Report No. 32, March 1999

Chapter 5

The Government monitoring of electricity supply companies

Summary and key findings

A. Introduction. In Hong Kong, electricity is supplied by two companies, i.e. Company A and Company B. The Government makes use of the Scheme of Control Agreements (SCAs) to monitor the performance of the electricity supply companies. The Government overall responsibility for the supply of electricity is to ensure that consumers receive a reliable electricity supply service at a reasonable price (paras. 1.1 to 1.3). B. The SCAs provide a basis for determining the permitted return of the electricity supply companies. The permitted return is directly proportional to the average net fixed assets (ANFA) of the electricity supply companies. The purpose of the permitted return is to ensure that the electricity supply companies have sufficient incentive to invest in fixed assets to maintain a reliable electricity supply. The SCAs also provide a mechanism by which the Government monitors the performance of the electricity supply companies (paras. 1.6 to 1.8). C. Excess power generation capacity. Excess power generation capacity has aroused much public concern because, under the SCAs, it will lead to higher tariff rates than what would otherwise be. Company A has built a new power station in Black Point. Company A Black Point project has aggravated its problem of excess power generation capacity (paras. 1.14 and 1.17). D. Audit review. Audit recently conducted a review to assess: (a) whether the Government had carried out its monitoring role effectively, particularly on Company A Black Point project; and (b) whether there were any issues that the Government should pursue with the electricity supply companies for making necessary modifications to the SCAs in the current interim reviews of the SCAs (para. 1.18). E. Company A 1992 development plan and financial plan. In January 1992, Company A submitted its 1992 development plan and financial plan to the Government. According to the proposed development option, i.e. the Modified Gas Option, Company A would: (a) commission two 600 megawatts (MW) combined cycle units at a new power station in Black Point, one in 1996 and the other in 1997; and (b) decommission the existing units at the Tsing Yi A and B Power Stations between 1996 and 1998 and commission another two 600 MW combined cycle units at these stations, one in 1998 and the other in 1999. In December 1992, the Executive Council (ExCo) approved the 1992 development plan and financial plan (paras. 2.1 and 2.2). F. The Government employed a consultant to assist it in assessing the 1992 development plan. In the assessment, it was found that, although there was flexibility in the timing of the commissioning of the power generation units in the Modified Gas Option, the flexibility was inadequate to cope with the low-growth scenario. Under the low-growth scenario, the reserve margin (i.e. the reserve power generation capacity expressed as a percentage of the maximum demand) would remain high and there would be excess power generation capacity. Audit considers that the Administration did not adequately deal with the risk of excess power generation capacity. As it transpired, during the period 1992 to 1997, the actual maximum demand was persistently lower than the forecasted maximum demand under the low-growth scenario (paras. 2.25 to 2.30). G. Furthermore, in the Memorandum seeking ExCo approval for the 1992 development plan and financial plan, the Administration did not mention that the flexibility in the Modified Gas Option was inadequate to cope with the low-growth scenario. The Administration only mentioned that Company A had included in the power generation plant procurement tender an option to defer the commissioning of the third and fourth units each by up to two years. Audit considers that the Administration did not provide sufficient information regarding the risk of excess power generation capacity in the ExCo Memorandum (paras. 2.31 and 2.32). H. Location of units. Shortly after the approval of the 1992 development plan and financial plan, the design of the combined cycle units was finalised. Consequently, the four 600 MW units were substituted by eight 312.5 MW units. In April 1993, Company A proposed to also locate the last four units, originally planned to be located in Tsing Yi, in Black Point. The Government later accepted the proposal (paras. 2.35 and 2.36). I. Company A 1994 development plan. In June 1994, the Government requested Company A to find ways to reduce its high reserve margin. In October 1994, Company A submitted its 1994 development plan in which Company A proposed a spread deferral option which would provide for deferring the commissioning of units 5 to 8 to 1998-2001. In December 1994, the Government accepted the spread deferral option (paras. 2.38, 2.39, 2.42 and 2.45). J. Further deferral of Black Point units. Company A reserve margin remained high. In November 1996, ExCo ordered that Company A should be urged to submit a proposal for the deferral in the commissioning of units 5 to 8. In February 1997, Company A submitted a report on the deferral in the commissioning of the units. After negotiation, in April 1997, it was agreed that: (a) units 5 and 6 would be commissioned in 1998 and 1999 respectively in accordance with the spread deferral option; and (b) the commissioning of units 7 and 8 would each be deferred initially by three years to 2003 and 2004 respectively (paras. 2.48, 2.53 and 2.55). K. Government forecasting methodology. The Economic Analysis Division (EAD) of the Financial Services Bureau produces independent forecasts of the demand for electricity for cross-checking the forecasts produced by the electricity supply companies. The accuracy of the forecasts of the maximum demand is critical for determining the timing of acquiring additional power generation capacity. The EAD used the load factor approach to forecast the maximum demand. Audit considers that the load factor approach is a viable approach. However, it is difficult to estimate the load factor when it has wide fluctuations. In Audit view, the EAD should use additional techniques, such as using an econometric model or a time-trend model to forecast the maximum demand directly, to cross-check the results of the load factor approach (para. 4.13). L. Modifications to SCAs. Audit considers that the Administration should negotiate with the electricity supply companies in the current interim reviews of the SCAs for making a number of modifications to the SCAs, including the exclusion of excess power generation capacity from the ANFA to calculate the permitted return. This arrangement will alleviate the burden on consumers in the event that an electricity supply company has excess power generation capacity. It is expected that, under this arrangement, the electricity supply companies will monitor more closely the demand for electricity and the timing of acquiring additional power generation capacity. Audit noted that the Administration had included the modifications to the SCAs in the current interim reviews and had reached agreements in principle with the electricity supply companies (paras. 5.7, 5.8, 5.10 and 5.12). M. Audit recommendations. Audit has made the following main recommendations: - the Administration should take necessary action to implement the new arrangement whereby the Government will approve the installation of new power generation units by an electricity supply company on a unit-by-unit basis and the actual procurement order for a power generation unit will be placed by the electricity supply company only upon completion of a review by the Government of the latest forecasts of the demand for electricity (sub-para. (a) of para. 2.34); - the Administration should, in seeking ExCo approval for the development plan and the financial plan of an electricity supply company, include sufficient relevant information in its submission to ExCo (sub-para. (b) of para. 2.34); - the EAD should, in producing independent forecasts of the maximum demand to cross-check the forecasts produced by an electricity supply company, always use additional techniques besides using the load factor approach, document and cross-check the forecasted results of different approaches and document the justifications for choosing the final forecasted results (para. 4.15); and - the Administration should take necessary action to reach formal agreements with the electricity supply companies to revise the SCAs so as to exclude excess power generation capacity from the ANFA for calculating the permitted return (sub-para. (a) of para. 5.13). N. Response from the Administration. The Administration has generally agreed with the audit recommendations (paras. 6.1 to 6.3).