ElectraNet SA

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ElectraNet SA
Draft Regulatory Principles Workshop Asset Base
(Strengthening Incentives for Investment) 2 April
2004
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Incentives for Investment
Financial capital maintenance investors should
have a reasonable expectation of recouping the
costs involved in the prudent provision of
assets. So long as this condition is met for
outlays efficiently incurred, then investment
will be appropriately encouraged
Henry Ergas, Epic in Retrospect and
Prospect, June 2003
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A Step in the Right Direction

• The ACCCs proposals on asset base and asset
  valuation are a good step towards achieving this
  objective
• ElectraNet supports the ACCCs preferred position
  to lock in the value of sunk assets and adopt
  an asset base roll forward methodology
• BUT only once a fair and reasonable asset
  valuation has been established

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A Step in the Right Direction

• A key benefit of the preferred approach is
  removal of the significant investment risk that
  prudent capital expenditure will not be recovered
  if it is excluded from future asset revaluation -
  i.e. removal of optimisation risk
• Optimisation doesnt really make sense
• difficult to administer ACCC methodology still
  not specified
• imposes risks for which TNSPs are not compensated
• difficult for TNSPs to manage risk limited
  value on influencing behaviour

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A Step in the Right Direction

• The ACCC has in recent revenue cap decisions
  recognised a key aspect of this risk arising from
  the use of the modern equivalent asset valuation
  (MEAV) methodology
• legitimate refurbishment capex does not
  necessarily affect the cost of buying a modern
  equivalent asset
• replacing the engine in a car may be necessary
  expenditure, but it does not change the cost of
  buying a new car
• The ACCCs short-term solution has been to
  quarantine refurbishment/ replacement capex from
  revaluation

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A Step in the Right Direction

• However, developing ODRC guidelines to address
  these and other issues for the longer-term would
  require a substantial investment of resources by
  the ACCC, TNSPs and other interested parties
• Guidelines would need to address
• unit costs
• brownfields or staged development factors
• locality, terrain and environmental factors
• level of asset recognition etc. etc. etc.

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A Step in the Right Direction

• Adopting a roll forward methodology would
  simplify and improve the efficiency of the
  regulatory regime by avoiding the subjectivity
  and cost of future revaluation exercises do it
  once and move on
• Approach is also consistent with
• Code objective of achieving reasonable certainty
  and consistency over time of regulatory outcomes
• ACCCs approach in gas
• ACCCs capex framework and other proposals for a
  more light handed approach to regulation

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Drawing a Line in the Sand

• The ACCCs proposal to effectively draw a line
  in the sand on the valuation of sunk assets
  makes it essential to first ensure that a fair
  and reasonable asset valuation has been
  established
• The valuations of TNSP fixed network assets have
  generally followed a consistent approach and
  methodology
• BUT there are some stand out anomalies for
  ElectraNet the treatment of project financing
  costs and easements has varied widely from that
  adopted in other States

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Comparison of Easement Values
Source ACCC revenue cap decisions
Note TransGrid value includes land
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Easement Valuation
It is apparent then, that the easements for
ElectraNet are grossly undervalued and that there
is a strong case for this aspect of the
ElectraNet SA asset base to be revalued
Sinclair Knight Merz, November 2003
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Easement Valuation

• Easements were not valued in ElectraNets initial
  asset base because
• asset valuations consistent with the approach
  set out in the ACCCs Draft Statement of
  Regulatory Principles have not yet been
  undertaken - Electricity Reform and Sale Unit,
  August 1999
• The ACCC did not address this issue in setting
  ElectraNets initial revenue cap - however, it
  must be addressed before any locking in of
  ElectraNets asset value

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Easement Valuation

• The ACCC has indicated that it is likely to adopt
  a historical cost approach when valuing easements
• In recent decisions, the ACCC has only recognised
  those costs for which a TNSP could produce
  receipts of actual costs incurred
• However, the ACCC paper recognises that a
  benchmark approach would
• deliver values for TNSPs which lack historical
  records. This approach would also maintain
  consistency between the valuation methods used
  for TNSPs

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Easement Valuation

• ElectraNet supports the proposed benchmark
  approach to easement valuation where reliable
  historical cost records are unavailable
• The omission of easement value from ElectraNets
  asset base has been clearly identified, is
  discrete, and can be easily remedied without
  imposing the burden of a full asset revaluation

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Project Financing Cost Comparison
IDC on fixed network assets
Source ACCC revenue cap decisions
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Project Financing Costs
In our view IDC is a valid project cost and
should be included in the valuation of all assets
in the ElectraNet asset base. In addition, the
treatment of IDC in the ElectraNet asset base is
inconsistent with the approach used for other
TNSP valuations. It is material and it is
considered that there are strong grounds for a
revaluation of this aspect of the ElectraNet
valuation
Sinclair Knight Merz, June 2002
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Asset Valuation Guidelines

• As for easements, the omission of IDC from
  ElectraNets asset base has been clearly
  identified, is discrete, and can be easily
  remedied without imposing the burden of a full
  asset revaluation
• If a full revaluation were to be conducted then
  considerable effort would be required to first
  develop transmission asset valuation guidelines
  that fully recognise the costs incurred in
  developing the network
• Current valuation tools fail to fully recognise
  significant prudent capital expenditure

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Depreciation Adjustment

• Consistent with the principle of financial
  capital maintenance, compensatory depreciation
  adjustments should only occur where a revaluation
  due to changes in replacement costs takes place
• In other circumstances, such as correcting
  errors, a depreciation adjustment would be
  inappropriate because it would simply cancel the
  effect of the intended error correction

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Asset Base Roll Forward

• Adoption of the asset base roll forward approach
  is generally supported
• BUT the devils in the detail the Regulatory
  Principles needs to clearly set out how the
  approach is to be implemented
• ElectraNet believes that within the current capex
  framework the currently accepted methodology for
  rolling forward the asset base from one year to
  the next should be maintained

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Asset Base Roll Forward

• i.e. closing asset base in year t equals
• The opening asset base in year t
• plus new investment rolled into the asset base at
  build cost (based on actual capitalisations
  during the year)
• plus indexation of the asset base by actual CPI
• less outturn straight-line depreciation
• less asset disposals
• The opening asset base in year t1 equals the
  closing asset base in year t

Note More detailed implementation issues are not
considered here
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Asset Base Roll Forward

• Benefit consistent with treatment of the
  regulatory accounts
• Does the ACCC agree that this is the currently
  accepted implementation? - understand that the
  ACCC may be considering other views
• Either way it is important that the ACCC share
  its views and consult with stakeholders on this
  important issue
• Suggest that this consultation include worked
  examples to clarify the roll forward methodology
  and settle any confusion these should be
  included in the Regulatory Principles

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Locking in?

• What does this mean how can we be sure that
  asset values will remain locked in and wont be
  revisited in 5 years time by a new ACCC/ AER
  team?
• How will locking in be achieved?
• correct obvious anomalies first
• is a Code change good enough?
• Improved certainty of asset valuation vital to
• avoid cost premium for customers and TNSPs
• allow regulatory regime to focus on getting
  incentives for future decisions right