Cost-benefit analysis of central database options. Report to the Electricity Commission

Transcription

1 Cost-benefit analysis of central database options Report to the Electricity Commission Draft of 6 September 2009

2 Preface The New Zealand Institute of Economic Research (NZIER) is a specialist consulting firm that uses applied economic research and analysis to provide a wide range of strategic advice to clients in the public and private sectors, throughout New Zealand and Australia, and further afield. NZIER is also known for its long-established Quarterly Survey of Business Opinion and Quarterly Predictions. Our aim is to be the premier centre of applied economic research in New Zealand. We pride ourselves on our reputation for independence and delivering quality analysis in the right form, and at the right time, for our clients. We ensure quality through teamwork on individual projects, critical review at internal seminars, and by peer review at various stages through a project by a senior staff member otherwise not involved in the project. NZIER was established in Authorship This report has been prepared at NZIER by Johannah Branson and reviewed by Brent Layton. 8 Halswell St, Thorndon P O Box 3479, Wellington Tel: Fax: econ@nzier.org.nz NZIER s standard terms of engagement for contract research can be found at While NZIER will use all reasonable endeavours in undertaking contract research and producing reports to ensure the information is as accurate as practicable, the Institute, its contributors, employees, and Board shall not be liable (whether in contract, tort (including negligence), equity or on any other basis) for any loss or damage sustained by any person relying on such work whatever the cause of such loss or damage.

3 Executive summary Part D of the Electricity Governance Rules 2003 (the Rules) provides the regulatory framework for metering in the New Zealand electricity industry. The Electricicty Commission (the Commission) is undertaking a fundamental review of Part D to identify and address the problems and deficiencies of the existing Rules. Workstream 4 of the review concerns establishing a central database of metering information to promote a more transparent market system. A central database would enable market participants trading at an installation to obtain information on certification and meter attributes to the meter register level, for use in switching and reconciliation. The Commission identified five possible options in improving access to metering information. The Commission s analysis and consultation with the an industry reference group (IRG) reduced these to two implementing electricity information exchange protocols (EIEP) (option 1B) or enhancing the Commission s existing electricity registry (option 2A). The Commission used the IRG to explore these two options and their likely effects on distributors, retailers and metering participants. We use the averages of these opinions, together with the Commission s estimates, as inputs into cost-benefit analysis (CBA) of the two options. This CBA finds that although option 2A, enhancing the electricity registry, costs over 2.5 times as much to develop and implement and nearly four times as much to maintain each year, it delivers almost 10 times the annual benefits of option 1B, adopting EIEP. Over the 12 year period 2009/10 to 2020/21, the present value net benefits total $0.063 million from option 1B and $ million from option 2A a difference of $ million. For each dollar of cost, option 1B returns $1.03 in benefits, whilst option 2A returns $3.53. It takes the full 12 years to recoup the initial development and implementation costs of option 1B, but only four years for option 2A to break even. Option 2A is clearly superior in terms of net benefit. For both options, the largest cost component (around 60%) is implementation. The efficiency benefits resulting from better access to metering information enabling more accurate quotation, billing and reconciliation are the largest benefit (100% for option 1B and 87% for option 2A). Retailers and metering participants bear most of the costs of improving access to metering information, whilst most if not all of the benefits are market wide. Analysis of the sensitivity of these results across a range of unit values for each type of cost and benefit highlights how marginal option 1B is and how robust option 2A is. The sensitivity analysis indicates that market participants can be very confident that option 2A, enhancing the electricity registry, would provide net benefits and that this NZIER Cost-benefit analysis of central database options i

4 option would deliver greater net benefits than option 1B, adopting EIEP. In contrast, market participants cannot be confident that option 1B would deliver net benefits within the next 12 years, but could improve its likelihood if they could find lower cost ways of developing systems interfaces for EIEP. NZIER Cost-benefit analysis of central database options ii

