2020 Inflation Review - Technical workshop... · 2020 Inflation Review 13 August 2020 Jonathan...
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aer.gov.au 1 2020 Inflation Review 13 August 2020 Jonathan Seymour, Assistant Director Robyn Pickering, Director Warwick Anderson, General Manager, Networks Finance & Reporting Technical workshop
Transcript of 2020 Inflation Review - Technical workshop... · 2020 Inflation Review 13 August 2020 Jonathan...
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2020 Inflation Review
13 August 2020Jonathan Seymour, Assistant DirectorRobyn Pickering, DirectorWarwick Anderson, General Manager, Networks Finance & Reporting
Technical workshop
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Workshop purpose• Opportunity to model a range of scenarios
presented in stakeholder submissions on the treatment of inflation in the regulatory framework.
• Focus discussions on:– Outcomes of scenario– Impacts on consumers, NSPs and investors– Transitional matters– Rule change requirements.
• Workshop in no way pre-empts the AER’s draft position. This will be released on 30 September.
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Agenda
• Process for change• Modelling of alternatives
– Base assumptions– Estimation approaches (model change)– Alternate targets (framework change)
• Questions and issues
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Model change or Rule change
• Change to estimation method requires change to PTRM.
• Framework change (change of target) requires change to NER (and possibly NGR).– Amount of rules requiring change depends on
the change and how it is applied.
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Base scenario
• Current approach to RFM, PTRM and pricing• PTRM:
– Nominal rate of return applied to RAB indexed for expected inflation
– Expected inflation of RAB removed from depreciation– Real expected rate of return (nominal less expected
inflation) drives revenues.• RFM:
– Updates the RAB for actual capex and actual inflation.– Closing RAB forms the base for revenues in PTRM.
• Pricing:– Applies CPI-X in each year except first– i.e. Real expected revenue updated for actual inflation.
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Current approach
• If expected inflation 2.25% and actual inflation was 1.5%
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1 2 3 4 5Forecast RAB - at decision (RHS) Actual RAB - after roll forward (LHS)
Expected revenue - at decision (RHS) Actual revenue - after pricing (LHS)
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Alternative approaches modelled
• Estimation methods:– 5 year estimate (2 years SMP + mid-point)– Glide path (linear from year 2 to year 6)– Glide path + 5 year (2y SMP, glide to 2.5 at y5)– Market estimate (BBIR/ZCIR)
• Framework/target:– Hybrid target (nominal RoD, real RoE):
• Weighted CPI in Pricing and RFM– Nominal target
• Annual update/true-up (no expectation)
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Assumptions
• Opening RAB = $6 billion• Capex to offset depreciation (constant $real
RAB)• No Opex• Tax lives = RAB lives• Return on Debt = 4.30% all years• Return on Equity = 5.00%• Return on Capital = 4.58% (60% gearing)
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Estimation methods
• Below shows the outcomes of applying different RBA-based methods to estimate expected inflation.
