Labour has dumped its self damaging policies on GST exemptions. They should kill off one or two others before the election spotlight exposes them as similarly dumb. Prime candidate is the "NZ Power" nationalisation of generation, the most competitive, most risky, most capital intensive part of our industry. Adding political risk to the already daunting risks of investment decisions in generation where we have a world standard regime is nuttiness of the kind that resounds for decades.

Ask Max Bradford, and his was merely an early implementation of the regulatory separation that is now orthodox and respected around the world. In electricity, the economic consequences of wrong judgments last for decades, but the political consequences of unpopular changes last for the perpetrator's lifetime, and that is just when they are orthodox.

The best advice to a politician awaiting evisceration over a mistake is to spill all yourself. David Parker could earn respect in the long term if he said now that his brain-child was premature, and that after all the feed-back what he should have promoted was a resource rental charge on water through the turbines. The absence of such a charge is the only argument that even partially rescues his scheme.  To avoid distorting generation too far against hydro he could introduce it at the same time as Labour make the carbon charge bite, which they may be obliged to do by the Greens..

If he withdrew NZ Power shortly he could easily endure the mockery from National. The credit would outweigh it, as long as it did not appear to have been forced on him by David Cunliffe. At this stage of the cycle the mockery would be harmless by election time.

As a balancing position he could also undertake to over-ride any Commerce Commission failure to undertake an early review of the electricity distribution price control Input Methodologies on return on capital. That would ensure that at least part of any increase in the cost of electricity from a water price would be offset in the charge to consumers, by reducing the excess returns where there is a market structure (monopoly) problem.

For those who have not understood my earlier posts here and here on the High Court’s decision on Wellington International Airport Ltd & Ors v Commerce Commission, the 13 December edition of Energy News explains the issues. With their consent, here it is in full:

High Court urges ComCom to revisit energy sector WACC

Gavin Evans Fri, 13 Dec 2013 – published by Energy News www.energynews.co.nz

The Commerce Commission has been put on notice to reconsider how it uses the range of capital costs it calculates for the electricity sector.

The High Court has endorsed the input methodologies the commission uses in regulating electricity and gas distributors. But in a ruling issued late Wednesday, it says alternative proposals put up by the Major Electricity Users’ Group raised “significant doubt” about the commission’s decision to apply a weighted average cost of capital based on the 75th percentile of the industry range the regulator calculated.

MEUG had argued that the commission’s choice of the 75th percentile instead of the mid-point of the range showed an inappropriate bias in favour of suppliers and was unnecessarily generous. It calculated the difference between the two post-tax WACC estimates – 6.49 per cent and 7.22 per cent – would cost electricity consumers close to $129 million a year.

MEUG argued for a mid-point WACC, or for the commission to adopt a two-tier system with the higher return from the 75th percentile only available on new investments.

The court observed that it was probably understandable that the commission, establishing a new regulatory regime, would not want to risk deterring investment by providing too low a rate of return.

But the court – comprising Justice Denis Clifford and lay members Robin Davey and Rodney Shogren – doubted applying the higher WACC to a firm’s regulated asset base was necessary to promote investment and innovation.

Not rational

“The idea that greater revenues produced by higher allowed earnings on past investments (ie on the initial RAB) provide the wherewithal for more future investment is contrary to rational investment choice," the court said in its 661-page decision.

“Those existing higher earnings, once earned, are a given. The source of funds for future investments does not influence the riskiness of future investments; nor, therefore, does it influence their attractiveness. If anything, an abundance of capital is likely to lead to wasteful investment.”

But without more positive supporting evidence from MEUG, the court said it was not able to be sure that a mid-point WACC would have produced a `materially better’ input methodology – the standard to be met in a merits review appeal.

For the same reason it had no means of implementing the group’s `two-tier’ WACC suggestion and the commission’s doubts about it could not be addressed. Accordingly, the court left the commission’s 75th percentile choice unchanged.

“We are mindful that the IMs will be reviewed. At that time, we would expect that our scepticism about using a WACC substantially higher than the mid-point, as expressed above, will be considered by the commission.

