Overview of the Electricity Industry KEY ISSUES Need for by kyliemc

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									                Overview of the Electricity Industry

KEY ISSUES

Need for Additional Generation Capacity

National Electricity Market Management Company Ltd (NEMMCO) has calculated that the failure to
increase generation capacity or the ability to carry electricity between States will inevitably result
in supply shortfalls. Normal projected demands will only be met by current capacity in the short
term in some States, with NSW calculated to reach its low reserve condition in 2008-09.

According to industry estimates, an additional $37 billion investment is needed across Australia
over the next decade on new generators, distribution networks and transmission lines. New
interconnectors between the eastern states are needed and existing ones improved. The
distributors in NSW propose to spend $4.3 billion over the next five years on capital works.
However, the Director-General of the Department of Energy, Utilities and Sustainability recently
commented that demand in New South Wales would outstrip supply by 2008 and that over the next
four years there would need to be an investment of $17 billion in the network, transmission and
power plants.

Other announcements and developments include:

      laying of a 360 kilometre cable linking Tasmania to the Victorian grid has commenced. It is on
      target to be operating by the end of 2005. It has an estimated cost of $500 million and will
      carry 600 MW. Electricity from Tasmania will mostly come from hydro-electric sources with
      some wind generation, while power sent from Victoria will be generated by gas and coal-
      fired stations

      two coal burning power stations have come into production in Queensland and are connected
      to the eastern States’ network. The Queensland government has plans for the construction of
      another power station at Kogan Creek, which will provide 750 MW and be operational in
      2007. Using interconnectors, these power stations will compete to supply electricity into New
      South Wales

      two wind farms are being considered in New South Wales that will add 50 MW to the grid.
      One is to be built at Red Hill in the south-west of the State and the other at Binalong near
      Canberra. Development applications are being considered for two other wind farm projects
      that will add 180 MW. Earlier in the year SEDA reported that the State has just 17 MW of
      installed wind energy capacity but has potential for over 1,000 MW

      methane-fuelled power units using waste coal gas are being installed or under development
      in NSW adding nearly 30 MW to the State or National grid over the next few years

      the Commonwealth Government announced in July 2004 that all Australian governments have
      signed the Australian Energy Market Agreement. Legislation established the Australian Energy
      Market Commission (AEMC) and Australian Energy Regulator (AER), which together will more
      easily develop the energy market. The AEMC will accelerate and can even order the
      development of interstate electricity transmission projects for the benefit of a national
      market

      the Commonwealth Government recently announced plans for a $675 million fund over four
      years for technological development to reduce greenhouse emissions, research for renewable
      energy development and trialling of solar technologies




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                                                                         Overview of the Electricity Industry



       however, the Commonwealth Government did not increase the mandatory renewable energy
       targets (MRETs) as part of that package, arguing that any further increase would impose
       substantial new costs on the economy. This was despite a review earlier in 2004 concluding
       that the renewable energy industry would stop developing by 2007 unless the MRETs were
       increased. In response to the federal decision to leave MRETs at their existing levels, some
       state energy ministers are considering trading carbon credits or renewable energy
       certificates across those states to encourage investment in renewable energy.

Sale of Electricity Industry Entities and Businesses

Pacific Solar, a subsidiary of the Residual Business Management Corporation (formerly Pacific
Power) was the subject of a buyout on 31 May 2004.

The Government announced that it was considering the outsourcing to the private sector of the
State’s wholesale power trading in the national electricity market. This proposal is being
considered to spread the risk of trading activities away from the ownership of infrastructure.

Electricity Merger

On 5 November 2004 the Treasurer announced the merger of Australian Inland Electricity Water
Infrastructure and Country Energy. The new entity will serve some 800,000 customers and manage a
network covering 90 per cent of the State.

