16 October 2013
In a speech at the Annual Energy Users Association of Australia's (EUAA) Conference, AER Chairman, Andrew Reeves outlined how the AER will address the challenge of integrating the consumer voice into energy network regulation.
Transcript
Thank you for the opportunity to speak with you today. It is a pleasure to take part in the EUAA’s annual conference and to discuss opportunities to enable consumers to participate in energy markets.
Today I want to talk about the recent network regulation reforms, the developments in the AER’s approach to regulation under the new electricity Rules, and the ways in which we propose to bring the consumer voice into our regulatory decisions.
The urgency for energy reforms
Energy prices have become a major concern for the Australian community in recent years. Why? Because of significant price rises in our energy bills. And, as many of you are aware, electricity network costs were the main driver of higher prices in all states—accounting for between 40 to 50 per cent of the price increases over the past five years or so.
The electricity price shocks put a spotlight on network regulation. There were good reasons for higher prices to an extent. The drivers of increased network costs include replacement of ageing equipment, peak demand and higher borrowing costs at the time the determinations were made. However, some of the price increases were unnecessary and can be attributed to deficiencies in the electricity rules and reliability settings, which led to inflated proposals and inefficient expenditure on network infrastructure.
We are in the middle of a wave of energy reforms. The overall thrust of these reforms is ‘putting consumers first’. They are designed to deliver an energy sector that is more able to deliver for energy consumers. The bottom line is consumers should only pay for the efficient costs of reliable electricity supply.
Allow me to highlight four important areas of reform in energy.
First, there is the AEMC’s 2012 Power of Choice review, which looks at demand-side participation in the National Electricity Market. There is the potential for significant productivity gains from improvements to pricing, demand-side management and metering, as already highlighted by John. This area of reform needs to be progressed now and should be a priority for the Standing Council on Energy and Resources.
Second, the AEMC is undertaking reviews of the national frameworks for network reliability. The AEMC’s work places greater emphasis on the needs of consumers by moving towards more consistently defined standards, improving consumer engagement and setting standards that are based on the value that customers place on reliability.
Third, reforms to the limited merits review regime have been agreed to by the Standing Council on Energy and Resources. Our concern with the old regime was that there was the lack of a real opportunity for the Australian Competition Tribunal to consider the overall balance of a regulatory determination to ensure that the outcomes achieved are in the long-term interests of consumers. Now, the Tribunal must assess not only whether a ground of review has been made out, but whether addressing that ground of review, having regard to any interlinked matters would deliver a regulatory determination that results in a materially preferable outcome in the long term interests of consumers. In short, the hurdle for seeking review is now higher.
Fourth, there have been significant changes to the regulatory framework that we administer, which is a focus of this speech.
In 2011, the AER got on the front foot and submitted proposals to the AEMC to address weaknesses in the regulatory framework that limited our ability to reject excessive expenditure forecasts.
The AEMC’s final Rules, released in November last year, set out a framework for the balanced assessment of the need to allow for efficient investment required to ensure a continued reliable energy supply, with the need to minimise costs to consumers. Further, the reforms target more constructive approaches for us and network businesses to engage with consumers.
The AEMC passed the implementation of these changes back to the AER and, in December last year, we initiated the Better Regulation program to draw together these important reforms in developing our approach to network regulation.
The Better Regulation program – we’re getting… better
We are improving how energy network businesses are regulated through the Better Regulation program. You can expect better energy regulation, better investment decisions and better consumer engagement, which means a more efficient energy sector and, therefore, lower prices for consumers. When finished, the Better Regulation guidelines will come close to being a complete manual of how we go about economic regulation. The guidelines will apply for the next round of regulatory determinations commencing in 2014.
The guidelines clearly set out why we approach things the way we do. For example, we provide a simple explanation for why we have preference for one form of incentive regulation over other approaches. We also set out the legal and economic basis for our approach.
The scope of our Better Regulation program is extensive. We are developing guidelines on how we will calculate the allowed return on assets, assess expenditure proposals, encourage efficient spending by businesses, and engage consumers in the regulatory process.
Allow me to highlight some important developments in our Better Regulation guidelines that are designed to incentivise network businesses to make efficient investment decisions.
First, we have developed new measures to strengthen the incentives for businesses to undertake capital expenditure efficiently, and for consumers to share in the benefits of efficiency improvements. Under our proposed capital expenditure sharing scheme, businesses are offered equal reward and penalties for becoming more or less efficient over time. Some consumer representatives are proposing that there be stricter penalties on overspends than there are rewards for underspends, which we are considering.
