Getting Ready! Potential issues for consumers Ergon Distribution Network Regulatory Proposal Bev Hughson, Consumer Challenge Panel (CCP) 2 September 2014.

Getting Ready!

Potential issues for consumers Ergon Distribution Network Regulatory

Proposal

Bev Hughson, Consumer Challenge Panel (CCP)2 September 2014

The data and charts in this presentation are based on the information provided by Ergon to the Australian Energy Regulator in its 2006-13 Economic Benchmarking Regulatory Information Notice

(Consolidated), 30 April 2014, Public Version. The author cannot vouch for the accuracy of the information provided by Ergon in its Notice.

Agenda• Some background – Ergon is special! – The regulatory dance

• Revenue trends• Capital requirements– The RAB– Demand forecasts– Growth, Replacement & Reliability capex

• Operating costs (opex)• Return on capital (WACC)• Wrap up – some key questions to ask

A Regulatory Reset The things that matter

• The total revenue that the AER allows Ergon– This is today’s topic– We are looking at history – to help us assess future

• The way Ergon allocates this revenue in their prices – very important, but for another day

• The way prices change across the 5 years– The big jump (up usually, down if your lucky)– Or smooth across the years

• How Ergon engages with their customers in making these decisions

A warning: Ergon is a special case!• Non-Ergon regions (Qld SE, NSW, Vic, SA)

– Most customers don’t see a network price in their bill• But the retail price will be influenced by the size & structure of the

network tariff

– For larger customers the network price is a ‘pass-through’• Ergon is different

– Most customers have the same retail price as Energex• What Ergon does is not of concern (except to Govt)?

– However, larger customers (>100 MWh/year) do see Ergon’s network price• And, they are not all happy!• Tariff structures matter

– Will the status quo change?– Importance of the very large high voltage (HV) customers

Ergon’s reliance on High Voltage Demand Consumers

34%

6%

23%

37%

Ergon Energy Use 2012-13Residential Business LV Demand HV Demand

37%

10%25%

27%

Energex Energy Use 2012-13Residential Business LV Demand HV Demand

The regulatory dance

The regulatory dance• We have a “propose-respond” regulatory model

– Important because it defines the roles of the networks & the AER (and consumers – more on this later)

– Step 1: Ergon “proposes” to the AER• Revenue requirements, based on:• Forecast capital and operating expenditure, return on assets, depreciation, tax costs, incentive

payments, tariff strategy

– Step 2: The AER responds (“Draft Determination)• Yes, no, maybe yes if you fix up this and that

– Step 3: Ergon amends their proposal– Step 4: The AER approves or rejects (“Final Determination”)– Step 5 (A): Ergon accepts, and publishes tariffs, or – Step 5(B): Ergon rejects and takes the issue to the Competition Tribunal

• Where do consumers fit in? Where is the most impact?– Talking to Ergon before the proposal?– Making submissions after the proposal?– Responding to the AER’s Draft Determination? – Other?

• Culture shock! Are all the players ready for a brave new world

Reading the Crystal Ball• Things we need to do before we start:– Learn from history– Forecast energy use– Forecast customer numbers– Forecast average use/customer– Forecast technology change– Forecast government policies– Forecast input prices (labour/materials)– Forecast the weather…

• These forecasts will underpin revenue, tariffs, capex and opex– See later slides

What’s happening to Revenue?

2006 2007 2008 2009 2010 2011 2012 20130

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

Ergon Revenue by Customer Class

Residential Moving average (Residential ) Non Res Volume TariffsLV Demand Tariffs HV Demand Tariffs

Reve

nue

($00

0s)

Ergon’s revenue per customer accelerates – but not for all (truly strange!)

2006 2007 2008 2009 2010 2011 2012 2013 -

200

400

600

800

1,000

1,200

1,400 ERGON: Revenue per customer

(Volume Tariffs)

Residential Non Res Volume Tariffs

Ave

rage

Rev

enue

/Cus

tom

er ($

/cus

tom

er)

2006 2007 2008 2009 2010 2011 2012 2013 -

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

-

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

ERGON: Revenue per Customer (Demand Tariffs)

LV Demand Tariffs (LHS)

HV Demand Tariffs (RHS)

LV D

eman

d Ta

riff

s A

vera

ge $

/Cus

tom

er

HV

Dem

and

Tari

ff A

vera

ge $

/Cus

tom

er

What determines the revenue allowance next reset?

