Briefing on the AER Decision on the Victorian Electricity Companies Orion Economic Services June 2010

Decision on Capital Costs The companies forecast that capital costs would have to rise by 66% or $5.4 billion (in 2010 prices) to meet supply objectives. The AER Draft Decision means total capital expenditure is $3.4 billion an increase of around 38%. Decisions by the Victorian Government on the Bushfires Royal Commission may lead to greater capital expenditure in the final decision.

Decision on Operational Costs The Victorian distributors proposed an increase in operational costs of 38% to meet supply objectives but the AER draft decision involves an increase of only 2% for a total opex allowance of $2.2b. The AER reduced the distributors’ proposed step changes from $293m to $44m.

The AER’s Approach Mirrors the CALC and other Consumer and User Submissions “ The approach of the AER is to begin its assessment of the Victorian DNSPs ’ proposals by having regard to historical performance (actual capital and operating cost expenditure) in comparison with that forecast, both in previous periods and in relation to that forecast over the forthcoming regulatory control period. This analysis suggests the Victorian DNSPs ’ past forecasts have been high relative to their actual expenditures over the past two regulatory control periods (10 years) and also relative to their allowed (benchmark) expenditures set by the ESCV. The Victorian DNSPs' actual expenditures have followed a relatively constant trend in contrast to the significant forecast increases proposed. ” (p.vii) “ The AER ’ s investigation has found that the models and estimation techniques individually employed by all the Victorian DNSPs to develop their forecasts cannot be relied upon to give an accurate estimation of future needs. The AER considered the proposals for substantial increases in the volume of network build (augmentation and replacement) as compared to actual historical outcomes. This conclusion takes account of the impact of increases in peak electricity demand. ” (p.vii)

The Impact of the AER Decision on Prices The AER Decision means that Distributor prices will fall in 2011 from a low of -2.0% for SP AusNet to a high of % for United Energy. The only prices to increase in 2011 are for Jemena of 1.1%. Average prices for the period increase from a high of 5.1 for United Energy to a low for Jemena of o.4%. As inflation over the period may average 2.5% per annum in means that price increases will be much lower (e.g. for CitiPower = 1.1)

CALC PROPOSALS Chapter 5 Growth Forecasts – CALC Quotes “ Submissions by the Victorian Council of Social Services (VCOSS) and the Consumer Action Law Centre (CALC) recommended the Victorian DNSPs provide a full set of data including the actual and forecast customer numbers and energy consumption for 2006 – 10 and 2010 – 15 respectively, to be published by the AER. ” (p.77) “ The submissions also argued that if the AER were to adopt these forecasts, this would result in higher capex requirements spread over fewer sales, leading to higher tariff rates and unit prices for consumers. ” ( p.77) Appendix One “The Consumer Action Law Centre (CALC) recommended that the AER collate and make data available to stakeholders, including benchmark data, to enable them to more effectively comment on the DNSPs’ proposals. The Victorian Council of Social Services supported the recommendation by CALC for the AER to publish a full data set.”(Appendix 1 Benchmarking p.76)

CALC PROPOSALS Chapter 7 Operational and Maintenance Costs – CALC Quotes “The analysis also confirms that the Victorian DNSPs' actual costs generally sit below the approved efficient regulatory opex allowance. The Victorian DNSPs, during the current and previous regulatory control periods, have demonstrated they continually outperform their opex regulatory benchmarks.” (p.215) “ The Consumer Action Law Centre (CALC) considered that the forecast opex figures, when compared to the previous actual spend for regulatory periods, highlights that the AER should evaluate operational costs closely to ensure they are efficient and effective ” (p.214) “ The Consumer Action Law Centre (CALC) considered that the forecast opex figures, when compared to the previous actual spend for regulatory periods, highlights that the AER should evaluate operational costs closely to ensure they are efficient and effective ” (p.221)

CALC PROPOSALS Chapter 8 – Forecast Capital Expenditure – CALC Quotes The AER received submissions from a range of end user representatives, energy retailers, embedded generators and government, including VicUrban, Victorian Employers Chamber of Commerce and Industry (VECCI), Victorian Council of Social Service (VCOSS), Total Environment Centre (TEC), Streetlight Group of Councils, Origin, Victorian Minister for Energy and Resources, Mars Petcare, Energy Users Coalition of Victoria (EUCV), Energy Users Association of Australia (EUAA), Consumer Utilities Advocacy Centre, Consumer Action Law Centre (CALC), Central Victorian Greenhouse Alliance, City of Darebin and the Australian Industry Group. The submissions raised the following concerns: Efficiency and prudency of capex — submissions by Origin, CALC, EUCV, and EUAA questioned the accuracy of DNSPs' forecast capex given historical levels of capex. In particular, submissions by CALC and EUCV noted the trend of DNSPs underspending capex. Customer contributions forecasts — CALC noted that historically the DNSPs' have been poor in forecasting customer contributions and that the AER should look closely at a more accurate way of forecasting customer contributions. (p.284) Deferral or prioritisation of capex — submissions by CALC, Origin and EUCV noted the significant volumes of replacement capex/ageing assets sought by DNSPs and questioned whether deferrals could be considered.(p. 285) Benchmarking –– the need to benchmark DNSPs capex was raised by CALC, VCOSS and EUAA, including a request for the AER to collate and make data available to stakeholders to enable them to more effectively comment on the DNSPs' proposals (p.285)

