With network costs accounting for around 40 per cent of a typical Australian household electricity bill, getting network regulation right matters for affordability, reliability and the pace of the energy transition. That’s the backdrop to the Australian Energy Market Commission’s (AEMC) Electricity Network Regulation Review (ENRR), which examines whether the current framework remains fit for purpose in a rapidly changing energy system.
The AEMC has split the review into two parts. The first package focused on service classification, ring-fencing arrangements and two potential rule changes.The AEC is a strong supporter of the Nexa Advisory Rule Change Proposal within package 1.
The second package looked at how revenues are determined, how incentives are structured and how risks are allocated between consumers and electricity network businesses.
The AEC’s submission to package 2 is guided by two core principles: lowering customer costs and ensuring competitive markets are used wherever they can deliver outcomes more efficiently than monopoly regulation.
To start with, it’s worth considering how the system is changing. Australia’s energy networks are moving away from connecting comparatively few large-scale coal, gas and hydro-electric generators and bringing that energy to homes and businesses. More renewable energy – mostly solar, wind and now batteries – is being connected, across a widespread geographic area. That leads to a lot of new build in the transmission network to bring that supply to consumers.
At the same time, Australian households and businesses have invested in rooftop solar PV at a world-leading rate and are now turning to small-scale batteries. This is turning the distribution network into more of a two-way system than was originally envisaged, with energy being fed in instead of just being drawn out.
Fundamentally, this is a technological transformation. The network framework was developed for a largely one-way electricity system built around centralised generation. Today’s grid is becoming increasingly decentralised, digital and dynamic.
Do networks have to change how they operate to cater to this change? Perhaps. While the technologies connected to the grid are changing, the underlying objective is not. Networks still exist to deliver reliable electricity services to consumers at the lowest efficient cost. The question is whether the current regulatory framework remains the best way to achieve that outcome.
For this stage of the ENRR, the AEMC in considering three parts of the regulatory process:
- The revenue determination process. That is how the Australian Energy Regulator (AER) goes about reviewing and determining the revenues that networks are allowed to recover from consumers.
- Networks have a range of incentives to behave in certain ways, largely due to the fact they are regulated monopoly businesses. To counteract some of these behaviours, they have access to a range of incentive schemes to encourage them to operate in a way more akin to competitive businesses.
- Risk allocation. Again, due to their position as regulated monopolies, networks are provided with a return commensurate with the risks they face. But that does not mean they shouldn’t be prepared to take risks, or that the return they get accurately reflects the risks they actually face. Similarly, it’s possible consumers face too much risk for what they pay.
Revenue determination process
This is where networks tell the AER what they intend to spend money on over the next 5 years – generally building new stuff and making sure what’s already there still works – and why it’s justified. The AER then reviews those claims and decides how much networks can recover from consumers over a five-year period. The aim is to deliver value for money for consumers. The AER wants to make sure the networks spend money on things that are needed and that consumers don’t have to pay more than they need to. Suffice to say, it’s a complex task.
But the AER has to review 20 electricity networks and interconnectors every 5 years. Networks need to provide their proposals, respond to the AER’s questions and everyone needs to engage with consumers. The AER asks if this could be done better.
It’s always worthwhile investigating if improvements to a system can be made. But ‘improving’ the process is largely subjective. A process that delivers greater certainty for networks may not necessarily deliver better outcomes for consumers.
The AEC wants to ensure that customer interests are at the heart of this. And perhaps retailers, which deliver network prices to customers, can play a stronger role here. Retailers offer a practical perspective on what products consumers value and what they are willing to pay for.
Incentives
Because electricity networks are monopoly providers, regulation seeks to replicate some of the disciplines that competition would otherwise impose. Incentive schemes are a key part of that framework, encouraging networks to improve efficiency, innovation and customer outcomes Networks have a total of seven incentive schemes available to them:
- Efficiency Benefit Sharing Scheme (EBSS)
- Capital Expenditure Sharing Scheme (CESS)
- Service Target Performance Incentive Scheme (STPIS)
- Customer Service Incentive Scheme (CSIS)
- Demand Management Incentive Scheme (DMIS)
- Demand Management Innovation Allowance Mechanism (DMIAM)
- Export Service Incentive Scheme (ESIS)
In examining these, the AEMC asks whether another may be needed – an incentive to encourage networks to improve utilisation rates.
We see that as a strange concept given the AER is supposed to regulate networks to ensure that any investment is efficient. Presumably, efficient investment should lead to efficiently used networks.
Risk allocation
Most people are familiar with the idea of risk versus reward: take a higher risk for the chance of a greater return. But because networks are regulated monopolies, it’s not quite as simple. The financial return that networks get is based on the risks they’re taking. The system is designed to avoid a situation where if networks take risks and they fail, consumers face the costs. Or that if a network takes a risk and succeeds, they get the benefit and consumers don’t.
The AEMC is exploring whether the regulatory framework provides the right signals for taking risks, if networks are getting the right rewards for the amount of risk they bear, and if consumers are facing too much risk.
The challenge is that the nature of Australia’s electricity networks is changing. The risks associated with connecting large volumes of renewable generation, managing distributed energy resources and investing in major transmission expansions may differ materially from those envisaged when today’s framework was first established.
It’s possible the AER, networks and consumers need to think about risks differently. It’s also possible that the risks on transmission businesses are different to the risks on distribution businesses. At the moment, the AER must treat the rate of return on that risk identically.
Consumers are wearing enough of the risk as it is. Customers are already paying for large, long-lived investments in infrastructure that may or may not deliver benefits. We want to see that they get a good deal.
Priorities
Firstly, the aim of any reform to network regulation should be to bring down overall costs to consumers. With network costs such a large proportion of the total cost of residential electricity costs, finding ways to deliver energy to consumers – both large and small – at lower costs would be expected to deliver economy wide benefits. It would also help ensure the social licence for the energy transition is strengthened.
Secondly, competition can deliver significant benefits to the wider market. Allowing for competitive markets to deliver services, responses, or other options would be expected to deliver a far greater benefit to electricity consumers than relying purely on networks to deliver these.
With these themes in mind, the AEC supports:
- examining whether retailers and other service providers should be considered ‘consumer’ for the purposes of the revenue determination process, given the role retailers play in managing risk and directly engaging with customers
- providing clear requirements or targets for networks to pursue non-network options ahead of capital expenditure
- considering what mechanisms are required to increase uptake of non-network options e.g. flexibility markets
- consideration of adopting a UK-style total expenditure (TotEx) framework. This could address the current financial bias towards capital expenditure (CapEx) by making networks financially indifferent between Capex and operational expenditure (OpEx), helping ensure they select the lowest-cost solution for consumers
- rather than an incentive for improving network utilisation, it may be preferable for the AER to set a target for utilisation (noting utilisation rates will be different in different parts of the network), with penalties for failing to reach the targets
- enabling competitive markets to deliver a range of services the energy market needs, including inertia and system strength.
Ultimately, the review presents an opportunity to revisit a framework that influences billions of dollars of investment and a substantial share of customer bills. If competitive markets can deliver services more effectively than regulated monopolies, the framework should create space for them to do so. If not, consumers should have confidence they are paying no more than necessary for the network services they receive.