International Financial Reporting Standards

The energy industry has planned to implement the Australian equivalents of the standards. In
particular, the expected adoption of International Accounting Standard IAS 39 ‘Financial
Instruments: Recognition and Measurement’ for the reporting period ending 30 June 2006 means
there is potential for significant volatility the in the operating result, income taxes and dividends of
electricity entities. The impacts of this standard will vary substantially across the industry,
although the extent of these will depend on the size and structure of individual entities’ derivatives
portfolios. Importantly, these potential fluctuations caused by recording derivative instruments will
need to be carefully considered when determining tax and dividend targets specified in Budgets and
Statements of Corporate Intent. The possibility that entities may report operating losses must also
be considered.


OTHER ISSUES

New South Wales Greenhouse Abatement Scheme Certificates

From 1 January 2003 electricity retailers and other participants are required to meet targets for
reducing greenhouse gases created by electricity generation and use. They will have to pay a
penalty for each carbon tonne above the target or surrender abatement certificates bought from
low-emission electricity generators or accredited providers. The targets are set by the Scheme
Administrator (Independent Pricing and Regulatory Tribunal - (IPART)) and are based on Kyoto
Protocol baselines. Allowable emissions will be reduced each year.

Certificates can be issued for activities that:

       reduce the carbon created by generating electricity
       reduce the consumption of electricity
       capture carbon from the atmosphere in forests for at least 100 years
       otherwise reduce on-site emissions through indirect means.

New South Wales has strengthened the importance of these by supporting initiatives that will add
to the success of the scheme. Some of these include:

       the establishment of a new gas plant capable of supplying 30 per cent of the State’s gas
       supply and powering 500,000 homes. The coal-seam methane gas will be delivered from wells
       near Camden over the next few years


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Overview of the Electricity Industry



        IPART allowing distributors (in its June 2004 determination) to pass on the costs to customers
        of developing ways to reduce the demand for electricity.

In June 2004 IPART released its report on the first year of operation and compliance with the
scheme. The report states that 6.6 million certificates were issued, equating to that number of
tonnes of carbon dioxide emissions not being released into the atmosphere. Its report can be found
at www.ipart.nsw.gov.au.

Competition

From 1 January 2002, domestic and small business customers in New South Wales have been able to
choose their electricity supplier and negotiate prices and conditions of supply. Customers who do
not enter into contracts remain with their existing retailer.

NEMMCO reported that 263,932 meters in New South Wales and Australian Capital Territory had
been transferred under signed negotiated contracts with other retailers at 30 June 2004 (125,263 at
30 June 2003). This compares with 479,984 (206,643) in Victoria and 2,873 (1,944) in Queensland
(which has a different timetable for full retail contestability).

Asset Acquisition

The 2003-04 Budget set out an asset acquisition program of $1.4 billion for maintaining and
upgrading electricity supply infrastructure. This included funds for network expansion, faster
recovery from supply interruptions, and improving the efficiency of generation and transmission. In
the 2004-05 Budget, the asset acquisition program was for a further $1.4 billion to be spent.


ELECTRICITY INDUSTRY PERFORMANCE

Prices for Electricity

For the last six years the average daily prices of electricity in New South Wales have remained
reasonably stable. On a financial year basis, NEMMCO price statistics show:

     Year ended           NSW             Qld              SA               Snowy                Vic
      30 June            $/MWh          $/MWh            $/MWh              $/MWh              $/MWh

       1999              33.13           51.65           156.02              32.34               36.33
       2000              28.27           44.11            59.27              27.96               26.35
       2001              37.69           41.33            56.39              37.06               44.57
       2002              34.76           35.34            31.61              31.59               30.97
       2003              32.91           37.79            30.11              29.83               27.56
       2004              32.37           28.18            34.86              30.80               25.38



During the year NEMMCO reported that the lowest average price for a day in NSW was $13.07 per
MWh on 19 October 2003, with the highest being $1,293.00 per MWh on 9 March 2004. The highest
NSW half-hour price was $9,702.18 per MWh on 9 March 2004. The high prices on 9 March 2004 were
caused by an unusual combination of extremely high temperatures and transmission issues.

