Getting Ready!
Potential issues for consumers Ergon Distribution Network Regulatory
Proposal
Bev Hughson, Consumer Challenge Panel (CCP)2 September 2014
The data and charts in this presentation are based on the information provided by Ergon to the Australian Energy Regulator in its 2006-13 Economic Benchmarking Regulatory Information Notice
(Consolidated), 30 April 2014, Public Version. The author cannot vouch for the accuracy of the information provided by Ergon in its Notice.
Agenda• Some background – Ergon is special! – The regulatory dance
• Revenue trends• Capital requirements– The RAB– Demand forecasts– Growth, Replacement & Reliability capex
• Operating costs (opex)• Return on capital (WACC)• Wrap up – some key questions to ask
A Regulatory Reset The things that matter
• The total revenue that the AER allows Ergon– This is today’s topic– We are looking at history – to help us assess future
• The way Ergon allocates this revenue in their prices – very important, but for another day
• The way prices change across the 5 years– The big jump (up usually, down if your lucky)– Or smooth across the years
• How Ergon engages with their customers in making these decisions
A warning: Ergon is a special case!• Non-Ergon regions (Qld SE, NSW, Vic, SA)
– Most customers don’t see a network price in their bill• But the retail price will be influenced by the size & structure of the
network tariff
– For larger customers the network price is a ‘pass-through’• Ergon is different
– Most customers have the same retail price as Energex• What Ergon does is not of concern (except to Govt)?
– However, larger customers (>100 MWh/year) do see Ergon’s network price• And, they are not all happy!• Tariff structures matter
– Will the status quo change?– Importance of the very large high voltage (HV) customers
Ergon’s reliance on High Voltage Demand Consumers
34%
6%
23%
37%
Ergon Energy Use 2012-13Residential Business LV Demand HV Demand
37%
10%25%
27%
Energex Energy Use 2012-13Residential Business LV Demand HV Demand
The regulatory dance
The regulatory dance• We have a “propose-respond” regulatory model
– Important because it defines the roles of the networks & the AER (and consumers – more on this later)
– Step 1: Ergon “proposes” to the AER• Revenue requirements, based on:• Forecast capital and operating expenditure, return on assets, depreciation, tax costs, incentive
payments, tariff strategy
– Step 2: The AER responds (“Draft Determination)• Yes, no, maybe yes if you fix up this and that
– Step 3: Ergon amends their proposal– Step 4: The AER approves or rejects (“Final Determination”)– Step 5 (A): Ergon accepts, and publishes tariffs, or – Step 5(B): Ergon rejects and takes the issue to the Competition Tribunal
• Where do consumers fit in? Where is the most impact?– Talking to Ergon before the proposal?– Making submissions after the proposal?– Responding to the AER’s Draft Determination? – Other?
• Culture shock! Are all the players ready for a brave new world
Reading the Crystal Ball• Things we need to do before we start:– Learn from history– Forecast energy use– Forecast customer numbers– Forecast average use/customer– Forecast technology change– Forecast government policies– Forecast input prices (labour/materials)– Forecast the weather…
• These forecasts will underpin revenue, tariffs, capex and opex– See later slides
What’s happening to Revenue?
2006 2007 2008 2009 2010 2011 2012 20130
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
Ergon Revenue by Customer Class
Residential Moving average (Residential ) Non Res Volume TariffsLV Demand Tariffs HV Demand Tariffs
Reve
nue
($00
0s)
Ergon’s revenue per customer accelerates – but not for all (truly strange!)
2006 2007 2008 2009 2010 2011 2012 2013 -
200
400
600
800
1,000
1,200
1,400 ERGON: Revenue per customer
(Volume Tariffs)
Residential Non Res Volume Tariffs
Ave
rage
Rev
enue
/Cus
tom
er ($
/cus
tom
er)
2006 2007 2008 2009 2010 2011 2012 2013 -
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
-
1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
7,000,000
8,000,000
9,000,000
ERGON: Revenue per Customer (Demand Tariffs)
LV Demand Tariffs (LHS)
HV Demand Tariffs (RHS)
LV D
eman
d Ta
riff
s A
vera
ge $
/Cus
tom
er
HV
Dem
and
Tari
ff A
vera
ge $
/Cus
tom
er
What determines the revenue allowance next reset?
