1 North Island Seismic Zone Map 109 A2.2 South Island Seismic Zone Map 110 A4.1 North Isthmus Region - Actual System 117 A4.2 North Isthmus Region - Optimised System 118 A4.3 Auckland Region Actual System 119 A4.4 Auckland Region - Optimised System 120 A4.5 Waikato Region - Actual System 121 A4.6 Waikato Region - Optimised System 122 A4.7 Bay of Plenty Region - Actual System 123 A4.8 Bay of Plenty Region - Optimised System 124 A4.9 Central North Island Region Actual System 125 A4.10 Central North Island Region. - Optimised System 126 A4.11 Taranaki Region - Actual System 127 A4.12 Taranaki Region - Optimised System 128 A4.13 Hawkes Bay Region - Actual System 129 A4.14 Hawkes Bay Region - Optimised System 130 A4.15 Wellington Region - Actual System 131 A4.16 Wellington Region - Optimised System 132 A4.17 Nelson-Marlborough Region - Actual System 133 A4.18 Nelson Marborough Region - Optimised System 134 A4.19 West Coast Region - Actual System 135 A4.20 West Coast Region- Optimised System 136 A4.21 Canterbury Region - Actual System 137 A4.22 Canterbury Region Optimised System 138 A4.23 South Canterbury Region - Actual System 139 A4.24 South Canterbury Region - Optimised System 140 A4.25 Otago- Southland Region - Actual System 141 A4.26 Otago Southland Region - Optimised System 142 iv

7 1. Executive Summary Valuation Results The 2006 Optimised Deprival Valuation (ODV) provides the value of Transpower New Zealand Limited s (Transpower s) transmission grid (system fixed assets), using optimisation and deprival techniques. The value of system fixed assets includes communications assets at their net book value. The ODV methodology provides a proxy for the market value of the grid assets in the absence of a ready market for such assets. The valuation is prepared in accordance with the methodology set out in the "Handbook for Optimised Deprival Valuation of System Fixed Assets of Electricity Line Businesses", published by the Commerce Commission, August 2004 (the ODV Handbook ). The valuation is based on the best available information as at 30 June The resultant value of Transpower s system fixed assets is $2,031 million as at 30 June 2006, an increase of $52 million from the The results are summarised in Table 1. Table 1: Summary of Optimised Deprival Valuation as at 30 June ODV ODV Movement Asset Category $m $m $m AC Stations AC Transmission Lines HVDC System Communications System Fixed Assets 2,031 1, This valuation does not purport to be a business valuation from a purchaser's perspective. The valuation covers only the system fixed assets in use; it does not cover assets under construction or the remaining components of operating capital employed (e.g. current assets and current liabilities). For the purposes of this valuation Transpower attributes no value to the access rights pertaining to the transmission system assets, other than those easements specifically purchased since The inclusion of the value of statutory rights of access to the transmission system assets is specifically precluded in the ODV Handbook. The estimated range of the valuation of system fixed assets is 3%, i.e. +/- $ 61 million or between $1,970 million and $2,092 million. The size of the range reflects the use of standard building blocks and a number of estimates in the valuation. Figure 1, below, sets out the ORC and ODV valuations of Transpower s assets for each of the valuations to date. The comparative year's figures have been adjusted to reflect only system fixed assets. 1

8 Figure 1: ORC Valuation and ODV Valuation Value $billion Year ORC ODV The movement in the total valuation of Transpower s system fixed assets is summarised in Table 2. Table 2: Movement in Valuation of Fixed Assets from 2005 to 2006 Trans Sub HVDC Comms Lines Stations Link Systems Total $mil $mil $mil $mil $mil ODV as at 30 June Depreciation (32) (42) (28) (7) (108) Disposals (1) (12) 0 (0) (13) Capital Expenditure ODV before revaluations Minimum Life Adjustments Replacement Cost Changes 5 15 (18) 0 2 Capital Expenditure Adjustment (13) (11) (1) 0 (25) Optimisations 15 (11) Total Revaluations ODV as at 30 June