Financial Performance

The Productivity Commission concluded in a recent research paper that most electricity sector
entities were not achieving a sufficient return on their assets compared to benchmark returns
recommended and applied by regulatory agencies. For example, the return on equity for the
Moomba-Sydney pipeline allowed by the ACCC in its approval was 11.3 per cent and the return
allowed for the Murraylink interconnector was 11.4 per cent. This compares to the 7.0 per cent
return on assets for the Australian electricity sector in 2002-03. The Commission also observed that
the overall performance of the electricity sector did not improve for the five year period of its
review to June 2003, but it did make the strongest returns of all the monitored government trading
enterprise sectors.

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For the New South Wales electricity industry (generation, distribution and transmission combined),
the key financial ratios were:

                                                                                          2003-04              2002-03

   Return on average equity (%) (a)                                                          7.9                     4.8
   Return on average assets (%) (b)                                                          8.1                     6.7
   Interest cover (times) (c)                                                                2.6                     2.0
   Debt to equity ratio (d)                                                                  1.0                     1.0

   Calculated as:
   (a) profit after income tax expense
   (b) profit before tax and interest expense
   (c) operating profit plus interest and tax expense divided by interest expense
   (d) external debt less creditors and accrued expenses divided by equity (net assets)



Generators and Distributors

Pre-tax profits of the distributors in 2003-04 were $561 million compared to $343 million in
2002-03. Profits before tax from generators were $355 million ($234 million).

Total revenue for the NSW electricity industry increased by $116 million to $8.2 billion. However,
expenses fell, resulting in a $294 million increase in operating profit after tax.

The following table shows key financial ratios for generators and distributors:

                                                           Generators                                 Distributors
                                                  2003-04            2002-03                2003-04             2002-03

   Return on average equity (%) (a)                  7.3                 4.3                    8.8                  5.3
   Return on average assets (%) (b)                  8.4                 7.2                    8.3                  6.6
   Interest cover times (c)                          3.0                 2.2                    2.5                  2.0
   Debt to equity ratio (d)                          0.6                 0.7                    1.2                  1.2

    Calculated as:
    (a) profit after income tax expense
    (b) profit before tax and interest expense
    (c) operating profit plus interest and tax expense divided by interest expense
    (d) external debt less creditors and accrued expenses divided by equity (net assets)



Equity repayments and debt restructures can significantly affect these ratios.

Transmission

TransGrid made a profit before tax of $115 million in 2003-04 ($82.3 million in 2002-03). This
resulted in the return on average assets increasing from 6.2 per cent to 6.6 per cent and return on
average equity increasing from 4.3 per cent to 6.3 per cent.

Non-financial Performance

Relevant non-financial key performance indicators are included in the comments for each industry
entity. These indicators are used by the entities in measuring their performance and include supply
interruptions and customer satisfaction.




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Overview of the Electricity Industry



The following sites provide financial and non-financial performance indicators for the industry:

        ‘Electricity Australia’ – The Electricity Supply Association of Australia www.esaa.com.au

        ‘Performance of NSW Government Businesses’ – NSW Treasury
        www.treasury.nsw.gov.au/indexes/pubs_by_pol.htm#perbus

        ‘Financial Performance of Government Trading Enterprises’ – Productivity Commission
        www.pc.gov.au


DISTRIBUTIONS TO GOVERNMENT

In 2003-04 electricity entities paid the Government $958 million ($835 million in 2002-03), being
$358 million ($281 million) of tax and $600 million ($554 million) of dividends paid and payable.
The timing of tax payments to the Consolidated Fund will vary while dividends are paid by
instalments.

Overall, these distributions compare to the 2003-04 Budget expectations of $921 million for
dividends and income tax equivalents.

Cash payments to the Consolidated Fund were:

                                                                             2003-04           2002-03
                                                                              $’000             $’000

     Income tax equivalents                                                   150.9              171.8
     Dividends                                                                380.3              564.3
     Equity repayments                                                           --              580.0
     Total                                                                    531.2            1,316.1



The cash payments came from:

                                                                             2003-04           2002-03
                                                                              $’000             $’000

     Distributors                                                              292.6             274.1
     Generators                                                                185.2             975.2
     Transmission                                                               53.4              66.8
     Total                                                                     531.2           1,316.1



The Government also receives loan guarantee fees (included within total borrowing costs) and
payroll tax.