Second, we outline new ex post assessments of capital expenditure, a further tool designed to promote efficient investment. Previously, there was no ex post review. All expenditure undertaken by the businesses, including any inefficient overspending, was added to the regulated asset base and paid for by consumers.
Third, we are developing benchmarking techniques to assess proposals from businesses. Benchmarking is a way of determining how well a network business is performing against its peers, and provides valuable information on what is ‘best practice’. We will use benchmarking to inform us of a businesses’ comparative efficiency, and help us focus on those areas where expenditure does not appear efficient and warrants further examination. It will also be used to inform our allowances for efficient expenditure where we are not satisfied that a business’ own costs are efficient.
Fourth, we are improving the way we determine the return that electricity and gas network businesses can earn on their investments. The allowed rate of return is an estimate of the appropriate cost of capital expenditure for the network business. Returns can account for 40–70 per cent of network businesses’ revenues in this capital intensive industry. The rate of return must be calculated as a weighted average of the return on equity and the return on debt.
We are proposing to draw on a broad range of information to set rates of return that reflect efficient financing practices. The revised approach is also expected to lead to a more stable rate of return estimate over time, decreasing the volatility in prices that consumers previously experienced.
In addition to our work on how we regulate the network businesses, we have been focused on improving consumer engagement in our regulatory processes. I will come back to what we are doing in this space in a moment. First, it is useful to explain our role in the promotion of the National Electricity Objective (NEO). As you would be aware, the NEO talks about the promotion of efficient investment in and efficient operation of network services in the long term interests of consumers. (The NEO is similar to the National Gas Objective.)
The AER is not a consumer advocate
There is a view that it is the role of the regulator to act on behalf of consumers—that is, to bring to our work a consumer focus. Another view is that the regulator acts as a ‘referee’ between customers and the network businesses, taking account of submissions from competing interests. These views come through in the comments we hear, such as: “isn’t it your role to be out there batting for consumers?” or “maybe you haven’t been doing your job well enough in acting for consumers, and now consumer groups have to beef up resources to keep you on track.”
I have taken these opportunities to describe what our role is and how we actually go about applying the NEO.
We are not a consumer advocate, nor are we an arbiter. We administer the National Electricity Rules, which requires us to make regulatory decisions that are consistent with, and contribute to achieving, the NEO.
We also routinely initiate changes to the Rules that we consider allow us to better deliver against the NEO. For example, the Rule changes we submitted to the AEMC in 2011—that were a basis for recent energy reforms—were not so much about the promotion of consumer interests (though these were clearly the outcomes), but rather they were about reframing the Rules for a better expression of the NEO. It is an important nuance and it colours what we are trying to achieve in integrating the consumer voice into network regulation.
Giving consumers a say
We must be unbiased and objective as an administrator of the Rules. We must be impartial when considering the arguments put to us in a regulatory process—regardless of who they are from.
That said, we recognise that the submissions we have received to date have been heavily weighted towards the network businesses’ arguments. There is an obvious ‘gap’ in the information submitted to us. If we have few submissions from consumers or consumer groups, how can we be sure that we are making decisions that reflect the long term interests of consumers?
It is important for us to gain consumer perspectives and observations to help us understand if a regulatory decision is consistent with the NEO. Consumer involvement is critical if the regulatory regime is to be focused on promoting consumers’ long term interests, which can have a different meaning for different people. It is also important in ensuring spending proposals are efficient and reflect the priorities of the Australian community.
Further, transparency and accountability are core values of the AER. We want to inform consumers about our regulatory processes and decisions. If consumers are aware of and understand our reasons for our regulatory decisions, we are more accountable. Accountability creates a discipline on us to make decisions in the consumers’ best interests and in accordance with the law. It also helps to ensure that deficiencies in the Rules are identified and remedied.
We are committed to improving how we communicate our price review processes and decisions to allow better consumer participation and engagement. This requires innovative thinking about how we communicate with consumers. For the recent Victorian gas prices review, we released a customer consultation paper for the draft decision and a consumer guide to the final decision. These documents provide helpful background material and describe: the basics of how we assess a network pricing proposal, the regulatory process and how consumers can get involved, and key aspects of the decision and how they impact consumers. Consumer groups and other stakeholders welcomed this initiative. Similar consumer documents will be attached to regulatory decisions going forward.