• Capital costs – now over 70% of costs– Opening regulatory asset base (RAB)

• Plus capital investment (Capex)• Plus inflation adjustment• Minus depreciation

– Closing RAB– Rate of Return on asset base

• Operating Costs (Opex)• Tax allowance • Incentive scheme payments (+/-)

How much capital & for what return• Assess the regulatory asset base for each year

– What is the capital expenditure (capex) each year?– Is it prudent and efficient?– Is it growth, replacement, or reliability capex?

• Growth: Forecasts of energy demand, peak demand & customers• Replacement: Assess age & condition of network• Reliability: Assess service performance (time off supply etc)

• What is the rate of return on asset base– Return on equity (shareholder) & – Return on debt

• What is the credit rating of the DNSP?• What is the business risk profile?

– Should government ownership make a difference?

Capex keeps driving the RAB

2006 2007 2008 2009 2010 2011 2012 2013 3,000

4,000

5,000

6,000

7,000

8,000

9,000

400

450

500

550

600

650

700

750

800

850

900

ERGON: Asset Base & Capex

Regualated Asset Base (mid-yr) (LHS) Regulated Capex (RHS)

Regu

late

d A

sset

Bas

e ($

M)

Regu

late

d Ca

pex

($M

)

And per customer: Ergon’s RAB is bigger & growing faster

2006 2007 2008 2009 2010 2011 2012 2013 -

2,000

4,000

6,000

8,000

10,000

12,000

14,000

f(x) = 688.913727923186 x + 6528.95098801956R² = 0.998593973257353

f(x) = 493.292020220287 x + 3272.95723546861R² = 0.996612555797228

Ergon & Energex: Regulated Asset Base/Customer

Ergon RAB/customer Linear (Ergon RAB/customer)Energex RAB/customer Linear (Energex RAB/customer)

RAB/

cust

omer

($)

Growth capex: What’s happening to demand?

2006 2007 2008 2009 2010 2011 2012 2013 -

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

Ergon: Total Annual Demand (GWh)

Residential Non-residential vol tariffLV demand tariff HV demand tariff

Annu

al D

eman

d (G

Wh)

2006 2007 2008 2009 2010 2011 2012 2013 -

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

Energex: Total Annual Demand (GWh)

Residential Non-residential vol tariffs LV demand tariffs HV demand tariff customers

Annu

al D

eman

d (G

Wh)

Ergon is only network where there is no big decline in residential volumes?

What’s behind the demand trends?

2006 2007 2008 2009 2010 2011 2012 2013 -

100,000

200,000

300,000

400,000

500,000

600,000

700,000

f(x) = 9441.52380952381 x + 520940.142857143

Ergon: Customer Number Growth

Residential Linear (Residential )Total all others Linear (Total all others)

2006 2007 2008 2009 2010 2011 2012 2013 -

5.0

10.0

15.0

20.0

25.0

8.4 8.3 8.6 8.2 8.5 7.9 8.0 7.6

21.6 21.4 21.3 21.3 21.1 19.2 19.6 19.0

Ergon: Average Use per Customer

Residential use/CustomerTotal use/Customer

Aver

age

Annu

al E

nerg

y Us

e (M

Wh)

Decline in residential use from 2009-10 is only 7.3%. Energex is 15.6%

Growth Capex: Peak demand a bit of a question mark?

2006 2007 2008 2009 2010 2011 2012 2013 2,000

2,100

2,200

2,300

2,400

2,500

2,600

2,700

2,800

2,900

Coincident Maximum Demand (MW)Weather Normalised

Coincident Max Demand 10% POE Coincident Max Demand 50% POE

Max

imum

Dem

and

(Wea

ther

adj

uste

d) (M

W)

Growth & replacement capexHow much more improvement required?

2006 2007 2008 2009 2010 2011 2012 201320.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

3.00%

3.50%

4.00%

4.50%

5.00%

5.50%

6.00%

6.50%

7.00%

Ergon & Energex : System Utilisation & Energy Losses

Ergon Utilisation (LHS) Energex Utilisation (LHS)Ergon System Losses (RHS) Energex System Losses (RHS)

Util

isati

on (%

)

Syst

em L

osse

s (%

)

Getting younger by the year

2006 2007 2008 2009 2010 2011 2012 20130.0

5.0

10.0

15.0

20.0

25.0

30.0

Ergon: Average Age of Assets

O/H wires & poles (<33kv)O/H wires & poles (>33kv)Network substations/transmformerZone substantions & TransformersMeters

Age

of a

sset

s (y

ears

)

2006 2007 2008 2009 2010 2011 2012 20130.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

Ergon: Residual Life of Assets

O/H wires & poles (<33kv)O/H wires & poles (>33kv)Network substations/transmformerZone substantions & TransformersMeters

Resid

ual l

ife (y

ears

)

Reliability CapexAre there still performance issues?

