Economic regulation of electricity and gas network
businesses
Mark Feather, Acting Executive Director
23 November 2011
Background
• January 2009 – economic regulation of distributors
transferred to AER
• October 2010 – final determination on revenues
for Victorian electricity distributors 2011-15 (first
under NER)
• Victorian Government concerned that outcomes
not consistent with interests of consumers
• Made several submissions to process
• Intervened in Tribunal proceedings
Key issues and concerns
• NER too prescriptive
– objective was to provide greater investor certainty
– experience indicates that consumer interests not
appropriately protected
• AER not taking jurisdictional circumstances into
consideration
– particularly different incentives on public versus private
businesses
• Merits review process
− concern that process does not balance the interests of
consumers with networks.
NER too prescriptive
• Prescription can bring regulatory certainty
• But excessive prescription has downsides:
– limits the ability of the regulator to innovate and develop
the regulatory framework in a dynamic manner to
promote efficient behaviour and protect consumers (e.g
with respect to incentive schemes)
– can lead to sub-optimal and erroneous outcomes.
• Examples include:
– Treatment of related party margins under the NER
– Treatment of side constraints between price control
periods in Victoria
– Closure of Victorian S-factor regime and transition to
Service Target Performance Incentive scheme
– DB recovery of transmission costs
NER too prescriptive – related party margins
• Unjustified related party margins removed from capex
forecasts by AER
• However, AER determined that it had to roll
unjustified related party margins into RAB
– based on interpretation of NER
• AER’s final determination states that:
The apparent requirement for the AER to automatically roll into the RAB
all amounts characterised as capex creates an incentive for DNSPs
to enter into related party contracts and seek outcomes contrary to
the efficiency objectives of the regulatory framework.
• Could lead to significant costs being imposed on
Victorian consumers in the future
NER too prescriptive – related party margins
• Victorian Government appealed AER decision to
the Tribunal
– Perverse incentive for networks to contract for related party
services at fees unrelated to cost of providing those services
– Victoria sought alternative interpretation of NER
– Awaiting Tribunal Decision
• Rule change proposal
– Clarifies that related party margins can be excluded
from RAB
• Victorian Government supports the amendments
Jurisdictional differences - Regulatory vs
actual depreciation
• NER provides AER with discretion to apply actual
or forecast (regulatory) depreciation to RAB
– discretion provided as different approaches have been
applied historically across jurisdictions
• Actual depreciation is based on actual capex
• Forecast depreciation is based on forecast capex
• In practical terms:
RAB = Opening balance + capex – depreciation - disposals
• Under forecast depreciation if network
underspends relative to capex forecasts, it’s
depreciation will be higher and the RAB will be
lower – consumers pay less
Jurisdictional differences – regulatory vs
actual depreciation
•
In Victoria forecast depreciation used by ESC
•
AER Vic EDPR decision – applied actual depreciation
• national consistency, noting that NER prescribe actual
depreciation for transmission businesses
• AER view that actual depreciation will lead to capex
efficiencies
• Victorian Government appealed decision
•
•
•
Regulatory depreciation provides strong incentives on networks not to
over-forecast
Relevant to privately owned Victorian DBs which generally
underspend relative to forecast
Actual depreciation will increase incentives for over-forecasting and
lead to a larger RAB
Jurisdictional differences – regulatory vs
actual depreciation
• Rule change proposal
– provides AER with discretion to use actual or forecast
depreciation for transmission businesses
– proposal recognises that apply a nationally consistent
(“actual depreciation”) approach may not be appropriate
• Rule change supports Victorian Government’s
arguments
• Victorian Government supports proposal
Merits review – issues and concerns
• NER provides for a merits review
•
•
•
•
•
•
allows businesses to ‘cherry pick’ issues for appeal
difficult for parties other than businesses and AER to
participate
asymmetric process creates outcomes that favour only
the businesses
is this consistent with the long term interests of
consumers under the NGO and NEO?
commentators raising concerns (Garnaut, IPART,
consumer groups)
Victorian Government shares these concerns
Merits review – issues and concerns
• SCER proposing to bring forward review of merits
review framework
• Terms of Reference under development by
officials
• Regulatory accountability important
• Does the existing framework balance the interests
of networks and consumers?
• Is a narrower judicial review framework sufficient?
Merits review – international developments
•
•
•
Ofgem appeal mechanisms are being amended to meet EU
requirements
There will be an ability to appeal individual elements of a
determination, but with scope for wider review if the individual element
is considered to have a wider impact.
The Government response to consultation states:
“[A]s price control decisions are essentially a package of balancing measures,
there is the potential that upholding an appeal on a single element could have
a knock-on effect on other elements of the package and upset the balance of
the price control mechanism as a whole. The appeal body would therefore
have discretion to consider additional elements or the whole package of the
price control decision if the evidence submitted shows that reviewing individual
elements is likely to upset the balance of the whole package.”
Source: Implementation of the EU Third Internal Energy Package Government Response, para 2.23
Merits review
• Example 1 – appeal of Victorian decision on debt
risk premium
– only businesses and AER participating in process
– Victorian Government observing given impact on
consumers
– no party arguing for consumer interests
• Example 2 – expenditure allowances
– key driver of significantly increased network prices
– only businesses and AER able to effectively participate
in process
– Victorian Government not well positioned to appeal
Rule change proposals
• Expenditure allowances
– remove requirement for AER to accept or reject
businesses’ expenditure proposals
– allow AER to determine efficient and prudent level of
expenditure to meet objectives
• Less reliance on “bottom up” approach, under which AER
faces significant information asymmetries
• Enables more reliance on benchmarking, comparative
regulation
• In principle, a better balance of network and consumer
interests
Rolling capex overspends into RAB
• To increase incentive to not overspend, AER has
proposed that only 60% of capex overspends are
rolled into RAB.
• Risks creating perverse incentives
– provides a stronger incentive to over forecast
– privatised businesses will not overspend, even where
expenditure is efficient and prudent
– Potential detrimental impact on service levels
• AER changes relating to pass through events and
contingent projects unlikely to address concerns
Conclusion
• Victorian Government supports changes to NER
to ensure consumers’ interests are protected
• Victorian Government supports NER changes in
relation to:
– related party margins
– regulatory vs actual depreciation
– review of expenditure proposals
• Victorian Government has concerns with proposal
to restrict rolling capex overspends into RAB