Time to stop building castles in the air

If you gather some youthful blokes in a flat and give them some beer, they will probably develop an enthusiasm for pointless projects.

Building a tower of empty beer cans, floor to ceiling, may seem like an idea worth absorbing the total intellectual and physical resources of the group. As each can is added, the sense of achievement mounts until the final structure tops out in all its futile glory.

Bureaucracy is like a tower of beer cans. Rules are piled upon rules to construct a complex, creaking edifice of marvellous sophistication that seemed like a great project initially but on reflection, in the bright light of the morning, is really a bit useless.

Chalkie reckons the regulation of lines companies has the tell-tale characteristics of a vertical aluminium cylinder assembly - ambition, difficulty, groupthink and ultimate futility - with the devilish extra complexity only trained specialists can achieve.

Consider this gem from the Commerce Commission's consultation document on how much money some lines companies will be allowed to make between 2015 and 2020: "A Non-exempt EDB must adjust the amount of any Pass-through Cost or Non Transmission Recoverable Cost for the time value of money in accordance with paragraph 4 where it is used to calculate allowable notional revenue or notional revenue for any Assessment Period other than that to which the amount relates."

Lines companies are responsible for the local electricity wires that take power from the grid and distribute it. There are 17 of them subject to price and quality regulation by the commission, and 12 exempt. The exempt ones get off by virtue of being consumer-owned as defined by the Commerce Act, although in Chalkie's view this definition is not tight enough to keep them honest.

For the non-exempt ones, the time, effort and, ultimately, money they have to spend hacking through the regulatory jungle is considerable. For example, the process to set price and quality standards from 2015 to 2020 has so far clocked up 95 documents and is nowhere near complete. Before those standards are set there is a further four months of proposals, submissions and analysis. A final decision is due on November 28.

The regulation will determine how much money these lines companies can make in five years. No wonder they sift every detail for its financial implications.

The commission's role is to ensure the monopoly lines companies don't rip off their customers, while letting them make enough cash to keep the network in good nick. Not only that, it wants to do so in a legally bullet-proof way because you can bet your bottom dollar it will have to justify itself in court.

So far, so tortuous. If it produced reliable results in the end, you could almost forgive the ludicrous effort.

Chalkie reckons it doesn't. Many consumers will struggle to figure out why their lines charges seem to keep going up so much when they are supposed to be strictly controlled.

Indeed, it's not easy to figure out what lines company prices are in the first place. Mainly this is because lines companies charge electricity retailers, which then charge us, so their pricing is opaque at consumer level. (The Electricity Authority is consulting on whether to change this.)

But it is also because the regulation does not target actual prices, but instead covers the amount of revenue the lines company is allowed to collect from its network, after adjusting for a complex set of factors such as how much the lines company must pay Transpower for delivering power from generators.

The result is a maximum allowable revenue. The lines companies are subject to sanctions if they exceed the maximum.

As far as Chalkie can tell, breaches are rare and sanctions rarer still.

Lines companies are presumably good at sticking to the limits. Or is it that the limits are easy to stick to?

Chalkie reviewed a sample of lines company disclosures to see how their actual regulatory revenue compared to their maximum limit. The results suggest some lines companies have been allowed to raise their income a lot.

The biggest increase in the sample was at Aurora Energy, owned by Dunedin City Council. From 2010 to 2014, Aurora's maximum allowable revenue rose by 41 per cent, from $40 million to $56.5m. During the same period, its actual regulatory revenue rose by 41 per cent, from $39.9m to $56.2m.

It's unclear why Aurora was allowed to increase its income, but the commission's general justification for it is that companies have under-invested and they need higher revenue to get their networks up to scratch.

As commission chairman Mark Berry told your correspondent: "When this regulatory regime started, we just rolled over the old prices, it was all we could do pragmatically. But in 2012 we set the first proper default price/quality path. There were some price shocks and there were reasons for that, in that a number of these consumer and council-owned utilities had underinvested over the years."

Fair enough. However, in Aurora's case that can't be the reason, because its accounts show its capital investment spending actually declined from $23.2m in 2010 to $18.8m in 2013, the latest year accounts are available.

The same thing happened at Unison, provider of power distribution across Hawke's Bay, Taupo and Rotorua. Its allowable revenue increased 35 per cent from 2010 to 2014, from $67.5m to $91.5m.

Unison's actual regulatory revenue tracks the upward trajectory closely, rising from $67.5m to $91.2m.

So did its capital investment increase during the period? Er, no. It fell from $44.8m in 2010 to $35.1m last year.

Another company with major investment requirements is The Lines Company, whose network in the King Country covers some inhospitable terrain and a widespread customer base.

THE Lines Company (let's call it TLC) breached its price limit big time in 2010 - $26m in regulatory revenue versus a limit of $20.8m. Its limit was then increased to $25.7m in 2011, and yes, TLC hit the target with revenue of $24.5m.

Since 2010, TLC's maximum allowable revenue has risen 61 per cent to $33.4m, although it has not taken full advantage of that allowance. This year its regulatory revenue was $28m.

The funny thing is, TLC's accounts show a decline in capital investment. In 2009 it invested $15.9m but the figure fell each following year until in 2013 it was $9.6m.

Chalkie notices that in its 2011 report, TLC said it was entitled to earn a commercial return and that the main factor influencing its allowable return was its network value.

Strangely enough, it looks like about half the increase in TLC's network value during the period has come from revaluations, not investment.

Meanwhile TLC's customers, only some of whom benefit from the distributions of TLC's owner Waitomo Energy Services Consumer Trust, have vented anger in the media and on Facebook about its charges.

This sort of thing makes Chalkie far from confident the regulatory regime is justifying its burden by delivering results, which is disturbing. But fear not, Chalkie has the solution. The problem with these lines companies is that they can only be monopolies, so they will naturally try to use that market power to divert cash from their customers to their owners. If customers and owners are one and the same, the problem disappears.

The regulatory exemption for community-owned lines companies exists for that very reason. However, as drafted it does not prevent some community-owned companies building little empires. Marlborough Lines has been making enough money to invest in other people's networks as well, acquiring stakes in Otagonet and Nelson Electricity. This means customers in other areas are contributing to profits for the beneficiaries of Marlborough Electric Power Trust.

Electricity distribution has a straightforward function - to deliver electricity safely and sustainably - and that function has natural geographical boundaries. Match those areas with lines companies owned exclusively by customers within them and you can say goodbye to building empires and towers of bureaucratic beer cans.

Chalkie is written by Fairfax business bureau deputy editor Tim Hunter.