on 26 October 1998
Legislative Council Panel on Economic Services
INTERIM REVIEW OF SCHEME OF CONTROL AGREEMENTS
This paper informs members of the progress on the interim review of the Scheme of Control Agreements (SCAs)
2. The SCA between the Government and CLP and its electricity generation partner Exxon (CLP/Exxon) and the one between the Government and HEC and its holding company (HEC/Holdings) respectively set out the obligations of the power companies, the reasonable returns for shareholders and the processes by which Government monitors the power companies' financial affairs. The overall objectives are to ensure that with the least interference by the Government, the two private sector investor-owned power companies supply electricity in the territory safely, reliably, and efficiently and at a reasonable price to the consuming public.
3. The current SCAs are valid for 15 years and date from 1.10.1993 and 1.1.1994 for CLP/Exxon and HEC/Holdings respectively. They provide for two interim reviews of one-year duration each, as follows :
|1st interim review||1.10.1997 - 30.9.1998||1.1.1998 - 31.12.1998
|2nd interim review||1.10.2002 - 30.9.2003||1.1.2003 - 31.12.2003
During these reviews each party to the SCA may request modifications to the SCA which may be implemented only with the mutual agreement of both parties.
PRESENT POSITION OF THE INTERIM REVIEW
4. During the past ten months we have conducted the review with the power companies and sought the advice of the Energy Advisory Committee on proposed modifications to the SCAs and related arrangements. We have achieved mutual agreement in some areas to address issues of concern to the public. We have also reached agreement in principle on certain proposals which aim at clarifying, up-dating and streamlining accounting and administrative arrangements. They do not involve matters of principle and are therefore not included in this paper. The key proposals are set out in the following paragraphs.
Exclude excess generating capacity from attracting permitted returns
5. The level of generating capacity is a major area of concern to the Government, to the power companies who have the obligations under the SCAs to provide sufficient facilities to meet present and future demand, and to the consuming public who are to meet the costs through the tariff. Any addition to capacity requires a lead time of up to six or seven years. The processes include assessment of future demand by the power companies and independently by the Government's consultants, site search, environmental impact assessments, detailed engineering studies, site formation, procurement of the plant and machinery and their installation.
6. Demand by itself is influenced by a lot of factors most of which are uncontrollable and indeed not precisely predictable, e.g. the economic situation, structure of the economy, climate and consumption behaviour. The longer the lead time the chance of a bigger difference between forecast and actual demand would be. In approving the periodic generation development plans of the power companies the Government's priority is to ensure that sufficient generating capacity is installed to meet forecast demand and any necessary reserve requirements, such that the risk of an inadequate supply situation would be minimized.
7. Should actual demand instead turn out to be much lower than forecast, there would then be excess reserve capacity and consumers would bear the additional costs which could have otherwise been avoided. This is a trade-off for the security and reliability of supply. However we believe that there is room for the power companies to share some of the costs of excess capacity.
8. During the public discussions on the problem of excess capacity of the Black Point generation units, there have been suggestions made by members of the then Legislative Council and interested groups that one way to minimise the burden on consumers in the event of excess capacity is to exclude the excess from attracting permitted returns. The Government share this concern and have pursued this with the two power companies during the current interim review of the SCAs.
9. Both power companies have now agreed that expenditure on machinery and equipment of additional generating units installed in future should be excluded from the companies' average net fixed assets (ANFA), if their installation gives rise to excess generating capacity. They have been working with us on devising a mechanism for determining the excess capacity and the attributable amount of machinery and equipment expenditure to be excluded. The key features that have been agreed in principle with the power companies are explained below.
10. Whenever a new generating unit is commissioned in a year, the installed capacity of the power company would then be compared with the optimal level of capacity that would have been required based on the actual maximum demand and the minimum reserve capacity required of that year, plus an allowance to take account of short term fluctuations in demand. If it exceeds the optimal level then excess capacity exists. A similar comparison will then be done again in the following year. If it again shows that excess capacity still exists (i.e. for a consecutive two years), a proportion of the new unit's machinery and equipment costs would be excluded from the ANFA as from the second year for as long as the excess capacity situation exists.
