Gold-plating the power grid

This story investigates claims of how Citipower and SP Ausnet used the electricity rules and bureaucracy to turn what should have been a $107 million public investment on an enhancement to the Melbourne CBD electricity network into a $271 million spend.

It was the week before Christmas in 2009 when Anne Voss, a microbiologist at the Walter & Eliza Hall Institute of Medical Research, smelt a rat.

Dr Voss saw a notice pinned to the wire gate of the electricity terminal across the street from her house in Brunswick. It was a planning application, flagging “Maintenance works and upgrades”.

This innocuous development notice turned out to be an upgrade alright. Voss conducted  some elementary research and soon found her fellow residents of Brunswick Street were to have 12 spanking new pylons, each 26 metres tall, on their doorsteps. “There was no letter from council”, she says.

News of the towering forest of steel spread through the neighbourhood like a 40,000 volt shock through an electric circuit, setting in train a tortuous two-year process of objections and local resident rallies which have now culminated in an investigation by the Australian Energy Regulator (AER) into overspending.

Although demand for electricity in Australia is actually falling, power bills are poised to spiral again this year at double-digit rates in every state. And it is network costs – not the carbon tax (although that is a factor) – which are the principal culprit behind the surge in prices.

Against this backdrop, and mounting concern that the power companies are “gold-plating” their networks – because the more money they spend, the more money they make – AER chairman Andrew Reeves told BusinessDay last week that the energy regulator was looking at whether SP Ausnet might have built its  Melbourne power terminal more cheaply elsewhere.

This is the third investigation of this sort by the AER. It follows similar inquiries into overspending by transmission giants Transgrid in NSW and Powerlink Queensland.

Forget school stimulus wastage

Power industry insiders say that the gold-plating of the National Electricity Market (NEM) puts the controversial schools stimulus program in the shade. And it is not all taxpayers who get hit evenly, but pensioners in wintertime when they open that quarterly envelope to find a bill they can ill afford to pay.

There is a fundamental flaw in the structure of the power industry. Thanks to its regulated returns on assets, the more the power companies spend the more money comes through the door.

Perversely, they have an incentive to spend big, to “gold-plate” their networks, and in the battle over the Brunswick Terminal Station, the years of jousting with greenies and commissioning experts’ reports only fattens up the bottom line of the power companies SP Ausnet and the Hong Kong-controlled Citipower.

This story investigates claims of how Citipower and SP Ausnet, the listed provider of transmission assets, majority-owned by the Singaporean government, used the electricity rules and bureaucracy to turn what should have been a $107 million public spend in 2006 dollars on an enhancement to the Melbourne CBD electricity network into a $271 million (and still counting) spend in 2012.

Melbourne blackouts

In 2001, the Melbourne CBD experienced two electricity outages. They followed network failures in Auckland and Sydney that had caused major disruptions.

The first event occurred in January 2001. Some 12,200 customers were left without power for 30 minutes. The second outage, in November that year, left 65,000 customers without power for more than an hour and affected up to 200,000 people around the CBD.

It was the stuff of nightmares for power executives.

Citipower – the major distributor of electricity to the Melbourne CBD – quickly identified that there were problems in the security of supply (even though the network was assessed as being at an international standard).

It couldn’t get the green light to pass on the costs of increasing its capacity in the general submissions for price increases between 2006-10 (because the network was already at standard), and commissioned Sinclair Knight Mertz to come up with a business case for the additional investment required.

The wheels of power planning turn slowly, and by 2006 SKM presented its arguments and identified the most economic solution to bring additional capacity to the Melbourne CBD and ensure that these outages did not happen again.

The City of Melbourne, the Essential Services Commission and even the Victoria Police all thought it a grand idea.

Two options were laid down:

Option 1 suggested locating the main infrastructure for the new capacity at Bouverie Street in the CBD with expensive Gas Insulated Switchgear (so that it could be safely housed in a building). There were other works involved and the price came in at a total of $135 million in 2006 dollars.

Option 2 was to achieve the same result for the security of supply for the CBD but with a different technical solution and at a much lower cost. Air Insulated Switchgear (AIS) – basically big pylons with wires draped between them – was to be deployed and a new Terminal Station constructed at Brunswick, where SP Ausnet already owned a site. The cost was forecast to be $107.8 million for the total works, some $27 million cheaper.

Gaming the regulators

All good so far. Yet it took until 2008 for Citipower to submit the relevant documentation for the expenditure, known as the “Reg Test”. It is via the Reg Test, say critics of the industry structure, where the industry players get to “game” the regulators, or maximise their returns at the expense of the consumer.