9 1.2 Valuation Drivers Background This 1 valuation has been carried out by Transpower staff (the valuation team) and has been subject to independent external review. In performing the valuation, Transpower has sought expert input from external consultants where necessary. The process followed in completing this valuation is consistent with that applied in completing the 1998, and all subsequent valuations. A range of factors are relevant to the context in which this valuation has been performed. These factors include: past reforms to the structure of the electricity industry, including splitting energy trading functions from distribution line businesses, splitting the dominant generator (ECNZ) into three smaller entities and the sale of Contact Energy; the ongoing reform process including the establishment of the Electricity Commission as a regulatory authority for the electricity sector, and the Commerce Commission s establishment of price and quality thresholds for electricity lines businesses; the release of the Commerce Commission s August 2004 ODV Handbook; the objectives set for Transpower in its Statement of Corporate Intent; focusing on the provision of services in a contestable manner where possible, based upon customer requirements and provided at least cost. The industry continues to develop in response to changing competitive dynamics such as retail competition, vertical integration and ownership changes. There continues to be a significant degree of uncertainty as to future behaviour in the evolving market. This valuation assumes that competitive pressures in the market will compel the pursuit of rational market behaviour. The underlying approach to the valuation is to apply a reasoned and reasonable approach to framing these market assumptions Asset Replacement Costs The replacement costs for Transpower s AC network assets are based on those included in the 2004 ODV Handbook. The Commerce Commission is currently in the process of updating the transmission asset replacement costs contained in 2004 ODV Handbook. The ODV Handbook replacement costs used in the 2006 ODV valuation have not been updated since Whilst it is not yet possible to estimate what the updated replacement costs will be, Transpower expects the increase in the ODV value resulting from the revised replacement costs to be greater than the 3% materiality threshold provided for in the ODV Handbook. An appropriate external expert provided replacement costs for the HVDC Link assets. The HVDC costs are updated for changes in exchange rates and price indices. These replacement costs are not specified in the ODV Handbook. 1 The Capital Expenditure Adjustment reflects the difference between capital spent on the system fixed assets and the value recognised in repect of those assets in the ODV. 3

10 1.2.3 Optimisations There have been a relatively large number of optimisation changes to the AC network optimisation during This is the result of a comprehensive review of previous optimisations coupled with an updated demand forecast. The HVDC optimised configuration has changed in 2006 with the inclusion of all three submarine cables. The impact of all optimisations is summarized in Table 3 which compares the ratio of Optimised Replacement Cost (ORC) to Replacement Cost (RC) for 2006 and Table 3: Comparison of ORC/RC between 2006 and 2005 Asset Category 2006 ORC/RC 2005 ORC/RC AC Substations 81% 80% AC Transmission Lines 91% 88% HVDC System 2 92% 85% Communication System 2 n/a n/a System Fixed Assets 87% 85% Economic Value Assessments As part of the 2006 ODV valuation Transpower has reviewed its system fixed assets and identified assets that are potentially uneconomic. Transpower is satisfied that an economic valuation of those assets would not have resulted in a material reduction of the ODV of system fixed assets. This conclusion is based upon a comparison of the total value of potentially uneconomic assets relative to the ODRC of Transpower s system fixed assets. 2 No separate assessment of replacement value prior to optimisation has been made for these assets. 4

11 2. Director s Certification and External Reviewer s Letters 5

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25 3. Compliance with Information Disclosure Regulations 3.1 Background This valuation report is issued in accordance with the Commerce Commission s Electricity Information Disclosure Requirements Valuations disclosed under the requirements are to be prepared in accordance with the Optimised Deprival Valuation methodology. The Handbook for Optimised Deprival Valuation of System Fixed Assets of Electricity Lines Businesses contains specific requirements regarding the content of valuation reports. This section identifies the specific information requirements of the Handbook and identifies where that information is located in this report. 1. The valuation report must state the asset quantities in the valuation asset base, excluding stores and spares. This must be broken down into asset classes consistent with the asset classes contained in the tables in Appendix A of the Handbook. Asset quantities are shown in Appendix 1 2. The valuation report must contain the RC, ORC, DRC, ODRC and ODV for each asset class and for the valuation asset base as a whole. These are shown in Table 24 of Section The valuation report must include a description of the method used for the valuation of any assets where the ELB considers that the valuation method is not specifically prescribed by the valuation rules in the Handbook. The method used to value HVDC link assets is described in Section 7. The method used to value other such assets is described in Section The valuation report must include a schedule of asset classes where asset quantities and/or asset ages have been estimated. For each such asset class the valuation report shall describe the methodology used to derive the estimates. There are no asset classes for which asset quantities have been estimated. Remaining lives for transmission lines were estimated in 1994 using engineering assessments. This is discussed further in Section The valuation report must include a schedule of asset classes and asset quantities to which multipliers or other adjustments have been made to the standard replacement costs given in the tables in Appendix A of the Handbook. These are identified in Table A2.2 of Appendix A schedule of replacement costs and asset lives used as a basis for valuing non-standard assets must be included in the report where standard replacement costs or asset lives are not provided in Appendix A of the Handbook. Replacement costs and lives for HVDC assets are provided in Section 7. Asset replacement costs for each category of assets including non-standard assets are shown in Tables A1.7 to A1.15 of Appendix 1. These tables also provide the quantities of assets in each category. Asset lives are given in Table A2.4 and A2.5 of Appendix A schedule of asset classes and quantities for which standard asset lives have been extended or reduced in accordance with the provisions of clauses A.32-19

