ACCC Forum on Draft Statement of Principles for Transmission Regulation – New Investment Roman Domanski Executive Director Energy Users Association of.

ACCC Forum on Draft Statement of Principles for

Transmission Regulation – New Investment

Roman Domanski

Executive Director

Energy Users Association of Australia

Melbourne, 2nd April 2004

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Contents

Setting of Capex Basis for new and replacement investment

“Ex ante Cap” approachRegulatory TestService standardsInvestment in new technology

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Setting Capex

ACCC’s preferred position to adopt Regulatory Test when assessing & reviewing capex program. But, evidence suggests that TNSPs seek to

increase short-term profitability by cutting costs below revenue benchmarks, including by reducing and putting off capex as long as possible.

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Setting CapexNo mention in Discussion Paper of observed CAPEX

‘spending habits’ of TNSPs based on 4 regulatory reviews conducted since of 1999.

Comparing forecast & actual CAPEX undertaken routinely by UK regulators to assess prudency of past & efficiency of future CAPEX Clear that regulated companies always seek to increase profit by

reducing costs below revenue benchmarks TransGrid reporting actual CAPEX spending some $155.1m (or

13%) above that forecast in 1999/2000 due to “unforeseen” circumstances

ACCC will need to assess if this is “prudent” and TransGrid’s forecasting skills are up to the mark

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Setting Capex

ACCC needs to confirm it will treat differences between forecast & actual CAPEX in a symmetrical manner when it is rolled into the regulated asset base TNSPs permitted to retain benefits of ‘out-performing’

revenue benchmarks, which include benefits from under-spending CAPEX

Where ‘required’ to over-spend CAPEX, they should only be entitled to roll-in efficient actual CAPEX and not be ‘compensated’ for ‘holding costs’ associated with over-spent amount

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Setting Capex

Jurisdictional regulators have required NSPs to ‘wear the cost’ of depreciation and return on CAPEX over-spend even where over-spent amount deemed ‘prudent’ or ‘efficient’

Symmetrical treatment of CAPEX efficiency gains provides clear incentive for TNSPs to focus attention on accurate forecasting, on mechanisms to achieve most efficient outcomes and is consistent with competitive markets

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Strategic Behavior

Incentive for regulated companies to overstate forecast costs (and under-forecast sales)

If forecasts accepted by regulators, the companies are able to increase profits by achieving lower than forecast actual costs (or higher prices) and then claim this as an ‘efficiency gain’, which it clearly is not

ACCC does not mention how it will deal with ‘strategic behaviour’, widely recognised as a major negative feature of ‘incentive regulation’

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Evidence of Strategic Behavior

Evidence of how it occurs presented in submission Regulated companies reduce CAPEX early in regulatory

period as profits increase by delaying CAPEX Substantially overstate CAPEX in forecasts, regulators

‘prune’ back forecasts and companies generally still ‘out-perform’ the regulators’ benchmarks

CAPEX spending rises towards end of regulatory period as companies react to the looming prospect of actual CAPEX being rolled into the asset base and address need to construct assets deferred earlier

Exposes end user to higher costs, lower reliability

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UK Approach

UK regulators make judgements on efficient level of CAPEX based on technical and econometric analysis of actual and forecast expenditure Rely on profit maximisation incentives to produce

efficient outcomesWhere they have provided substantially increased

CAPEX, have generally only required utilities to publish information comparing actuals & forecasts Used this information to inform their judgements on

efficiency and ‘strategic’ behaviour at next reset. EUAA would prefer that SRP moved closer to UK

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ACCC’s Approach & End Users

Strong evidence that "incentives" in incentive regulation don’t work as intended If TNSPs can increase profitability by changing forecast

spending, they will Eg, finding lower cost ways of delivering same OUTPUT and

deferring CAPEX as long as possibleACCC's proposals will not bring regulation of TNSPs

anywhere near to "incentives" in UK  UK regime focuses almost entirely on "incentives" for NGC

to ensure "value" to users Regulatory Test, even in modified form, still focused on

inputs

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ACCC’s Approach & End Users

If ACCC really wants to move closer to UK model, must shift focus from analysis of inputs to "incentives" to deliver efficient inputs and concentrate analysis of inputs on how effective inputs have been in delivering "efficient" output

Should improve analysis of forecast inputs (ex-ante) to ensure rewards from "strategic behaviour" minimised

No evidence that end users well served by current arrangements

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Ex Post v’s Ex Ante Assessment

ACCC proposes to subject TNSPs’ execution of Regulatory Test to ex-ante and ex-post reviews so as to evaluate whether or not TNSPs actual CAPEX is ‘prudent’ and forecast CAPEX ‘efficient’ This seems to be micro-managing TNSPs’ CAPEX or even

putting pressure on them to spend CAPEX because it has been approved

Could shift responsibility for investment decisions away from TNSPs who are in best position to make such decisions Reduce incentives for CAPEX efficiency savings

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Comments on Regulatory Test

Focuses attention on "satisfying the regulator", rather than focussing TNSPs on achieving outcomes that deliver efficient services to users

No such thing in UK or in distribution No evidence that this hasn’t delivered more effective

outcomes to users than RT If ACCC got the incentives right, couldn’t we get rid of

RT? If it stays it should be altered to focus on benefits to

those that pay (end users) and limiting appeal rights

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Service Standards

Basis for delivery of reliable and competitive energy to end users (who pay TUoS) Linked to need for capex

Current regime next to uselessACCC has been sitting on issue for too long

Now a process in place, but will it deliver anything useful to end users?

Seems to be bogged down and in need of more leadership/direction

Not good enough to offer ‘creeping incremetalism’ to end users

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New Technology & Innovation

Becoming more apparent that ‘incentive’ regulation in Australia not material in fostering technological change & innovation by NSPs

No incentive to ‘modernise’ the grid eg, measure behavior in real time, use devices and

information to control power flows, upgrades to pump more juice through, produce and store power closer to consumers, demand management initiatives

Regulators need to pay more attention to this Create incentives for TNSPs to be more innovative in

delivering power more reliably and economically