17 February 2015
In a speech at the 2015 Committee for Economic Development of Australia Conference in Melbourne, AER Chair Paula Conboy, delivered her inaugral speech as Chair of the Australian Energy Regulator.
Check against delivery
Introduction
Thank you and good afternoon. It is great to be delivering my inaugural speech as Chair of the Australian Energy Regulator on such an important and interesting topic.
I have been in this role for just over four months, and it is an opportune time to reflect on my initial impressions and share my views on the task ahead.
The upcoming year will be a significant one for the AER and our stakeholders - particularly in the networks area.
- New guidelines and schemes published under our Better Regulation program, will take effect for the first time in 2015. The draft network decisions we issued in November marked the implementation of those guidelines. They flow from changes to the Rules for the Economic Regulation of Network Services, determined by the Australian Energy Market Commission. Equally importantly for the upcoming regulatory periods are legislated changes to the merits review process made by the COAG Energy Council that change the test for altering AER decisions to one focused on the overall outcome for consumers.
- During 2015 we will review, or begin reviews of revenue forecasts for more than twenty network businesses. We will assume for the first time, the regulation of networks in the Northern Territory.
- New rules for distribution pricing in electricity have begun—with some businesses due to submit tariff structure statements for the first time this year.
- We are continuing our work in the upstream and downstream energy markets. The transition to national retail regulation is progressing with Queensland expected to implement the National Retail Energy Law on 1 July.
- We are building consumer confidence in energy retail markets through our compliance and enforcement programs, and refinements to our Energy Made Easy website.
- We are also continuously monitoring activity in the wholesale energy markets. Where we see potential breaches we will take appropriate action. Participants need to have confidence they are participating in a well-functioning market.
- Our consultation on the regulation of alternative energy sellers this year will look at how the current framework for selling energy relates to emerging products and services in the electricity retail market.
Among all this activity, it is important that that we continue to take time to consider the broader questions affecting the energy industry. Questions about the future of energy markets, the role of regulation and the hallmarks of good regulatory practice.
These are topics I would like to explore today.
Energy markets in change
Energy markets worldwide are evolving.
The evolution is being driven by consumers and fuelled by new technologies.
Consumers are becoming more active participants in the markets; making more informed choices about their energy consumption and investments.
Rising cost pressures in Australia provided the impetus for a growth in alternatives such as demand side response and small scale local generation.
New technologies such as innovations in network communications, customer owned generation are also allowing consumers to have greater control over how they source and manage their energy use and related functionalities/services.
Accompanying these changes is speculation about what the future might look like and how the markets can adapt.
Many are seeking to define the role of distribution networks in enabling the evolution and modernisation of the grid.
Some commentators are also questioning whether the existing regulatory regimes are up to the task and how the roles of market participants and the regulator might change going forward.
Australia is not alone in asking these questions.
Market participants, regulators and policy makers worldwide are grappling with the reality that energy markets and the role of networks in those markets are rapidly changing.
The Ontario Energy Board (OEB), where I was a member before coming to the AER, participated on a Smart Grid Advisory Committee established to make recommendations on how various stakeholders in the Ontario electricity sector should proceed with grid modernisation.
The OEB is also looking at changes through its renewed regulatory framework at how its regulatory regime needs to change to meet market evolutions.
Regulators in other parts of the world are also asking similar questions. In New York for example, the Public Service Commission has launched its ‘Reforming the Energy Vision’ initiative.
Among other things, this initiative will look at wider deployment of distributed energy resources and promoting greater use of advanced energy management products.
The Commission is asking what should be the role of networks in this new market and what changes should be made in the current regulatory regimes.
In this era of change, effective regulation remains an important platform in delivering the services that consumers want and need.
As the new chair of the AER, the challenges associated with a changing market and uncertain future is at the front and centre of my mind.
How can I make sure that our regulatory regime promotes the efficient investment in and efficient operation and use of electricity services for the long term interests of consumers?
Or for those of you in the room with the lingo – how do we make sure that in this evolving market our regime continues to meet the NEO.
The underlying question—why do we regulate?
In getting caught up in all this debate and speculation I think it is critical that we do not lose sight of the key question—the fundamental principle—that underlies everything we do as a regulator—why do we regulate services?
