Drivers of network investment in electricity and gas networks – an update

By Andrew Reeves, Chairman AER

There have been rising concerns about increases in energy prices in 2010. The increases have been mostly attributed to rising network charges and wholesale energy costs, but retailer costs and climate change policies will become more significant factors in the future.

Recent regulatory decisions, in particular, have allowed significant increases in capital investment and operating expenditure to enable energy networks to reliably meet greater demand. With network costs accounting for around 50 per cent of a typical electricity bill, rising capital and operating expenditure are flowing through to energy consumers.

The AER regulates electricity networks and gas pipelines in southern and eastern Australia (and gas pipelines in the Northern Territory). In electricity, this involves the assessment and approval of revenues that network businesses may earn from transporting electricity to customers. The framework for gas pipelines is similar, but derives prices for reference services set out in access arrangements.

In this article, which follows an earlier contribution in the July/August 2010 issue of Energy Source & Distribution, the AER provides some further information on the key drivers of increased capital investment in network businesses, taking account particularly of its recent Victorian distribution determination decision, which was released on 29 October, 2010.

In 2010 the AER completed electricity distribution reviews for the Queensland and South Australian networks (released May 2010) and Victoria (released October 2010). It also approved access arrangements for the ACT and New South Wales gas distribution networks (released April and June 2010 respectively).

The AER’s recent regulatory decisions have allowed significant increases in capital investment in networks. A combination of factors are driving these increases. The key drivers include:

• more rigorous licensing conditions
and other obligations for network security, safety and reliability, including to mitigate bushfires;

• load growth and rising peak demand;

• new connections;

• the need to replace ageing assets, which were largely built between the 1950s and 1970s; and

• higher input (labour and material) costs as well as higher financing costs.

While these factors are driving higher levels of investment, each network faces a somewhat different set of challenges – for example, each network has unique issues relating to its age and technology, its load characteristics, the costs of meeting the demand for new connections, and licensing and reliability/safety requirements. By contrast, higher input and financing costs are common to all businesses.

These differences in operating environments result in significant variations in capital investment requirements. Notwithstanding these differences, electricity distribution investment over the current five-year regulatory periods is expected to exceed investment in the previous regulatory periods as shown in the table above.

While the AER agrees that the above factors of higher demand and the need to replace ageing assets and meet new technical obligations require greater expenditures, the AER has not agreed with the size of the increases sought by the network businesses; these allowed increases are all below those proposed by the network businesses, as noted in the table.

A good example is in its recent decision on the five Victorian distribution businesses.

Over the past two regulatory periods (10 years) the Victorian distribution businesses actual expenditures have generally followed a constant trend and have typically been close to or below the allowances set by the previous regulator, although this has varied between businesses. This means the historical trend analysis provides a good starting point for consideration of any new needs, however, the AER must also take account of changed circumstances or requirements in the future. In reviewing claims for further expenditure, the AER considered the factors driving higher investment and agreed to increases in capital investment of 45 per cent and increases in operating expenditure of 32 per cent on the current period.

These increases are driven by largely similar factors to those affecting other distribution businesses – replacement of ageing assets and the need to meet higher customer peak demand. However, in Victoria other key factors were the new safety obligations that were imposed on the businesses since the AER made its draft decision. These obligations are directly linked to concerns over the management of vegetation and line clearance following the 2009 Victorian bushfires.

The impact of higher financing costs is also significant. The global financial crisis has significantly increased financing costs (debt and equity) for all networks, which has increased the revenues for network businesses by nearly 10 per cent. The capital drivers for gas distribution networks are broadly similar to electricity distribution. The AER’s recent determination for the New South Wales gas networks approved higher capital expenditure to meet demand growth and maintain network capacity.

Energy customers will look to network businesses to make sustained efforts to translate rising investment and operating costs into stable or improving reliability outcomes. In light of this, the AER is developing an enhanced national information framework to facilitate its regulatory oversight of network businesses. This includes making the businesses more publicly accountable for the way they spend their regulatory allowances and improving the transparency of regulated outcomes.