• 10y inflation swaps and 5yr glide both around 1.80%
Year Estimate Source Outcome Year Estimate Source Outcome Year Estimate Source Outcome Year Estimate Source Outcome1 1.00% RBA SMP 2.25% 1 1.00% RBA SMP 2.00% 1 1.00% RBA SMP 2.10% 1 1.00% RBA SMP 1.80%2 1.50% RBA SMP 2 1.50% RBA SMP 2 1.50% RBA SMP 2 1.50% RBA SMP3 2.50% RBA mid-band 3 2.50% RBA mid-band 3 1.75% glide 3 1.83% glide4 2.50% RBA mid-band 4 2.50% RBA mid-band 4 2.00% glide 4 2.17% glide5 2.50% RBA mid-band 5 2.50% RBA mid-band 5 2.25% glide 5 2.50% RBA mid-band6 2.50% RBA mid-band 6 2.50% RBA mid-band7 2.50% RBA mid-band 7 2.50% RBA mid-band8 2.50% RBA mid-band 8 2.50% RBA mid-band9 2.50% RBA mid-band 9 2.50% RBA mid-band
10 2.50% RBA mid-band 10 2.50% RBA mid-bandEx-ante rate of return = 2.28% Ex-ante rate of return = 2.53% Ex-ante rate of return = 2.43% Ex-ante rate of return = 2.73%
5 year + glide/swapsLinear glide path (2.5 @y6)Current AER estimation approach 5 year RBA approach
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Random inflation (around 2.4% on average)
• Ex-ante and ex-post returns:Rate of return Nominal
ex-anteNominal ex-post
Realex-ante
Realex-post
Base (2.25%) 4.58% 4.70% 2.28% 2.25%5 year (2.00%) 4.58% 4.94% 2.53% 2.48%10y Glide (2.10%) 4.58% 4.84% 2.43% 2.38%Swaps (1.80%) 4.58% 5.13% 2.73% 2.66%
Return to Equity Nominalex-ante
Nominal ex-post
Realex-ante
Realex-post
Base (2.25%) 5.00% 5.32% 2.69% 2.84%5 year (2.00%) 5.00% 5.94% 2.94% 3.43%10y Glide (2.10%) 5.00% 5.69% 2.84% 3.20%Swaps (1.80%) 5.00% 6.43% 3.14% 3.90%
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Cash flows to debt and equity
• Assuming random inflation:
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Base case Interest payments Base case Cash flow to Equity5 year Interest payments 5 year Cash flow to EquityExpected CF to Equity
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Random inflation (not so random)
• Reflects actual inflation from 2002 (post-GST) back then reversed, then forward.
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Consistently lower than expected inflation (1.5%)
• Ex-ante and ex-post returns:Rate of return Nominal
ex-anteNominal ex-post
Realex-ante
Realex-post
Base (2.25%) 4.58% 3.87% 2.28% 2.34%5 year (2.00%) 4.58% 4.11% 2.53% 2.57%10y Glide (2.10%) 4.58% 4.02% 2.43% 2.48%Swaps (1.80%) 4.58% 4.30% 2.73% 2.76%
Return to Equity Nominalex-ante
Nominal ex-post
Realex-ante
Realex-post
Base (2.25%) 5.00% 3.24% 2.69% 1.71%5 year (2.00%) 5.00% 3.83% 2.94% 2.29%10y Glide (2.10%) 5.00% 3.59% 2.84% 2.06%Swaps (1.80%) 5.00% 4.30% 3.14% 2.75%
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Real returns to capital and equity (1.5% actual)
• Ex-ante and ex-post real returns:
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Base case 5 year Glide path Swaps
Real return to capital ex-ante Real return to capital ex-post
Real return to equity ex-ante Real return to equity ex-post
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Cash flows to debt and equity
• Assuming 1.5% inflation:
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Base case Interest payments Base case Cash flow to Equity5 year Interest payments 5 year Cash flow to EquityExpected CF to Equity
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Revenue profiles (1.5% actual)
• Nominal revenues:
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Base case 5 year Glide path Swaps
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Bill impact (1.5% actual)
• Profile of customer bill ($real)
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Base case 5 year Glide path Swaps
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Volatility (random inflation)
• Inflation assumptions:
• Real vs nominal revenue
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Impact of annual pricing
• In all scenarios presented the approach to pricing is unchanged (CPI-X).
• First year set equal to PTRM, subsequent years updated for actual inflation.
• Short term actual cash flows therefore do not reflect the PTRM estimate (unless actual = expected).
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Impact of Pricing
• If CPI-X is not applied to annual pricing.• Impact on returns (1.5% inflation):
Rate of returnNominal Real
Ex-ante Ex-post Ex-postNo CPI-X Ex-ante Ex-post Ex-post
No CPI-XBase (2.25%) 4.58% 3.87% 3.99% 2.28% 2.34% 2.46%5 year (2.00%) 4.58% 4.11% 4.19% 2.53% 2.57% 2.65%Swaps (1.80%) 4.58% 4.30% 4.35% 2.73% 2.76% 2.81%
Return to EquityNominal Real
Ex-ante Ex-post Ex-postNo CPI-X Ex-ante Ex-post Ex-post
No CPI-XBase (2.25%) 5.00% 3.24% 3.54% 2.69% 1.71% 2.01%5 year (2.00%) 5.00% 3.83% 4.03% 2.94% 2.29% 2.49%Swaps (1.80%) 5.00% 4.30% 4.42% 3.14% 2.75% 2.88%
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Alternate targets
• Hybrid target– Nominal debt target – real equity– Can be achieved by applying weighted CPI in Pricing
and RFM (60% exp | 40% actual).– CEG modelled only change to RFM
• Hybrid + market measure– ENA/APGA approach– Modelled with same RoD and RoE term.
