Reform crossroads

By James Dillon

Distribution and transmission utilities investing in future reliability are under fire for rising electricity prices. With the final draft of the Federal Government’s Energy White Paper approaching and a new round of determinations on the calendar, Energy Source & Distribution examines the reform catharsis needed to strengthen public confidence in the industry.

The energy industry has weathered its share of negative electricity price debate. In 2010, public interest appeared to reach fever pitch as the Victorian smart meter rollout sparked privacy concerns and threatened pensioners’ pockets. But as electricity prices continue to rise, relations between government and industry recently plunged to new lows.

Addressing the Energy Policy Institute of Australia (EPIA) in August, Prime Minister Julia Gillard blamed state governments for profiting from electrical generation and challenged the energy industry to change. New South Wales and Queensland have reaped ample revenue through electricity and need to do more to cut future price rises, Ms Gillard stated. Large network inefficiencies and excessive regulated prices within the “pragmatic, patchwork design” of the National Electricity Market will be weeded out through the implementation of energy market reforms. Efficient investments must be made, and a push for states to come to an agreement through the Council of Australian Governments can be expected before the end of the year.

“At the bottom of all this is this economic reality: the market for supplying energy services in Australia needs to be more efficient,” Ms Gillard said.

Following the Prime Minister’s speech, Federal Minister for Finance and Deregulation Senator Penny Wong announced the creation of a Senate select committee to identify the key causes of electricity price increases over recent years and into the future. The government proposes the committee deliver its final report on or before November 1, 2012.

Clean Energy Council CEO David Green said insufficient competition, incentives to build expensive infrastructure rather than reduce power demand and the limited ability for consumers to be rewarded for being more energy efficient have led to the current situation. Effective energy market reform could help free vulnerable consumers and businesses from the “tyranny of rising power prices”.

“Australia has started work on a National Energy Savings Initiative that will help to reward people for using less power. We need to accelerate processes like these and move towards a smarter energy system which allows consumers to make the most of the energy we all need to use,” Mr Green said.

“The reality is that the energy market we have had for the last few decades cannot be the system we have for the coming decades.”

The COAG meeting at the end of the year will be a critical opportunity to embrace reform, Mr Green said.

“These are changes which can not only help to contain price rises for consumers, but unlock the economic, social and environmental benefits of cleaner, smarter energy systems.”

Energy Networks Association (ENA) CEO Malcolm Roberts shares this spirit for reform, but believes that blame for rising prices should not be levelled so squarely at state governments and network utilities. Higher network costs are symptoms of deeper problems – hidden cost pressures in electricity markets, he argues.

Speaking at the Australian Energy & Utility Summit 2012 in June, Mr Roberts outlined the factors in play – including peak demand, supply reliability, asset expenditure and debt risk premiums – and how changing the economic regulation applied by the Australian Energy Regulator (AER) would have little effect on these underlying causes for higher network costs. Other factors, such as the impact of green schemes, the cost of installing smart meters in Victoria, connecting more than 430,000 PV panels in only two years and falling volumes carried over the networks, are all adding to the final bill to consumers.

Distribution reliability outcomes are currently set separately for each of the National Electricity Market (NEM) jurisdictions by regulators, relevant government bodies or distribution network service providers (DNSP) under different frameworks that are in place for each. According to Mr Roberts, the Australian Energy Market Commission (AEMC) admits there is a lack of consistency and transparency in how distribution reliability outcomes are determined.

“Is there merit in developing a nationally consistent framework for expressing, delivering, and reporting on distribution reliability outcomes?” he asked at the summit.

In an August opinion article published in The Australian, Mr Roberts said Ms Gillard was “kicking scapegoats” in her EPIA speech and needed to look at reform as an opportunity for positive change.

“In short, the energy market needs another round of commonwealth-state reforms to boost competition, innovation and productivity,” Mr Roberts states.

“Reforms should concentrate on supporting consumers with the tools and incentives to make cost effective choices.”

According to the Sydney Morning Herald, an independent member of the reference group advising the Federal Government on the Energy White Paper also contradicts the Prime Minister’s assertion that the states are to blame.

‘”It’s all very well for the Prime Minister to say ‘you’ve been doing it wrong’. No they haven’t. They’ve been doing it within the rules,” The Sydney Morning Herald reported University of Sydney energy and regulatory expert and former EnergyAustralia executive Lynne Chester as saying.

“It’s the rules that need fixing; the energy regulator needs the power to be able to scrutinise and reject over-inflated bids by companies for price rises,” Dr Chester said.

The AEMC proposed to reform the rules for setting prices for energy network businesses in late August. The draft ruling will allow the regulator to prevent the costs of inefficient, excessive upgrades to the network being passed on to customers in future. The AER considers that changes proposed to the National Electricity Rules would benefit electricity consumers and promote efficient network investment. The AER’s initial view of the AEMC’s proposed changes is that they would significantly improve the rules for setting prices for energy network businesses.

“Changes to the approach for setting operating and capital allowances give the regulator greater scope to reject excessive proposals. Clear authority to benchmark network business practices and costs will ensure customers are paying no more than necessary for the services they require,” AER chairman Andrew Reeves said.

The AEMC’s proposed changes would also provide the AER with greater scope to scrutinise investment spending by network businesses.