CALC PROPOSALS Chapter 8 Forecast Capital Expenditure - CALC Quotes Continued Consumer Action Law Centre (CALC) noted: the capex forecasts may indicate inefficient management of capex while some overspend may indicate a need for increased capex, closer scrutiny should be applied to ensure that ‘ gold-plating ’ was not occurring there appears to be evidence of a disparity between asset ageing and responsible asset management the deliverability of the program should be taken into account The CALC also recommended the AER to further scrutinise the proposals to determine the efficiency of forecast capex (including unit costs), to track the expenditure outcomes for future determinations, and to introduce a wide capital works model.(p.341)

CALC PROPOSALS Chapter 8 Forecast Capital Expenditure - Customer Contributions –CALC Quotes “ The Consumer Action Law Centre (CALC) raised in its submission that it was concerned that distributors are very poor at forecasting customer contributions and that the AER should look closely at a more accurate way of forecasting customer contributions. The CALC also suggested estimating customer contributions by dividing forecast capex by forecast customer contributions ” (p.304) The AER has compared the actual capex incurred during the current and previous regulatory control periods against the DNSPs' proposed capex and the AER ’ s estimate of the required capex for the forthcoming regulatory control period taking into account any observed trends in actual capex.(p.305) Regarding forecast customer contributions, the AER notes CALC's submission to this review process concerning how customer contributions were under forecast in the past and how businesses subsequently over recovered customer contributions. The AER has assessed the Victorian DNSPs' forecast customer contributions to ensure that the estimates are consistent with historical levels, and where it deviates, reasonable justification has been made consistent with the capex criteria. (p.305)

CALC PROPOSALS Chapter 8 – Forecast Capital Expenditure –CALC Quotes The AER notes the CALC ’ s, CUAC's, EUAA's and Origin's concerns regarding the DNSPs ’ forecasts capex. In assessing and determining whether each of the Victorian DNSPs ’ proposed capex forecast and the AER ’ s estimate of the required forecast capex which reasonably reflects the capex criteria, the AER has had regard the capex factors as relevant. Specifically the AER ’ s analysis of forecast capex takes into account the stakeholder's comments in: benchmarking and assessing the DNSPs ’ historical and forecast capex assessing the timing of the capex program (including deliverability) and the justification behind them including options for deferrals. In response to the CALC ’ s specific recommendation regarding tracking expenditure for future determinations, the AER has over time expanded its data collection and accordingly, the AER is continuing to establish policies, techniques and standardised systems and processes for data collection. The AER is also in the process of modifying RINs and the annual reporting regime to improve the data collection for future determination purposes. (p.344)

CALC PROPOSALS Chapter 8-Forecast Capital Expenditure – CALC Quotes Continued “The AER will monitor the capex activities of Victorian DNSPs to allow comparison of the capex forecasts of DNSPs as approved by the AER in its distribution determination, with actual expenditure in the regulatory control period. It is proposed that the Victorian DNSPs will be asked to report annually: actual capex activities according to the building blocks, further separated into different network types (or other suitable sub-categories), similar to those currently provided under the AER's RINs for the Victorian distribution determinations changes to the regulatory asset base (RAB), including depreciation, write-downs and disposals.”(p.910)

CALC PROPOSALS Chapter 9 – Opening Asset Base –CALC Quotes “The Consumer Action Law Centre (CALC) submitted that the AER should assess any over-spend of capital and if the DNSP cannot justify that it is efficient, it should not be included in the asset base of the DNSP.2 CALC submitted that with underspending, the AER should also assess whether it is a case of deferral.” (p.443)

CALC PROPOSALS Chapter 11 - Cost of Capital - the MRP- CALC Quotes In relation to the MRP, the EUCV and the CALC noted that various financial market indicators suggest that an 8 per cent MRP is unjustified, and an MRP estimate should not exceed 6.5 per cent. (483) The CALC noted that falling credit spreads between corporate bonds and CGS and declining LIBOR rates, suggests a falling cost of debt. CALC considered that given the interrelation of debt and equity markets, the MRP has also more than likely fallen.(p.490) While the AER acknowledges the submissions of the EUCV and CALC and agrees that increasing the MRP from 6.5 per cent to 8 per cent is unjustified the current market circumstances, it considers that there is not sufficient market evidence to suggest a 6 per cent MRP should be used in the current determination.(p.502)

CALC PROPOSALS Chapter 16 - Pass Throughs-CALC Quotes “The CALC submitted that the AER should: … implement a range of measures to ensure that distributors more closely follow benchmarks including monitoring capital works to ensure that deferrals are efficient, basing forecasting on general conditions instead of trying to cater for unpredictable or extreme events while allowing future pass throughs for events that cannot be forecast with some certainty, and ensuring that distributors become as efficient as possible. Consumers will get cheaper prices if benchmarks are more closely followed and if the industry becomes more efficient.16 CALC recommended that the AER use pass through mechanisms to limit the uncertainty of forecasting.” (p.704) “The AER notes CALC's assertions that the pass through mechanism should not be used to compensate for inaccuracies in forecasts. The AER agrees with CALC and notes that inaccuracies in forecasts should be symmetric over time and the regulatory regime minimises forecast error to the extent that costs are reset every five years.”(p.723)

Where to From Here The AER has produced made a good decision for consumers and electricity users and thus we need to do the following for the next submission: Support the AER in its decisions on capital and operational costs Support the AER in its decision on the MRP especially given the recent rise in the LIBOR given the financial crisis bedevilling some European economies Submit that a new approach to determining Capex amounts might be to standardize Asset Management Plans that trade off maintenance and renewals.