26 A.44 of the 2004 ODV Handbook, must be included in the report together with the actual lives used, and a schedule showing the date of return to service and remaining life applied to individual assets that have been refurbished since the last valuation. Details are provided in Section 6.6.1, Table A2.5 and Appendix 5 8. The valuation report must provide a general description of the evidence forming the basis for any change in the date of commissioning of assets from that used in the previous ODV valuation, except where this change is due to the replacement of assets. There have been no instances where the commissioning date of an asset has been changed since the last valuation. 9. The valuation report must provide details of assets to which a reduction in standard lives is applied due to routine replacement as part of the evolution of the network. There are no assets meeting this reporting criteria. 10. The valuation report must include a general description of the methodology used to optimise the network. A high level description of the methodology is found in Section 4.4. More detailed descriptions of the methodology are found in Section 6.5, and Appendix The valuation report must include a general description of the analysis and assumptions used where life cycle cost analysis is relied upon to avoid the use of an asset with a lower replacement cost in an optimised network. Life-cycle cost analysis has not been relied upon to avoid the use of an asset with a lower replacement cost in an optimised network. 12. The valuation report must include the existing load and the load growth forecast used as a basis for optimisation. National and regional load forecasts are provided in Section 5. Existing and forecast loads are given for each grid exit point in Table A7.1 of Appendix Forecast new loads or load increases should be separately disclosed as required by the Handbook. There are no separately identifiable new loads or increments of an existing load greater than 100 MW. There are no situations where the load forecast includes an increase of greater than 20% of the maximum demand of a grid exit point within a 2 year period. 14. The valuation report must include details of the ELB s quality of supply criteria used as the basis for optimisation. Quality of supply criteria used for transmission planning is provided in Appendix B Table B.6 of the ODV Handbook. These are reproduced in Appendix The valuation report must include a schedule of all network optimisations, and details of the valuation impact of each optimisation, including details of the assets removed as stranded assets. Details of major optimisations are provided in Section

27 Details of the extent of optimisation for AC system fixed assets are shown, by location, in Tables A6.1, and A6.2 of Appendix 6. Details of the extent of optimisation for HVDC system fixed assets are shown, by components in Section 7.1 and Table A The valuation report must include the justification for the inclusion of underground circuits in the optimised system fixed assets base. This justification is included in Appendix Where an ELB has not undertaken a comprehensive EV test on any of its system fixed assets the valuation report must include (i) a statement that it has reviewed its system fixed assets base stating that it has reviewed its system fixed asset base and identified assets that are potentially uneconomic, and (ii) a statement that it is satisfied that an economic valuation of those assets would not result in a material reduction of the ODV of its system fixed assets, and a description of the basis on which that conclusion was formed. These requirements are satisfied in Section 6.7 of this report. 21

