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Is it ok for the regulator to ignore electricity networks’ extraordinary profits?

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Australia’s monopoly electricity networks are extremely low risk businesses. If the regulatory system was working effectively, the networks would be achieving profitability levels commensurate with those low risks.

However, that this is not the case.

Over nine months ago, ResponseAbility performed an analysis of the actual returns that the Queensland government has realised from its investment in two electricity networks (Powerlink Queensland and Energex) over the previous 15 years; and compared those returns with the returns that it would have realised if it had invested the same dollars in blue-chip ASX 50 companies in other sectors of the economy.

This is the first time that such an analysis has been performed on the Australian electricity networks’ actual profitability.

The analysis confirmed what the networks and their investors have known for many years – that Australia’s monopoly electricity networks are achieving many multiples of the returns being achieved by Australia’s best performing ASX 50 companies.

It identified that the networks are achieving extraordinary returns, from both an income and a capital growth perspective.

For example, from an income perspective, over the past 15 years, Powerlink Queensland achieved an average annual ‘return on equity’ of 27%, whereas most ASX50 companies struggled to deliver annual returns of 5% over that period.

The profitability analysis also identified that the networks are very highly debt geared and that the Queensland Government has taken advantage of the unique arrangements in the regulatory framework by extracting additional income from the networks through unconventional ‘equity drawdowns’ that are not possible in any other sector of the Australian economy.

With Australia’s electricity networks achieving such extraordinary returns, it is not surprising that investors are queuing up to purchase them when they come up for sale, paying well in excess of the networks’ regulatory valuations. For example, an international consortium recently purchased the NSW transmission network (TransGrid) for 165% of TransGrid’s regulatory valuation.

The key conclusion of the study was that the Queensland government has achieved many multiples of the returns that it would have achieved if it had invested in businesses in any other sector of the Australian economy.

For example, as illustrated in the chart below, over the past 15 years, the Queensland government’s equity investment in Powerlink Queensland has accrued returns of:

  • 23 times the returns achieved by the Australian construction sector (Lend Lease)
  • 15.5 times the returns achieved by the Australian telecommunications sector (Telstra)
  • 10.5 times the returns achieved by the Australian minerals and resources sector (BHP)
  • 10 times the returns achieved by the Australian banking sector (NAB)
  • 3.6 times the returns achieved by Australia’s most profitable supermarket (Woolworths)

No ASX 50 stock came close to Powerlink’s returns.

Clearly those returns are grossly excessive and are not in consumers’ long-term interest.

Note – the above chart actually understates Powerlink’s returns, as it does not include the income that the Queensland Government has extracted through unconventional equity drawdowns and does not include the other pecuniary benefits that the Queensland Government has realised from its investment in Powerlink (tax receipts and debt fees)

Note – the above chart actually understates Powerlink’s returns, as it does not include the income that the Queensland Government has extracted through unconventional equity drawdowns and does not include the other pecuniary benefits that the Queensland Government has realised from its investment in Powerlink (tax receipts and debt fees)

Not My Problem’, Says The Regulator

With the networks’ extraordinary returns driving the majority of their revenue, it is reasonable to expect that the regulator (the AER) would be acutely interested in understanding why the networks that it regulates are achieving returns well in excess of the returns that it assumes, and many multiples of the returns being achieved by businesses in all other sectors of the economy that face much higher risks.

However, the AER has never performed an analysis of the networks’ actual profitability, and has never used the networks’ actual profitability to inform its approach to setting the networks’ ‘return on capital’ allowances, despite numerous calls from many stakeholders over the past decade for it to do so.

My previous submissions have asserted that the National Electricity Rules (NER) actually require the AER to consider the networks’ actual profitability when setting their ‘return on capital’ allowances. However, the AER adopts a much narrower interpretation of its obligations and claims that the rules do not require it to do so.

Disappointingly, the AER has a track record in demonstrating a defiant indifference to the networks’ actual profitability. Every time stakeholders raise issues regarding the networks’ actual profitability, the AER attempts to shut down the conversation and defend its existing ‘return on capital’ estimation approach.

The profitability analysis has been in the public domain for over 9 months and there has been a deafening silence from the AER and the networks on its findings, with their limited responses being clearly aimed at deflecting attention from the analysis and shutting down any serious conversation on the findings.

It is clear that the networks’ actual profitability is an “inconvenient truth” to the AER, and to the networks.

What Is Driving The Networks’ Extraordinary Profitability?

The AER has received numerous submissions over recent years outlining reasons for the electricity networks’ extraordinary profitability. For example, my recent submissions have provided detailed critiques of systemic deficiencies in the AER’s ‘return on capital’ determination methodology and have asserted that those deficiencies are the most significant driver of the networks’ extraordinary profitability. However, the AER has consistently refused to acknowledge that there is a problem, despite extensive evidence to the contrary.

How Can The Current Impasse Be Resolved?

