Economic Benchmarking vs Financial Incentives – an alternative to incentivising performance in the gas industry? Ashley Muldrew, Gas Speak 2015

Regulatory Regime in the Australian Gas Distribution Industry Australian Energy Regulator (AER) regulates gas distribution businesses (GDBs) around Australia, in 5 year “Access Arrangement” (AA) periods. As the current AA period comes to an end, GDBs submit a proposal to the AER detailing the plans and associated expenditures of the work to be delivered in the next AA period. AER assesses proposal and makes a final decision on the revenue that can be recovered by GDBs in the next AA period, through prices charged to customers.

National Gas Objective Guiding the AER’s decision-making process, is the National Gas Objective: “… to promote efficient investment in, and efficient operation and use of natural gas services for the long term interest of consumers of natural gas with respect to price, quality, safety, reliability and security of supply of natural gas.”

National Gas Objective Guiding the AER’s decision-making process, is the National Gas Objective: “… to promote efficient investment in, and efficient operation and use of natural gas services for the long term interest of consumers of natural gas with respect to price, quality, safety, reliability and security of supply of natural gas.”

Australian Energy Regulator: Approach to performance improvement in the electricity industry Introduction of Better Regulation in Implementation of economic benchmarking, a form of comparative analysis. Use of Multilateral Total Factor Productivity (MTFP). o MTFP = Outputs / Inputs (i.e. ratio of outputs generated per unit of input). o Results of MTFP analysis compare efficiency levels of businesses. Worst performers in MTFP analysis are at risk of significant cuts to proposed expenditures.

Source: AER’s Annual Distribution Benchmarking Report 2014, p. 31. Australian Energy Regulator: Approach to performance improvement in the electricity industry Good performance Poor performance

Australian Energy Regulator: Approach to performance improvement in the electricity industry Ausgrid – subject to 25% cut to opex, based on MTFP results. Chief Operating Officer has stated; “In my opinion, based on current information, the reductions proposed by the AER would likely lead to substantial under investment by Ausgrid in both capital and operating expenditure, and would compromise the safety, the reliability and the ongoing sustainability of its network.” Source: Ausgrid’s Revised Proposal, Attachment 1.02, “Statement of Chief Operating Officer of Ausgrid”, p. 1. What has the outcome been so far? Caused great controversy and debate within the industry. Price cut delivered to consumers (through lower expenditures). Other outcomes of the NGO?

Office of Gas & Electricity Markets: Approach to performance improvement in the gas industry The AER-equivalent in the UK is the Office of Gas & Electricity Markets (OFGEM). Introduced “RIIO” form of regulation in 2012: Revenue = Incentive + Innovation + Outputs. Incentives are key. Incentives encourage GDBs to outperform the targets set by OFGEM at the beginning of the regulatory period (i.e. AA period). o Cost-based incentive vs Output incentive OFGEM has increased the number and scope of incentives available to GDBs, in order to encourage performance improvement.

Office of Gas & Electricity Markets: Approach to performance improvement in the gas industry Example 1 – Totex Incentive Mechanism o Cost-based incentive Example 2 – Broad Measure of Consumer Satisfaction o Output-based incentive What has the outcome been so far? Cost efficiencies forecast to be GBP1.06 billion by the end of 2020/21. Customer complaints unresolved after 31 days: dropped from 20% prior to 2012/13 to 6% in 2013/14. Real price decreases delivered to consumers.

What could this mean for the gas distribution industry in Australia? If AER is looking to increase their ability to encourage improved performance of GDBs, what should they do? Considering the success of RIIO so far, could this be a better alternative than economic benchmarking? Yes.

What could this mean for the gas distribution industry in Australia? Increasing the number and scope of incentives available to businesses has; Driven cost efficiencies; and Achieved other outcomes valued by consumers. AER should look closely at the success of RIIO, and consider increasing the scope of incentives available to GDBs in order to deliver a well-balanced regulatory outcome for consumers.

Thank you

Comparison of Incentive Strength