• Capital costs – now over 70% 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 (+/-)
How much capital & for what return• 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?
Capex keeps driving the RAB
2006 2007 2008 2009 2010 2011 2012 2013 3,000
4,000
5,000
6,000
7,000
8,000
9,000
400
450
500
550
600
650
700
750
800
850
900
ERGON: Asset Base & Capex
Regualated Asset Base (mid-yr) (LHS) Regulated Capex (RHS)
Regu
late
d A
sset
Bas
e ($
M)
Regu
late
d Ca
pex
($M
)
And per customer: Ergon’s RAB is bigger & growing faster
2006 2007 2008 2009 2010 2011 2012 2013 -
2,000
4,000
6,000
8,000
10,000
12,000
14,000
f(x) = 688.913727923186 x + 6528.95098801956R² = 0.998593973257353
f(x) = 493.292020220287 x + 3272.95723546861R² = 0.996612555797228
Ergon & Energex: Regulated Asset Base/Customer
Ergon RAB/customer Linear (Ergon RAB/customer)Energex RAB/customer Linear (Energex RAB/customer)
RAB/
cust
omer
($)
Growth capex: What’s happening to demand?
2006 2007 2008 2009 2010 2011 2012 2013 -
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
Ergon: Total Annual Demand (GWh)
Residential Non-residential vol tariffLV demand tariff HV demand tariff
Annu
al D
eman
d (G
Wh)
2006 2007 2008 2009 2010 2011 2012 2013 -
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
Energex: Total Annual Demand (GWh)
Residential Non-residential vol tariffs LV demand tariffs HV demand tariff customers
Annu
al D
eman
d (G
Wh)
Ergon is only network where there is no big decline in residential volumes?
What’s behind the demand trends?
2006 2007 2008 2009 2010 2011 2012 2013 -
100,000
200,000
300,000
400,000
500,000
600,000
700,000
f(x) = 9441.52380952381 x + 520940.142857143
Ergon: Customer Number Growth
Residential Linear (Residential )Total all others Linear (Total all others)
2006 2007 2008 2009 2010 2011 2012 2013 -
5.0
10.0
15.0
20.0
25.0
8.4 8.3 8.6 8.2 8.5 7.9 8.0 7.6
21.6 21.4 21.3 21.3 21.1 19.2 19.6 19.0
Ergon: Average Use per Customer
Residential use/CustomerTotal use/Customer
Aver
age
Annu
al E
nerg
y Us
e (M
Wh)
Decline in residential use from 2009-10 is only 7.3%. Energex is 15.6%
Growth Capex: Peak demand a bit of a question mark?
2006 2007 2008 2009 2010 2011 2012 2013 2,000
2,100
2,200
2,300
2,400
2,500
2,600
2,700
2,800
2,900
Coincident Maximum Demand (MW)Weather Normalised
Coincident Max Demand 10% POE Coincident Max Demand 50% POE
Max
imum
Dem
and
(Wea
ther
adj
uste
d) (M
W)
Growth & replacement capexHow much more improvement required?
2006 2007 2008 2009 2010 2011 2012 201320.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
3.00%
3.50%
4.00%
4.50%
5.00%
5.50%
6.00%
6.50%
7.00%
Ergon & Energex : System Utilisation & Energy Losses
Ergon Utilisation (LHS) Energex Utilisation (LHS)Ergon System Losses (RHS) Energex System Losses (RHS)
Util
isati
on (%
)
Syst
em L
osse
s (%
)
Getting younger by the year
2006 2007 2008 2009 2010 2011 2012 20130.0
5.0
10.0
15.0
20.0
25.0
30.0
Ergon: Average Age of Assets
O/H wires & poles (<33kv)O/H wires & poles (>33kv)Network substations/transmformerZone substantions & TransformersMeters
Age
of a
sset
s (y
ears
)
2006 2007 2008 2009 2010 2011 2012 20130.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
Ergon: Residual Life of Assets
O/H wires & poles (<33kv)O/H wires & poles (>33kv)Network substations/transmformerZone substantions & TransformersMeters
Resid
ual l
ife (y
ears
)
Reliability CapexAre there still performance issues?
