Networks continue spending spree, and the customer pays

The dust is beginning to settle after the Australian Energy Regulator’s decisions on the revenues that electricity distributors in the National Electricity Market are allowed to recover from their captive customers. Final decisions for distributors in New South Wales, Queensland and South Australia, and preliminary decisions covering the five Victorian distributors have now been issued.

Judged by the tedious vitriol that some distributors had engaged in the lead up to these decisions, the popular perception was that the AER had become an existential threat to their lifestyle support systems. For those close to the action this was never terribly convincing. Now that the cake is out of the oven we can all judge for ourselves.

Equity analysts, as is their want, took little time to tell us what they thought: “surprised at the upward revision”, “positive for the sector”, “more favourable than expected”. Consumer groups panned the decisions declaring them “extremely disappointing”.

So where does the truth lie? This note looks at regulated revenues, the regulatory valuation of assets and total expenditure (“totex”) which is the sum of capital and operating expenditure. For all of these we have gone back to the start of commission regulation (by state authorities initially) from the first regulatory period in 1999 (RP1) to the AER’s latest decisions (RP4). State commissions made the first two decisions and the AER the last two.

Figure 1 shows the regulated asset value per connection. It shows that the gap between the distributors in New South Wales and Queensland continues to grow relative to their peers in Victoria and South Australia.

Figure 1. Average RAB per customer (2015$ per connection)

Figure 2 shows that regulated revenues per customer in RP4 are starting to moderate compared to the levels in the last regulatory period. In NSW and QLD revenues per customer are less than were after the last AER decision but still well above what they were after the state commission decisions. In Vic and SA they are at about the same level as they were after the last state commission decisions.

Figure 2. Average revenue per customer (2015$ per connection)

The biggest factor reducing revenues in RP4 is the “risk free rate” – the yield on 10 year Australian Government bonds. These are near record lows, as those of us with mortgages know. If risk free rates were currently at the levels that they were in RP3, in all cases revenues per customer would be at or above the levels they were in RP3.

Figure 3 shows the totex allowances per customer. Expenditure that will be incurred over the next five years has less effect on revenues than the charges for depreciation and return on the vast regulated asset bases that most distributors have built over over the last decade.

Figure 3. Allowed totex per customer (2015$ per connection)

Figure 3 shows that the VIC and SA distributors are to be allowed to charge consumers for as much expenditure in the coming regulatory period as they were allowed in the last. In NSW and QLD, allowed expenditure is being brought back to the level allowed in the last state commission decision, while in Queensland the allowed level is about midway between the first and last state commission decisions.

It would be churlish not to acknowledge the “totex” reductions in Queensland and New South Wales. But should consumers be grateful for small mercies?  Between 2006 and 2013 the distributors in these states, on average, expanded their substation capacity 108 times more than the increase in peak demand. With a history of such spectacular profligacy, might something a little more ambitious than reversion to state commission totex levels be expected?

Finally, lets have a look at how the AER’s expenditure allowances shape up against the distributors’ expenditure proposals. The distributors’ regulatory managers have incentives to publicly decry the brutality of the regulator. But what does the evidence show – has the AER been as brutal as the distributors would have us believe?

Figure 4 shows how much the AER decision reduced totex compared to what the distributors proposed in the coming regulatory period (RP4) and the one now nearing its end (RP3).

Figure 4. AER allowed totex as a percentage of distributor totex proposals

Figure 4 does not suggest that the AER has been tougher on the distributors in RP4 than in RP3. In QLD and VIC the cuts are comparable. In SA, the AER has been a little tougher this time than last. In NSW it has been tougher this time, but off a very low base, and as noted it has still been more generous to distributors in NSW than to the distributors elsewhere.

This evidence disabuses the notion that the AER has been draconian. To the contrary, the government-owned distributors in NSW and QLD have continued to have the easiest ride. The intemperate bluster from the NSW distributors, in particular, can be called out for what it is.

But do these decisions suggest the better outcomes repeatedly promised in the “Better Regulation” program have been achieved? I don’t think so. Addressing the errors of the past calls for a much more decisive response than the one we see.

But where should the fingers be pointed at for this? Its all too easy to blame the AER: they are the convenient whipping boy. But to whip them would be to misdirect. The AER is hemmed-in between the Australian Energy Markets Commission (AEMC) and the Australian Competition Tribunal (ACT). Neither of these organisations have a track record of encouraging the AER to go harder. Indeed the AEMC was created precisely to ensure “investment certainty” for networks.

And, in what must be a stinging indictment of the ACT’s involvement in electricity regulation, the Queensland Premier has instructed its distributors not to take matters to the ACT. Consumers might offer two cheers for the Premier, but three had she done this before the regulatory process had started rather than after it had been completed.

The Productivity Commission’s productivity indices show that electricity utilities have been, to use the words of the now departed, “leaners”. The latest batch of regulatory decisions do almost nothing to change this. And, as consumer survey after consumer survey tell us, consumers have little doubt what they think of the electricity sector, consistently ranking it lower than all others.

But the energy establishment says the people are wrong. Last month the Governance Review concluded that Australian energy market governance is “amongst best practice internationally”. Cake anyone?

Democracies have ways of dealing with such cognitive dissonance. Its past time that the people were heard.