Productivity Commission Weighs In On Energy Network Regulation - Consumer Trading & Unfair Trading

It was no surprise that the Productivity Commission (PC) weighed in to the broader debate on Energy Network Regulation in its Review of the se of Benchmarking and Interconnectors in the Electricity Regulatory Regime.

While the PC's terms of reference were ostensibly narrow, the PC's Draft Report, Electricity Network Regulatory Frameworks, October 2012 (Draft Report ¹ ) covers all aspects of the regulatory framework. The PC reasoned that "[t]here is, in effect, no point in simply fixing a punctured tyre if the car has no engine". ²

The PC's review is just one of the many reviews in response to what has been seen as steep price rises in network (particularly electricity) tariffs. This update sets out our observations regarding some of the key draft recommendations of the PC ³ and highlights where these recommendations overlap with other reviews.

BENCHMARKING

The PC is realistic about the shortcomings of benchmarking and the difficulties of using aggregate benchmarking to simplify the regulatory review process, at least in the short term. However, the PC put forward innovative (and sensible) uses of benchmarking in the long run. For instance, the suggestion that if sufficiently robust benchmarking can be developed there may be scope to dispense with detailed analysis of network service providers' proposals (draft recommendation 8.5) could dramatically change the way regulatory reviews are conducted in Australia. ⁴

This is supported by the recommendation that the National Electricity Rules (NER) be clarified to indicate that the Australian Energy Regulator (AER) is only required to test the reasonableness of the overall expenditure proposal (draft recommendation 5.5), a recommendation echoed by the Senate Select Committee on Electricity Prices. ⁵

While this might be reflected in the final determination regarding the electricity regulatory framework expected from the Australian Energy Market Commission (AEMC) later this month, as a practical matter, until benchmarking improves to a sufficiently robust level to play a more significant role in regulatory reviews, the current approach of detailed analysis of regulatory proposals will continue, even if such a recommendation is adopted.

The PC's draft recommendation that regular benchmarking be conducted by the AER (draft recommendation 8.1) supports the draft rule change proposed by the AEMC, which would require the AER to prepare annual benchmarking reports. The PC goes further, however, in recommending the types of benchmarking that should be conducted (draft recommendations 8.1 to 8.3). These recommendations might be expected to influence the AEMC's final determination and/or the AER in completing the annual benchmarking in compliance with the new rule requirements.

RETURN ON CAPITAL

The PC supports the AEMC's proposed rule changes providing for the consideration of linkages between the weighted average cost of capital parameters and allowing for averages for the estimation of the cost of debt to be taken over longer periods (draft recommendations 5.2 and 5.3). If the draft recommendations are maintained by the PC, this is likely to increase pressure on the AER to utilise the additional flexibility likely to be given to it by the AEMC to implement a trailing average approach to estimating the cost of debt.

EXPENDITURE ALLOWANCES

The PC is explicit in indicating that the regulator should not seek to set revenue allowances at its "best estimate". ⁶ Rather, the PC contemplates the regulator will "start from the business proposal and reduce it just enough to meet a reasonableness criterion". ⁷ The PC suggests that the efficiency threshold applied to firms for benchmarking purposes be set at "close to, but below, the level of the most efficient firm" (draft recommendation 8.5). The PC refers to the 75th percentile. ⁸ The Draft Report thus amounts to a rejection of the AER's proposal that it be free to replace a network service provider's forecast with its own forecast if it is of the view that it has a "better estimate". ⁹ It also raises the prospect that the NER may require amendment to ensure this approach is adequately reflected in the regulatory framework.

CAPEX INCENTIVES

The PC supports the development of an efficiency benefit sharing scheme for capital expenditure (capex) (draft recommendation 5.1). It also supports an ex post review of capex as a "safety mechanism" if spending levels are not being controlled by the incentive regime. ¹⁰ However, the PC Draft Report offers greater protection for investors than the AEMC's draft position. For instance, on the PC's proposal (draft recommendation 5.4):

The review could only be conducted if a network service provider spends "materially" more than the capex allowance (on the draft rule the review can be conducted if actual spend exceeds the allowance).
A network service provider that is aware it is going to exceed pre-approved spending levels would be able to apply for pre-approval to avoid the ex post assessment (while similar to a capex reopener, the limitations that apply to a capex reopener would not appear to arise on the PC's proposal).
The ex post review would not extend to cost pass throughs and contingent projects.

Such protections may be the subject of consideration by the AEMC in its final determination.

