1 ACCC Workshop on the DRP Incentive Mechanisms and Benchmarking

2 Observations on ACCC proposals on efficiency incentives and benefit sharing mechanismsObservations on ACCC proposals on efficiency incentives and benefit sharing mechanisms Proposed framework for assessing the most appropriate expenditure benchmarking approachProposed framework for assessing the most appropriate expenditure benchmarking approach Way forwardWay forward Structure of presentation

3 Based on the ESC Scheme in Victoria developed for use on distribution companies expenditure.Based on the ESC Scheme in Victoria developed for use on distribution companies expenditure. Proposed incentive scheme seems a reasonable starting point for opex:Proposed incentive scheme seems a reasonable starting point for opex: –Delivers even incentives over time; –Simple to apply and administer; –Reasonable sharing ratios; and –Similar schemes successfully in operation elsewhere. ACCC Incentive Mechanism — Observations

4 TNSP expenditures are more volatile (lumpy) than distribution expendituresTNSP expenditures are more volatile (lumpy) than distribution expenditures No reason is put forward for the less generous proposed treatment of capex efficienciesNo reason is put forward for the less generous proposed treatment of capex efficiencies For the successful implementation of a such a scheme for TNSPs the sharing mechanism itself will not be the key determinantFor the successful implementation of a such a scheme for TNSPs the sharing mechanism itself will not be the key determinant Rather, it will depend on how the benchmark for expenditure is set in the current period and in future periodsRather, it will depend on how the benchmark for expenditure is set in the current period and in future periods ACCC Incentive Mechanism — Observations

5 Two important considerations when considering how to set expenditures for a regulated businessTwo important considerations when considering how to set expenditures for a regulated business Degree of predictability with-in a 5-year reset periodDegree of predictability with-in a 5-year reset period –Types of cost exposures can be predictable or unpredictable with-in the reset period Degree of variability from reset to resetDegree of variability from reset to reset –The quantum of expenditure can be variable or stable (including a consistent trend) from one five year period to the next (therefore, allows averaging of annual variability) Framework for Suitable Benchmark Technique

6 Expenditure characteristics matrix Unpredictable but Stable Unpredictable and Variable Predictable and Stable Predictable but Variable

7 Types of expenditures can be assessed against these two factors and placed in one of the quadrants. For example:Types of expenditures can be assessed against these two factors and placed in one of the quadrants. For example: –Planned maintenance of the transmission network tends to be both highly predictable and stable from reset to reset; –Unplanned maintenance is, by its nature, unpredictable, however, is also relatively stable when averaged over a five year period; and –Replacement Capex is predictable for a given five year period, however, it is highly variable from one five year period to the next Assessment of Expenditure in Framework

8 By placing an expenditure type in its appropriate quadrant the TNSP and Regulator can strike a regulatory bargain on how expenditures are to be set both with-in the regulatory period and in future regulatory periodsBy placing an expenditure type in its appropriate quadrant the TNSP and Regulator can strike a regulatory bargain on how expenditures are to be set both with-in the regulatory period and in future regulatory periods This is helped by the fact that there is some broad agreement on the appropriate treatment to be used in each quadrantThis is helped by the fact that there is some broad agreement on the appropriate treatment to be used in each quadrant This allows a reduction of regulatory risk by helping minimise arguments at the next revenue reviewThis allows a reduction of regulatory risk by helping minimise arguments at the next revenue review How does this help?

9 Setting ACCC Benchmarks (1) Unpredictable but Stable Unpredictable and Variable Predictable and Stable Predictable but Variable Suitable for benchmarking against historical expenditure and possibly long term against industry averagesSuitable for benchmarking against historical expenditure and possibly long term against industry averages

10 Setting ACCC Benchmarks (2) Unpredictable but Stable Unpredictable and Variable Predictable and Stable Predictable but Variable Need for ex-ante review to set benchmarks for each reset periodNeed for ex-ante review to set benchmarks for each reset period

11 Setting ACCC Benchmarks (3) Unpredictable but Stable Unpredictable and Variable Predictable and Stable Predictable but Variable Should be excluded from the cap in case of capexShould be excluded from the cap in case of capex Should be handled via pass-through in case of opexShould be handled via pass-through in case of opex

12 This frame work allows this issue to separated into two questions: What type of benchmark or revenue setting mechanism is appropriate for each quadrant? What types of expenditure belongs in which quadrant? Possible Way Forward