2006 2007 2008 2009 2010 2011 2012 2013 -
500
1,000
1,500
2,000
2,500
-
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
5.00
Ergon: SAIDI & SAIFI Performance Measures
Total SAIDI (LHS) Underlying SAIDI (LHS)Total SAIFI (RHS) Underlying SAIFI (RHS)Linear (Underlying SAIFI (RHS))
SAID
I: M
inut
es/C
usto
mer
Off
Sup
ply
SAIF
I: N
umbe
r of
inte
rrup
tions
/Cus
tom
erEnergex average SAIFI is less than 1.5
Energex average SAIDI is less than 100 minutes
Do we see improvements in opex?
2006 2007 2008 2009 2010 2011 2012 20130
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
500,000
0
100
200
300
400
500
600
700
Ergon: Total Operating Costs & Opex/Customer
Total Opex (LHS) Total Opex exc FIT (LHS)Opex/Customer (RHS) Opex/Customer (Exc FIT)(RHS)
Ope
ratin
g Co
sts
($00
0s)
Ave
rage
Ope
x/Cu
stom
er ($
)
Feed-In Tariffs for Solar PV adding a $100/year/customer to opex by 2012-13
Ergon & Energex Opex & the FIT(and a corrigendum)
2006 2007 2008 2009 2010 2011 2012 20130
100
200
300
400
500
600
700
Ergon & Energex: Average Operating Costs/Customer
ERGON Opex/Customer ERGON Opex/Customer (Exc FIT)Energex Opex/Customer Energex Opex/Customer exc FIT
Ave
rage
Ope
x/Cu
stom
er ($
/Yea
r)
Rate of Return (WACC) -a new approach?
• Most networks seen very rapid price increases & currently very high profits – 2012-13 changes to Rules
• Cost of Debt (60% WACC): – AER new approach - move to 10 year average of 10-year tenor
bonds over a ten year transition period – disputed– Credit rating (BBB+), and data sources - disputed
• Cost of Equity (40% WACC)– Cost of equity = [risk free rate + (MRP * beta)] - disputed– Risk free rate assessment (about 3.5% at this time) - disputed– Market Risk Premium (6.5%) - disputed– Equity beta (0.7) – disputed
• Imputation Credits (adjust the tax cost allowance) –disputed
Cost of Capital – going down… (cost of debt*0.6)+(cost of equity*0.4)
2010-2015 cost of debtApprox 8.98%
2016-2020Cost of Debt?Ergon’s reported weighted average cost of debt (12/13) is 7.31%
2016-2020Input to Cost of Equity?
Cost of Equity Regulatory BenchmarksSource: AER Explanatory Statement RoR Guideline, Appendix C, p 32
NSW NSP’s proposing 10.1%; AER NSW Transitional Determination 8.9%
The bottom line & why you should care
20062008
20102012
20142016
20192021
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
400
600
800
1,000
1,200
1,400
1,600
Ergon: RAB trend growth & "interest" bill per customer
(interest rate 7.5%)
Interest Bill Ergon RAB/customer
RAB/
Cust
omer
($)
Ann
ual i
nter
est
bill/
cust
omer
20062008
20102012
20142016
20192021
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
400
600
800
1,000
1,200
1,400
1,600
Ergon: RAB trend growth & "in-terest" bill per customer ( in-
terest rate (8.83%))
Interest Bill Ergon RAB/customer
RAB/
Cust
omer
($)
Ann
ual I
nter
est
Bill/
Cust
omer
Forecast RAB & “Interest “rate figures are estimates – for illustration purposes only
Summary of Issues to Watch• Are the forecasts reasonable?• Is the capex prudent and efficient?• Is the opex prudent and efficient?
– 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)?– A problem unless AER sets tight allowances– Witness NSW distribution companies…
• Have consumers been adequately engaged in the decisions by the networks and the AER?