I suggest that there are 3 options for resolving the current impasse:

  1. The AER Accepts That It Needs To Explain The Differences Between The Networks’ Actual Returns And The AER’s Theoretical Returns

As outlined above, the profitability analysis identified dramatic differences between the electricity networks’ actual returns and the AER’s theoretical returns.

This has understandably led to calls from various stakeholders for the AER to explain the reasons for the differences. However, the AER has indicated that it has no intention of doing so.

Many stakeholders are understandably appalled by the AER’s response.

The AER is required to make regulatory decisions that are in consumers’ long-term interests. In light of consumers’ lack of trust in the AER’s approach to setting the networks’ ‘return on capital’ allowances, surely it is in the AER’s interest to demonstrate that its existing approach is resulting in the networks achieving returns similar to the level that it assumes?

  1. The National Electricity Rules Are Modified To Require The AER’s ‘Return On Capital’     Determination Methodology To Be Informed by The Networks’ Actual Returns

If the AER does not accept the need to explain the differences between the networks’ actual returns and its theoretical returns, then the National Electricity Rules (NER) could be modified to require the AER’s ‘return on capital’ determination methodology to be informed by the networks’ actual returns.

Just as the National Electricity Rules (NER) require the AER to consider the networks’ past capex and opex expenditure when determining their future capex and opex allowances, the rules could be revised to formally require the AER to ensure that its ‘return on capital’ determination methodology is informed by the outcomes of its previous ‘return on capital’ allowances.

This requirement could incorporate reporting obligations for the networks similar to the obligations that apply to UK energy companies.

In 2008, in response to consumers’ lack of confidence in the UK energy market, the UK energy regulator (Ofgem) decided that ensuring transparency of UK energy companies’ profitability levels was essential to rebuilding consumer confidence. To achieve this, Ofgem introduced the requirement for UK energy companies to produce and publish annual reports that outline their actual profitability.

There are many stakeholders that would be willing to propose such a rule change to the Australian Energy Market Commission (AEMC).

  1. An independent Review Is Performed To Compare the Electricity Networks’ Actual Returns With The AER’s Theoretical Returns

In the absence of the AER or the AEMC accepting the need to implement options 1 or 2, I suggest that it is inevitable that stakeholders will demand that an independent review is performed to compare the electricity networks’ actual returns with the AER’s theoretical returns, and to identify the reasons for the differences.

I humbly suggest that it is time for the AER and the AEMC to face up to that reality.


Hugh Grant has performed various executive roles in the Australian energy sector. As Executive Director –  ResponseAbility, he currently assists a diverse range of consumer advocacy groups to develop submissions on energy market policy and regulatory developments, aimed at ensuring that consumers’ long-term interests are appropriately considered.  

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  • trackdaze

    Thanks Hugh,

    Is there any relationship between the Aer and the networks that may explain AERs stance?

    How might a seperate body such as the ACCC get involved in what has a major effect on pricing?

    • Alex

      The AER is essentially a subsidiary of the ACCC with the respective roles of the AER and ACCC set out in legislation

  • Mike D

    What to do:
    Tune in (to the sun).
    Turn on (your solar PV system).
    Drop out (from the grid (as far as you can)).

    • MaxG

      Spot on!

  • CaresAboutHealth

    Today (Dec 6), a couple of MPs have been talking about opposing all policies that increase electricity prices. Hugh Grant has shown that the shockingly inadequate regulation of power networks is increasing electricity prices. I suggest we all write to these MPs and ask them to keep their word and oppose the policies that have allowed this to happen.

  • DevMac

    One would think that profits would be one of the pillars of a regulatory framework.
    But then again, one would think a great many things which aren’t the case in reality.

  • Renewable lie

    What a bunch of leftist crap. The networks are benchmarked against each other and incentivised to improve efficiencies or be penalised. Some of the outperformance is due to higher gearing than regulatory assumptions but that shifts risk to the equity holder, who needs higher returns to compensate. You’ve conveniently picked a bunch of the worst performing top 50 stocks to do your analysis (nab is the worst of the big 4). Why not put in CSL and see how things stack up?

    • trackdaze

      Nice try.

      Your handle gives the game away.

    • hugh grant

      CSL’s total returns were between Woolworth’s and NABs’ total returns – i.e. CSL achieved total returns of around 20% of Powerlink’s total returns – I’d be happy to share those results with you.

  • solarguy

    Wow, what a mega gouging business model this capper is, a right wing capitalist wet dream and protected by the regulator it seems. It’s obscene, when you consider that old coal fired plant can produce electricity for 5cents/kwh, but the end user can pay up to 950% more for it. And what profit share do the utilities make I wonder?

  • neroden

    Does the law require that the AER regulate the network’s profits based on their return on capital?

    If so, the AER is violating the law by using a fictional return on capital rather than actual return on capital as reported by normal accounting standards.

    Someone surely has standing to file a lawsuit demanding that the AER follow the law.

  • Les Johnston

    It is no wonder our Prime Minister supports the coal industry. Those with shares in the coal fired electricity generators see the profits from a monopoly position and make sure the COALition does likewise. A Federal ICAC is required to investigate the tangled web.