“We would expect that consideration to include analysis – if practicable – of the type proposed by MEUG. We would also expect the commission to consider MEUG’s two-tier proposal in light of our observations. We acknowledge that further analysis and experience may support the commission’s original position. But they may not.”

Win for consumers

MEUG executive director Ralph Matthes says the decision is a win for the group and potentially for consumers. Next time the input methodologies are up for review, a move back to the 50^th percentile will definitely be “on the table.”

But given the large sums involved – a reduction of about 4 per cent, or $20 million a year, in the gross revenue from Vector’s electricity business alone – the group will try to get early action from the commission, Matthes says.

Whether that could be achieved before the start of the next regulatory period starting in April 2015 is unclear, but the group will certainly investigate that.

“I think there’s an urgency to actually undertake that review,” he says. “We’re talking about some pretty big sums.”

MEUG was among nine parties that went to court in September last year to challenge the input methodologies the commission settled on in December 2010 to police the returns of electricity and gas distributors and some services provided by the Auckland Wellington and Christchurch airports.

Other appellants included Powerco, Transpower, Wellington Electricity Lines, Air New Zealand and the airports.

Leverage

The WACC range was one of four appeals MEUG lodged. Matthes says it was defeated on two minor claims relating to how debt issuance costs and asset betas should be applied in the cost of capital calculation.

But he says the court also gave some support on its argument around the commission’s treatment of leverage in the WACC calculation.

In setting the mid-point WACC at 6.49 per cent, the commission assumed a notional leverage of 44 per cent for Transpower and the electricity and gas distributors.

MEUG had argued the model the commission used should have either assumed no leverage, or should have had debt beta added to provide a more reasonable figure.

The court did not accept MEUG’s “novel” proposal, but nor was it satisfied that the commission had really addressed an anomaly in the capital asset pricing model it used in which WACC increased with leverage, when it should have fallen.

“The commission’s estimate may overstate the WACC. MEUG’s proposal certainly understates the WACC,” the court observed.

Matthes says the issues are complicated and MEUG’s proposal is at the leading edge of finance theory and regulatory practice. The group has gathered more information since 2010 and will keep working away at the issue.

“We’re not going to give up on bringing that one back into play.”

The Aussie criminal justice scene is fascinating. A headlong retreat from the 30 year failed experiment with 'offender centred' sentencing is getting cross-party support. Instead of justice as therapy for the offender they are unapologetically going back to justice to balance the scales for the victim, to deter, and to incapacitate offenders.

The NSW government has announced a serious (8 year) mandatory prison sentencing for 'king hit' assaults while drunk or under the influence of drugs. Instead of the whining we would expect from Labour and the Greens here it has been welcomed by the political opposition.

What a contrast with New Zealand's recent reversion to 'tag and release' policing, and prosecutors under severe cost pressure to drop charges or plea bargain.Our National government has leapt on the crime reduction response to the toughening up of the last few years as an excuse to take the pressure off criminals just when the message should be driven home. National is treating criminal justice reform like feckless patients treat their prescriptions. Instead of staying the course to wipe out an epidemic, they stop taking the pills as soon as they feel better. We'll pay the price here as the infection breaks out again

Rawdon Christie interviewed me this morning as spokesman for our client the Sensible Sentencing Trust.

I emphasized the need for law to be more simple and certain. We are deemed to know the law when in reality it has become so complex and subject to judicial discretion that even lawyers cant tell you in advance the costs and consequences of your actions.

I am sympathetic to the certainty objectives of the NSW approach and support it against fellow lawyers’ hostility to mandatory sentencing. But I think it would be better to start with a more simple kind of offending. 8 years mandatory for a punch could be too arbitrary. It will need carve-outs. For example, a punch could be justified self defence, especially if the confrontation is with more than one threatening person.

The key question should be provocation. When a person is essentially defenceless there is no excuse.

There is no excuse for kicking a person on the ground in the head. We should trial mandatory law in the assault area first by borrowing an approach used in Europe, where a kick in the head is deemed to be evidence of intent to kill or recklessness about killing.  Accordingly the charge for head kicking of a person on the ground, or any serious bashing of a person on the ground, could be attempted murder, with intention deemed, and a minimum sentence prescribed in the absence of a serious miscarriage of justice.

