AER releases final inflation position for regulatory decisions

The Australian Energy Regulator (AER) released its final position paper on the treatment of inflation in the regulatory framework. The final position paper outlines how inflation will be treated in our decisions for regulated electricity and gas networks. It is important to account for the best estimates of expected inflation to assist in determining how much revenue the regulated networks are allowed to recover from consumers.

Our final position sets out changes to our current approach.

  • Reduce the length of our estimate term from 10 years to 5 years to match the typical length of our regulatory periods
  • Include an adjustment mechanisms (known as a ‘glide-path’) to recognise that it is likely to take longer for inflation to settle back into the Reserve Bank’s target band of 2 to 3 per cent.
  • Immediately apply our final position to regulatory determinations.

This approach is able to operate across a breadth of market conditions and forecasts and is more responsive to changes in market conditions than our current approach. In this way it will advance the National Electricity Objective and the National Gas Objective as service providers will more accurately recover their efficient costs in the long-term interest of consumers.

The impact on revenues and prices resulting from our final position will vary from time-to-time, depending on market data and forecasts. Sometimes it might produce a higher estimate of expected inflation than our current approach and at other times it might produce a lower estimate.

We consider that our final position is in the long-term interest of consumers. 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 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 AER is now required under the National Electricity and National Gas Rules to commence a formal process to make amendments to the method for estimating expected inflation in the relevant regulatory models (the post-tax revenue model for electricity and revenue model for gas). This process will be complete by mid-April 2021.

Further information on the consultation process for the electricity models and the gas models is available.

Issued date: 
17 December 2020
AER reference: 
AC 174/20
General enquiries - Inflation review