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Australian Energy Regulator
Predetermination conference:
AER draft decisions on NSW electricity distribution regulatory
proposals 2015-19
8 December 2014
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AER draft decisions on NSW regulatory proposals
Warwick Anderson
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ContentsHigh level generalised presentationThe businesses The AER and our roleOverview of the proposals and draft decisionsKey driversMain elements
◦RAB◦Capex◦Opex◦Rate of return
Next steps
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The NSW distribution businesses
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Ausgrid’s service area
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Endeavour Energy’s service area
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Essential Energy’s servicearea
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Electricity industry structure
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Contribution to total bill
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The AER and our role
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The current processDraft decisions released on 27 Nov 2014 for:
◦4 distribution businesses (1 in ACT, 3 in NSW) ◦3 transmission businesses (2 in NSW, 1 in Tasmania)◦1 gas distribution business (Jemena Gas Networks NSW)
Final decisions due 30 April 2015 (Jemena a bit later)We are also assessing three regulatory proposals for Qld/SA
distribution businessesPreliminary decisions on the Qld/SA proposals are to be
released by 30 Apr 2015 and final decisions by 31 Oct 2015
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The NEO
Our task – to set a maximum allowance that the networks are permitted to recover from customers consistent with the NEO:
To promote efficient investment in, and efficient operation and use of, electricity services for the long term interests of consumers of electricity with respect to –◦Price, quality, safety, reliability and security of supply of
electricity; and◦The reliability, safety and security of the national
electricity system
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Better regulationExpenditure forecast assessment guidelineExpenditure incentives guidelineRate of return guidelineConsumer engagement guidelineShared assets guidelineConfidentiality guideline
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The proposals and AER draft decision
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AER draft decisionsNot to accept proposalsWe are not satisfied the proposals advance the NEO to the
greatest degreeInstead we have made draft decisions that we are satisfied
reflects the underlying driversWe see the influence of these drivers in the main
components of our draft decision
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Total revenue
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Total revenue - Ausgrid
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Total revenue – Endeavour Energy
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Total revenue – Essential Energy
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Key drivers
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Key drivers
Our draft decisions reflect the key drivers:Opportunities for services to be provided more efficientlyAssessment and management of riskDemandFinancial market conditions
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Key driver – efficiency
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Better Regulation benchmarking consultation started in 2012
Produced robust, consistent data setModels prepared by benchmarking consultant – Economic
InsightsOverall benchmarks (MTFP) indicate:
◦Productivity across the sector been in decline ◦VIC / SA DNSPs most productive◦NSW/ACT less productive
Key driver - efficiency
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Key driver – efficiency
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2006 2007 2008 2009 2010 2011 2012 2013
SA
VIC
QLD
NSW
ACT
TAS
MTFP Index
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Key driver – risk assessment and management
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Issues in risk assessment and management
Evidence that the businesses have overstated asset riskNSW government has adjusted reliability standardsIn addition, trend improvement in high level indicators of
risk on the networks◦Asset age◦Utilisation◦Service performance
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Residual asset lives – Ausgrid
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Network utilisation - Ausgrid
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Ausgrid SAIFI performance – CBD and urban
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Key driver - demand
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Summer peak demand – Ausgrid
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Key driver – financial market conditions
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Financial market conditions
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Main elements of the decision
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Elements• Regulatory Asset Base (RAB)• Capital expenditure (capex)• Operating expenditure (opex)• Rate of Return (RoR)• Meters• Public lighting
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Regulatory asset base (RAB)
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RAB• Our draft decisions provide for increases in the
businesses’ RAB• But at a lower rate than proposed
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RAB - Ausgrid
38
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
Opening RAB($m, nominal)
Actual (incl. meters) Proposed (excl. meters) Draft Decision (excl. meters)
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RAB – Endeavour Energy
39
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Opening RAB($m, nominal)
Actual (incl. meters) Proposed (excl. meters) Draft Decision (excl. meters)
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RAB – Essential Energy
40
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
Opening RAB($m, nominal)
Actual (incl. meters) Proposed (excl. meters) Draft Decision (excl. meters)
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Capital expenditure (Capex)
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CapexAugmentation expenditure (augex)
• Key drivers of augmentation expenditure are• maximum demand and • reliability standards
Replacement expenditure (repex)◦Replacing an asset with its modern equivalent where the
asset has reached the end of its economic life.
42
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Ausgrid – Augex
43
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19
100
200
300
400
500
600
700
Actual Ausgrid's Proposal AER Draft Decision
Capex($m 2013-14)
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Endeavour Energy – Augex
44
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19
50
100
150
200
250
300
Actual Endeavour Energy's Proposal AER Draft Decision
Capex($m 2013-14)
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Essential Energy – Augex
45
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19
50
100
150
200
250
300
350
Actual Essential Energy's Proposal AER Draft Decision
Capex($m 2013-14)
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Ausgrid – Repex
46
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19
100
200
300
400
500
600
700
800
900
1 000
Actual Ausgrid's Proposal AER Draft Decision
Capex($m 2013-14)
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Endeavour Energy – Repex
47
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19
50
100
150
200
250
Actual Endeavour Energy's Proposal AER Draft Decision
Capex($m 2013-14)
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Essential Energy – Repex
48
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19
20
40
60
80
100
120
140
160
180
200
Actual Essential Energy's Proposal
Capex($m 2013-14)
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Operating expenditure (Opex)
49
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Opex criteria
50
The opex criteria provide that the total forecast must reasonably reflect: ◦the efficient costs of achieving the operating expenditure
objectives◦the costs that a prudent operator would require to
achieve the operating expenditure objectives◦a realistic expectation of the demand forecast and cost
inputs required to achieve the operating expenditure objectives.
