Blood Through New Veins - The New Era of Transmission Competition
With disruption emerging on so many fronts in the electricity sector, it is inevitable that transmission will be impacted. One plausible disruption is the threat of increased competition in transmission connection services.
This threat is real for three main reasons. Firstly, recent changes to the National Electricity Rules (NER) provide the impetus for increased competition in connection services. Secondly, there will be a demand for transmission infrastructure investment into the future, creating the runway for competition. Thirdly, the most likely competition to incumbent transmission companies are already active in the market.
The NER change
An increase in the volume of renewable energy generators and customers connecting to transmission networks led the Australian Energy Market Commission (AEMC) to review the national connection and planning framework. This resulted in changes to the NER, which came into effect on 1 July 2018, aimed at promoting contestability of connection services; facilitating more efficient connection processes; improving transparency of information for customers; and enhancing network planning.
To promote contestability for as many connection services as possible, the NER defines two types of connection assets – Dedicated Connection Assets (DCAs) and Identified User Shared Assets (IUSAs) – to distinguish which connection services are contestable, and the parties who can own, design, build, control and operate them.
DCAs are used to connect a customer to the existing transmission network, are used exclusively by the customer or customer group, and can be electrically isolated from the network e.g. a dedicated transmission line connecting a generator to the shared transmission network. The Rule change clarified that all connection services for DCAs, including design, construction, ownership and operation and maintenance (O&M), are contestable services that can be provided by any party on commercial terms.
IUSAs are used to connect a customer to the existing transmission network, are not used exclusively by the customer or customer group, and cannot be electrically isolated from the network e.g. a new substation. Where the IUSA meets the contestability capital cost threshold and criteria under the NER, design, construction and ownership can be provided by any third party (but not the generator or load customer) on commercial terms. As TNSPs remain accountable for network outcomes, they are obliged to provide O&M services for third party contestable IUSA under a network operating agreement.
The runway for competition
The current and anticipated demand for transmission connection services means the opportunity or ‘runway’ for competition exists. The energy resource mix will continue to transform over the next 20 years from a coal-fired generation dominated system to significantly greater renewable energy penetration and energy storage, particularly as coal-fired power stations retire and the levelised cost of renewable energy and storage continues to decline. This new generation will require connection to the grid (transmission or distribution networks).
AEMO’s Integrated System Plan clearly identifies a need for future investment in transmission infrastructure. “The projected portfolio of new resources involves substantial amounts of geographically dispersed renewable generation, placing a greater reliance on the role of the transmission network. A much larger network footprint with transmission investment will be needed to efficiently connect and share these low fuel cost resources.”
The ISP forecasts that some States in Australia have the potential for greater renewable energy penetration, and associated transmission investment requirements, than others. This means that TNSPs in those States with less potential will likely be hungrier to chase commercial opportunities in other jurisdictions.
The threat of competition
The obvious threat to incumbent TNSPs is therefore from other TNSPs, particularly at a time when regulated revenues are being squeezed by the regulator, and the businesses are facing increased pressure from shareholders to generate new revenue streams.
However, the threat of competition is broader. Many TNSPs sub-contract their design and construction services to engineering, procurement and construction companies. Over time these companies, and potentially other non-incumbents, are likely to compete for contestable transmission connection services in their own right.
This trend is already evident in a number of other countries. EY has found that non-incumbents are competing for point-to-point transmission projects in the US, Canada and Mexico due to regulatory changes that promote competitive bidding. In the US, EY estimates that more than 50% of bids for competitive projects are submitted by non-incumbents and between 20-30% of new builds are awarded to non-incumbents. Developers with more sophisticated tools for taking on construction risk, and mitigating cost and schedule risks, are being favoured.
A strategic response
When faced with disruption, like the threat of increased competition, businesses often react in one of two ways – ignore or defend. With the high volume of transmission connections currently occurring across the NEM, incumbent TNSPs could be lulled into a false sense of security and choose to ignore the threat of increased competition.
It is more likely that TNSPs will at a minimum defend themselves from other TNSPs by exploiting their geographical position, market visibility, relationship with customers and local experience. ‘Ignore’ and ‘defend’, however, are not necessarily sustainable long-term strategies. Incumbent TNSPs need to build a competitive strategy that will ensure they get ahead of the competition, whether it be from other TNSPs, non-incumbents, or new market entrants over time.
Four key actions are worth considering:
Firstly, acknowledge the threat of competition – recognise that other TNSPs seeking new sources of revenue are likely to compete outside their patches, and more importantly don’t underestimate potential competition from other players who already have the capabilities and scale to compete.
Secondly, consciously decide whether to take a reactive stance, or take the offensive by actively exploiting the runway. The latter requires a proactive and strategic approach to identifying and pursuing opportunities in other jurisdictions.
Thirdly, optimise competitive advantage by reviewing three key competitive levers – time (can our project delivery timeframes be improved?); risk (can we take on greater risk or better manage risk?); and price (are our margins competitive?).
Lastly, adaption is key – a customer-focused, commercial and agile culture and capability will equip the business to pursue competitive opportunities. The AER’s Transmission Ring-fencing Guidelines provide TNSPs with an opportunity to consider the commerciality of current business models.
As Professor Michel E Porter of the Harvard Business School once said “…it is easy to view competition too narrowly and too pessimistically…competitive forces exist that go well beyond the established combatants in a particular industry”. The threat of increased competition is real, and non-incumbents that have a willingness to take greater risk or lower returns will be more competitive. The question is, are incumbent transmission companies prepared to respond?
Contact me at srennie@renniepartners.com.au to continue the discussion or to arrange a meeting.