Australian network operators need to slash the values of their poles and wires by up to half – and their costs accordingly – if they are to remain competitive in the face of new technologies such as solar and storage and avoid an inevitable and damaging “death spiral.”
The conclusions come in a new independent study – one of the most comprehensive to date – that shows that Australia has the highest network costs in the world – more than twice those of the UK and the US – and suggests that the network owners should voluntarily slash the value of their assets.
The report, by Hugh Grant of the analyst firm ResponseAbility – shows the massive cost of delivery of electricity through the networks means that Australian consumers have one of the highest electricity prices in the western world, despite its much touted “cheap” coal power.
It has certainly been the cause of the biggest increases in electricity the world. This graph below shows how network prices have underpinned the huge rises in electricity costs.
The study suggests that if the regulated asset base was reduced then consumer costs could also fall by nearly half, particularly in those states such as NSW and Queensland which have been by far the worst offenders in inflating the asset base and cost of their networks.
That would then put the networks in a better position to compete with, and have an incentive to integrate, new technologies, such as solar and storage and the push towards micro-grids.
Some networks are refusing such initiatives now because they have no financial incentive to pick the cheaper and more efficient option. It is an absurd situation, but one the regulators have been slow to address.
The report is not the first independent analyse to conclude that the Regulated Asset Base of Australia’s electricity networks need to be written down, either by regulation or by choice, but it does appear to be the most comprehensive.
Importantly, it highlights that RAB reductions are not only in the electricity networks’ long-term interests, but are also imperative for the viability of other participants in energy supply chain, including the generators and retailers.
“The clear message from the paper is that business as usual will inevitably result in the “industry death spiral”,” Grant says. “RAB reductions are not only in the electricity networks’ long-term interests, but will also be critical for the viability of other energy supply chain participants.”
Networks and their lobby groups have argued forcefully against the idea that their asset values should be written down – partly because some of those assets are owned by state governments – Queensland, NSW and Western Australia – which are in process of seeking offers or considering it.
The Energy Networks Association has also suggested that imposing write-downs will be counter-productive, because it will “increase risk” and the cost of finance, and will mean that costs to consumers will be little changed, and may even increase. It describes even a 20 per cent cut as “extremely large” and “massive”.
But Grant argues that this is not true. He points out that others in the energy industry – generator and retailers – have all been forced to incur write downs when the value of their assets decreases, as has occurred in other industries.
He further states that the networks are already allowed a cost of capital allowance that reflects the risk of stranded assets, despite the fact that they are able to borrow at rates significantly lower than that allowed, and profit from it – so much so that network profits are 23 times the return in the construction sector and 16 times that in the telco sector.
“The ENA paper conveniently ignores this fact and attempts to create the impression that the networks’ returns are commensurate with their low risks, and that introducing the “new risk” of asset revaluations would dramatically increase their cost of capital,” Grant writes.
The report calls for extensive changes to the way the market is regulated, because it is the regulations that allowed the networks to rapidly boost the value of their networks and then pass on the cost to the consumers.
Until 2006, the regulator imposed an “optimisation” rule, that meant that if an asset was found to be surplus to requirements, then the network was not allowed to pass on the cost of this asset to consumers.
Similar rules still exist in most international markets, but in Australia they were swept aside in 2006 when the Australian Energy Markets Commission issued new rules that simply encouraged networks to build bigger networks, with the guarantee that they could pass on the costs, and be protected by indexing for inflation.
Some government-owned networks increased their asset values five-fold in just a few years. They are now protecting those valuations and revenues by seeking to increased fixed charges.
Many network operators admit that the future is vastly different to the past, thanks to new technologies, and that these networks will be broken up into smaller series of distinct and interconnected micro-grids, such as the scenario outlined by Western Power this month. That means many poles and wires will be redundant.
But getting to this point is the tricky bit, and regulators are not making it easy for networks to take the obvious move and write down the value of stranded and unwanted assets. Grant says that the AEMC has adopted a “systemic bias” towards “investment certainty”, and this has come at the expense of the long term interest of consumers.
He quotes the Public Interest Advocacy Centre, which noted: “The underlying assumption in the rules from 2006 onwards was that investment has to be incentivised regardless of the cost to current customers.”
And the AEMC stands accused of being dismissive of customer perspectives. “It’s responsiveness to consumer interest and issues has been poor,” PIAC noted. “Arguments put by consumer advocates are rarely accepted, regardless of the quality of the argument or evince offered.”
Grant says that the most rational non-rule change solution is for the networks’ owners to voluntarily write down their RABs to sustainable levels, or their “maximum efficient” values. (See graph above). If that doesn’t happen, then he recommends an independent panel be appointed to advise on what those valuations should be.
“In competitive sectors, when technologies and assets are made redundant by cheaper alternatives, or are clearly going to deliver less revenue than anticipated at the time of the investment, the value of the assets are written down,” he notes.
“This is a rational decision that is commonly implemented in all other sectors of the Australian economy where capacity exceeds demand.”
But, his paper notes, successive state governments have consistently chosen short-term profits over sound long-term energy policy, either by influencing the regulatory arrangements to enable their networks to achieve extraordinary profits; and by not considering the long-term consequences of inflicting excessive electricity prices on their communities and their state economies
“The continuation of the industry death spiral will ultimately be much more destructive to the long-term value of government-owned energy companies than the short-term implications of reducing prices to sustainable levels,” Grant writes.