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Upsizing – the other half of the hidden side of CapEx
Presented at the Electricity Engineers Association (EEA) Conference, Christchurch, June 2008by Phil Caffyn from Utility Consultants Ltd.
www.utilityconsultants.co.nz
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Disclaimer• This presentation has been prepared primarily for the
EEA Conference 2008 and is not to be relied upon by event participants or any other person as professional advice.
• This presentation has been compiled at the invitation of the EEA. Neither the EEA nor its officers or its employees take any responsibility for the factual accuracy of this presentation, nor for any opinions, views or biases in this presentation.
• Utility Consultants Ltd as the author of this presentation shall not be liable in any way whatsoever for any action or failure to act based on the content of this presentation.
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Scope of application• This presentation has been prepared primarily for an
electricity lines audience, with examples drawn from that sector.
• However the principles of upsizing and many of the comments about regulatory price control will be applicable to other network infrastructure sectors such as gas, water, sewage, drainage, roads and rail.
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Presentation topics• What actually is upsizing.
• The other half of the hidden side of CapEx.
• Investment characteristics of CapEx modes.
• Why should assets be upsized.
• When should assets be upsized.
• The regulatory issues around headroom.
• The regulatory issues around spend plans.
• Five quick things to take away.
• More information.
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What actually is upsizing
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What actually is upsizing• Upsizing is the replacement of a non-consumable
component with a non-consumable component of
greater functionality (usually capacity, but
increasingly often, voltage).
• Two key criteria for upsizing...
• Must involve replacing a non-consumable component with
a non-consumable component.
• Must increase functionality.
• Table on the next page illustrates the upsizing
concept using an overhead electric line.
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What actually is upsizing
Activity Description Why it is or isn’t upsizing
Replacing a blown fuse. Maintenance Not upsizing because a consumable component has been replaced.
Replacing a frayed conductor with a similar size conductor.
Renewal Not upsizing because although a non-consumable component has been replaced with a non-consumable component no increase in functionality has occurred.
Replacing a small conductor with a bigger conductor.
Upsizing Upsizing because the functionality of a non-consumable component has been increased.
Adding a new length of line to reach a new customer.
Extension Not upsizing because the functionality of a non-consumable component has not been altered (more components have been added).
Replacing an existing line with cable.
OHUG Not upsizing because the functionality of a non-consumable asset has not been altered.
Inserting a recloser halfway along a line.
Reliability enhancement
Not upsizing because the functionality of a non-consumable component has not been altered.
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What actually is upsizing• Couple of issues arise from the previous table...
• What if the frayed conductor is replaced with a bigger
conductor – do we treat that as renewal or upsizing ??
• Suggested approach – might want to consider allocating
between both categories, but perhaps more importantly,
be consistent over time.
• What about areas where technology is advancing rapidly
(eg. SCADA) and a like-for-like replacement (renewal) is
impossible ?? Does that need to be treated as an
upsizing.
• Suggested approach – treat as a renewal, but again be
consistent over time.
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The other half of thehidden side of CapEx
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The other half of the hidden side• As set out in the previous table, there are five broad
types of CapEx…
• Renewal.
• Upsizing.
• Extension.
• Overhead to underground conversion (OHUG).
• Reliability enhancements.
• Each of these different types of CapEx has different
characteristics and arises in different circumstances.
• Following chart indicates these circumstances and
tries to apply some easily understood terms to those
circumstances…
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The other half of the hidden side
Existing asset
Condition
Service capability hasdeclined to below an
acceptable level(“too sick”)
Insufficient capacityto meet demand
(“too thin”)
Cannot physicallyreach new customer
(“too short”)
Pressure to replacelines with cables
(“too ugly”)
Reliability doesn’t meet requirements(“too unreliable”)
Required modeOf CapEx
Renewal
Up-sizing
Extension
OHUG
Reliabilityenhancement
Hidden
Obvious
The hidden aspect is the important bit of this argument.
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The other half of the hidden side• As indicated the other half of the hidden side of CapEx
is renewal.