28 4. Valuation Process Overview 4.1 Background Transpower is required, under the Commerce Commission s Electricity Information Disclosure Requirements 2004, to prepare an Optimised Deprival Valuation (ODV) of its system fixed assets, in accordance with the "Handbook for Optimised Deprival Valuation of System Fixed Assets of Electricity Line Businesses". The Handbook was published by the Commerce Commission in August 2004 and sets out the methodology for valuing line business system fixed assets. Transpower has completed this valuation using internal resources and commissioned PricewaterhouseCoopers to undertake an independent review of the valuation. Sinclair Knight Merz have assisted PricewaterhouseCoopers with the engineering aspects of the review. 4.2 ODV Methodology The ODV methodology is based on an assessment of the Optimised Depreciated Replacement Cost (ODRC) and Economic Value (EV) of the system fixed assets. The ODRC value of an asset reflects the value users place on the service provided and is established as the cost of meeting current supply needs with the most technically efficient design and configuration of assets after adjustment for depreciation. An allowance for growth is included for prudent engineering and economic reasons. The EV of an asset is the minimum cost to the user of replacing the asset with the most economic alternative capable of providing the same level of service. If the ODRC of an asset is lower than the EV of the asset, then the ODRC is the appropriate value for the asset since if the system was deprived of the asset, it would be replaced with the technically optimum equivalent. On the other hand, if the ODRC of an asset is greater than the EV of the asset, then the EV is the appropriate value since the asset would not be replaced; rather, the users would replace it with their more economic alternative. In other words, the ODV of an asset is the lower of the ODRC and EV. Therefore, in the application of the ODV methodology to Transpower's fixed assets, the two key valuation issues are: to calculate the replacement cost of an asset s optimal equivalent; and to establish if the users of the asset can obtain their required services from a lower cost alternative. Optimised Depreciated Replacement Cost Calculation The optimised depreciated replacement cost (ODRC) of an asset is calculated as follows: a) The modern equivalent asset (MEA) is established for each existing asset. The MEA represents the technology that would be selected today to provide the same service capability as an existing asset. The basis for selecting the MEA, given that it provides the same service level as the 22

29 existing asset, is that it has the least life time costs of the alternatives available. b) The optimal size and/or configuration of an asset is determined by taking into account load, security, reliability and other relevant criteria and the overall system integrity. c) The overall cost of installing the optimal asset is established by using present day labour charges and modern, efficient technology and work practices. The extent that MEAs are prescribed in the ODV Handbook these costs are estimated using handbook values. d) The optimal asset is then depreciated to reflect the remaining economic life or service potential of the grid asset being valued. Economic Value Calculation An economic value calculation is made where there is sufficient information indicating the economic value of an asset may be less than its ORC. Examples of such instances are: where an existing point of supply can be bypassed through a distribution level connection into a neighbouring point of supply; and where it is more economic for a customer to install local generation than to receive supply from the grid. In comparing alternative bypass and generation options, it is assumed that the economic alternatives are subject to the same security/reliability and service criteria used in the technical optimisation assessment of the transmission system. 4.3 The Assets Being Valued Figures 2 and 3 at the end of this section show the extent of the actual transmission systems in the North and South Islands respectively. The 350 kv HVDC link running from Benmore to Haywards, including the submarine cables across Cook Strait, connects the AC transmission systems in the two islands. The boundaries of the transmission system are power station injection points (interface with generators) at one end and supply points (interface with Distribution Line Businesses (DLB s) and direct supply customers) at the other end. The bulk of the AC system is at the 220 kv level, with the remaining AC system at 110 kv and 66/50 kv, with switchgear and feeders at lower voltages. Transpower s key physical system fixed assets are: 11,800 route kilometres of (mainly) high voltage transmission lines; 171 substations and switchyards - most of these are connection points to the national grid for generators and distributors; 23

30 the HVDC facilities, comprising two mercury arc valve and two thyristor AC/DC converter stations at Haywards (North Island) and Benmore (South Island), ± 350 kv overhead DC transmission line (included above), and three submarine cables across Cook Strait (three other inoperative cables have a nil value in the valuation); the communication network comprising radio and microwave links, power line carriers, telephone lines and leased circuits. For the purpose of the valuation, the physical system fixed assets are classified into the following groups: AC transmission lines; AC substations; HVDC link; communication systems; It should be noted that the regulatory ODV covered by the Commerce Commission Handbook is only concerned with the valuation of system fixed assets. The valuation is of the system fixed assets in use as at 30 June

31 Figure 2: Transpower North Island Transmission System

32 Figure 3: Transpower South Island Transmission System

33 4.4 Transpower s Valuation Process A high level summary of the process to calculate the ODV of Transpower s assets is presented in Figure 4 below: Figure 4: Overview of the Valuation Process and Outputs Process Outputs Determine the MEA building blocks that represent Transpower s physical assets Obtaining replacement costs for the MEA building blocks Replacement Cost (RC) of Transpower s assets Assess load forecast and generation patterns Depreciated Replacement Cost (DRC) of Transpower s assets Developing an optimum grid based on fixed points of injection and offtake Reducing the physical grid wherever it is in excess of the optimum Optimised replacement cost (ORC) of Transpower s assets Depreciating the ORC to reflect the age and condition of the assets currently in use Optimised depreciated replacement cost (ODRC) of Transpower s assets Reviewing situations where the economic value is less than the ODRC, eg bypass opportunities or where revenue constraints exist Optimised deprival value (ODV) of Transpower s assets 27