5 Contents 1. Purpose Central database options Method Cost-benefit analysis Baseline scenario Types of costs and benefits Efficiency benefits Unit values of costs and benefits Efficiency benefits Numbers of market participants Time horizon Results Annual costs and benefits Total costs and benefits Sensitivity analysis Figures Figure 1 Annual costs and benefits of option 1B EIEP... 8 Figure 2 Annual costs and benefits of option 2A enhanced electricity registry... 9 Figure 3 Annual net benefits... 9 Figure 4 Present value total costs and benefits over 2009/10 to 2020/ Figure 5 Distribution of present value total costs and benefits over 2009/10 to 2020/21.11 Tables Table 1 Unit costs and benefits... 7 Table 2 Sensitivity analysis present value total net benefits over 2009/10 to 2020/ NZIER Cost-benefit analysis of central database options iii

6 1. Purpose Part D of the Electricity Governance Rules 2003 (the Rules) provides the regulatory framework for metering in the New Zealand electricity industry. The Electricicty Commission (the Commission) is undertaking a fundamental review of Part D to identify and address the problems and deficiencies of the existing Rules. The review has been divided into four workstreams 1. Workstream 4 concerns establishing a central database of metering information to promote a more transparent market system. A central database would enable market participants trading at an installation to obtain information on certification and meter attributes to the meter register level, for use in switching and reconciliation. Implementing central database requirments would necessitate changing the Rules. Before making a recommendation to the Minister on any Rules, under Section 172F(1) of the Electricity Act 1993, the Commission must: identify all reasonably practicable options for achieving the objective of the Rules assess those options by considering: the benefits and costs of each option the extent to which the objective would be promoted or achieved by each option and any other matter that the Commission considers relevant. The Commission has asked NZIER to assist in preparing a cost-benefit analysis (CBA) of the options for establishing a central database. This report outlines the method and results of this CBA. 2. Central database options In its review of Part D, the Commission identified the existing regulatory framework to have deficiencies around the transparency of metering information. Improving market participants access to meter asset information would promote: transparency, particularly around load management devices and metering compliance accuracy in offering prices to consumers simplified and more efficient switching, which would increase competition integrity in settlements and billing ablity to meter advanced metering infrastructure (AMI) and cost effciiency. 1 For further details, see Electricity Commission (2009) Workstreams Terms of Reference Part D Review Project. NZIER Cost-benefit analysis of central database options 1

7 Consultation with an industry reference group (IRG) showed general agreement that a single party should be responsible for maintaining information on meters and metering installations. There was also considerable support for the creation of a central repository for this information. This would enable market participants trading at an installation to obtain information on certification and meter attributes to the meter register level, for use in switching and reconciliation. The Commission identified five possible options in improving access to metering information. The Commission s analysis and consultation with the IRG reduced these to two 2 : option 1B no central database of meter asset information, but implement electricity information exchange protocols (EIEP) to exchange metering installation information between participants or option 2A enhanced electricity registry, by incorporating the new meter asset information into the Commission s existing electricity registry using the existing technology platform, hardware, facilities and processes. In this report, we assess how these two options compare in terms of their costs and benefits. 3. Method 3.1 Cost-benefit analysis CBA provides a formal, structured method for systematically assessing proposals in terms of their outcomes relative to their use of resources. In the analysis of government policy, CBA is normally undertaken from a national economy perspective, weighing up the relative costs and benefits to New Zealand as a whole. The CBA process comprises 10 steps: 1. define the problem 2. select the options for assessment 3. specify the baseline scenario 4. identify the impacts of the options positive (benefits) and negative (costs) 5. where possible, quantify the impacts 6. where possible, value the impacts 7. adjust for differences in the timing of the impacts 8. calculate decision criteria 9. analyse the sensitivity of the results and 10. document the CBA 3.2 Baseline scenario A critical step in any CBA is defining the baseline scenario the default or prevailing situation or conditions that would occur in the absence of the options under 2 For further details, see Electricity Commission (2009) Part D Fundamental Review IRG Options Paper Workstream 4 Central Database. NZIER Cost-benefit analysis of central database options 2