• Renewal is replacing a non-consumable component
with a non-consumable component of equal
functionality (usually capacity).
• So why have I called upsizing and renewal “the hidden
side of CapEx” ??
• Because they can be deferred or avoided, usually with
no immediately obvious consequences but often with
catastrophic eventual consequences (the big storms in
Queensland in early 2004 are a good example).
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The other half of the hidden side• In contrast extensions cannot be avoided because a
physical connection between the existing network and
the new customer must be provided.
• The following Investment Strategy Matrix identifies
the predominant CapEx mode under each of four
growth scenarios.
• In particular, upsizing will be a predominant CapEx
mode if growth is occurring within the existing
network footprint.
• If the growth is occurring outside of the existing
footprint, existing assets will still need to be
eventually upsized.
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The other half of the hidden side
Prevailing load growth
Location of demand growth
Lo Hi
Within existing network footprint
Outside of existing network
footprint
Quadrant 4
· CapEx will be an even mix of both extensions to reach new customers and then up-sizing to supply that demand through existing upstream assets .
Quadrant 3
· CapEx will be dominated by extensions because load growth is occurring beyond the reach of existing assets, and then maybe some up-sizing to supply this additional demand through existing upstream assets.
Quadrant 1
· CapEx will be dominated by renewals because assets will wear out before they get “too small”.
Quadrant 2
· CapEx will be dominated by up-sizing because assets become “too small” before they wear out.
Growth within the existing network footprint will require upsizing to meet increased demand and security
Growth outside the existing network footprint will firstly require extensions, but will also ultimately require upsizing to meet increased demand and security
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The other half of the hidden side• With upsizing and renewal the physical connections
are already in place and the electricity just keeps on
flowing.
• So it’s very easy to overlook an undersized asset as
long as the electricity keeps flowing - afterall how
many of us have said something like “sure we can get
another winter (or summer) out of those cables”.
• When the total CapEx budget is fixed and new
consumers are wanting connection (extensions), guess
which modes of CapEx are most likely to take the hit
(again, the Queensland storms in 2004) ??
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Investment characteristicsof CapEx modes
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Investment characteristicsof CapEx modes
• Already commented that the three predominant
modes of CapEx (renewals, extensions and upsizing)
have different investment characteristics.
• Useful to take a slight diversion from the main theme
of upsizing to quickly compare and contrast the
investment characteristics of these three modes.
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Investment characteristicsof CapEx modes
Characteristic Renewal Upsizing Extension
Location Within the existing network foot-print by definition.
Within the existing network foot-print by definition.
Outside of existing network foot-print by definition.
Nature of load increase
Isn’t any – driven by asset condition, not capacity.
Supplying either new load or increasing load at an existing connection within existing foot-print.
New supply to a new customer outside of network footprint.
Upstream reinforcement
Isn’t any – by definition renewal replaces assets with assets of similar capacity of functionality.
Forms the focus of upsizing.
Will only be needed if demand from new customers cannot be supplied by existing upstream assets.
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Investment characteristicsof CapEx modes
Characteristic Renewal Upsizing Extension
Visibility Generally invisible (might look new and shiny).
Generally invisible (might look new, but hard to tell that the wires are bigger)
Generally very visible – new asset where previously there wasn’t any.
Quadrant in the investment strategy matrix
Tends to be restricted to Quadrant 1 because assets wear out before they become too small.
Usually restricted to Quadrants 2 and 4 because it requires assets to get too small rather than wear out.
Restricted to Quadrants 3 or 4 by definition. Precise quadrant will depend on rate of load growth and will define degree of associated upsizing.
Necessity Possible to avoid by deferring renewal – carries increased risk of condition related failure.
Possible to avoid by over loading – carries increased risk of capacity related failure.
Can’t avoid – a new physical connection is required between the network at large and the new load.
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Investment characteristicsof CapEx modes
Characteristic Renewal Upsizing Extension
Impact on revenue
Generally doesn’t result in any increased revenue.
Hard to attribute revenue from increased demand or connections to up-sized assets.
Generally results in increased revenue directly attributable to new connections.
