1. The Australian Energy Regulator Expenditure Forecast Assessment Guidelines Category analysis – Overheads and accounting issues 16 May 2013

2. Agenda 9:00 -Introductions and objectives 9:15 - Context and framework considerations 9:30 - Overheads 10:30 - Break 10:45 - Accounting issues 12:15 - Summary & next steps 2

3. Where are we today? Issues paper 20 Dec 2012 Initial Roundtable 12 Feb 2013 Category selection 28 Feb 2013 Replacement/Demand 7/8 Mar 2013 Connection/Customer driven capex 19/20 Mar 2013 Repex/Augex models, demand forecasting 27 Mar 2013 Opex category assessment 11 Apr 2013 Base-step-trend/Productivity change 8 May 2013 Overheads, Cost allocation and accounting 16 May 2013 Expenditure setting process TBC (~mid June) 3

4. Objectives for today Provide context for overheads assessment Test potential assessment methods and data requirements: ◦Expenditure categorisations ◦Normalisations ◦cost drivers Explore cost comparability issues: ◦Cost allocation ◦Capitalisation ◦Other NSP reporting inconsistencies 4

5. Context for today Overheads, accounting and the incentive framework: ◦Opex (including overheads) may be set using revealed cost ◦Consistency in ex post/ ex ante capex assessments  Dealing with changes to capitalisation policies  Reporting of related party margins AER will compare overhead costs anyway: ◦Opex activities in benchmarking reports ◦Benchmarking of capex (including overheads) ◦Capex/ opex category trade-offs 5

6. Overheads expenditures 6

7. Overheads – what’s in/ out “Overheads” = anything not yet covered in workshops “direct” overheads ◦functions that are focussed on the management and general operation of the network ◦e.g. Network planning and operations “Indirect” overheads ◦corporate functions that are standard to almost all large businesses ◦e.g. CEO, HR, licence fees Non-system capex, capitalised overheads 7

8. Expenditure opex direct emergency maintenance Veg mgt Direct overheads operations Network planning & management Billing, customer interface Indirect/ corporate Licence fees CEO/ finance/ HR Allocated overheads capex Direct/ system connections augex repex Non-system Vehicles Land and Buildings IT, comms Indirect/ Corporate Capitalised overheads 8

9. Opex breakdown, all NSPs 9 Source: Latest RIN data

10. Capex breakdown, all NSPs 10 Source: Latest RIN data

11. Previous AER approaches In opex trends, recognition of: ◦Correlation to network growth ◦economies of scale/ presence of fixed costs Detailed expert review NSP justifications ◦bottom up e.g. CBA ◦non-bottom up/ modelling Some benchmarking (e.g. NSW reset) Limited consistency and transparency in reported categories 11

12. Ofgem’s general approach Direct overheads = “closely associated indirects” ◦11 sub-categories, eg network design, project management, control, call centre, training ◦Grouped according to normalisation “metrics” MEAV Total network investment Total direct costs Drivers for the associated direct cost Combination of the above 12

13. Ofgem’s general approach Corporate / Indirect overheads = “business support costs” Eg HR, CEO, Finance, Property ◦External benchmarking (ie with other, unregulated businesses) ◦NSPs to provide evidence of insourcing/ outsourcing decisions/ business models ◦Metrics (not drivers) – employee numbers, revenue, end users (eg IT clients) ◦Expert review – IT and land 13

14. Ofgem’s general approach Boundary issues in direct vs indirect Treatment of once-off costs, use of averages for lumpy costs Benchmarking before and after allocations, to services as well as DNOs in a group Choice of metrics & transparency of assessment ◦Use of (direct) expenditures as a driver/ metric potentially rewards inefficient behaviour ◦“Metrics/ scale factors should be stable over time, outside the DNO’s control, not collinear with other measures” 14