Industry rejects this. Reg Tests said a spokesman for SP Ausnet last week are done in conjunction with the industry planning body AEMO (Australian Energy Market Operator). AEMO is 60 per cent government owned and 40 per cent owned by industry. It was unavailable to respond to questions for this story.

Back to Brunswick. SKM confirmed for the Reg Test that, in 2008 dollars, Brunswick was still the best option – at $104 million. This number is not directly comparable with the earlier 2006 number ($107 million) as there were additional works involved in the 2006 number. Comparing apples with apples in this caper is hard. And the industry structure is byzantinely complex as lay readers will have noticed by now!

From here, however, the story is easy to follow.

SKM’s recommendation on the Reg Test flew through. In the arcane world of electricity economics, the Reg Test is all important, as it is the green light for the owners of transmission assets to build something and then lift the prices charged to consumers, via their power bills, to recover the costs.

Although the rules on the Reg Test are administered in Victoria by the Australian Energy Market Operator (AEMO), they are also subject to the authority of the Australian Energy Regulator (AER), which is tasked with administering the National Electricity Rules for the National Electricity Market – a market ironically dominated, in Victoria at least, by foreign players.

The 2008 Reg Test for the Brunswick Terminal Station didn’t consider the possibility that the Air Insulated System that it had identified for the site was unlikely to receive local council planning approval. This was notwithstanding that the Brunswick site was zoned residential and the locals might have been loath to embrace the prospect of humungous metal towers nearby shimmering with high voltage.

A robust green case was put against the proposal. The site sits on the banks of the Merri Creek in an environmentally sensitive area, borders three electorates and on a two-party preferred basis is the highest Green voting area in Australia!

As one resident wryly put it, “They thought that the erection of 12, 26-metre high pylons visible from the vegetable patches of the inner city elites would pass through without comment”.

Grave misstep

History records this to be a grave misstep. Citipower and AMEO finally fixed on the proposed solution in October of 2009 and instructed SP Ausnet, the developer of the transmission assets, to lodge the necessary planning approvals, which it duly did in the week before Christmas 2009, alerting Dr Voss and her neighbours.

The Moreland City Council duly knocked back the planning approval for the Brunswick Terminal Station amid celebratory scenes in June 2010. The decision was struck on both planning and environmental grounds.

Things then became curious. It was too late to revert to the earlier, alternative $135 million option as Bouverie Street was now being transformed into a new residential area. So Citipower, SP Ausnet and AEMO set about an extensive nine-month “consultation” process with various interest groups. There were town hall meetings, surveys and websites. No expense was spared in listening to the community concerns.

Industry v residents

And this is where the stories – industry vs residents – wildly diverge. Industry spokespeople told BusinessDay the best process was pursued to find the best, most cost effective solution. Residents say industry made the process and the solution as expensive as possible because that is how they make higher profits.

Brunswick resident and assistant school principal Trevor Smith says it is impossible to believe the power companies could not find an industrial site to locate a cheap system.

“(They) have a massive vested interest in coming up with a rolled gold option to maximise their (guaranteed) returns whilst consumers – mums, dads & pensioners pay,” said Smith. “They have not done due diligence as demanded by the Reg Test – have not seriously nor genuinely looked at alternative options, they have been focussed on Brunswick all along.

“The electricity mafia spotted an opportunity,” says another local who declined to be named. “If they could convince the insiders that the Brunswick site was the only feasible option, it would submit a proposal to build a new terminal station at Brunswick with far more expensive equipment, satisfying the inner city elites, the local council and making a motza in the process.”

After the residents won the first battle in June 2010, the Victorian ALP government fell a few months later, but not before it had published a policy on the Brunswick terminal – committing to examine alternative sites to balance the needs of the local communities with security of supply to the CBD and the costs of power users.

Eventually, in early 2011, the industry players had determined that the same technical solution could be achieved at Brunswick, by using Gas Insulated Switchgear (GIS), and housing the majority of the infrastructure in buildings so that it was not so visually intrusive. It published a consultation paper in March 2011 indicating its preferences and then on May 31, NERA, a new consultant, published the document that was required for the Reg Test.

Most efficient option?

The document nominated Brunswick as the most efficient option by spending $271 million. It was a far cry from the original $107 million earmarked for the site or the $135 million considered for the  Bouverie St alternatives. Brunswick residents say the consultant’s report told the industry players what they wanted to hear. It is simply not credible, says Trevor Smith, that a site somewhere else near the Melbourne CBD could not be located  on which to house the cheaper technical solution. than $271 million.