8 consideration. It is relative to this baseline that the options costs and benefits are measured. For the purpose of comparing the two central database options, we define the baseline scenario as the status quo continuation of the existing regulatory framework for metering under the existing Rules. We therefore assess how much each of the two options would incur additional costs and deliver additional benefits over current access to metering information. 3.3 Types of costs and benefits The Commission used the IRG to explore the two central database options and their likely effects on distributors, retailers and metering participants. Members of the IRG were asked to identify the types of costs and benefits they thought each of the two options would have, both one off and ongoing. These are summarised in Table 1 below Efficiency benefits Improved access to metering information would enable more accurate quotation, billing and reconciliation and thereby more accurate allocation of costs between market participants, including consumers. The direct effect of more accurate allocation of costs to the correct participants is a transfer from participants who are being charged or paid too much currently to those who are being charged or paid too little currently. As simply a transfer between participants, in aggregate this constitutes no net benefit to the market as a whole. Indirectly, however, a potential consequence of more accurate allocation of costs between participants is increased efficiency. With more accurate quotation, billing and reconciliation, participants have greater certainty about the actual costs and benefits to them of buying and selling electricity and improved confidence that they will secure the actual net benefits of the electricity they supply or demand. This may in turn increase or decrease the amount of electricity they are willing to supply or demand. The consequence of better market information is better in terms of more economically efficient production and consumption decisions. The three components of economic efficiency are: allocative efficiency the price and quantity of electricity supplied productive efficiency the cost of supplying electricity and dynamic efficiency investment and innovation to pursue reduction over time in the cost of supplying electricity. A consequence of better market information and potentially more trading is increased competition. Increased competition between participants would exert downward pressure on the sale price and supply cost of electricity and enhance the incentive to pursue future cost reductions, to avoid losing business to competing participants. NZIER Cost-benefit analysis of central database options 3

9 3.4 Unit values of costs and benefits Members of the IRG were also asked for their opinions on the likely magnitudes of these costs and benefits to individual distributors, retailers and metering participants, relative to current access to metering information. In the absence of more definitive data, we use the averages of these opinions, together with the Commission s estimates, as inputs into the CBA. These are shown in Table 1 below. Given the uncertainty of these unit values, we test the sensitivity of the results across a range of unit values for each type of cost and benefit (see Section 4.3 below) Efficiency benefits The magnitudes of efficiency benefits from improved access to metering information are unknown. For the purpose of assessing whether the benefits of options 1 and 2 are likely to outweigh the costs, we model the potential efficiency benefits as follows. There is likely to be an imbalance in the extent of under and over charging, or under and over paying, as participants are more likely to complain about being overcharged or underpaid than undercharged or overpaid. If the net balance written off currently due to inaccurate metering information were equivalent to around 1% of New Zealand s total annual electricity generation of 42,245 GWh 3, at an average price of $75/MWh, this would amount to a loss of around $32 million per year. As noted above, the direct benefit of improved access to metering information in reducing the extent of this loss would be simply a transfer between market participants and therefore of no net benefit to the market, regardless of how much options 1B and 2A reduced this loss. Indirectly, however, improving access to metering information would deliver real net benefits to the market by promoting allocative efficiency through providing greater certainty about costs and increased competition between participants, option 2A more so than option 1B. If this effect of option 1B lowered the price at which electricity is supplied by, say, 0.27%, at an average price of around $75/MWh, this would reduce the average price by $0.20/MWh. For existing demand, this reduction in price is simply a transfer from producers to consumers, resulting in no net benefit. Under a price elasticity of demand of , a 0.27% reduction in price would increase demand by 0.07%, which would be an additional 30 GWh per year. For this additional demand, there is a benefit to additional consumers who did not consume electricity at the previous higher price, in the form of a consumer surplus of half the price reduction, applied across the increase in quantity demanded. This suggests an allocative efficiency benefit to the market of around $3,000 per year. 3 Ministry of Economic Development (2009) New Zealand Energy Data File, Tables G.2a and G.3b. 4 Sinclair Knight Merz (2005) National Cost Benefit Analysis of Proposals to Take Water from the Waitaki River, final report to Ministry of Economic Development, Appendix H. NZIER Cost-benefit analysis of central database options 4