15. Direct overheads (opex) Potential categorisations: ◦Asset/Network Management ◦Network operations ◦“other” - Customer service, metering, billing? Potential drivers - network size/ value? ◦Undepreciated RAB/ MEAV ◦Revenue ◦Customer numbers Impact of any “uncontrollable” factors as per direct capex/opex? 15

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21. Non-system capex Potential high level categories: ◦IT ◦Communications ◦Vehicles ◦Land ◦Buildings ◦Furniture, plant and equipment ◦Other Drivers - network size, employees? Isolating recurrent from irregular costs 21

22. Non-system capex IT – subcategories and supporting data: ◦recurrent vs one-off ◦Leased vs purchased ◦Fixed vs variable ◦Cost per end user or employee? Communications - similar points to IT ◦Hardware vs software ◦Data vs oral communications ◦Cost per end user or employee? 22

23. 23 Source: NSP RIN data

24. Non-system capex Vehicles – subcategories and supporting data: ◦Leased vs purchased ◦Cost and number of vehicles for: Heavy/ light Passenger/ commercial ◦Impact of network area, km of line, employees, direct capex/ opex “workload”, number of jobs? ◦Utilisation data – kms, days used? 24

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27. Indirect overheads Typical inclusions: CEO, Legal and secretariat, HR, Finance, Treasury Not visible in existing reporting Expect these costs to be largely fixed, otherwise by FTEs? May reflect uncontrollable jurisdictional/ regulatory differences Comparable with competitive firms? Expensed and capitalised Cost allocation issues 27

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29. Accounting & reporting issues 29

30. “Accounting issues” Things which detract from like-for-like comparisons ◦Capitalisation ◦CAMs and cost allocation ◦Related party margins/ fees ◦Service classifications ◦Standard voltage differences ◦Different reporting years (calendar vs financial) 30

31. Capitalisation What’s the problem? ◦Accounting rules/ discretion in expensing/ capitalising ◦Policy not currently disclosed/explained by NSPs ◦Lack of comparability, e.g. in capitalised labour, overheads What AER/ stakeholders previously said ◦Issues paper canvassed possible AER prescription ◦No support for this (ENA) Considerations for discussion ◦If no prescription, what is “transparency”? ◦New Rules require accounting for capitalisation policy changes in RAB roll-forward – how to do this? 31

32. Cost allocation issues What’s the problem? ◦Allocation between services and within standard control categories ◦Assessment of allocated/ shared costs but also preserving comparisons of directly attributable costs What AER/ stakeholders previously said ◦Issues paper canvassed possible AER prescription ◦Responses – NSPs do not support single approach Considerations for discussion ◦If no prescription, what is “transparency”? ◦Full visibility (calculations) of overheads allocation ◦Reconciliation to statutory accounts 32

33. Related-party margins What’s the problem? oMargins currently assessed through specific efficiency test oRequire ongoing visibility of amounts What AER/ stakeholders previously said ◦Issues paper identified existing approach, noted potential overlap with capex incentives/ ex post reviews Considerations for discussion ◦Ongoing need for transparency ◦Differences between ex ante and potential ex post assessment? 33

34. Service classifications What’s the problem? ◦Differing classifications mainly due to previous classification under earlier legislation ◦New services, e.g. AMI in Victoria (from 2016) Considerations for discussion ◦Materiality of problem ◦Visibility and treatment of material differences ◦CAM issues - visibility of allocations between services 34

35. Jurisdictional voltage variation What’s the problem? ◦Differing operating voltages may affect cost benchmarking ◦Voltage identified previously as a potential cost driver e.g. capex Considerations for discussion ◦Consideration of capex categories that capture differences ◦Recognition of materially different conditions 35

36. Reporting year variations What’s the problem? ◦Different regulatory reporting years may inhibit comparison of expenditures What AER/ stakeholders previously said ◦Issues paper suggested long term alignment ◦Responses questioned materiality in context of other benchmarking issues Considerations for discussion ◦Recognition of lags in some annual reporting/ benchmarking information 36

37. Summary and next steps 37