11. The introduction of this mechanism would ensure that the power companies would more closely monitor demand situation in their respective service areas and timing of installation of additional generating facilities. This will be the case even though the need for installing additional generating facilities may have been approved in principle well in advance by the Government as part of the Financial Plans of the power companies.
12. This is a major improvement to the arrangements in the SCAs as the power companies are to accept a risk on their investment which they do not have to bear at present under the existing SCAs.
13. It has been agreed that the mechanism will not apply to CLP/Exxon's Units 7 and 8 at Black Point since these two units are already the subject of a separate deferral agreement with the Government.
Recognise environmental obligation
14. There is already a provision on environmental obligation in the SCA of HEC. CLP/Exxon have agreed to include in their SCA a similar obligation for them to conduct their business in a manner that is compatible with the balanced environmental and economic needs of the community.
15. This demonstrates the power companies' recognition of the interaction between electricity supply and environment, the rising environmental expectations of the community and the need to strike a balance when conducting their electricity-related business.
Recognise the obligation to implement Demand Side Management (DSM)
16. Both power companies have agreed to include DSM as one of their obligations under the SCAs.
17. This reflects that the power companies recognise their role in promoting energy efficiency and conservation and optimising the deployment of resources for electricity supply facilities.
18. The power companies have each entered into a separate DSM Agreement with the Government. The power companies will soon launch their first full-scale DSM programmes.
Lower rate of return on customers' deposits
19. At present the power companies obtain a permitted return of 13.5% on fixed assets financed by funds from customers' deposits.
20. Both power companies have agreed that in future fixed assets financed by additional customers' deposits collected by them will attract a lower rate of return. This rate of return will be the permitted rate of return less the interest the companies pay to their customers on these deposits up to a rate of 8%. The two power companies pay the interest based on the Hong Kong savings deposit interest rate.
21. We consider this a reasonable arrangement as it is in line with the existing arrangement for determining the return on fixed assets financed by funds from the companies' external borrowings under the SCAs. On these funds the permitted return is 13.5% less the interest on these borrowings up to a rate of 8%. We also consider it reasonable to apply this arrangement to additional deposits collected by the companies in future as this would cause minimum disruption to the companies' financing arrangements already entered by them based on the existing terms of the SCAs.
22. This is another important achievement as it would directly lower the future returns to shareholders, hence the cost of electricity supply to consumers.
Establish indicators/benchmarks for performance evaluation
23. The Scheme of Control Agreements provide the mechanism for the Government to monitor the performance of the power companies. However, we believe that there is room to increase the accountability of their performance.
24. The two power companies have agreed to establish performance indicators/benchmarks so that the Government would be able to evaluate and assess their performance in a more systematic and objective manner. This will also streamline the existing monitoring procedure.
25. Both power companies have been working to identify a set of key performance indicators that could reflect the most important aspects of the companies' operations for our consideration. In each case there would be a standard or target agreed between us and the companies. This would provide the opportunity to make comparison with other utilities where appropriate.
26. This is a major improvement as the processes of Government monitoring of the power companies could be streamlined and more performance targeted.
Update the periods of useful life and depreciation of fixed assets
27. There appears to be room for extending the period of the useful life of the power companies' plant and facilities in the light of the current technological quality and maintenance standards. The extension of the replacement cycle of the plant and facilities will bring economic benefits to consumers as the frequency of plant and facilities replacement will be reduced.
28. Both power companies have agreed to review the life period of their plant and facilities and put forward proposals. We will examine their proposals with the assistance of our electricity consultants.
29. We will continue to work with the two power companies to finalise details of the amendments agreed by both parties . We will also seek the approval of ExCo for the modifications to SCAs and related administrative arrangements.
Economic Services Bureau
26 October 1998