34 4.4.1 Determining the MEA Building Blocks The MEA building blocks that represent the physical system are described in Appendix 1. These building blocks have been specified in sufficient detail to support the related costing exercise MEA Replacement Costs AC System Costing Data Estimation. Where replacement costs have been included in the ODV Handbook, these costs have been used. The ODV Handbook incorporates the costs determined by Transpower in 1998, following a major review of its replacement cost estimates at that time. A relatively small number of AC asset building blocks do not have costs included in the ODV Handbook. The replacement cost of these building blocks were updated in 1999 and 2001 by external consultants. 3 A summary of the replacement costs used in the valuation is included in Appendix 1. HVDC Costing Data, Technical Optimisation and Valuation of the DC System Assets Cost estimates for the components of the HVDC link are based on current price estimates provided by an international consulting firm expert in HVDC facilities. 4 Transpower determined the optimal set of assets required to meet the expected level of demand for HVDC capacity (considered to be around 1000MW). For the purposes of translating the quoted prices into effective costs to Transpower, contract conditions are assumed to be similar to the 1989 DC1 contract. Refer to Section for details of the HVDC valuation calculations Assessment of Load Forecasts To establish an appropriate level of demand for service from the grid over the fifteen-year horizon, Transpower forecasts future electricity consumption. This forecast is adjusted to reflect existing embedded generation together with an assessment of how much electricity consumption is likely to be met by future investment that avoids use of the grid. The analysis focuses primarily on investment in alternative combined heat and power co-generation technologies. Refer to Section 5 for details of the load forecast assumptions and calculations. 3 These are generally Beca Carter Hollings & Ferner Ltd, and Maunsell Ltd. 4 Teshmont Consultants Inc. 28

35 4.4.4 Developing the Optimum Grid Security / Reliability Criteria Security guidelines for Transpower s assets are included in the ODV Handbook. These reflect work previously done by Transpower in consultation with the industry and ensure that the technical optimisation is applied consistently across all transmission assets. The security criteria included in the ODV Handbook are reproduced in Appendix 3. Technical Optimisation of the Transmission System As discussed earlier, the ODV of the transmission system is performed on the premise that the system would be built today in the most efficient way, to provide customers their desired services, while ensuring grid integrity. In doing so, the system chosen for valuation is based on currently available information relating to customer demand for services now and, to be prudent, in the foreseeable future. The detailed technical optimisation study of the AC transmission system is not a totally greenfield study. The power station injection points, the supply points to the distributors and internal system nodes are generally taken as fixed. However, the potential to rationalise supply points is assessed in the economic value assessment subsequent to establishing the solution to the technical optimisation. The fundamental criterion in the technical optimisation is: What would be an electrically effective and economically efficient system configuration and asset specification to meet the forecast load (up to the year 2021) given the security criteria agreed for the DLB supply points and for direct supply customers? The criteria for technical optimisations are discussed in detail in Section Reducing the Physical Grid where it is in Excess of the Optimum The optimisation process involves removing assets in excess of the requirements for the optimal grid. It is a principle of the valuation methodology that the characteristics of an asset, or group of assets, as valued cannot be greater than the physical capability of the assets concerned. In short, the valuation cannot reflect something greater than that which actually exists. Where the existing assets are less than required to satisfy the optimum grid it is the capability of the physical assets that is valued. As a result, the grid that is valued may be of a lower standard or capability than both the physical grid and what would otherwise be regarded as being the optimal grid. However, the grid that is valued is considered to be operational and provides a level of service, in any particular area, equivalent to the lesser of the optimal configuration or the currently supplied level of service, within a reasonable set of credible contingency events. 29