We need it to be simple folklore, known to everyone in the land, whether thug or not, that the result of deliberate kicking people in the head on the ground will be serious time in jail, even if it is your first offence. In other words, it should be folklore that if you attack a person who is no longer in a position to respond or to threaten you, with actions likely to cause permanent brain injury, there is no defence.

The research on what works as a violent crime deterrent is very unequivocal. Speed and certainty of consequence beats severity of sentence.

Judges and lawyers hate mandatory sentencing. They hate certainty in rules. They have some justification for concern. It can be harsh, and have unintended applications. Judges, prosecution and defence may collude to avoid charges or convictions that will attract the application of the minimum where it seems excessive.

But from my experience lawyers never test their fears and preferences against rigorous research – asking what will best reduce temptations to crime for the marginal offender (the one most likely to be affected by the probability of detection, conviction, punishment and being obliged to serve the sentence in full).  They do not acknowledge what I think the be their primary reason for hating mandatory sentencing – that it diminishes their power and  the importance of what they do. They cease to be the controlling spiders at the centre of the web, deciding what happens. Under mandatory sentencing what happens is determined by the law, and the offender’s behaviour, not the lawyer lottery.

President Clinton’s 1996 criminal justice reforms brought in the mandatory sentencing matrix at a federal level in the US. The huge number of lives saved as their violent offending rates plummeted are the kind of political bequest SST wants to leave.

Still spare tickets for the Wellington Rugby Sevens 2014!

Signs that the passion is ebbing have attracted surprisingly little comment, given how much our city has invested in keeping the Sevens. Are we not puffed with pride in the unique carnival it has become? Did we not have the insider's smugness about our ability to get tickets, given the huge unsatisfied demand in the recent past (and special measures to discourage scalping).

Whatever our feelings, the spare ticket phenomenon should be driving Wellington local government to some soul searching.When government routinely offers bread and circuses, but they've ceased to excite the citizenry, what comes next?

Low attendances at Phoenix matches have inflamed Gareth Morgan. It is not just the team's unpredictability. Stadium attendances for non-test rugby have plummeted. Until recently, part of the fun of living here was the certainty that without prior arrangement you'd meet friends at the Stadium. When we all stay home ot watch, TV coverage shows the emptiness.

My private market focus group gave early warnings of this loss of interest. It is merely my work colleagues, clients and friends, in discussion at morning tea or in cafes. They are reasonably spread in age, gender and interests. They're no longer spontaneously talking about anything much at the Stadium. For them at least the buzz has gone. The reasons are not necessarily discontent, or any problem that the promoters can easily fix. It is just 'been there, done that'. Many other things compete for time and money.

That same 'focus group' suggests WOW still has good years ahead of it. But it is signalling problems for this year's Wellington International Arts Festival.

Without any inside information, I predict that it will struggle to break even.

When I raised the issue with a group of friends only one out of seven had any firm plans to make bookings. I contrast that with the intense anticipation and excitement of a decade ago.

But another friend had a solution. The Festival programme is a glossy hard sell document that applauds alike both inspirational genius and self indulgent tosh (often political and social preachifying). Instead the organisers need sophisticated dating site software. It would ask (or know) what you had liked in the past, and what you definitely did not like, and recommend among the offerings accordingly.

Reflecting on why I have yet to book despite regarding it as a civic duty (when it should be just eagerness for pleasure) I realise that my reservations lie in a reluctance to again be the sucker for hype. Even making allowances for common arty breathlessness the descriptions are often less informative than real estate blurbs.

 I like theatre and dance. I routinely attend Circa. I've found some Festival performances enrapturing. But the blurbs rarely give sufficient warning of the acts I will want to walk out of 15 minutes after they start.

Sure – there are code words that give some warning ('complex', 'daring', 'confounding', 'challenging' and so on) but they are sometimes used also of brilliant stuff. I want to feel that the Festival organisers are neutral, or at least acknowledge obligations to us, the audience, even if their primary loyalties lie with the artists. We the market need to feel that the organisers are at least not knowingly complicit with the pseuds and dreary folk and second raters. In particular I want to be warned off those who see us as their moral inferiors, there to be bored, mulcted and instructed by their juvenilia, with entertainment coming last.