2006 2007 2008 2009 2010 2011 2012 2013 -

500

1,000

1,500

2,000

2,500

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Ergon: SAIDI & SAIFI Performance Measures

Total SAIDI (LHS) Underlying SAIDI (LHS)Total SAIFI (RHS) Underlying SAIFI (RHS)Linear (Underlying SAIFI (RHS))

SAID

I: M

inut

es/C

usto

mer

Off

Sup

ply

SAIF

I: N

umbe

r of

inte

rrup

tions

/Cus

tom

erEnergex average SAIFI is less than 1.5

Energex average SAIDI is less than 100 minutes

Do we see improvements in opex?

2006 2007 2008 2009 2010 2011 2012 20130

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

0

100

200

300

400

500

600

700

Ergon: Total Operating Costs & Opex/Customer

Total Opex (LHS) Total Opex exc FIT (LHS)Opex/Customer (RHS) Opex/Customer (Exc FIT)(RHS)

Ope

ratin

g Co

sts

($00

0s)

Ave

rage

Ope

x/Cu

stom

er ($

)

Feed-In Tariffs for Solar PV adding a $100/year/customer to opex by 2012-13

Ergon & Energex Opex & the FIT(and a corrigendum)

2006 2007 2008 2009 2010 2011 2012 20130

100

200

300

400

500

600

700

Ergon & Energex: Average Operating Costs/Customer

ERGON Opex/Customer ERGON Opex/Customer (Exc FIT)Energex Opex/Customer Energex Opex/Customer exc FIT

Ave

rage

Ope

x/Cu

stom

er ($

/Yea

r)

Rate of Return (WACC) -a new approach?

• Most networks seen very rapid price increases & currently very high profits – 2012-13 changes to Rules

• Cost of Debt (60% WACC): – AER new approach - move to 10 year average of 10-year tenor

bonds over a ten year transition period – disputed– Credit rating (BBB+), and data sources - disputed

• Cost of Equity (40% WACC)– Cost of equity = [risk free rate + (MRP * beta)] - disputed– Risk free rate assessment (about 3.5% at this time) - disputed– Market Risk Premium (6.5%) - disputed– Equity beta (0.7) – disputed

• Imputation Credits (adjust the tax cost allowance) –disputed

Cost of Capital – going down… (cost of debt*0.6)+(cost of equity*0.4)

2010-2015 cost of debtApprox 8.98%

2016-2020Cost of Debt?Ergon’s reported weighted average cost of debt (12/13) is 7.31%

2016-2020Input to Cost of Equity?

Cost of Equity Regulatory BenchmarksSource: AER Explanatory Statement RoR Guideline, Appendix C, p 32

NSW NSP’s proposing 10.1%; AER NSW Transitional Determination 8.9%

The bottom line & why you should care

20062008

20102012

20142016

20192021

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

400

600

800

1,000

1,200

1,400

1,600

Ergon: RAB trend growth & "interest" bill per customer

(interest rate 7.5%)

Interest Bill Ergon RAB/customer

RAB/

Cust

omer

($)

Ann

ual i

nter

est

bill/

cust

omer

20062008

20102012

20142016

20192021

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

400

600

800

1,000

1,200

1,400

1,600

Ergon: RAB trend growth & "in-terest" bill per customer ( in-

terest rate (8.83%))

Interest Bill Ergon RAB/customer

RAB/

Cust

omer

($)

Ann

ual I

nter

est

Bill/

Cust

omer

Forecast RAB & “Interest “rate figures are estimates – for illustration purposes only

Summary of Issues to Watch• Are the forecasts reasonable?• Is the capex prudent and efficient?• Is the opex prudent and efficient?

– 2012/13 will be the base year for next period• Is the cost of capital reasonable given economic conditions?

– Consistent with risk, and fair to consumers– Provide the right incentives for efficient investment

• Efficiency schemes (opex and capex)?– A problem unless AER sets tight allowances– Witness NSW distribution companies…

• Have consumers been adequately engaged in the decisions by the networks and the AER?