The Australian Energy Regulator (AER) is calling for submissions to its draft position paper on the treatment of inflation in the regulatory framework. Our draft position paper details how we should treat inflation in our decisions for regulated electricity and gas networks. It is important to account for inflation in order to determine how much revenue the regulated networks are allowed to recover from consumers.
We commenced this review in May 2020 when ongoing monitoring of market data, cumulatively, indicated that there may be a better way to estimate expected inflation than the current approach. A number of stakeholders had also raised questions about whether our current approach was delivering the best result.
The draft paper comes to the view that while our current approach is sound, it could be improved. The proposed changes are set out in the draft position paper.
We welcome submissions from all parties on our draft position and the changes we are proposing by 6 November 2020. In addition, stakeholders are invited to an online forum on 21 October 2020. We invite stakeholders to register their attendance by 16 October 2020. Stakeholders are also invited to submit questions on our draft position in advance of the forum. Questions are due by 16 October 2020.
Inflation is the term for the changing purchasing power of a dollar. If the rate of inflation is high, a dollar purchases fewer goods and services today than in the recent past. In other words, inflation reduces the purchasing power of the dollar.
Many factors might cause inflation, such as changes in fuel prices, changes in exchange rates, or the natural progression of wage growth.
We must account for inflation in our decisions so that regulated networks can recover the efficient costs of their investment over the life of their assets.
When we make regulatory decisions, in the first instance, we use an estimate of expected inflation until actual inflation becomes known. We must determine the best estimate of expected inflation to set the amount of money that regulated networks are allowed to collect from consumers.
While the current approach to inflation is fundamentally sound, we think the approach can be improved to avoid incentives for over or under investment in energy networks. Our draft position therefore proposes to:
- Shorten the period over which we calculate our estimate of expected inflation from ten years to five years. We consider that the shorter period is more consistent with the adjustments we make for inflation in our decisions. It is also more responsive to market disturbances.
- Include an adjustment mechanism to recognise that in future it may take longer than previously for inflation to settle back into the Reserve Bank’s target band of 2 to 3 per cent.
At the current time, market data and forecasts indicate that our draft approach is likely to generate a lower estimate of expected inflation when compared to our current approach. If implemented, our draft approach would result in higher revenues for business and higher prices for consumers when compared to our current approach.
Should our draft approach be implemented, we are of the view that it would be in the long-term interest of consumers. While it may be to consumers’ short-term advantage to have lower prices, we are concerned that in the long-term, not adopting the best method will risk undermining efficient investment signals and leave consumers with an energy network that does not deliver services that they are seeking in a safe and reliable way.
We have carefully considered stakeholders’ submissions and concerns in reaching our draft position. We consider that our draft position delivers a method that is likely to result in the best estimates of expected inflation and balances the needs of regulated networks and consumers.
Invitation for submissions
Interested parties are invited to make submissions on the draft position paper by the close of business of 6 November 2020. Submissions should be emailed to Inflationreview2020@aer.gov.au or alternatively submissions can be posted to:
Mr Warwick Anderson
General Manager, Network Finance and Reporting
Australian Energy Regulator
GPO Box 3131
Canberra ACT 2601
The AER prefers that all submissions be sent in an electronic format (Microsoft Word) and are publicly available, to facilitate an informed, transparent and robust consultation process. Accordingly, submissions will be treated as public documents and posted on the AER's website, unless prior arrangements are made with the AER to treat the submission, or portions of it, as confidential. Those wishing to submit confidential information are requested to:
- clearly identify the information that is the subject of the confidentiality claim; and
- provide a non-confidential version of the submission