Department of Finance

Market participants and stakeholder briefing session

Merger Implementation Group

5 December 2013

Merger of Synergy and Verve Energy

©  State of Western Australia

Merger Implementation Group

PRESENTATION OVERVIEW

Background/Perspective

Merger Objectives

Regulatory Approach

o Functional Structure

o Ring Fencing

o Transfer pricing

o Wholesale Arrangements

Checks & Balances

Remaining Steps

Merger Implementation Group

MERGER OBJECTIVES

o Reduce costs within the industry, thereby limiting the increase in future increases in electricity tariffs

o Ensure that the security of electricity supply is capable of being maintained when adverse and unforeseen circumstances arise

o Ensure the private sector has opportunities in the future expansion of the industry, but ensure this future involvement is commensurate with the private sector accepting market risk and not, as has been in the past ,being underpinned by government support

Merger Implementation Group

REGULATORY APPROACHPurpose of the regime

Overarching goals

o The purpose of this regulatory regime is to address market power concerns, and to provide transparency and accountability in respect of the Merged Entity’s activities

o The regulatory regime is intended to sustain:

• competition;

• economic efficiency; and

• future private sector investment in the Western Australian electricity sector

Merger Implementation Group

REGULATORY APPROACHExisting arrangements

Existing market power safeguards

o Cap on generation capacity maintained

o Economic Regulation Authority market review maintained

o Minor procedural changes as a result of the merger

o All existing 3rd party contractual arrangements will be honoured

Merger Implementation Group

Ring Fencing

o Regulates the flow of restricted information between the Merged Entity’s functional divisions by imposing access and security controls

Segregation & Transfer Pricing

o Divides the functions of the Merged Entity into segments

o Governs internal transactions between the Merged Entity’s functional divisions

Wholesale Arrangements

o Places a non-discrimination obligation on the Merged Entity

o Sets out the process for developing the standard products regime in the Wholesale Products Rules

REGULATORY APPROACHCore issues

Merger Implementation Group

Instrument Ring-fencing Transfer Pricing Wholesale Arrangements

Legislation √ √ √

Regulation √ √ √

Regulatory arrangements

√ √

Internal policies & procedures

√ √ √

REGULATORY APPROACHInstruments in the regulatory regime

Merger Implementation Group

Generation Activities

• Power stations (operations and maintenance)

Wholesale Activities• Nominations• Fuel management• Portfolio management• Wholesale procurement• Trading with the retail division and third parties

Retail Activities

Franchise

Contestable

Information + MWh

Nominations for MWh

Cost stackCost stack Transfer pricingTransfer pricing

• Third Party generators PPAs• Third party retailers ESCs• STEM and the balancing market

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• Organisational development• Non-energy procurement and facilities

Corporate Shared Services

• Information technology • Communications • Human resources• Corporate risk management

• Planning and strategy• Legal• Regulatory and compliance

• Industrial relations • Accounting and finance• Records and information

REGULATORY APPROACHFunctional structure

Merger Implementation Group

o Restrictions will apply to all information about third parties that might reasonably be expected to materially affect the commercial interests of the third party if disclosed to the Generation and/or Retail Divisions

o Where such restrictions apply this information will be classified as ‘retail restricted information’ and/or ‘generation restricted information’, as relevant. This information will be protected by:

• Physical separation of ring fenced wholesale activities within the Merged Entity using a secure location

• Suitable information technology controls

• Management separation between the Retail, Wholesale and Generation Divisions

• Staff training and debriefing

o Restricted information constraints will not apply to the CEO, CFO, and members of the board, although they will not be able to act in manner contrary to the spirit of the regime

REGULATORY APPROACHRing fencing

Merger Implementation Group

o Regulations will divide the functions of the Merged Entity into segments for accounting and reporting purposes

• For the purposes of record-keeping there will be four segments: Retail, Generation, Wholesale and Corporate Shared Services

• The Merged Entity will be required to prepare financial reports in respect of its Retail, Generation and Wholesale Divisions

• The costs associated with the Corporate Shared Services will be allocated reasonably across the functional divisions