Nevertheless, making our assessment and decisions accessible to a wide ranging consumer audience is far from straightforward because network price reviews deal with inherently complex and technical issues. The complexities of the energy market and the regulatory processes that make up much of our work have made it difficult for consumers, and even their representatives, to participate meaningfully to date.
In particular, we receive feedback that it is hard for consumers to ‘add value’ to the economic analysis. But that is not necessarily what we are trying to achieve.
I do not see better consumer engagement as being about more technical analysis in consumer submissions. We welcome such submissions of course, but economic analysis and understanding incentives are our strengths as an organisation. And, as I touched on earlier, the new Rules framework and Better Regulation guidelines strengthen our capacity for this approach.
More so, the consumer engagement reforms are designed to give consumers a say in energy market developments that impact on them. They strengthen consumer involvement in the regulatory process.
This requires flexibility on our part to allow consumer representatives to have input without necessarily writing formal submissions into our processes. Traditionally, our engagement approach was based on an iterative documentation exchange and public forums. Our new approach to engagement focuses on engagement, inquiry, questioning and understanding. Consumers are not expected to speak our ‘regulatory language’. The onus is on us to understand consumer perspectives and reflect them in our regulatory decisions.
New institutional arrangements that place consumers at the centre of the energy market
The new Rules support consumer involvement in the regulatory process, and enable us to engage more productively with energy consumers and businesses.
Most significantly, the new Rules framework requires us to take account of network businesses’ consultation with their customers in considering their regulatory proposals. This is a powerful incentive for the businesses to engage with end users.
To assist with this, we are developing a Consumer Engagement Guideline for Network Service Providers. A draft has been released, it has been discussed with the Consumer Reference Group, and submissions have been received. The guideline sets out our expectations for consumer engagement by network businesses. It aims to assist network businesses to engage systematically, consistently and strategically with consumers on significant issues, to better align the provision of services with the long term interest of consumers.
Businesses will need to demonstrate that they have listened to consumers, they have heard what has been said and that this is reflected in their proposals. We expect the network businesses to demonstrate a commitment to ongoing and genuine consumer engagement on a broad range of issues relevant to consumers. We want to see businesses being more accountable to their consumers.
We do not think the businesses can effectively engage around their network proposals if they do not engage effectively more broadly. And engagement with consumers should be a subset of their engagement with the communities they serve and other stakeholders. In short, we think that the consumer engagement guideline will support greater transparency and accountability for the network businesses. This engagement should extend, for example, to the public process around major investment proposals.
We are developing benchmarking reports, to enable consumers to assess how their network business is performing in comparison to others. These reports may provide a starting point for conversations between businesses and consumers.
In addition, the Rules require consumer-focused written documents, including AER issues papers and requirements on the businesses to include overview papers for a consumer audience.
There are also new arrangements for dealing with confidentiality claims over the information network businesses put forward. The aim is to protect genuinely confidential information, while publishing for public scrutiny as much information as possible to allow for an open and transparent process.
Finally, there is now more time allowed in the regulatory process for stakeholders to prepare submissions and put their views forward. Additional time also allows for more consumer seminars and workshops.
So, consumers will be in a better position to understand regulatory proposals, will have additional information to form a view, and will have more time and flexibility to provide their input into the process.
A promising start
We are undertaking work on a number of fronts that is designed to give consumers a greater voice in our regulatory processes. Consumers and consumer groups have already seen a significant improvement in our engagement approach in the development of the Better Regulation guidelines.
We have been innovative in how we engage stakeholders. Traditionally we have developed guidelines and the like by: putting out an issues paper, taking submissions, putting out a draft report, holding a public hearing (where no one comes), taking more submissions, and then releasing a final report.
In contrast, for the development of the Better Regulation guidelines, we have been more proactive in the way we consult. For example, we set up a Consumer Reference Group to make it easier for consumer representatives to have input into the development of our guidelines. We have worked closely with the group to inform them of our position and have sought feedback from members throughout the development process.
To facilitate input in meetings with the Consumer Reference Group, we explained the key issues and reasons for why each guideline adopted certain approaches. We clearly set out what problem we are trying to fix, and the options we are considering or intending to adopt. We also prioritise the significant issues.
Our new engagement approach has added significant value to the Better Regulation guideline development process. Consumer Reference Group members have been able to distil key issues and information to constituents for consideration, consult and report back to us.