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OpexBase-step-trend approach
• Select an efficient base level• Typically the revealed cost in a particular year• In this case we have looked carefully at the efficiency of
the base year• Step changes to take account of external drivers such as
changes to regulatory obligations• Trend underlying costs such as labour cost escalations
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Base opex
52
In light of previous productivity estimates we have carefully reviewed the efficiency of the base opex of each business
Developed cost modelling and other detailed assessments◦ Accounts for customer density, demand density and underground
assets◦ Also considered voltages, asset age and climate
Peers in other states are able to provide safe reliable services at lower overall levels of opex
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Benchmarking
53
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Contributing factors
54
Labour and workforce management◦relatively inflexible workforces ◦Labour costs above peer costs◦Management of costs e.g. overtime◦Less outsourcing than more efficient peers
Full benefits of Networks NSW efficiency programs not reflected in base year
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Adjustment to base opex
55
The combination of evidence indicated that base opex for the NSW DNSPs could not be used as our starting point
Cost modelling and benchmarking used to determine scope of adjustment
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Step changes
56
Significant list of step changes from the 3 businessesLargely not accepted because they are internally generated
rather than external
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Rate of return
57
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Rate of Return
2009–14Decision
2015–19Ausgrid's proposal
2015–19AER draft decision
Nominal risk free rate (cost of equity)
5.82% 4.78% 3.55%
Nominal post–tax return on equity 11.82% 10.11% 8.1%
Nominal pre–tax return on debt 8.82% 7.98% 6.51%
Nominal vanilla WACC 10.02% 8.83% 7.15%
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Return on Equity (RoE)
59
No single objective measure of expected RoEEmploy a 6 step process to make use of all available
information according to its meritsUse Capital Asset Pricing Model (CAPM) as our foundation
modelThen review outcome of foundation model against other
information that can inform our decisionOutcome of foundation model consistent with other
indicators
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Return on Equity
60
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Return on Debt (RoD)
61
How to estimate RoD?◦RBA series or Bloomberg series
Type of methodology◦On-the-day, trailing average or some combination
Advantages and disadvantages of each approach, but we selected the trailing average approach◦Wide support from customers and networks◦Reduces volatility in prices between regulatory periods◦Reduces interest rate risk for networks
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How to commence the trailing average?
62
We applied the approach set out in our RoR guideline◦New debt incorporated as it is progressively refinanced
each year◦Our starting point for existing debt is continuation of on-
the-day approach◦Consistent with the application of the benchmark
efficient approach◦Avoids windfall gains and losses◦Preserves the outcomes and risk profile of the debt
strategies chosen by the businesses under incentive regulation
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Gamma
63
No single objective indicatorDraw on a wide range of material to inform our decisionIn guideline we said 0.5After reviewing material and latest estimates we have
updated to 0.4
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Metering
64
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Metering
65
No exit fees Residual capital costs will be classified as a
standard control service and recovered from the general network customer base
An annual charge for existing customers will recover the costs associated with the existing meter regulatory asset base
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Public lighting
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Public lightingWe amended proposed maintenance costs associated with:bulk light replacementspot replacements per day lamp spot failure labour and overheadsOutcomesEssential Energy’s revenue up 5 per cent from current levels
(proposed 60 per cent increase)Ausgrid and Endeavour’s revenue down 20 per cent from
existing levels
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Consumer engagement
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Consumer engagement
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Seen as increasingly important◦AEMC in its 2012 rule determination require◦ .. the NSP to indicate in its regulatory proposal the extent to which it
has engaged with consumer representatives. The NSP must also include an overview paper in its proposal for consumers…
Still a work in progress from all parties, but we are making advances◦Unprecedented level of consumer engagement in the AER’s
decision making process◦Better regulation process◦Submissions◦Engagement activities of businesses
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Consumer Challenge Panel (CCP)
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On 1 July 2013, the AER established the CCP as part of our Better Regulation program
The CCP assists the AER to make better regulatory determinations by providing input on issues of importance to consumers.
In December 2013 the AER published its consumer engagement guideline
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Summary of submissions
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Around 80 submissionsMost submissions considered regulatory proposals are not in
the long term interests of consumersWe have taken all submissions from stakeholders into account
in reaching our draft decisionBased on the submissions and our consultation with
consumers, we are not satisfied that the proposals adequately reflects the views of consumers
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Next steps
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Task Date
Pre-determination conference/ public forum on AER draft decisions
8 December 2014
Distributors submit revised revenue proposals
20 January 2015
Stakeholder submissions on AER draft decisions and revised revenue proposals close
13 February 2015
AER issues final decision By 30 April 2015
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