A suitably objective booking information system could restore that trust in the organisers.

I like Craig Brown's (the Daily Mail book critic) resolution of his conflicts of interest between authors and readers, in favour of readers.

"The best critics do not worry about what the author might think. That would be like a detective worrying about what a suspect might think. Instead they treat the reader as an intelligent friend, and describe the book as honestly and as entertainingly as possible. And if that process requires back-up in the form of a handy tool, then bring on the hatchet"

With his characteristic straight talk, Gareth Morgan at Interest.co.nz tells it like it is on the 'Avatar' film subsidy. As a Wellingtonian though, I'm hopelessly compromised. It is too hard to look a gift horse in the mouth when it might be the only thing keeping the good times rolling, as head offices continue to leach away.

I wonder whether the National Ministers have thought far ahead. From my direct experience many film industry leaders are irrational, irretrievably reactionary and hostile to achievement values.

I'll not forget attending the annual awards ceremony as an MP where 'arts' and theatre speaker after speaker took their turn to worship Helen Clark. Their greasing might have been endured, but they found joy (supported by audience whooping) in going on to show her their love by pouring personal venom on National and its leadership. They had no reason for it, other than to show their tribal affiliation with the envious left.

Avatar's anti-business socialism is a strange cultural beneficiary of a National Party whose principles it despises.

Throughout history those who laud themselves as 'creatives' have sided with whoever despises the values of ordinary people.

Increasing Class Sizes Can Actually Improve Student Learning

I wonder whether we will hear from the NZEI about the research reported here, that suggests we could help a lot of kids and schools by increasing class sizes in the care of the best teachers, pay them more in recognition and compensation, and cut the numbers of kids iin the classes of the poor teachers.

Of course, the best teachers would feel they were being penalised for their excellence if the had to take on greater numbers than the incompetents, if they were not properly compensated with a substantial pay difference.

In most professions the best performers tend to be the busiest. They often also carry administrative and leadership roles at the same time, even in firms that try to avoid significant pay differentials. The best performers seem often to feel there is enough reward for greater burden by first choice of more interesting work, and the advancement that accompanies peer recognition.

The problem for teachers, almost alone among professions, is that they have insisted on a monopoly employer and industrial style fixing of wages and conditions. The greatest change in pay and respect for teachers would be if they worked like most other professionals, effectively in their own businesses, as 'worker co-ops' (otherwise known as partnerships).

Syndicates or partnerships of teachers, freed of dumb consumer council rule (Boards of Trustees) should own their own school businesses (not necessarily the premises). They would be disciplined like most other professionals by having to attract custom in competition with other self-governing worker co-op run schools.

They would soon find ways to use the best teachers to best advantage, and get rid of the worst.

The Aussie fund manager quoted in today's on-line NBR (behind the pay-wall sorry) saying Australia is a more favourable regulatory jurisdiction, might be getting some under-arm kiwi advice.

The Vector predicament covered in the same NBR is the result of applying an Aussie regulatory approach, to question the generosity of the NZ regulator toward suppliers.

NBR has picked up my blog yesterday. I did not go into the detail of our High Court reasoning, though I gave the paragraph references. Essentially, all the High Court has done in the area that matters to MEUG and consumers generally, is apply Aussie rigour.

The Court looked for the same standard of proof and foundation for assumptions by the Commerce Commission, as is required of  Aussie utilities. The Court could not find it. We cited the leading Australian case to the Court because the NZ regulator has been deliberately generous to suppliers, based on assumptions that are novel, internationally, and in our view unsupportable.

In other words, any price downgrade of NZ line company values arising from MEUG's success will probably just take prices to where they should have been, if the suppliers had not badgered the Commission into assuring them indefinite long term above market returns – a favourable treatment for which the Court could see no justification.

The Government should be grateful to Clifford J for his (and Messrs Shogren and Davey’s) electricity price control merit review decision (click on Wellington International Airport Ltd & Ors v Commerce Commission ) . If  the Commerce Commission picks up the baton thrown by the High Court, there could be a $150m election year announcement of a reduction in cost to consumers. From 2015 to 2020 it could save up to $750m. MEUG sought this for its members and all consumers.