10 For option 2A, if this effect lowered the price at which electricity is supplied by, say, 1.55%, at an average price of around $75/MWh, this would reduce the average price by $1.16/MWh. For existing demand, this reduction in price is simply a transfer from producers to consumers, resulting in no net benefit. Under a price elasticity of demand of , a 1.55% reduction in price would increase demand by 0.40%, which would be an additional 170 GWh per year. For this additional demand, there is a benefit to additional consumers who did not consume electricity at the previous higher price, in the form of a consumer surplus of half 6 the price reduction, applied across the increase in quantity demanded. This suggests an allocative efficiency benefit to the market of around $100,000 per year. Option 1B and Option 2A would also promote more productive efficiency through increased competition between participants improving the efficiency with which electricity is produced and supplied. Unlike the immediate allocative efficiency benefits above, Improvements to production and supply processes are likely take time to develop and implement. If this effect of option 1B lowered the average unit cost of supplying electricity by, say, $0.01/MWh (equivalent to % of the price of electricity, at an average price of around $75/MWh), phased in over five years, this suggests a productive efficiency benefit market wide, across total electricity supply, averaging around $347,000 per year over the time horizon of the CBA. If this effect of option 2A lowered the average unit cost of supplying electricity by, say, $0.09/MWh (equivalent to 0.124% of the price of electricity, at an average price of around $75/MWh), phased in over five years, this suggests a productive efficiency benefit market wide, across total electricity supply, averaging around $2.945 million per year over the time horizon of the CBA. Over time, dynamic efficiency benefits have potential to far outweigh the above static efficiency improvements. These are much longer term, however, so we assume for simplicity that they are beyond the time horizon of the CBA. 3.5 Numbers of market participants The central database options are modelled as impacting on 28 distributors, seven retailers and three metering participants, in addition to the Commission. For the purpose of comparing the costs and benefits of the two database options, we assume the numbers of market participants to remain constant for the time horizon of the CBA. 5 Sinclair Knight Merz (2005) National Cost Benefit Analysis of Proposals to Take Water from the Waitaki River, final report to Ministry of Economic Development, Appendix H. 6 To give the area of the consumer surplus triangle formed by the intersection of the demand and supply curves. NZIER Cost-benefit analysis of central database options 5

11 3.6 Time horizon Once the preferred option has been selected, the Commission will work with market participants to develop and agree the detailed requirements. It expects to seek ministerial approval of the new Rules by late 2010 and to complete implementation by mid The benefits of the selected option are therefore expected to start flowing from mid In the CBA, we model the costs and benefits of the two options over a period of 12 years from 2009/10 to 2020/21 (in June years). This time horizon seeks to capture enough of the ongoing costs and benefits after the initial development and implementation costs to provide a robust assessment of the two options. We do not extend the CBA beyond 12 years as further new metering technologies could be expected to be developed by this time, necessitating further changes to the regulatory regime. So that we can compare directly costs and benefits occurring at different points in time, we adopt a discount rate of 10% to convert future costs and benefits to their present values in In the sensitivity analysis, we also model discount rates of 6%, to reflect a public policy perspective, and 12%, to reflect a commercial perspective 7. 7 Treasury now recommends an 8% real discount rate for energy and water infrastructure projects. This is covered by the range we model in the sensitivity analysis. NZIER Cost-benefit analysis of central database options 6