36 4.4.6 Depreciating the Optimised Replacement Cost The ODV methodology applies a traditional straight-line depreciation approach to each asset category, including AC transmission lines. There has been no revision to the class lives that were used in the previous valuation of Transpower s fixed assets, however, work continues in this area in order to assess the impact of changing technology Reviewing Economic Alternatives AC System Economic Assessment During the valuation process an economic analysis is undertaken to identify potentially uneconomic assets. Bypass and generation options are identified from a general assessment of the cost of delivered energy at each node. HVDC Economic Assessment Under the Commerce Commission s ODV methodology comprehensive economic value assessment is undertaken on potentially uneconomic assets following a determination that likely writedowns would be material. Unlike in the previous two years, Transpower has come to a view that a comprehensive assessment of the HVDC link should be undertaken in Under the ODV methodology, the economic value of an asset is determined by considering the best economic alternative, or mix of alternatives, to the assets (or group of assets) being valued. The EV is then calculated as the net present cost of the alternative mix. In the case of the HVDC link, the optimal mix of alternatives relates to the cost of alternatives for the overall electricity system. This is largely the cost of power station construction and operations (which are hypothetically brought forward as alternatives to the link) and any increase in fuel and operating and maintenance costs. The HVDC Link derives its economic value from three factors: the opportunity cost of energy flows across the Link; the time value of accelerating or delaying investment in additional generating capacity to cater for demand growth in the North Island; and the avoided cost of providing security of supply to the South Island in times of hydrological shortage. 4.5 Other Aspects of Transpower s Valuation Process Communication Systems The 30 June 2006 book values of communication systems are taken as representative of the market values for these assets. The values of these assets are described in Section 8. Asset Valuation Compilation Section 9 summarises the asset values for each group of assets. 30

37 4.6 Easements Most transmission lines owned and operated by Transpower were constructed under the terms and provisions of the Electricity Act The 1968 Act gave the Crown extensive rights of entry to land for the purpose of gaining access to transmission lines. The Electricity Act 1992 allows Transpower to access lines in existence or under construction at 1 January 1988 for the purposes of inspecting, maintaining or operating them. The value of these statutory easements is not included in the valuation. In accordance with the ODV Handbook, easements are only included in the valuation if the easements are: registered against title; paid for; and capitalised instead of expensed. The impact of easement costs is taken into account in the assessment of appropriate modern equivalent asset (MEA) designs. The selection of a particular technical solution and design as the appropriate modern equivalent asset is based on identifying the least cost option for meeting the operational and service requirements. Easement costs form part of the lifetime cost of the various technically viable solutions. However, once the appropriate MEA has been selected, the assumed cost of easements is excluded from the standard cost and therefore is not represented in the final valuation outcome. The cost of easements is also considered when establishing the cost of alternatives to the grid as part of economic value assessments. 4.7 Scope of the ODV The ODV Handbook requires a valuation of Transpower s system fixed assets. These comprise AC transmission lines, AC substations, HVDC link assets and communications assets. For completeness, the value of service centres, minor fixed assets and works under construction are added to establish a value for all Transpower s assets. This valuation does not purport to be a business valuation from a purchaser's perspective. It covers only the fixed assets in use and under construction, and does not include any non-fixed assets or liabilities of the Transpower business. 4.8 Use of the ODV Transpower uses the ODV of its fixed assets in a number of ways: Reporting The primary requirement for the completion of the ODV is its incorporation in the information disclosures required pursuant to the Electricity Information Disclosure Requirements

38 Revenue ODV is one of the factors which governs the level of Transpower s annual revenue target. It is often believed that a revaluation of Transpower s assets, as a result of the ODV process, results in an increase in Transpower s revenue. Putting aside issues such as ongoing contractual arrangements and other practical constraints upon changes in the revenue level for Transpower, it is important for Transpower s stakeholders to understand that this is not necessarily the case. Changes in Transpower s asset value can be categorised into three main areas: Depreciation and capital expenditure effects Asset value changes as a result of changes in the demand for the assets (optimisation or economic value adjustments) Asset value changes as a result of changes in underlying costs of assets (replacement cost changes) Depreciation and Capital Expenditure Effects These effects are not components of the annual asset revaluation, but rather the consequence of normal operational activity. Depreciation reflects the use of the assets over the period. To the extent that the annual depreciation charge has been collected through revenue then that portion of the capital invested in the assets has been recovered and there is no longer a need to earn a rate of return on those funds. Thus, depreciation has the effect of reducing the revenue in subsequent years. Capital expenditure represents new investment in assets. This is a legitimate increase in the asset value and will logically result in an increase in overall revenue, other things being equal, because the value of the investment must be progressively recovered and a rate of return must be earned on the invested capital. Capital invested in system fixed assets is subject to the ODV process. Changes in the Demand for Services from the Assets As the assessed level of demand for services from the assets changes, the level of optimisation of the assets may change, i.e. either greater or lesser degree of optimisation. Where customers have an economic alternative to the grid assets then the economic value adjustment process in the ODV will reduce the value of the assets concerned. These changes will result in a change in the level of revenue. Consider an asset that is optimised to zero value as it is no longer required. If Transpower s revenue did not reduce then the customers would not see any benefit from this change. Conversely, if an asset that was previously optimised to zero is now reinstated, as a result of increased demand, Transpower s revenue must increase because it is now effectively providing additional services (satisfying new demand) and the value of the investment in used and useful assets has increased. 32