But it now depends on the Commerce Commission. Because of the way price-quality paths interact with Input Methodologies, if the Commission does not bring forward a review of the current IM before the end of September next year, the monopoly suppliers will retain their current ability to extract excessive profits until 2020. The scheduled 2015 reset of their price-quality paths will apply the current, uncorrected IM for the full length of the paths till 2020, even though that current IM must be reviewed in two years time.

The Commission could have a busy January, working out how to resource a review of the Cost of Capital Input Methodology for completion by September 2014. If they can’t do it, they’ll leave years of uncertainty for investors in the regulated suppliers.

It is possible, but not at all certain, that it could be clarified on appeal. The Court of Appeal may share the High Court’s strong views ( see paragraphs 1472 to 1486 in the decision linked above) on the errors in the Commission’s approach without disturbing the High Court's narrow view on its power to send an issue back to the Commission for correction.  So the mistake could apply uncorrected for the next six years. The Commission now has nine months to avoid being blamed for the next 6 years' extraction of monopoly profits for which the High Court could see no justification.

The impact of the mistake is exacerbated by Vector’s small win in the High Court merit review. They gained an ability to seek a reset of DPP part way through a DPP period (5 years) to cover costs incurred from catastrophic events. Read with the recent Orion CPP decision the “pure” ex ante set and forget regime is heavily undermined. The pure regime allows suppliers during a period to take excess profits from being more efficient than the ex ante set parameters, but also to accept the downside of increasing costs.

Now suppliers can seek ex post compensation for “unexpected” costs but customers have no right to seek a DPP reset to share wind fall gains. The reduction in risk to suppliers as a combined result of the High Court decision and the ComComs’s liberal interpretation of “catastrophic event” should also affect their beta. If more suppliers risks’ can now be laid off to consumers, there is even less justification for them to retain permitted WACCs that are by definition expected to be higher than market.

At 1730 today Paul Henry wants to talk to me about CIR, given the Labour/Green failed stunt with the recent one on partial floats of SOEs.

It is some time since I thought about them, and time has reduced my scorn for them. They are much more expensive and generally no more useful than a well conducted opinion poll. The 'dont sack a fireman'  poll was the most stupid.

But I will offer a defence in relation to issues that are permanently politically difficult.  For issues that won't go away despite a fervent consensus in the political class, they serve as an incontrovertible record of awkward voter opinion.

For example, through-out my time in Parliament the Norm Withers petition on criminal justice sat like a  cop car parked just off  the road of debate. Whenever drips on left and right were sneering at the instincts of ordinary people on criminal justice, we only had to mention that petition to cause a sudden standing on the brakes, to get back within the speed limit of pretended respect for voters (from all but the most arrogant).

Supporters of making referenda mandatory often refer to Switzerland. I'm attracted by the initiatives that sometimes direct US States toward democratic respect (like three strikes). But on balance I think our non-mandatory position is prudent.

Many people look enviously at  Switzerland's great democracy. Years ago I asked a Swiss Minister about direct popular voting. It appears that its usefulness is a direct reflection of the seriousness and high-mindedness for which the Swiss are famous. We may have become too frivolous for such direct democracy. Swiss friends once opined that few other people could entrust themselves with it.  We spend more time on celebrities and sport and knowing wines than we do on knowing detail, self restraint, and community responsibilities. Rugby, The Block and celeb gossip mags take the time our forebears might have devoted to less selfish interests.

Referenda could be more useful if they were more confined, for example to yes no decisions on questions thrashed out before with proper analysis. But no one has really cracked the problem of distinguishing between dopey questions and issues, and ones that should be decided with the benefit of a broad consensus developed over a campaign.

A 647 page High Court decision last week should eventually mean a reduction in monopoly profits of up to $150m per year, to the benefit of electricity consumers. I'm proud of my firm's role in making this likely, and surprised that it may have not been recognised in relevant share prices.

We acted for the Major Electricity Users' Group in the High Court merit review of the price control methodologies announced by the Commerce Commission in 2010. Given market whining about lack of warning of the effects of monopoly price control on Chorus I'd have expected an 'efficient market' in company analysis to be keeping a close watch on the merit review decision.