We have held a number of workshops, including around 20 workshops on both the expenditure assessment guidelines and the cost of capital guideline. All up, there have been over 50 workshops for consumers and the network businesses. In addition, there have been a large number of bilateral discussions with investors, network businesses and certain consumer groups.
To help stakeholders understand the guidelines and prepare their submissions, we have also developed factsheets to accompany each of the draft guidelines. The factsheets provide a summary of our key positions. We will develop factsheets for the final guidelines too.
I am unaware of a regulatory agency having that level of engagement and openness in such important matters. There have been significant resources devoted to equipping stakeholders and, importantly, genuine engagement with and involving people in the development of our thinking. The success of this approach is also attributable to the very significant investment of time by the members of the Consumer Reference Group On this point, I thank the EUAA for supporting Bruce Mountain’s participation in the Consumer Reference Group.
Improvements to the way we consult have paid off. Ultimately consumers have helped shape the Better Regulation program. We have taken into account consumer perspectives and observations and we have reflected them in our guidelines.
Opportunities ahead
Going forward there will be ample opportunity and considerable demand for consumer engagement in our network price reviews. We will be required to consider regulatory proposals for 12 network businesses in 2014 and up to 25 in 2015. This peak workload is unprecedented and puts significant pressure on the resources of everyone involved in the processes. Our consumer engagement will need to be efficient and effective.
Building on our consultation approach for the Better Regulation program, we will establish jurisdictional groups of consumer representatives for each reset. We expect to meet with these groups throughout the determination process to discuss the network businesses’ proposals and seek their feedback on the options we may be considering to address any identified issue. This approach gives us a mechanism for coordinated and informed views from a cross-section of consumer groups. It also makes it easier for them to have input into the regulatory process—just as it did for the Better Regulation program.
The newly formed Consumer Challenge Panel will also play a significant role in our processes—advising us on issues that are important to consumers. The Panel sits within the AER. It will give us greater confidence that consumer perspectives, particularly those of residential and small business consumers, are being properly considered throughout these technical and complex regulatory processes.
We have assigned the individuals Consumer Challenge Panel members to subpanels, to provide advice on particular projects. The subpanels align with the way that we conduct regulatory determinations. As an example we have one subpanel for the New South Wales/ACT electricity distribution determination. The subpanels have been designed to incorporate a mix of technical, regulatory and consumer advocacy skills, and will vary in size from two members to five members depending on, for example, how many businesses are part of the project as well as the likely impact on consumers.
Subpanels will be involved throughout the process. The interaction between subpanel members and the AER will be different for each reset. They will be engaged from the ‘framework and approach’ phase and continue to be involved until the AER makes its final decision. They will bring the consumer perspective to meetings with the AER Board, AER staff as well as the regulated businesses. I note that the Panel is not intended to be a replacement for any of our other consumer engagement—it is in addition to those processes.
There are interlinkages between the jurisdictional consultation groups and Consumer Challenge Panel. The key distinction is that the Panel is a strategic analytical tool for us to make better decisions. It casts a critical eye over what we do at more of a macro level. Although the Panel gives us consumer perspectives, it does not represent constituents in the same way as consumer representative groups.
Adding yet another layer to consumer engagement, I note that the Standing Council on Energy and Resources—made up of Ministers from all Australian governments—agreed in principal to establish a national energy consumer advocacy body from 1 July 2014. The Australian Energy Consumers Organisation will be an important stakeholder. Its formation is an important step toward increasing consumer advocacy on national energy market matters of strategic importance and of material consequence for energy consumers, particularly household and small business consumers. We look forward to further developments in this space.
As we see it, this body should have the capacity for research, maintaining a knowledge base, and critical analysis and commentary on strategic issues facing energy consumers. With changing technology, there will be an inevitable transformation in the energy sector and delivery of services. It is essential that there be an informed consumer voice to ensure that these changes do deliver better services for consumers.
Our commitment to consumer engagement
The vision is putting consumer at the centre of the market. We are committed to meaningful and effective consumer engagement within our processes for these reviews. Authenticity and leadership are important components of achieving the level of cultural change that is required in the energy market around the role of customers.
We expect that this increased level of engagement, coupled with energy reforms that strengthen the regulatory framework, will lead to consumers and governments having increased confidence in the energy market, its regulation and the outcomes it delivers.