39 Changes in the Underlying Cost of Assets Effects such as inflation, improvements in production techniques and the balance of supply and demand for equipment can alter the replacement cost of the MEA building blocks. This will result in an increase or decrease in the value of Transpower s ODV. However, these changes should not result in an increase or decrease in Transpower s revenue. The following example illustrates how Transpower achieves this result through its Economic Value statements. Consider a company that does not use ODV but rather, records the value of its investment in assets in historical cost terms. This company may invest, say, $100 in an asset and require a rate of return of 10%. This company does not recognise the effects of inflation on the value of its assets but its rate of return is expressed in nominal terms, i.e., the rate of return includes the effects of inflation. This company s investment will be a good one if it earns a stream of cashflows over the life of the asset that has a present value, when discounted using the rate of return that equals the initial investment, i.e. the NPV of the investment equals zero. If this company were to use a valuation methodology such as ODV the effects of inflation would be included in both the rate of return and the asset value. This would obviously produce a stream of larger cashflows over the life of the asset. This stream of larger cashflows would have a present value, when discounted using the rate of return, which is greater than the initial investment. This result would seem to be neither logical nor fair. The conclusion, then, is that the cashflows over the life of the asset, arising from an ODV asset value should produce the same present value as would arise if the asset value were based on historical cost. Transpower achieves this result, in principle, by deducting the amount of asset revaluations arising from changes in the underlying costs of the assets from its revenue requirement. Pricing One of the core uses of ODV is to allocate Transpower s revenue requirement to individual customers per Transpower s Pricing Methodology 5. Transmission charges for assets deemed to be connection assets under the Pricing Methodology are calculated based on the ORC of the assets used. It should be noted that the Electricity Commission is currently developing a new pricing methodology, which may or may not include replacement cost concepts. Management The ODV is also used as a tool to assess management decisions within a value based framework. Value based management concepts, including the revenue earning ability of an investment, based on the sound application of the ODV rules, form a critical part of the investment decision in respect of expenditure on new assets and the maintenance or refurbishment of existing assets. 5 Full details of Transpower s Pricing Methodology are contained in the information booklet Pricing for Grid Connection Services. 33

40 5.0 Basis of Load Forecasts 5.1 Background and Summary The economic value of the transmission network is a function of its ability to meet current and future requirements for energy. Forecasts of energy consumption are required to undertake economic value testing of AC system assets, the economic valuation of the HVDC link assets and in determining the necessary levels of capacity for optimisation purposes. Econometric modelling techniques are used to forecast future energy consumption based on the functional relationship between economic growth indices, price elasticities and growth in electricity consumption. These relationships are determined from historical data. The econometric forecast data for GDP and population is shown in Table 4 below: Table 4: Econometric Forecast Data GDP ($m in % change Population % change Year 1991/92 prices) (000's) ,566 4, , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % , % 4, % The population estimates above are taken from numbers provided by Statistics New Zealand. In addition to the forecast econometric data in the above table, price elasticities and lag effects are also considered in arriving at the forecast level of electricity consumption. The price elasticities used are shown in Table 5. Table 5: Price Elasticities of Demand Short Term Long Term Domestic consumption

41 Electricity Consumption The forecast of electricity consumption is produced for each of the approximately 200 nodes on the system over the 15 years in the forecasting period. The forecasts represent the energy requirements (in GWh) at grid offtake points, i.e. end customer consumption plus distribution losses. These electricity consumption forecasts are implicitly uncertain and are provided as expected forecasts. The electricity forecasts are shown in Tables 6 and 7. Table 6: Expected Total Electricity Consumption Forecast Annual % Year GWh change , , % , % , % , % , % , % , % , % , % , % , % , % , % , % , % 35