Impact on costs Can range from modest to large, no revenue impact to be phased to.
Can range from modest to large, generally better matched to revenue growth than extensions.
Likely to be large and over a short period, generally always occurs ahead of revenue, precise phasing depends on nature of new load.
Impact on asset valuation
Can range from modest to large.
Can range from modest to large.
Generally large depending on length of extension and degree of upsizing required.
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Investment characteristicsof CapEx modes
Characteristic Renewal Upsizing Extension
Impact on profit
Can range from modest to large.
Can range from modest to large.
Can be large, but often mitigated through customer contributions.
Means of cost recovery
Generally spread over all customers as part of on-going line charges.
Generally spread over all customers as part of on-going line charges.
Generally through capital contribution, possibly up to 100% depending on policy.
Nature of work carried out
Replacement of worn out assets with new assets of similar capacity or functionality.
Replacement of assets that are “too small” by new assets of greater capacity or functionality.
Construction of new assets to connect new customers to existing assets, may also require upsizing depending on surplus of up-stream capacity.
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Why should assets be upsized
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Why should assets be upsized• This is the simplest of the two headline questions - the
short answers are…
• The need to provide sufficient capacity for present and
future demand.
• The need to provide sufficient security of supply for both
the present and future.
• I’ll use the broad term “headroom” to embrace both of
these concepts.
• Both of these answers embody a wide range of
engineering, economic and regulatory issues which
the following sections will try to address.
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When should assets be upsized
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When should assets be upsized• The ideal answers for an ideal world are…
• Just before its needed (and when that might be is likely
to depend strongly on the assets criticality).
• Just a little bit at a time.
• This would be a curve exactly following the demand or
required security headroom increase – perhaps like a
giant hand slowly winding up a knob.
• For those of us in the real world, investment is likely
to be stepped or lumpy like this…
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When should assets be upsized
Time
Demand or security
headroom
Investment
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When should assets be upsized• Like any other business decision, the “when to upsize”
decision is just a matter of maximising benefits and
minimising costs subject to any constraints.
• Lets re-visit the previous chart and examine exactly
what these benefits, costs and constraints are.
• It goes without saying that in these sorts of situations
the predominant benefit will be avoiding the risk of
asset failure (and hence supply interruption).
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When should assets be upsized
TimeOne-off cost of works
Risk of failure due to under investment
Over investment
Possible constraint of maximum recovery of investment
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When should assets be upsized
• If we muck about with the time interval between upsizing
we can derive the following two curves...
Time Time
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When should assets be upsized
• These two curves have different whole of life costs as
follows...
Time
•Reduces one-off works costs.
•Increases level of over investment.
•May increase risk of failure due to under investment (depends on when next upsizing is timed).
•May reach the limit of how much investment can be recovered, and may therefore include regulatory risk.
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When should assets be upsized
• These two curves have different whole of life costs as
follows...•Increases one-off works costs.
•Reduces level of over investment.
•May reduce risk of failure due to under investment (depends on when next upsizing is timed).
•Unlikely to reach the limit of how much investment can be recovered, so unlikely to include regulatory risk.
Time
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Time interval between upsizing
Whole of life upsizing cost
When should assets be upsized
• Plotting the value of each cost against the time interval
between upsizing gives something like this…
Cost of over investment
Cost of under investment (depending on when upsizing occurs – likely to accelerate away rather than be linear
One-off costs
Total costs
Optimum time interval between upsizing
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When should assets be upsized• Key features of the previous chart include...
• As one-off costs increase (resource and building
consents, design, fuel, travel time, reinstatement etc) the
optimum time interval between upsizing increases.
• As the costs of under investing increases (increased risk
of asset failure due to insufficient capacity or security
headroom) the optimum time interval between upsizing
decreases (the precise shape of this curve will reflect
both the asymmetry between under and over-investing
and the likely acceleration of failure probability as
demand exceeds capacity).
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When should assets be upsized• What is difficult to show on this chart is that as the
interval between upsizing increases, the constraints in
the ODV Handbook may be reached.