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                                                                         Overview of the Electricity Industry



BUDGET ESTIMATES

The 2004-05 Budget shows:

                                       2003-04                       Forward Estimates
                               Budget         Actual      2004-05   2005-06      2006-07        2007-08
                                 $m            $m           $m        $m           $m             $m

 Revenue Source
 Dividends                       645             600        628       681            701            705
 Income Tax                      276             358        383       400            421            443
 Total                           921             958      1,011     1,081          1,122          1,148



The Electricity Distributors Levy was again suspended in the Budget, which has an impact of
$100 million a year as foregone revenue.


INDUSTRY DEBT

Borrowing costs for the year were $631 million compared to $647 million in 2002-03. The industry’s
debt at 30 June 2004 was about $8.4 billion with $1.8 billion current and $6.6 billion non-current
($1.9 billion and $6.4 billion at 30 June 2003).


INDUSTRY RISK FACTORS

The electricity market remains volatile due to the growth of the national market and the effect of
the spot market price. Spot market prices may ‘spike’ to levels substantially above the cost of
production. At present the maximum spot price is capped at $10,000 per MWh in any half hour. The
highest average daily peak retail price occurred on 9 March 2004 when it went to $2,055 per MWh.

To manage this exposure, NSW Treasury issued guidelines in October 1999 on minimum controls for
distributors and generators. These guidelines focus on strong control structures, with particular
emphasis on the segregation of duties in the trading areas and the need for regular reporting to
management and the Board of Directors prepared independently from the trading and settlement
areas.


ELECTRICITY TARIFF EQUALISATION FUND (ETEF)

From 1 January 2002, all residential and small business customers have had the option of remaining
on regulated retail tariffs with their local retailer or choosing to enter into a negotiated supply
contract with any retailer.

ETEF manages the variability of wholesale electricity prices for those Government-owned retailers
that are required to supply small retail customers at regulated tariffs. When spot prices are high
the generators may be levied and the proceeds distributed to the retailers to cover the gap
between the regulated tariff and the market price. However, there is no requirement for the Fund
to match transactions between retailers and generators.

ETEF can be required to pay a dividend directly to Consolidated Fund although the Fund did not
make any payments in 2003-04 or the previous year. At 30 June 2004, $258 million was held by the
Fund ($182 million in 2002-03).

As the number of small retail customers receiving supply under negotiated arrangements increases,
ETEF transactions will decline.

Volume Five of the Auditor-General’s 2004 Report to Parliament will comment on the activities of
the Fund.

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Overview of the Electricity Industry



REGULATION

IPART is the NSW regulator for electricity distribution pricing. In June 2004, IPART made a five-year
determination under the National Electricity Code, which established base revenue requirements
for each electricity distributor from 1 July 2004. The determination, for the first time, provides
incentives for the retailers to manage demand instead of increasing the capacity of the network
only.

IPART plans for the distribution prices across the State to increase in real terms by 14 per cent over
the five years, or 2.7 per cent per annum. For a typical Sydney residential customer, the annual
2004-05 increase will be about $50 to $60 per year, with regional customers paying between $50
and $70 more per year.

Transmission prices are set by the Australian Competition and Consumer Commission. A draft report
for Transgrid and EnergyAustralia was issued on 28 April 2004, allowing both a nominal return of
8.8 per cent on their weighted average cost of capital. The final determination will also cover a
five year period when it is released.


BACKGROUND

All NSW public sector electricity entities are statutory state owned corporations (SOCs) with the
exception of the Residual Business Management Corporation (formerly Pacific Power), which is a
statutory authority and now responsible for liquidating its assets and exiting the industry in the
near future.

They have common objectives of:

       operating a successful business
       protecting the environment
       operating efficient, safe and reliable facilities for generating and distributing electricity and
       other forms of energy
       participating in the wholesale and retail markets for electricity and other forms of energy.

The voting shareholders of the SOCs are the Treasurer and the Special Minister of State.


INDUSTRY FINANCIAL TABLES

Following are abridged statements of financial performance and statements of financial position
tables for generators and distributors for 2003–04 and the previous year. Comment on each entity
and TransGrid follows this section.




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