DEMAND MANAGEMENT

The PC's recommendation that the AER take responsibility for determining the optimal start date for the roll-out of advanced metering infrastructure by distribution network service providers (draft recommendation 10.1) would push the AER into new analytical territory. In placing the AER in this role, the PC is perhaps seeking to remove political involvement in the roll-out decision. The proposed mandated introduction of time-based network charges after smart meters are rolled out, again, perhaps seeks to remove any politicisation of the decision to allow the introduction of time-of-use tariffs and thus avoid any delay to the introduction of such tariffs (which would significantly reduce the benefits associated with the roll-out, as has occurred in Victoria). Without seeking to duplicate the work of the AEMC in its Power of Choice review (which gives particular focus to securing demand-side participation from commercial and industrial end-users), the PC supports the AEMC's proposal, ¹¹ whose draft report is also supported by the Senate Select Committee. ¹²

INDUSTRY FUNDED CONSUMER BODY

While consistent with the preliminary view of the AEMC ¹³ and view the Senate Select Committee, ¹⁴ the PC's draft recommendation that an industry funded consumer body be established (draft recommendation 21.3) is inconsistent with the findings of the expert panel appointed by the Standing Council on Energy and Resources (SCER) to consider the limited merits review under the National Electricity and Gas Laws. Among other things, the SCER panel did not recommend a consumer body on the basis that "different consumers have different interests, and the panel, based on its own experience, is of the view that the presentation of a variety of consumer perspectives is of assistance in investigative processes". ¹⁵ The SCER panel's comments also undermine the PC's proposal for a three-way negotiation between the network service provider, the regulator and the peak customer body (draft recommendation 8.4). This is particularly the case given the uncertainty that would then arise in respect of review rights after a negotiated outcome for those customer groups not privy to the negotiations.

A regulator such as the AER should be expected to take into account a variety of consumer perspectives (and not just one group's):

The AER is required to act in accordance with the NER, which have been developed to promote the national electricity objective, which is to promote the efficient investment in, and efficient operation and use of, electricity services "for the long-term interests of consumers of electricity".
The AER is required to perform its functions or exercise its powers in a manner that will or is likely to contribute to the achievement of the national electricity objective.

In determining the prudent and efficient costs of the regulated business, the AER can be expected to scrutinise and adjust the big ticket items that would be the subject of submission by a peak consumer body. In circumstances where the consumer body would presumably need to consult with stakeholders to inform its views (a process which could equally be undertaken by an appropriately resourced regulator), it is difficult to understand how the consumer body would be uniquely placed to contribute to the process.

PROCESS FOR AMENDING THE NER

The PC's recommendation that the National Electricity Law allow for expedited amendments to the NER by the AEMC where there has been an independent review (draft recommendation 21.4) makes sense. However, the proposal that the South Australian Minister be given a broader power to make (with the agreement of the SCER) expedited changes to the NER raises concerns.

The NER are complex and various aspects of the regime intricately interrelated. Drafting changes to particular provisions (and, in particular, definitions) can have significant consequences for other provisions of the NER. It was never intended that the Ministers have an ongoing role in amending the NER. Ministers can, of course, propose rule changes, but the AEMC is the appropriate rulemaking body under the existing regime and should maintain responsibility over amendments the NER.

WHERE TO NEXT?

The PC has requested submissions on its Draft Report by 23 November 2012, with the PC's final report to be forwarded to the Federal Government by 9 April 2013. The AEMC's final rule determination on the economic regulation of electricity networks is expected on 15 November 2012. The Energy Ministers' responses to the SCER panel's report is as yet unknown. We will watch with interest how policy makers seek to tie together the tangled web of concurrent reviews of energy regulation in Australia.

If we can be of assistance in responding to any issue in the Draft Report or any of the other reviews under way, please contact us.

Footnotes

¹ The Draft Report is available on the PC website: http://www.pc.gov.au/projects/inquiry/electricity/draft.

² Draft Report, p7.

³ The Draft Report covers significant ground and naturally there are important matters we could not address in this update.

⁴ Of course, if a matter was to go on review, parties would likely be forced into the detail, whether before the review body or the AER on remittal.

⁵ The Senate, Select Committee on Electricity Prices, Reducing energy bills and improving efficiency, November 2012, recommendation 3.

⁶ Draft Report, pp215-216.

⁷ Draft Report, p215.

⁸ Draft Report, p291.

⁹ AER, Submission, AEMC Directions Paper, Economic regulation of Network Service Providers, April 2012, p11.

¹⁰ Draft Report, p209. The AEMC's proposal to conduct an ex post review is also supported by the Senate Select Committee: The Senate, Select Committee on Electricity Prices, Reducing energy bills and improving efficiency, November 2012, recommendation 6.

¹¹ Draft Report, p426.

¹² The Senate, Select Committee on Electricity Prices, Reducing energy bills and improving efficiency, November 2012, recommendation 9.

¹³ AEMC, Directions Paper, National Electricity Amendment (Economic Regulation of Network Service Providers) Rule 2012, National Gas Amendment (Price and Revenue Regulation of Gas Services) Rule 2012, 2 March 2012, p155.

¹⁴ The Senate, Select Committee on Electricity Prices, Reducing energy bills and improving efficiency, November 2012, recommendation 15.

¹⁵ Professor George Yarrow, The Hon Michael Egan, Dr John Tamblyn, Review of the Limited Merits Review Regime, Stage Two Report, 30 September 2012, p60.

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Australia: Productivity Commission Weighs In On Energy Network Regulation