Reform of capital expenditure regulation

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Reform of capital expenditure regulation

• Bruce Mountain
• Mountain Associates

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Content

• Review of the current capex regulatory contract
• Description
• Incentive properties
• Administrative requirements
• Is there a better way - how could we think about
  this?
• The ACCCs suggested ex-ante cap approach
  description, questions answers

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Current regulatory contract Description

• Commissions Code obligations
• Economic incentives for efficient investment.
• Commissions Draft Regulatory Principles
• Step 1 Determine capex forecast and set revenue
  cap accordingly. Capex forecast is only
  ball-park estimate of efficient investment
• Step 2 Assess prudency of actual expenditure at
  end of regulatory period based on good industry
  practice. Roll-in efficient investment into
  RAB.

Ex-post optimisation
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Current regulatory contract Incentive properties

• But will threat of ex-post optimisation cause
  TNSPs to invest efficiently
• what if optimisation threat isnt credible
  would TNSPs still invest efficiently?
• what if optimisation threat is credible surely
  TNSPs would seek regulatory consent before
  undertaking major investments? (In which case, is
  an ex-post regime sustainable?)

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Current regulatory contract Incentive properties

• Also, does existing regime only offer a stick
  (i.e. no carrot) to TNSPs
• if actual capex lt forecast capex risk that
  regulator will take away part of the
  underspend
• if actual capex gt forecast capex risk that
  regulator will make them absorb part of the
  overspend.

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Current regulatory contract Administrative
requirements

• What needs to be done to assess the prudency of
  past investments?
• Assess whether bona fide need for investment
• Assess whether most efficient project chosen
• Assess whether most efficient project delivered.
• The assessment must only take account of what the
  TNSP knew (or should have known) at the time it
  invested.

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Current regulatory contract Administrative
requirements

• What does this mean in practice?
• From 1999 to 2004, TransGrid invested in more
  than 60 separate transmission augmentation
  projects and hundreds more replacement, IT, and
  support the business projects. Each project
  should be assessed.
• Prudency judgements requires that regulator can
  credibly second guess TNSP decisions. This
  means capability in transmission planning
  engineering environmental and local planning
  regulations the ability to judge what corporate
  entities could be expected to achieve etc.

Ex-post assessments are inevitably highly
intrusive, subjective, time consuming (for both
regulator and TNSP) and expensive.
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Developing and evaluating alternative regulatory
contracts variables for consideration

• Ex-ante vs ex-post
• Project-specific vs basket
• Variable price vs fixed price

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A range of possible capex regulatory contracts
Basket of projects
Ofgem UK DTe Holland NVE Norway
Ofwat
US Public Utility Commissions (PUCs)
Ofgem
Individual projects
VENCorp
VENCorp
Variable price contract
Fixed price contract
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Evaluating alternative regulatory contracts
Intrusiveness
Strength of efficiency incentive
Administrative requirements
Decision variables
Information asymmetry
Predictability
Impact on service standards reliability
Regulatory failure
Uncertainty regulatory risk
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The ACCCs suggested direction for capex
regulatory contract
Basket of projects
Ofgem UK DTe Holland NVE Norway
ACCCs current suggestion
Ofwat
US Public Utility Commissions (PUCs)
Ofgem
Individual projects
VENCorp
VENCorp
Variable price contract
Fixed price contract
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Whats the difference between the ACCCs current
suggestion and the existing regulatory contract?
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QA on the Commissions suggested direction for
reform

• What if demand much higher than expected -
  setting a fixed cap places reliability and
  service at risk?
• Conversely, if the cap too high, TNSPs profit at
  expense of customers?
• Why is suggested arrangement less intrusive than
  the existing arrangement both require
  assessment of efficiency?

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QA on the Commissions suggested direction for
reform

• New arrangement provides no incentive for
  efficiency why not simply investing in all the
  marginal projects first and then simply come
  back to ACCC for more money?
• Existing ex-post approach provides stronger
  customer protection because the ACCC retains the
  power to optimise?

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QA on the Commissions suggested direction for
reform

• Project-specific approach means the Commission
  can apply stronger efficiency incentive than it
  can with a basket of projects approach?
• Shouldnt ACCC simply exclude all large and
  uncertain projects from ex-ante cap this
  would allow a more accurate specification of the
  cap and greater protection for consumers?

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The last word

• A regulator is supposed to take the punch bowl
  away before the party gets out of hand. The
  impact of its actions is blunted if it waits
  until the miscreants are numb with remorse before
  bursting into the room and issuing fire and
  brimstone denunciations.
• Financial Review editorial on APRAs report into
  the NAB.