Now, this is obvious to many of you in the room but it’s always a good place to start.
Energy, for the most part, is an essential service. And energy is inextricably linked to the well-being of the economy. It is important that we have well-functioning, efficient energy markets.
And exposing the market to competitive forces is often the best way of getting there.
As you all know in the context of energy networks, regulation exists because energy networks are natural monopolies and we cannot rely on markets alone to deliver efficient outcomes. Regulation of network businesses is aimed at promoting efficiency as this is what we might expect in a competitive market. Different regulators use a range of different tools to undertake this task, but generally speaking, we are all aiming to reach the same end point—efficient investment in, use and operation of networks.
But regulators also need to know when to let go—where there is sufficient competition in the provision of certain services, we should forebear.
This has been the experience in our current review of the New South Wales and the ACT networks, where we reclassified certain metering services, facilitating an efficient transition to competition.
Similarly, there is an increasing amount of competition in certain states for the provision of connections services.
If leaving the market to competitive pressures provides efficient outcomes, then that is likely the appropriate course of action.
How do we meet our underlying efficiency objective in a changing environment?
So, once we have established a case for regulatory intervention, the next question is what should this regime look like? What tools should we use to promote efficient outcomes for the services we regulate? What works in an environment of change?
At the most basic level, our regulatory approach needs to promote efficient investment and operation of networks, provide predictability, but also respond flexibly to the needs of consumers and the industry.
And the current regimes are designed with these principles in mind.
Predictable regulation
In 2011, the AER put proposals before the rule making body, the AEMC, to address weaknesses in the Rules that were leading to network price increases beyond what was necessary to ensure reliable supply. In particular we raised concerns with the constraints in the rules on our ability to scrutinise investment proposals by businesses and weaknesses in the rate of return framework. Significant improvements were subsequently made to the Rules—I imagine many of you in the room participated in that process.
Following the changes to the Rules the AER put out a series of regulatory guidelines outlining in detail our approach to regulation under these new rules. These guidelines were finalised after an extensive period of consultation in 2013 under the AER’s Better Regulation reform package.
Together these new Rules and our Better Regulation reforms provide predictability in how we regulate.
The guidelines were developed after extensive consultation and engagement. They set out our approaches to regulation in advance of our determinations.
The regime continues to move to a uniform national framework.
To date the separation of functions between the AER as regulator, the AEMC as advisor to governments on market development and statutory rule maker, and AEMO as market operator and national transmission planner have served the markets well. The COAG Energy Council has just launched a review to ensure that this continues to be the case.
Incentive based approach
Our underlying approach to regulation also provides incentives with a strong emphasis on efficient investment in, and operation of, networks.
The ex-ante ‘incentive-based’ approach sets an overall revenue allowance that network businesses can recover from consumers to provide safe and reliable services—that allowance is based on an assessment of efficient costs.
If a network business can subsequently provide the required services at a lower costs it can ‘keep the difference’ for a period of time.
Conversely, if the network business incurs higher costs, it will bear the difference.
The combination of the ex-ante allowance and our Efficiency Benefit Sharing Scheme encourages network businesses to minimise their costs while continuing to provide safe and reliable electricity services.
An ex-ante incentive based approach also incorporates flexibility to allow businesses to adapt to a changing environment.
A network business has discretion as to how it runs its business within the overall allowance.
Businesses have incentives to continually look for innovative ways to deliver energy services and make efficiency savings. This flexibility is essential in a rapidly evolving environment where the ability to successfully adapt to constant technological change and obsolescence while avoiding asset stranding provides value for all stakeholders.
This approach contrasts with a traditional cost of service approach where allowances are based on actual costs incurred.
Benchmarking
Over time the ex-ante incentive based approach is intended to reveal the businesses’ efficient costs.
But, if those incentives don’t work, or if the information we are provided with cannot be relied on, we need access to other tools, a good example is benchmarking.
Benchmarking is an approach which is being used increasingly by regulators to assess efficiency and inform regulatory decisions.
It allows us to compare different network businesses and gain valuable information on what is best practice.
It also allows us to direct our focus on areas where expenditure does not appear efficient.