12 Table 1 Unit costs and benefits Additional to current access to metering information Frequency Cost or benefit per participant ($) Market wide Distributor Retailer Metering participant Commission cost or benefit ($) Option 1B EIEP Costs Develop and agree detailed requirements One off total 2,000 10,000 10,000 50,000 Develop systems interface for EIEP One off total 15,000 50, ,000 Compliance and audit Ongoing annual 10,000 10,000 Benefits Efficiency benefits from improved accuracy at time of switch and post switch, Ongoing annual 350,000 enabling more accurate quotation, billing and reconciliation Option 2A enhanced electricity registry Costs Develop and agree detailed requirements One off total 2,000 10,000 10,000 50,000 Upgrade Commission s electricity registry One off total 450,000 Implementation and integration One off total 300, ,000 Electricity registry operation and licensing Ongoing annual 50,000 Data maintenance Ongoing annual 60,000 Compliance and audit Ongoing annual 10,000 10,000 Monitoring of metering participant compliance Ongoing annual 50,000 Benefits Time saving in investigating sites to obtain accurate metering information Ongoing annual 10,000 10,000 Time saving from fewer customer complaints Ongoing annual 25,000 Lower costs of compliance and audit for retailers Ongoing annual 25,000 Efficiency benefits from improved accuracy at time of switch and post switch, enabling more accurate quotation, billing and reconciliation Ongoing annual 3,045,000 Notes: In 2009 dollars Source: Industry Reference Group, Electricity Commission NZIER Cost-benefit analysis of central database options 7

13 4. Results 4.1 Annual costs and benefits Both central database options incur initial development and implementation costs over the first two years, followed by ongoing annual costs and benefits. The total annual costs and benefits across all market participants are shown in Figure 1 and Figure 2. Option 1B, adopting EIEP, incurs initial development and implementation costs of $1.453 million, followed by ongoing costs of $0.100 million per year and delivers ongoing benefits of $0.350 million per year. Option 2A, enhancing the electricity registry, costs over 2.5 times as much to develop and implement ($3.731 million) and nearly four times as much to maintain ($0.380 million per year), but delivers almost 10 times as much in annual benefits ($3.495 million per year). Once implemented, option 2A therefore delivers a greater annual net benefits, as shown in Figure 3. The ongoing net benefit to all market participants is $0.250 million per year under option 1B and $3.115 million per year under option 2A, a difference of $2.865 million. Figure 1 Annual costs and benefits of option 1B EIEP $ million, year ending June Development and implementation costs Ongoing costs Ongoing benefits Notes: In 2009 dollars Source: NZIER NZIER Cost-benefit analysis of central database options 8

14 Figure 2 Annual costs and benefits of option 2A enhanced electricity registry $ million, year ending June Development and implementation costs Ongoing costs Ongoing benefits Notes: In 2009 dollars Source: NZIER Figure 3 Annual net benefits $ million, year ending June Option 1B - EIEP Option 2A - enhanced electricity registry -4 Notes: In 2009 dollars Source: NZIER NZIER Cost-benefit analysis of central database options 9

15 4.2 Total costs and benefits With discounting to reflect their relative timing, the above annual costs and benefits imply present value total costs over 2009/10 to 2020/21 of $1.892 million under option 1B and $5.527 million under option 2A. These options deliver present value total benefits over the next 12 years of $1.955 million and $ million respectively. The net benefits are therefore $0.063 million from option 1B and $ million from option 2A. For each dollar of cost, option 1B returns $1.03 in benefits, whilst option 2A returns $3.53. It takes the full 12 years to recoup the initial development and implementation costs of option 1B, but only four years for option 2A to break even. Option 2A, enhancing the electricity registry, therefore provides $ million more in net benefits over this period than option 1B, adopting EIEP. Although option 2A costs more to implement and maintain, it delivers considerably greater benefits, as highlighted in Figure 4. It is clearly the superior option in terms of net benefit. Figure 4 Present value total costs and benefits over 2009/10 to 2020/21 $ million Option 1B costs Option 2A costs Option 1B benefits Option 2A benefits Notes: In 2009 dollars Source: NZIER For both options, the largest cost component (around 60%) is implementation. The efficiency benefits resulting from better access to metering information enabling more accurate quotation, billing and reconciliation are the only benefit of option 1B and the largest benefit (87%) of option 2A. Retailers and metering participants bear most of the costs of improving access to metering information, whilst most if not all of the benefits are market wide, as shown in Figure 5. NZIER Cost-benefit analysis of central database options 10