• This may introduce regulatory risk into this cost which
in turn may merit a WACC higher than that applied to
invested capital for which recovery is certain.
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Time interval between upsizing
Whole of life upsizing cost
When should assets be upsized
Investment beyond the headroom limits set out in the ODV Handbook could incur a higher WACC because of regulatory uncertainty
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The regulatory issuesaround headroom
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The regulatory issuesaround headroom
• In broad terms the ODV Handbook allows the
following load growth horizons to be rolled into the
ODV…
• 15 years for trans lines, sub-trans lines, zone subs (excl.
transformers), primary distribution lines and grid
connection points.
• 10 years for zone sub transformers.
• 5 years for HV and LV distribution.
• Nil for distribution transformers.
• My view is that this limits the amount of capacity and
security headroom investment that can be rolled into
the ODV and therefore recovered from consumers.
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The regulatory issuesaround headroom
• Asset owners could therefore adopt one of two
approaches…
• Upsize to the level suggested by the optimum time
interval and accept that at least some of this
investment may be unrecoverable (or at least until
any revaluation occurs).
• Upsize to the limit allowed by the ODV Handbook
and accept that the time interval to the next
upsizing may be sub-optimal (ie. will incur greater
than necessary one-off costs).
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The regulatory issuesaround spend plans
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The regulatory issuesaround spend plans
• Since the requirement to disclose AMP’s emerged late
last century, my view is that the emphasis has been
on the format and the words rather than on the spend
plans, which is obviously concerning.
• Over the last two years I have suggested to several
lines businesses that they disaggregate their spend
projections by both asset class and by spend category,
and that in particular they clearly separate their
CapEx into renewals, extensions and upsizing to help
them understand in their own minds the different
investment characteristics of each mode.
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The regulatory issuesaround spend plans
• The latest requirements for presenting spend plans
are set out in paragraphs 446 to 466 of the Commerce
Commission’s Companion Paper to the Exposure Draft
of 20 December 2007.
• These requirements are similar to my suggested
CapEx disaggregation as follows…
• Customer connections
• System growth
• Replacement & renewal
• Reliability, safety & environmental
• Non-system.
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The regulatory issuesaround spend plans
• However my personal view is that the Commission’s
disaggregation doesn’t go far enough…
• System growth should be further split into upsizing and
extensions because these two modes of CapEx have
different investment characteristics.
• Reliability should be separated from safety &
environmental because of the somewhat discretionary
nature of reliability versus the largely unavoidable nature
of safety and environmental, and also because they
benefit different stakeholder groups.
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The regulatory issuesaround spend plans
• However the Commission is the final authority on this
matter and their published requirements will need to
be complied with as a minimum requirement.
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Five quick things to take away
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Five quick things to take away• Upsizing requires a non-consumable component to be
replaced with a non-consumable component of greater
functionality.
• Upsizing (and renewal) can be very much hidden, so
care must be taken not to overlook their
requirements.
• Recovering the cost of upsizing (and renewals) is
likely to be indirect, as opposed to extensions which
usually bring direct revenue and customer
contributions.
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Five quick things to take away• The principal benefit of upsizing is avoiding supply
interruption, hence the optimum time to upsize must
consider an assets criticality – if necessary err on the
side of sooner rather than later.
• Spend plans will need to be disaggregated to at least
the level specified in the December 2007 Companion
Paper.
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More information
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More information
• Phone +64-7-8546541
• Mobile +64-21-606670
• Email [email protected]
• Skype philcaffyn
• Web www.utilityconsultants.co.nz
• Web www.capex.cjb.net
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More information• Slide shows on similar issues…
• Implementing the UK asset management specification PAS 55-1:2004 in the infrastructure sector. Request
• Getting the CapEx right in the infrastructure sectors. Request
• Setting service levels for utility networks. Request
• Tariff control of pipes & wires utilities – where is it heading. Request
www.utilityconsultants.co.nz 50
More information• Visit Utility Consultants library to request other slide
shows, monographs and research reports.
• Visit Utility Consultants specialist CapEx website for more insights.