Indeed, sources at a leading industrial property group say city fringe industrial land (Clifton Hill, Abbotsford, Richmond – near the line) is worth $560-$750 per square metre. At $750 per square metre, the $100 million plus price differential would have bought 13 hectares of prime industrial land in the relevant corridor – four times the size of the land in Brunswick.

SP rejects this, saying it relied on its internal property and surveying team to identify suitable alternate locations on behalf of AEMO and Citipower.  “Further, assistance was also provided by the local community group which was welcomed. A total of 23 options and sub options were considered in the final report.”

Trevor Smith disagrees. “It was clear that they hadn’t explored all the options (for the alternative station site). For us, one of the key questions is who challenges these assumptions? AEMO is too heavily involved in planning with the commercial parties to be a disinterested party.”

Crucially, the NERA document set out the methodology which industry deployed. The Reg Test selected the Brunswick facility to construct the GIS terminal station at a cost of $190 million, and the sub-transmission cable to run the power to the CBD would cost $81 million (for the $271 million all up).

The next best GIS option cited by the consultant Nera however was the old polluted Gasworks site at 433 Smith Street, Fitzroy. EPA documents show that 78,000 tonnes of toxic soil would need to be removed from the site before construction of any type could take place.

Earthworks alone would account for a huge amount of the $125 million  “infrastructure” costs attributed to this option. “This site was guaranteed to be problematic with local councils, leading to a longer construction timeframe (assumption of 2016 availability) that made it further uncompetitive,” says Trevor Smith “This site should never have been  considered, yet ended up as the next best option.”

No alternative sites

Of greater concern, he said, was the failure to locate any alternative facility on which an alternative, feasible AIS could be developed. The next best option for an AIS facility that was considered was a site at Brooklyn (option 12E), so far from the city that a sub-transmission cable cost of $289 million ruled out an AIS option immediately.

The other site considered was Coburg (option 12K), where again the sub-transmission cable cost of $183 million put it out of contention.

“It defies credibility that in the nine months of gladhandling greenies, no alternative, non-polluted sites in Melbourne were considered in which – an AIS option could be built (preferably on industrial land), line cut-in costs avoided and sub-transmission cable costs contained to a reasonable figure. In fact they didn’t even commission a third party real estate agent to consider the alternatives,” says a power industry insider.

“The uplift in cost from the GIS option combined with the increase in cabling, should have compelled them to look at new sites.”

If the early versions of the Reg Test were a guide, the augmentation could have been achieved for $107 million which would indicate they could have acquired $100 million of land and still been in front.

Despite the recommendations in the report however there was no done deal yet. The revised Brunswick terminal proposal still had to get through local council and obtain the requisite planning approvals.

All the documentation was submitted in quick time in July 2011, though eventually rejected again by Moreland Council on November 23, 2011.

Appeal proves a winner

The power companies appealed immediately to the Victorian Civil and Administrative Appeals Tribunal (VCAT) and also took their concerns directly to the new Victorian Coalition Government. That proved a winner.

On February 3 this year, Planning Minister Matthew Guy obliged their request, rezoned the land, exempted it from environmental controls and snuffed out any avenue of appeal. In the process – he guaranteed that SP Ausnet would collect its rent on the $271 million project, project which residents robustly contend should have cost half the amount.

And now, with yet a sod of soil to be turned on the site, the cable is already laid to the door of the Brunswick terminal station, one last avenue of appeal remains.

The Australian Energy Regulator is investigating whether the Reg Test was cooked up.

“The actual capital cost if they go ahead may still end up being more than 30 per cent higher than their quote,” says Trevor Smith.

Strengthening the rules

For its part, the AER is acutely aware of the claims of bloated capital costs on power projects around the country and the drastic effect on consumers’ power bills – and this at a time when demand for electricity is actually falling.

AER chairman Andrew Reeves told BusinessDay that the regulator was seeking to strengthen the rules to eliminate both the potential for and the perception of excessive capital expenditure by the transmission operators and distributors.

“We have proposed changes to the rules to give us the power for a more balanced assessment,” says Reeves, referring to AER’s application to the Australian Energy Market Commission (AEMC).

At the moment, the rules operate “to promote efficient investment and long term interests of consumers”, he says. “The rules, as they stand, have too much emphasis on the promotion of investment”.

The network providers, naturally, are lobbying against any change in that direction.