“While network businesses will be rewarded for undertaking efficient and necessary investment, consumers will not be required to ‘foot the bill’ for inefficient overspending,” Mr Reeves said.

The energy industry is no stranger to beneficial reform. Following the transformational reforms of the 1990s, electricity prices had risen due to increased network asset values and generator market power. It has been 10 years since the COAG-commissioned Parer Review identified market savings in the National Electricity Market. The independent review of stationary energy market identified serious deficiencies in governance, regulation, the electricity pool system, generator competition and regulatory uncertainty. All had serious consequences and needed to be fixed.

Since that time, the AER has been created, interstate transmission lines have been built and major benefits have been delivered to energy customers. The current system, described by the ENA as form of ‘guided discretion’, has given investors a high degree of regulatory certainty. The final result is a “comprehensive” assessment that locks in for five years the operating and capital budgets of a network business.

“All the key costs of a network business – operating expenditure, capital expenditure, costs of debt and equity – are open to analysis by the regulator. This ‘building blocks’ approach, used effectively in the UK and the US as well as Australia, ensures that all cost drivers are scrutinised closely,” Mr Roberts said.

The ENA has responded with caution to the latest draft proposed by the AEMC and approved by the AER.

“The drivers of higher network costs are outside the regulatory system, in particular rising peak demand, the need to replace ageing assets and higher debt costs after the global financial crisis,” Mr Roberts was reported as saying by The Australian.

“Changing the national rules will not change these drivers. Networks will still need to have the capacity to meet customer demand on hot summer days. Assets past their working lives will still need to be replaced. Businesses will still need to borrow capital at market rates.”

In a recent government submission, the ENA advocates for an “under-resourced and under-performing” AER to separate from the ACCC and become more focused on it’s core business.

“There is clear independent evidence that the AER is having difficulties with applying network regulation,” the submission states.

“The Australian Competition Tribunal has found material and reoccurring errors in many AER network pricing determinations.

“The AER itself has conceded errors on its part in more than one-third of all matters raised by parties.”

The material errors relate to fundamental issues, such as the use of relevant evidence, correct interpretation and application of accepted statistical techniques, and the application of logically consistent principles to derive conclusions from empirical evidence.

“These errors are not due to uncertain evidence or a justifiable difference of opinion on a discretionary issue. Rather, they represent failures in decision-making and analysis.”

Federal and state governments find themselves having to choose between high standards of reliability while being pressured to reduce electricity costs. Network regulation is being analysed by several major reviews, such as the government’s Energy White Paper due before the end of the year, while the AEMC is reviewing peak power demand as well as considering rule changes for the east coast market. The Power of Choice report promises to be a landmark document, while a round of price determinations starting next year will begin setting prices for years to come. Wise reform targetting the appropriate areas will hopefully bring better efficiencies and clearer direction for an industry already being turned on its head by technological innovation.

REGULATOR UNDERPERFORMANCE

A “troubling indicator” of the AER’s “underperformance” is the results of its most recent stakeholder survey, according to the Energy Networks Association (ENA) in its submission to the Productivity Commission Review of Electricity Network Regulation in July.

“Responses from a broad range of stakeholders suggest that, on many self-selected measures of performance, the AER is experiencing difficulties,” ENA CEO Malcolm Roberts stated in the document submitted to presiding commissioner Philip Weickhardt.

The AER stakeholder surveys rated AER performance across metrics such as ‘professionalism’ and ‘quality of outputs’ in 2008 and 2011. Across all 12 measures of performance, stakeholders rated the AER’s performance more favourably in 2008 than in 2011, the ENA points out.

“Critically, the three metrics returning the least favourable ratings in 2011 were ‘understanding’, ‘quality of outputs’ and ‘technical competence’. The survey shows substantial declines on other key measures of performance,” Mr Roberts said.

The percentage of respondents rating the AER’s outputs as ‘good’ or ‘excellent’ fell from 62 per cent to 43 per cent. Ratings for ‘analytical/intellectual capacity’, and ‘professionalism’ declined sharply between 2008 and 2011. Ratings for reputational measures such as ‘credibility’, ‘reliability’ and ‘effectiveness’ also declined.

CONTROLLING EXPENDITURE

Speaking at the 10th Annual Energy & Utility Summit in June, ENA CEO Malcolm Roberts outlined four major factors affecting the energy industry.

  • Peak demand: Across national electricity networks, about $11 billion of infrastructure is used for the equivalent of four days a year, a costly investment in network capacity to meet peak demand. Flattening the growth of peak demand should be the priority for government action to eliminate substantial capital expenditure by networks.
  • Financial debt: The cost of debt for network businesses has spiked because of the global financial crisis. With the regulator assuming that the prudent and efficient level of gearing for network businesses is 60 per cent, changes to the approved return on debt have major cost implications.
  • Reliability: Consumers place a high value on reliable energy supply, but there is a clear conflict between guaranteeing high levels of reliability and minimising network costs. Therefore there is costly augmentations of the network to meet short lived spikes in demand; and rising unit costs of supply as higher costs are recovered from flat or falling volumes
  • Infrastructure investment: Cyclical reinvestment in network infrastructure to replace ageing assets; in New South Wales, expenditure on asset replacement will grow from 31 per cent of total capital expenditure in 2010-11 to 43 per cent in 2013-14.