Electricity prices in Australia have increased considerably
over the past five years. A key contributor to the price rises has been the
significant increases in network costs—that is, the costs associated with building,
maintaining and operating the networks that transport electricity from the
generator to the consumer. The average household in Australia pays significantly
higher network service charges than those imposed on consumers in the
electricity markets of other advanced economies, such as Great Britain and
the United States of America.
Some of the increases in network costs have been due to past
under-investment and a need to meet higher peak demand, particularly with the
increased use of air conditioning. However, the sustained increases have
led to allegations that network businesses have undertaken excessive investment
in the networks, an activity referred to as 'gold plating'. While the
regulatory rules are intended to address the risk of economically inefficient
outcomes arising from electricity network natural monopolies, many experts
identified institutional arrangements and regulatory design as the culprits for
over-investment and high network costs.
Over-investment and high prices caused by inadequacies in
institutional arrangements and regulatory methods is an even worse outcome if
the subsequent network investment is underutilised or, in the future, becomes a
stranded asset. In this regard, it is important to note that the increased
investment in electricity networks has come at a time when demand for
electricity has fallen and is forecast to be flat in upcoming years. A large
number of consumers are already involved in their own generation; for example,
there are over one million solar power systems on the roofs of homes and
businesses in Australia. High network costs may continue to encourage consumers
to reduce their energy consumption and/or to generate their own electricity,
leaving a smaller customer base available to support expensive, underutilised
The committee acknowledges the numerous reviews of the
electricity sector, recent changes to the regulatory rules for determining network
revenues and positive signs that the Australian Energy Regulator (AER) intends
to reduce the maximum allowed revenue network businesses may recover in the
future. However, the committee considers that fundamental problems with the regulatory
framework remain. The principal flaw is that network service providers are
protected from certain risks that businesses in competitive markets face. In
particular, network businesses do not appear to bear the risk of inefficient
investments and do not face risks associated with changing demand in a timely
The committee examined many aspects of the regulatory system
that is applied to most network businesses in Australia. While there are
several areas of the framework that may warrant attention, the committee
considers the treatment of the regulatory asset bases (the capital expenditure
investments of each network business) is the fundamental cause of high network
costs and will continue to be a major driver of revenue for network businesses
in the future. Although a recent rule change now enables the AER to review
capital expenditure that exceeds the forecast it approves as part of a determination,
the AER is unable to challenge past expenditure or expenditure where the
forecast is not exceeded. Network businesses are allowed to earn a return on
all of these investments.
The committee considers that the AER requires the discretion
to review the efficiency of all future investments and the need for their
inclusion in the RAB. However, to avoid sovereign risk concerns, the AER's
power to review assets should continue to apply only on a prospective basis.
The committee considers an expert review charged with considering these issues
would be an appropriate starting point for change in this area.
Another feature of the revenue determination process is the
use of hypothetical benchmarks, rather than actual costs. For example, when
considering the allowed rate of return, the financing costs of individual
network businesses are intended to be compared to the efficient financing costs
of a benchmark efficient entity with an apparently similar degree of risk. This
process may provide incentives for efficiencies; however, many informed
stakeholders that participated in this inquiry are concerned about the assumptions
and outcomes related to the weighted average cost of capital calculation and
the methodology for estimating the cost of corporate income tax. The committee considers that following the AER's latest round of revenue determinations,
a performance assessment of the benchmarking process should be undertaken.
This inquiry has also considered evidence that the network
businesses have an incentive to inundate the regulator with information and
documents during the regulatory process. While information asymmetry is a
common problem in regulation, the ability of a regulator with limited resources
to assess revenue proposals would be negatively affected if it is overwhelmed
by information. Similarly, a mass of supporting documentation is also likely to
make it more difficult for businesses, industry associations, consumer groups
and other interested parties to understand and provide feedback on the
regulatory proposals. The committee considers an improvement can be made by
capping the expenditure linked to a regulatory proposal that network businesses
can recover from their customers. A cap could rationalise the number of
supporting reports and other documents provided to the regulator, while still
ensuring the regulator receives all of the information relevant to its decision‑making.
While the major focus of this inquiry was the revenue
determination process, the committee also considered other matters related to
the performance of electricity network businesses and the regulatory framework under
which they operate.
Consumer consultation was one such area examined in detail.
Fundamentally, the committee considers that, for economic regulation to be
effective with outcomes accepted as legitimate by the community, the processes underpinning
it need to be transparent and accessible to external stakeholders. In this
regard, the interactions network businesses have with both their customers and
the regulator are important. The consumer consultation that network businesses
engage in about their regulatory proposals and network projects must be
meaningful. The recent revenue determination processes provide an opportunity
to assess the progress of efforts to enhance consumer input. Consumer
engagement in rule-making and regulatory processes may also be assisted if
clear, consolidated guidance about electricity regulation was developed and published.
Another area canvassed was the process for making changes to
the regulatory rules. The timeliness of the Australian Energy Market Commission
(AEMC) in considering proposed changes to the National Electricity Rules is of
significant concern to the committee. Even rule change requests lodged by the
COAG Energy Council do not appear to be dealt with expeditiously. Accordingly,
the committee has recommended that the rule change process is made more
The committee has also considered evidence about the future
requirements for Australia's electricity networks. This country has a large and
expensive electricity network built as a result of decades of centralised
generation. The evidence taken during this inquiry revealed that
stakeholders are increasingly starting to consider whether the current system
of networks, and the regulatory rules governing it, can be sustained.
In the coming years, this arrangement may no longer effectively deal with
how a significant amount of electricity is supplied. Sustained high network
costs and improvements in technology, such as more cost‑effective battery
storage, may result in a market that demands a smaller, more local, network
rather than the expansive networks based on centralised generation.
Given the concern that electricity networks are entering a
'death spiral', policymakers and regulators need to closely monitor
developments in the electricity market to ensure network businesses do not
discriminate against customers who seek to generate their own electricity. The
likely changes in the energy market also mean it is important that the
regulatory framework is flexible, so it can respond quickly in a way that
ensures networks operate in the long-term interests of consumers. It is also
important that the customers who continue to be supplied with electricity in
the conventional manner, particularly customers who cannot afford to invest in
their own electricity generation system, are not forced to pay an increasing
share of network costs as a result of other customers going 'off-grid'.
Finally, the committee has noted with concern the
allegations about data manipulation and other inefficient practices at a
particular network company. The committee will address this issue in its final
report, which will be presented by 5 May 2015.
In recent years, there have
been some welcome changes to how electricity network businesses are regulated
in Australia. However, the committee concludes that more work needs to be done.
The committee hopes this report and the evidence collected during this inquiry
inform and support efforts to ensure the electricity networks provide services
in a way that is in the long-term interests of consumers.
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