The cost of politics in energy regulation

2 Mar 2017
Emma Watts

Australia’s energy system is beset by issues of risk, with an ‘uninvestable’ generation market and  conflicting State and Federal policies.

While energy participants wait for the Finkel energy security review to provide a clear blueprint, Climate Change Authority member and Managing Director of Frontier Economics, Danny Price recently observed “This place is mad”.

“…we are heading towards a third world power system very rapidly. And it's very hard to arrest a decline in the quality of our power system.”                                 Danny Price, AM, ABC Radio National

Reducing risk in the investment environment is critical not just to minimise energy bills to customers but to ensure energy security. Australia’s energy grid will play a critical role in supporting energy security and efficient wholesale markets during rapid changes in our generation mix. For instance, Energy Ministers, the Australian Energy Market Operator and International Energy Agency are all expecting Australia will need timely investment in interconnectors, though each proposal must be efficient and thoroughly assessed against other options.

Many investors and other stakeholders were alarmed by the potential for increasing political risk in the regulatory process in 2016. Some governments proposed the abolition of Limited Merits Review, by which an independent Tribunal can identify issues in decisions by the Australian Energy Regulator (AER). The regime is there to benefit customers and, by law, the independent Australian Competition Tribunal cannot overturn decisions unless there is a ‘materially preferable’ outcome for customers. 

While the operation of the independent, expert Tribunal is intended to be removed from the political process, some governments intervened with proposals to abolish the Tribunal’s role after it found significant weaknesses in some AER decisions and asked they be corrected.

Last December, the COAG Energy Council decided to reform - not abolish - the regime. It agreed to develop a range of options including, for instance, changes to the grounds for review; financial thresholds; proceeding format; timeframes and consumer participation. 

This followed a consultation process in which over 80% of non-network stakeholders supported the retention or reform of these appeal rights. In fact, this was the only approach that had broad support across a set of stakeholders including consumer and user groups, current and former regulators, network businesses, and capital providers. Given how polarised most energy debates have been, Australian governments had an opportunity to progress sensible, widely supported reforms. Energy networks had been constructive, proposing some of the reforms which could lower the number and frequency of appeals.   

A key reform measure announced by COAG Energy Council in December and supported by many stakeholders was “introduction of a binding rate-of-return guideline, with relevant elements of the regulator’s decision not subject to merits review”.  A binding guideline was intended to address the potential for multiple and cascading reviews and was expected to be subject to merits review itself, as it is in New Zealand, without the need for merits review to apply in every individual network decision by the regulator.

State Governments advised their stakeholders that such a guideline would “…provide a single merits reviewable decision point for rate of return parameters, and assist in addressing the problem of multiple merits review processes on common issues.”[1] [emphasis added]

Networks and investors proceeding on this basis, have been surprised that some governments propose to reopen the December decision of COAG Energy Council.  They intend to strip limited merits review from the proposed binding rate-of-return guideline, which can represent over 50% of the cost of the regulated service.

At best, it’s a confusing environment, increasing unnecessary policy risk and uncertainty. It is another example of ‘stop-start’ political risk where decision making can be opaque, past decisions need not be followed through and jurisdictional differences are not resolved.

Why should customers care if the Regulator is accountable?

Investors have historically funded Australian energy infrastructure at a low cost of capital based on confidence in a regulatory regime independent of political interference; and a policy environment that was transparent and evidence based.  However, a low cost of capital is not a given and regulatory risk is an explicit driver of the cost of capital. Funding providers price Australian investment risk constantly, their perception of risk can change, and the outcomes matter for the costs borne by consumers.   

While political media releases promise that customer bills could be lowered by reducing accountability for the Regulator, it is far more likely to increase costs and service impacts on customers. This is because:

  1. The only basis for overturning a regulatory decision on appeal is that it is better for the long-term interest of consumers. The regulatory process is designed to assess these long-term impacts precisely to avoid political pressures which seeks short-term price reductions today at the expense of higher bills or service and safety risks for customers in the future.
  2. Customers will benefit if regulators are accountable, like other parties, for the quality of their decisions.  This provides incentives to make sound and well-evidenced decisions in the first place. 
  3. This lower risk helps minimise the significant ongoing financing costs paid by network customers. Australian energy networks are required to source approximate $4.5 billion in capital from debt markets annually to finance the delivery of the national grid. That equates to needing to raise around $2.2 million in debt capital each and every business hour to help support essential network services.

Rating agencies, and capital providers - including banks, investment firms and direct investors – provided unequivocal advice to the COAG Energy Council on the need for limited merits review:

  • A survey of 30 investors from Royal Bank of Canada found that 85% of investors in Australian utilities agreed or strongly agreed that merits review is crucial to ensuring accountable and transparent decision-making[2].
  • Moody’s separately highlighted that appeal mechanisms provide a ‘fundamental credit support’ for ensuring networks can access low cost funds to support delivery of services. [3]
  • Banks have similarly highlighted to the inquiry the role of independent review in lowering the price of credit to networks.

This is not new ground for Australian Governments. They have previously recognised that limited merits review is needed to balance the discretion of the Regulator and improve its decision making. Past expert reviews, regulators (such as former ACCC Chairs Professor Allan Fels and Professor Graeme Samuel), and regulatory commentators agree that the accountability of merits review is important for customers dependent on the regulatory process.

Under incentive-based regulation, networks have strong drivers to drive efficiency and sustainably reduce costs to customers and they expect robust regulation by the Australian Energy Regulator.

However, there are predictable social and economic risks to our community of politicising energy regulation. The ‘sugar rush’ of inducing artificially low prices today can be politically irresistible. Yet a regulatory decision that lowers bills today on the basis of flawed evidence, and harms consumers tomorrow, is not a genuine win or “saving” for customers. It’s for these reasons the regulatory process was intended to be both free from error, and free from political interference.

 

[1] Department of Energy and Water Supply, NatChat: National Reform News , December 2016

[2] Royal Bank of Canada Capital Markets ASX Network Utilities: Investor survey on regulation, 3 August 2016, p.13

[3] Australian Regulated Electricity and Gas Networks – 2017 Outlook, Moody’s, 14 June 2016