42 The Expected forecast, by island, is detailed in Table 7. Table 7: Expected Forecast of Total Electricity Consumption by Island Year NI GWh % Annual Change SI GWh % Annual Change Total GWh % Annual Change ,220 13,517 37, , % 13, % 38, % , % 13, % 39, % , % 14, % 40, % , % 14, % 41, % , % 14, % 42, % , % 14, % 42, % , % 14, % 43, % , % 15, % 44, % , % 15, % 45, % , % 15, % 46, % , % 15, % 47, % , % 16, % 48, % , % 16, % 49, % , % 16, % 50, % , % 16, % 51, % Existing Embedded Generation Transpower has identified a number of existing embedded generation plants that go some way toward meeting current and forecast demand for electricity. While there is most likely to be an ongoing need for connection to the Grid, for back up security, this is not considered in the assessment of the demand for grid services from a power flow perspective. As a result, the value of back up for this embedded plant is not reflected in Transpower s valuation. The amount of energy from existing embedded generation (excluding onsite cogeneration), that is assumed to meet local demand, is 1,780 GWh per year. The figure reflects updated information on generation plant capacity resulting from a review carried out as part of the 2006 valuation. Investment in Alternative Generation Technologies An assessment of the extent to which electricity consumption will be met by new alternative technologies, which by-pass the grid over the planning horizon (to 2021), has been included in the valuation. Transpower regards new technologies, enabling investment in distributed generation, to be a significant issue affecting the future of the grid. Accordingly, effort has been put into understanding the dynamics of these technologies and the associated investment decisions. However, predicting the future in the area of technological change is highly subjective and prone to gross error. It is possible that the levels of investment in such technologies and/or their impact on consumer s use or reliance on the grid will not follow the time scales predicted 36

43 here. This is primarily through competitive price responses by those currently meeting the electricity needs of consumers. The ODV process is an important element of the proxied competitive environment for Transpower and incorporating views on such issues in the ODV is therefore highly appropriate. Furthermore, there remains the possibility of dramatic change in the rate of technological developments in this area such that adoption rates take off. Analogies from other innovation initiatives suggest that this acceleration is likely to be the result of a development that, as yet, we are unaware of. Economics of Small Scale Generation Technologies The reducing cost of alternative distributed generation technologies (e.g. small scale or micro generation) will underpin the drive to install these alternatives to meet energy needs, often in conjunction with the satisfaction of other needs such as heat production. Whether this is attractive or not depends on a number of factors: rate of decline in the capital cost of the alternative technology; ability to match heat and power requirements; specific type of heat required for processing; the comparative size of the operation; and movement in the cost of electricity supplied via the grid. The cost of alternatives to grid delivered energy varies according to the type of technology, and the size and type of the consumer demand. The result is a matrix of alternative delivered energy costs that relates to different classes of consumers. The lowest cost technology for each unit size forms the best case scenario - which assumes that several very strict criteria are met - for the cost of the alternative. Table 8 shows the best case (lowest cost) distributed generation alternative for Table 8: Unit Size (MW) Best Case Guideline c/kwh Current best case cost frontier of delivered energy via a distributed generation technology alternative in The 2021 forecast assumptions assume a 5% universal increase in electrical efficiency due to technological improvement, and a reduction in the capital cost, ranging between 10% to 90%, based on forecast reduction in capital costs for each technology. These improvements are offset by forecast increases in diesel and gas prices. Table 9 shows the projected best case generation alternative in

44 Table 9: Best case cost frontier for delivered energy via a distributed generation technology alternative in 2021 Unit Size (MW) Best Case Guideline c/kwh Investigations have shown that economic installation of a distributed generation alternative will only be viable for limited numbers of consumers, with energy demands that meet the following criteria: Process runs for at least 16 hours per day (>2 shifts); Load profiles are flat during the period the generator is in use; Heat and electricity used concurrently, and in the proportions supplied by the relevant best case technology; Generator is larger than the minimum efficient scale - currently MW for mature reciprocating engine and turbine technology; Reticulated fuel is available. A small subset of electricity consumers will meet these best case criteria. We recognise that there are other factors that may make on-site generation economic, for example, access to free fuel from process waste products. However research indicates that the number of consumers able to access this type of advantage is small. Distributed Generation Market Size The potential for distributed generation uptake has been quantified through segmentation of electricity consumption in New Zealand. Electricity consumption has been segmented according to the industry classifications defined by the Ministry of Economic Development (Energy Data File). Data from NZ Department of Statistics has been used to establish an estimate of the size and number of business units/sub units within each segment on a regional basis. Research confirmed that the processes for which co-generation is potentially economic are generally in the Paper, Dairy, Meat, Steel, and Chemical industries. Processes in these industries have the best characteristics for uptake of cogeneration through their requirement for heat, the likely heat/electricity balance and plant utilisation. These factors are then used in the distributed generation costs model to establish those business units/sub units for which distributed generation might be economic when compared to the cost of electricity and back up supplied via the grid. The process is depicted in Figure 5 below. 38