16 Figure 5 Distribution of present value total costs and benefits over 2009/10 to 2020/21 Percentage of total 100% 90% 80% 70% 60% 50% 23% 41% 1% 43% 100% 12% 87% 1% 40% 30% 20% 10% 0% 38% Distributors Retailers 33% Metering participants Commission 18% Market wide 3% Option 1B costs Option 2A costs Option 1B benefits Option 2A benefits Source: NZIER 4.3 Sensitivity analysis As noted above, the unit costs and benefits used in the CBA reflect the opinions of the IRG and the Commission s estimates. Given the uncertainty of these unit values, we test the sensitivity of the above main results across a range of unit values for each type of cost and benefit. The results of this sensitivity analysis are shown in Table 2. This table shows how adopting 10% or 25% lower or higher unit costs or benefits would alter the present value total net benefits of each option over the next 12 years. Both options are most sensitive to the magnitude of efficiency benefits resulting from more accurate quotation, billing and reconciliation. The sensitivity analysis highlights how marginal option 1B is. If the efficiency benefits of option 1B were 10% lower, option 1B would take a further year to break even and if 25% lower, a further six years (until 2026/27). The present value net benefits of option 1B over this period are also sensitive to the initial cost of developing systems interfaces for EIEP. If this cost was just 10% higher, option 1B would not break even within 12 years, but require a further one year of benefits. If this cost was 25% higher, option 1B would take 16 years to break even (until 2024/25). Alternatively, if this cost was 10% lower, the net benefits of this option over the next 12 years would almost treble. If 25% lower, the net benefits would be over five times as large. NZIER Cost-benefit analysis of central database options 11

17 Table 2 Sensitivity analysis present value total net benefits over 2009/10 to 2020/21 $ million Change to unit value -25% -10% +10% +25% Option 1B EIEP Costs Develop and agree detailed requirements Develop systems interface for EIEP Compliance and audit Benefits Efficiency benefits from improved accuracy at time of switch and post switch, enabling more accurate quotation, billing and reconciliation Option 2A enhanced electricity registry Costs Develop and agree detailed requirements Upgrade Commission s electricity registry Implementation and integration Electricity registry operation and licensing Data maintenance Compliance and audit Monitoring of metering participant compliance Benefits Time saving in investigating sites to obtain accurate metering information Time saving from fewer customer complaints Lower costs of compliance and audit for retailers Efficiency benefits from improved accuracy at time of switch and post switch, enabling more accurate quotation, billing and reconciliation Notes: In 2009 dollars Source: NZIER NZIER Cost-benefit analysis of central database options 12

18 The sensitivity analysis also highlights how robust option 2A is. Option 2A is also most sensitive to the efficiency benefits. On the cost side, this option is most sensitive to the initial implementation and integration costs to metering participants and retailers. The net benefits of option 2A nevertheless remain strongly positive and considerably greater than those of option 1B throughout the sensitivity analysis of Table 2. Indeed, even if all of the costs of option 1B were each 25% lower and all of the benefits were 25% higher, whilst all of the costs of option 2A were 25% higher and all of this option s benefits were 25% lower, the net benefits of option 2A would still outweigh the net benefits of option 1B by $6.709 million over the next 12 years (net benefits would be $1.025 million under option 1B and $7.734 million under option 2A). Similarly, a 6% discount rate increases the present value net benefits of option 1B to $0.357 million and of option 2A to $ million a difference of $ million, whilst a 12% discount rate reduces the present value net benefits of option 1B to -$0.051 million and of option 2A to $ million a difference of $ million. The findings of the sensitivity analysis therefore indicate that market participants can be very confident that option 2A, enhancing the electricity registry, would provide net benefits and that this option would deliver greater net benefits than option 1B, adopting EIEP. In contrast, market participants cannot be confident that option 1B would deliver net benefits within the next 12 years, but could improve its likelihood if they could find lower cost ways of developing systems interfaces for EIEP. NZIER Cost-benefit analysis of central database options 13