With the delivery of network services advancing at a rapid pace, do current energy sector regulatory regimes encourage the innovation required to meet the future needs of customers or should new approaches be adopted to foster productive change in the market?

Current technology, consumer and digitisation trends are transforming the electricity network and reshaping it from the ground up.

This is supported by numerous studies conducted by the Australian Energy Market Commission (AEMC), COAG Energy Council, Australian Energy Market Operator (AEMO) and others, who have identified the high chance of rapid transformation in energy systems, driven by customer requirements and technological opportunities.

Current National Electricity Rules in Australia set out the regulatory framework for electricity networks. Regulated network businesses must apply to the Australian Energy Regulator (AER) to assess their revenue requirements periodically.

The AER monitors and enforces compliance with these rules and is responsible for economic regulation of distribution and transmission networks.

For electricity network businesses, the AER adopts five-year revenue caps based on the expected costs of running each network during this period. The electricity regulatory framework requires that a form of price control is applied to services with monopoly characteristics.

Under incentive regulation arrangements, network firms can achieve profits when they spend lower than the approved forecasts. Also, if firms spend more than the approved forecasts they will have to bear the costs associated with the amount of overspend. The efficiency benefits or costs are shared between the network businesses and customers.

A roadmap for innovation

The CSIRO and Energy Networks Australia developed a blueprint for transitioning Australia’s electricity system to provide better customer outcomes.

The Electricity Network Transformation Roadmap (the Roadmap) identified a number of areas that will require constant innovation over the long term in system operation and management, incentives and regulatory frameworks, and carbon abatement.

The mechanisms in the current framework focus on containing costs and deriving operational efficiencies.

The Roadmap identified that “a regulatory regime that is outpaced by technology and market developments cannot protect consumers or deliver a balanced scorecard of societal outcomes”.

The Australian electricity network regulatory framework contains some measures which specifically target innovation. These include the Small Scale Incentive Scheme and the Demand Management Incentive Scheme (Scheme).

The National Electricity Rules provide for a small-scale incentive scheme which can be introduced at the discretion of the AER. The rewards or penalties under such schemes are capped at 0.5 per cent of the allowed revenues, but can be up to one per cent of the annual revenue if the network business consents.

To date, however, the AER has not developed any small-scale incentive schemes.

The AER’s current Demand Management Incentive Scheme has three key features: the cost uplift, the net benefit constraint, and the overall incentive constraint.

The cost uplift gives network distributors an incentive of up to 50 per cent of their expected demand management costs. The incentive is only available for efficient demand management projects.

To allow consumers to benefit from the Scheme, the size of the incentive will not outweigh the value (or net benefit) the demand management project delivers across the electricity market. This is the net benefit constraint.

In addition, the overall incentive constraint will limit the incentive’s impact on short-term prices. The cap limits the total incentive that distribution businesses can receive in any one year.

Published on 14 December 2017, the Scheme complements the AER’s reforms targeting consumer choice and more efficient network pricing outcomes.

These include work on tariff reform, metering contestability, ring-fencing, and strengthening the transparency and efficiency of replacement expenditure.

The Scheme’s objective is to provide electricity distribution businesses with an incentive to undertake efficient expenditure on non-network options relating to demand management.

The separate Demand Management Innovation Allowance will provide distribution businesses with funding for research and development in demand management projects that have the potential to reduce long-term network costs.

Expert advice in the Roadmap, provided by Cambridge Economic Policy Associates, has suggested that there is strong potential over the medium term to move away from the existing schemes to TOTEX (Total Expenditure – both capital and operational) based approaches.

An acronym approach

Australian networks are at the cutting edge, trialling energy storage, blockchain approaches and demand management initiatives. Yet, despite the “technological development”, many parts of network regulation have not kept pace.

One utility sector regulatory innovation trialled in the United Kingdom, which currently has a longer regulatory period of eight years, and other European countries is the use of a “total expenditure framework” (TOTEX).

This framework changes how expenditure allowances are set, measured and reported.

Under a TOTEX approach, the distinction between capital and operating expenditure is removed, with regulated networks given a single expenditure allowance with a pre-determined capitalisation rate.

TOTEX has been adopted as a Roadmap recommendation to be trialled by 2018 and implemented by 2027.

A TOTEX approach may have significant benefits. For example, it could:

  • Improve stakeholder and customer confidence that perceived ‘bias towards building’ is removed. A frequent criticism of current frameworks is that they may lead to underinvestment in innovative operational solutions and subsequent potential losses in customer value
  • Focus decisions on the best value solution for customers over the life of the asset. Where long-lived assets are being funded, the customer gains from better optimisation and optionality can be significant
  • Better reflect what the current system says it does now. This is achieved by approving overall efficient allowances, rather than approving specific capital and operating projects
  • Improved simplicity. TOTEX would reduce the bureaucratic and complex regulatory requirements, and streamline incentive scheme approaches that have dominated network regulation over the past decade
  • Reduce the regulatory disputes and monitoring costs around capital and operating cost allocation, and the capital and operating mixtures in benchmarking

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