 Yet the Vector price, for example, seems to have been unaffected by a decision that could cut its revenue by as much as $20-25m p.a.. Unlike the Labour scheme for nationalising the electricity generation market, this win for consumers will come from confining monopoly prices to risk defined market returns, based on orthodox principles. It would eliminate a current generosity bias to monopolists. During the consultation process on the Input Methodologies the Commerce Commission simply ignored the relevant MEUG submissions so there was not enough material in the Commission's record of expert opinion (on which the Court must rely to rewrite a methodology). Accordingly the Court limited itself to delivering a strong steer to the Commerce Commission:

(paragraph [1486]) “In reaching this decision not to amend the IM in respect of the use of the 75^th percentile for DPP/CPP regulation, we are mindful that the IMs will be reviewed. At that time, we would expect that our scepticism about using a WACC substantially higher than the mid-point, as expressed above, will be considered by the Commission. We would expect that consideration to include analysis – if practicable – of the type proposed by MEUG. We would also expect the Commission to consider MEUG’s two-tier proposal in light of our observations. We acknowledge that further analysis and experience may support the Commission’s original position. But they may not…." 

This is a very strong direction to consider our claim that there should be a mid-point WACC or an alternative 2-tier WACC.

The ComCom could review their 75^th percentile decision next year so that the reduced return on capital could apply when the price path for lines companies is reset for the period 2015 to 2020.

In the merit review proceedings on the opening day of the substantive hearing the Franks & Ogilvie team (Nikki Pender, Jordan Williams and me) faced 29 lawyers (including 6 QCs) in the body of the Court with their supporting platoons in the gallery. MEUG was there alone representing consumers. The Commission lawyers were dedicated to defending its status quo, and the others were pushing for hundreds of millions more in permitted revenue.

I've previously mentioned these proceedings here, here and here. They took more  Franks & Ogilvie hours in 2012 than anything else.  We're enormously chuffed to have such a good outcome for our clients, and eventually for all consumers.

The High Court decision is extraordinarily assured and direct, despite the Judge's open acknowledgement in the early stages of the hearing that he was having to learn the arcane mysteries of cutting edge corporate finance. He was assisted by two experienced economic regulators from Australia. We think the merit review process could be improved to reduce the burden on the Court, but the decision shows the intellectual quality of good adjudicators.

Nevertheless I'll blog in future posts on some of the lessons for me of re-exposure to our courts after 30 years of strenuously keeping my clients as far away from them as possible. In my opinion they are immeasurably worse overall for litigants, and much more indulgent to lawyers' pretensions.. This is not within the power of even an outstanding High Court judge to control. It could be remedied only by a dedicated reform-minded Supreme Court.

Grasshopper Rock wine company has great email advertising, and great wine.

Today's message shows the right kind of sophistication:

"If you watch too much television, you won't be amazed by what is now described as iconic. Recently, we have seen Air New Zealand identified as iconic, a director describe an "iconic part of my life", Piha is an iconic west coast beach, Christchurch has restored its iconic tram, the A380 is Europe's iconic double decker jet, an actress enjoyed playing an "iconic Kiwi war hero", in Auckland the council is moving an iconic seat from in front of the library, and Alexandra has an iconic pie cart.

Let's run that again, using the most common synonyms from Roget's Thesaurus. Recently, we have seen Air New Zealand identified as important, a director describe "an important part of my life", Piha is a representative west coast beach, Christchurch has restored its historic tram, the A380 is Europe's ideal double decker jet, an actress enjoyed playing an "important Kiwi war hero", in Auckland the council is moving an historic seat from in front of the library, and Alexandra has a burnt out pie cart.

By using iconic, we can remove up to 20 common words from the English language, which TVNZ is doing on a daily basis.

Is Grasshopper Rock iconic? Or perhaps an icon? Too early for us to judge, but you can be iconic by celebrating that historic event, Christmas, in traditional fashion by, choosing the ideal wine, made in a classical style, and representative of the Alexandra sub region. And that's important."

They deserve to sell their wine for $330 per case.