• Nominal target– Updates PTRM for actual inflation impact each year
(no need for forecast).• Multitude of alternate modelling.
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Hybrid - Weighted CPI
• If expected inflation is 2.5% and actual is 1.5%:– Weighted CPI = 2.1%– Pricing applies this rate as CPI-X for each year– RFM applies this rate to indexation of entire RAB.
• Issues:– RAB not maintained in correct $real terms.– Gearing may diverge from 60% if average inflation
=/= expected inflation.
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Nominal - Updated
• PTRM updated each year (as per debt update) but also for actual inflation for previous year.
• No need to forecast inflation (other than for presentation of nominal revenues).
• Revenues move more year-to-year (may be mitigated somewhat with revenue smoothing)
• No need to apply CPI-X at pricing, just take revenues from PTRM.
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Alternate targets - Random inflation
• Ex-ante and ex-post returns:Rate of return Nominal ex-
anteNominal ex-post
Realex-ante
Realex-post
Base 4.58% 4.70% 2.28% 2.25%Hybrid (weighted) 4.58% 4.57% 2.28% 2.13%Hybrid + swaps 4.58% 4.84% 2.73% 2.38%Nominal -updated 4.58% 4.58% 1.56% 2.14%
Return to Equity
Nominal ex-ante
Nominal ex-post
Realex-ante
Realex-post
Base 5.00% 5.32% 2.69% 2.84%
Hybrid (weighted) 5.00% 5.00% 2.69% 2.54%
Hybrid + swaps 5.00% 5.61% 3.14% 3.12%
Nominal -updated 5.00% 5.01% 1.96% 2.14%
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Alternate targets - low inflation (1.5%)
• Ex-ante and ex-post returns:Rate of return Nominal ex-
anteNominal ex-post
Realex-ante
Realex-post
Base 4.58% 3.87% 2.28% 2.34%Hybrid (weighted) 4.58% 4.22% 2.28% 2.68%Hybrid + swaps 4.58% 4.42% 2.73% 2.88%Nominal -updated 4.58% 4.58% 3.03% 3.03%
Return to Equity
Nominal ex-ante
Nominal ex-post
Realex-ante
Realex-post
Base 5.00% 3.24% 2.69% 1.71%
Hybrid (weighted) 5.00% 4.09% 2.69% 2.55%
Hybrid + swaps 5.00% 4.61% 3.14% 3.06%
Nominal -updated 5.00% 5.00% 3.45% 3.03%
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Alternate targets - real returns (1.5% inflation)
• Ex-ante and ex-post real returns:
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Alternate targets – 1.5% inflation
• Revenues:
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Base case Hybrid (weighted CPI)Hybrid + swaps Nominal (updated)
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Alternate targets - Bill impact
• $real customer bill profile (1.5% actual)
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Base case Hybrid (weighted CPI)Hybrid + swaps Nominal (updated)
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Volatility (random inflation)
• Inflation assumptions:
• Real vs nominal revenue
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Volatility in bills
• Nominal updated leads to volatility as all revenue updated each year for actual inflation.
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Base case Hybrid (weighted CPI)Hybrid + swaps Nominal (updated)
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Questions?
• Is a transition required if a change is made?
• Should consumers pay for inflation risk premium (CEG)
• We see ‘inflation risk’ as the impact on purchasing power of returns and costs. Maintained under current real target.– How does hybrid/nominal change this?– NSPs are already compensated for ‘cash flow
inflation risk’.– How does change to hybrid/nominal change this? Is
change to equity beta required as well?