• The financial reports for the reporting segments of the Merged Entity will be made public along with the company’s consolidated financial report

REGULATORY APPROACHSegregation and transfer pricing

Merger Implementation Group

o In accordance with the regulatory requirements, the Merged Entity will be required to establish a transfer pricing mechanism between its Wholesale and Retail Divisions

o A foundation transfer price must be applied in respect of the existing contestable and non-contestable portfolio load – this arrangement will expire on 30 June 2017

• Before its expiry, a new transfer price will be established and will apply to non-contestable load and any remaining contestable customers whose contracts were transferred as part of the merger

o There will also be a transfer price associated with any deals entered into post 1 January 2014

• This transfer price will be based on the standardised and customised product regime

REGULATORY APPROACHSegregation and transfer pricing

Merger Implementation Group

o The foundation transfer pricing mechanism will cover the following customer groups:

• Franchise tariffs

• Contestable tariffs

• Existing contestable contracts up to their expiry. This will include:

– Contracts signed prior to 1 January 2014, where supply has commenced;

– Contracts signed prior to 1 January 2014, where supply has not yet commenced;

– Formal contract offers made by Synergy prior to 1 January 2014 which the customer accepts prior to 1 April 2014; and

– Any contractual options contained within the aforementioned agreements

o The pricing methodology for this mechanism will be developed by the Merged Entity in accordance with the prescribed transfer pricing Regulations and Guidelines

REGULATORY APPROACHFoundation transfer pricing mechanism

Merger Implementation Group

o Sets out the obligations for offering wholesale supply of electricity

• All offerings must be made on a non-discriminatory basis

• The Merged Entity will be required to respond to any requests for wholesale supply in a timely manner

• Internal policies must be established to ensure compliance with this regime

• Records of all correspondence and decisions made in respect of supply requests must be maintained

REGULATORY APPROACHWholesale arrangements

Merger Implementation Group

o The Merged Entity will be required to establish a standard credit policy and provide a copy of this arrangement to the Minister for Energy

• Any decisions made in respect of this policy will be subject to audit

• The credit policy will be published, subject to the removal of commercially confidential information

• The Retail Division will have a credit rating equivalent to that of the Merged Entity, but will be required to pay an appropriate risk premium

o Wholesale Product Rules will set out the standard product regime and the regime will come into effect on 1 July 2014

REGULATORY APPROACHWholesale arrangements

Merger Implementation Group

Standardised Products (as prescribed in the Wholesale Product Rules)

o Small parcels of electricity offered on standard terms and conditions

• Fixed volume and increments – 100% take or pay, small parcel sizes, no nominations required from purchaser

o Standardised product prices will be published in an easily accessible format and location for the market

• The Merged Entity may be required to buy back standard products at a mandated maximum buy/sell spread

• Incentivises the Merged Entity to determine prices on a reasonable basis

REGULATORY APPROACHWholesale offerings

Merger Implementation Group

Customised Products

o Electricity, capacity, gas and renewables

o The Retail Division and market participants can request supply of customised wholesale products

• Obligation for the Wholesale Division to provide a response within a reasonable timeframe

o These arrangements will allow for the formation of structured products (for example load-following products)

REGULATORY APPROACHWholesale offerings

Merger Implementation Group

Auditor General

o Assesses whether the Merged Entity’s activities comply with the Regulations and Regulatory Arrangements

o An adverse report will be lodged if a breach is detected

o The audit reports will be tabled before Parliament along with the company’s financial statements

CHECKS & BALANCES

Merger Implementation Group

Economic Regulation Authority

o Investigates alleged breaches

o May impose a civil penalty on the Merged Entity for breaches of the regulatory regime

• Has the power to impose a maximum penalty of A$100,000 with an additional daily penalty of A$20,000 for each day contravention continues past the stipulated rectification date (as specified in a warning notice)

• The Electricity Review Board will preside over appeals

o Conducts a review of the regulatory regime to assess its efficacy

CHECKS & BALANCES Enforcement

Merger Implementation Group

Questions