The rise of self-generation: changing the networks' business models

31 Jul 2015Archived News Gilles Walgenwitz Climate Change Matters

A number of common themes are emerging from recent network Determinations in NSW and Queensland.   After several years of persistent escalating network tariffs - which have created a consumer backlash - coupled with a downturn in electricity consumption, allowable network revenues are being challenged and dramatically reduced.  The ‘fall-off’ in energy consumption has meant network expansions can be delayed or in some cases abandoned altogether.  This has reduced both the need for capex funding and the associated ongoing operational costs. 

Furthermore, the move to self- generation at the point of consumption, that PV offers, is changing the dynamic for network businesses.

This article considers the implications for consumers and in particular, businesses.

Background
 

Over the last few months a number of draft and final network determinations have been released by the AER.  As the national economic regulator, they are responsible for setting the revenue streams for the monopoly electricity networks.  Understandably, these determinations are critical inputs for these businesses as they set their revenue for the next five years – July 2015 to June 2019 for the NSW networks. The most recent determinations have been for the NSW networks – Transgrid and the three local distribution networks of Ausgrid, Endeavour and Essential – collectively known as Networks NSW.  The Qld networks have been issued draft determinations.

The degree of change confronting the network businesses is put into stark reality by the following quote:  “The committee was told that in 2008 there were just over 14,000 solar photovoltaic (PV) systems in Australia; as at February 2015 that were over 1.3 million rooftop systems and another 900,000 solar hot water systems. 1
 

Summary of the latest Determinations

In the last round of Determinations all the networks experienced material cuts in their proposed revenue proposals.  For example, Ausgrid’s revenue proposal was reduced by over one third.  To put some numbers around this -  Ausgrid had sought $9.8 billion for the years  2015–19, but was permitted $6.6 billion.  For Endeavour and Essential the reductions are virtually the same – Endeavour’s proposal was marked down by 28% while Essential’s was down 31%. 

While it is difficult to quantify precisely the impact on a user’s electricity payments stemming from these reductions – because of the range of network tariffs and their application - which can be user and site specific, the Regulator has provided the following guide:

“ For small business customers (in Ausgrid area), we expect reductions of $264 (or 8 per cent) in 2015-16 and relatively stable bills over the rest of the period covered by this decision.2”  

Essential’s reductions offer the highest saving to small business with reductions of around $530 (or 11.9 per cent) in 2015-16.  The two Queensland networks faired a little better, with Energex’s proposal pruned by 23% and Ergon 27%.  Their final determinations will be released in October this year.
 

Networks NSW response
 

It is no surprise that Networks NSW announced they will appeal the AER’s decisions.   Their appeal will focus on the cuts to their operating expenditure and the allowable rates of return that are applied to the capital invested in the business.

The Australian Competition Tribunal will assess the merits of the determination – and if it finds that the Regulator has erred on a material fact or has been unreasonable in the exercise of a discretion it can modify the determination, or refer it back to the Regulator for amendment.

The Law (National Electricity Law) was changed in late 2012 to restrict the grounds for seeking a review and appeal.  It has been estimated that networks appealed 22 regulatory determinations between 2008 to 2012,increasing network revenues by around $3.3 billion.3  

Interestingly, one of the changes to the network appeal process, at the time, was to increase the range of parties eligible to lodge an appeal – beyond the network services business.   The intention was to extend these rights to other interested parties – such as consumer and industry groups. 

This is precisely what has happened – the Public Interest Advocacy Centre (PIAC)  has also joined the debate - appealing AER’s NSW Networks decision.  The PIAC’s position is that the AER cuts are insufficient, arguing that network prices in NSW are double that of those in Victoria.

Regional utility ACTEW/AGL will also appeal the recent AER ruling.  The appeal process will most likely run well into 2016.

Further pressures on the network businesses  

Aside from the reductions in network demand and the potential impact of emerging technologies, such as battery storage on solar, these businesses may not yet have experienced the full brunt of these changing industry dynamics.  

If it can be accepted that the industry is incurring structural change and that the changes are everlasting, this raises the question how will this translate into the future prospects for the industry.  Particularly over the issue of asset valuations and future determinations. 

A high proportion of the network revenues are derived from the rate of return applied to their asset base values – the culmination of the years of network investment.  These capital asset bases are rolled into the next regulatory determination period.  The proposition therefore is, if these assets are written down to an amount closer to their current market valuations – reflective of their current operating environments - what will be the impact?  

Although the current network determinations do not make allowances for write-downs in asset values there is growing pressure for change.  If these businesses operated under the standards that applied to publically listed companies they would be required to write down assets based upon the capacity of these assets to derive future cashflows. 
Arguments are being made on the grounds, “the entire regulatory system is, in theory, set up to mimic the structures and determinations of the competitive market”4

This is an issue for consumers – because setting network revenues based upon overvalued asset values effectively means they are funding stranded assets.  In a sense these network investments are being made, or have been made, risk free without any consideration of their long term need or prospects.  

To give an indication of magnitude on the push for change, the number one recommendation of the Senate Report (interim) was:

“The committee recommends that the Council of Australian Governments (COAG) Energy Council commission an independent expert review of options for excluding future imprudent capital expenditure and surplus network assets
from a network service provider's regulatory asset base (RAB).5”   

The Report further attested, “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”6.  

Although we are reluctant to rehash ‘overused’ clich├ęs, in this instance the dilemmas confronting these network businesses may be aptly described as the ‘perfect storm’. 

 

 

 

 

 

 

 

 

1 Page 15, The Senate, Environment and Communications References Committee, The performance and management of electricity network companies, April 2015.
2 AER, Fact Sheet  – Final decisions: Ausgrid (distribution) 2015 – 2019. www.aer.gov.au.
3 Allens, http://www.allens.com.au/pubs/ener/foener9jan14.htm, January 2013
4 Para 4.38, The Senate, Environment and Communications References Committee,  The performance and Management of electricity network companies, April 2015.
5 Ibid, Para. 4.75.
6 Ibid, Page ix.
 

 

 

Join the conversation

Get in touch with our expertsView All

Gilles Walgenwitz

Associate

View Profile