‘Mission control, we have a problem’ – that’s the way the Grattan Institute is describing our current approach to regulating electricity networks.
While the report authored by Tony Wood points out a range of problems that have been largely accepted by our main energy regulatory bodies and governments; it also shines a bright light on an area they continue to try to ignore – the inflated returns captured by network businesses.
In reading the Energy White Paper you could be fooled that there is little wrong with electricity network regulation in this country. The White Paper seems to suggest that all that’s required is the roll-out of smart meters and removal of retail price controls. It goes out of its way to justify the recent huge rises in network expenditure as legitimate and necessary. And it tries to bizarrely pretend that the Productivity Commission report was just about the use of benchmarking for regulatory purposes, when it actually delivered a scathing assessment of the entire regulatory framework.
While the Department of Resources and Energy would prefer to suggest there’s nothing untoward here, the Grattan Institute isn’t about to let them get away with it.
Network businesses are regulated rate of return monopoly businesses, who face minimal, if any, market risks. Their revenue is pretty much guaranteed and they operate on a cost-plus basis. While they do face some degree of regulatory risks, state government network businesses can rest safely in the knowledge that their owners largely control the regulatory levers (which also acts to reassure privately-owned network operators).
Because of these low risks, lenders and investors are happy to provide money to these businesses for noticeably lower returns than what they might require from businesses exposed to market and technology risks, like oil companies, or even electricity generators and retailers.
Yet in spite of these lower risks, the Grattan chart below illustrates that these network businesses earn returns that are competitive with the overall ASX All Ordinaries Index. They are also in many cases superior to AGL and Origin, who are exposed to wholesale electricity markets that can vary by the order of 300 per cent within a few hours. And they’re competitive with Santos – a company that has to explore for oil and gas deposits that can be like needles in a haystack and where prices can also be highly volatile.
Mean annual equity return for network businesses (orange diamonds) relative to other companies
In addition, the two charts below show that the NSW and Queensland state government network businesses have been allowed by the regulator to recover costs that assume a cost of debt noticeably higher than what they are actually charged by their own state Treasuries. What’s more, this ignores the other rort whereby these Treasuries pick up a margin referred to as “competitive neutrality fees” to supposedly compensate for the higher risk these businesses entail. This means that as an owner, state governments actually capture a much bigger margin that reflected in the charts below.
NSW distributors allowed and effective costs of debt
Queensland distributors allowed and effective costs of debt
Why is this such a problem?
Firstly, if allowed returns more closely reflected costs, according to the Grattan Institute, consumers would have saved close to $2 billion over the last five years just in interest costs.
But this is just the tip of the iceberg. That’s because when the regulator allows networks to make a healthy margin above their cost of funds, it encourages them to undertake network upgrades beyond what’s necessary, to maximise the amount of this cream. This means consumers are hit twice because we have to fork out for additional network infrastructure that we don’t really need, on top of giving these businesses a financial return higher than required.