Getting Ready! Potential issues for consumers Queensland Distribution Network Regulatory Proposals Bev Hughson, Consumer Challenge Panel (CCP) 8 August 2014 The data and charts in this presentation are based on the information provided by Energex to the Australian Energy Regulator in its Economic Benchmarking Regulatory Information Notice (Consolidated), 30 April 2014, Public Version. The author cannot vouch for the accuracy of the information provided by Energex in its Notice.

What AER decisions matter? Regulated distribution business prices will depend on: – The total revenue that the AER allows – The network pricing arrangements Focus today on the total revenue allowance – But important (later) to consider network pricing: How does the DNSP allocate allowed revenue across different customer classes? How do they design their network tariffs? – And to assess the effectiveness of consumer engagement in the process

Revenue Increases

What determines the revenue allowance? Cost of capital – around 50%-60% of costs – Opening regulatory asset base (RAB) Plus capital investment (Capex) Plus inflation adjustment Minus depreciation – Closing RAB – Rate of Return on asset base Operating Costs (Opex) Tax allowance Incentive scheme payments (+/-)

Cost of capital Assess the regulatory asset base for each year – What is the capital expenditure (capex) each year? – Is it prudent and efficient? – Is it growth, replacement, or reliability capex? Growth: Forecasts of energy demand, peak demand & customers Replacement: Assess age & condition of network Reliability: Assess service performance (time off supply etc) What is the rate of return on asset base – Return on equity (shareholder) & return on debt – What is the credit rating of the DNSP? – What is the business risk profile? – Should government ownership make a difference?

Asset Base Growth & Capex

Growth Capex: What’s happening to energy use?

Growth Capex: Average usage declining

Growth Capex: Peak Demand- Where to now?

Growth & Replacement Capex: Utilisation of capacity falling from low base; losses also declining

Replacement Capex Average asset age declining

Reliability Capex Performance above regulated standards?

Rate of Return-a new approach? Most networks currently demonstrating very high profits Cost of Debt (60%): – AER new approach - move to 10 year average of 10- year bonds (BBB+), over a ten year period – NSW disputing this transition approach, wanting to move immediately to new approach Cost of Equity (40%) – Risk free rate assessment disputed – Market Risk Premium (6.5%) disputed – Equity beta (0.7) disputed

Cost of Capital (cost of debt*0.6)+(cost of equity*0.4) cost of debt Approx 8.5% Cost of Debt? Input to Cost of Equity?

Cost of Equity Regulatory Benchmarks Source: AER Explanatory Statement RoR Guideline, Appendix C, p 32 NSW NSP’s proposing 10.1%; AER NSW Transitional Determination 8.9%

Increasing Opex/Customer –Why?

Summary of Issues to Watch Are the forecasts reasonable? Is the capex prudent and efficient? Is the opex efficient and prudent? – 2012/13 will be the base year for next period Is the cost of capital reasonable given economic conditions? – Consistent with risk, and fair to consumers – Provide the right incentives for efficient investment Efficiency schemes (opex and capex)? Have consumers been adequately engaged in the decisions by the networks and the AER?