Benchmarking will be a continuing area of focus for the AER. We have undertaken significant work to develop our techniques to be able to benchmark network businesses and many of you in the room have been involved in that work and consultation.
We are currently using benchmarking along with other analysis to inform our assessment of efficient costs in seven separate distribution network determination processes.
The draft determinations for the New South Wales and ACT distribution businesses issued late last year incorporate benchmarking analysis. Some businesses have questioned our benchmarking work in their revised proposals.
Submissions on our draft decisions and the businesses revised proposals were filed last Friday.
We will carefully consider the businesses revised proposals and the submissions received on this and other issues.
Hallmarks of good regulatory practice—transparent, open and predictable processes
There is one further question I would like to touch on today—what does good regulatory practice look like?
In my view the changes in market conditions and the uncertainty ahead do not alter the fundamental attributes of effective regulatory practice.
The regulator’s processes must be transparent, open and predictable. This is essential for building trust and is crucial to the overall effectiveness of regulation.
Stakeholder engagement
An area of our processes which will continue to be a priority in 2015 is effective engagement. Stakeholder engagement enhances our decisions and is essential for maintaining public confidence in the regime.
More broadly, engagement can assist the markets to better adapt to meet emerging challenges.
On network issues this task is now more important than ever; consumers are becoming more active participants and networks are transforming into a platform which facilitates the multilateral trade of a range of energy products.
Building a solid understanding of the current and future needs of consumers can assist both the regulator and network businesses to respond effectively to the challenges and opportunities this presents.
All of us involved in regulating energy networks have made improvements in the extent and quality of stakeholder engagement in recent years.
However, this task is never truly over—our approaches need to undergo a process of continuous review and improvement as priorities change and new issues emerge.
We all have a role to play in this.
For our part, the AER is committed to meaningful engagement with all stakeholders.
We have worked hard on giving consumers a greater voice in our network reviews, through the Consumer Challenge Panel and other jurisdictional stakeholder groups—and we continue this work in 2015.
Following the release of our draft determinations for the New South Wales and ACT networks late last year, some network businesses have expressed concern that the AER disregarded certain matters.
I want to make clear that while we may have disagreed with certain points, we did not disregard any of the material before us.
As with all our decisions, our task is to consider all the information before us and make decisions that are in the long term interests of consumers.
Our processes need to be open and transparent so that we can take account of the views of all those affected, including network businesses and consumers.
I also recognise however that where we exercise our discretion, there is an onus on us to clearly articulate the reasons for our decisions.
I appreciate that at the most basic level stakeholders want to be able to read our decisions and say “they heard what we had to say, they understood what we had to say”. And, probably equally importantly “where they didn’t agree with what we had to say, I can clearly see why”. Disregard and disagree are two very different concepts—stakeholders and businesses need to have confidence that we did not disregard what they put in front of us.
We are also working hard to engage with stakeholders beyond network regulation. Our Energy Made Easy website remains a key source of trusted information on the energy market, consumer protections and available energy offers.
We continue to engage with residential and small business intermediaries through our Consumer Consultative Group, whose members are often at the ‘front line’ of engaging with disadvantaged and vulnerable consumers.
We also look forward to working with the newly established Energy Consumers Australia.
Network businesses also need to demonstrate a continuing commitment to genuine engagement on a broad range of issues relevant to end-users.
Our consumer engagement guideline for network service providers sets out our expectations for consumer engagement by network businesses. It highlights the importance of network businesses being systematic, consistent and strategic in their engagement on significant issues.
Consumers and their representatives have a part to play too.
With discussion as to what the future might hold, key market reforms underway and the network determination cycle in full swing in most states and territories I encourage consumer groups to engage with network businesses, policy makers and the AER.
Tell us what we are doing well, what we could be doing better and what it is that works best.
Closing remarks
In conclusion: yes, the energy market is changing.
This change is transforming the networks sector.
However, even in this changing and uncertain environment, many things remain constant.
Promoting competition is still our primary mechanism for achieving well-functioning, energy markets.
In the absence of competition we still rely on effective regulation to achieve efficient outcomes.
Good regulation will continue to play a key role in facilitating change, provided we keep sight of the critical questions and principles that underpin the framework for everything we do.