ACCC Workshop on the DRP Incentive Mechanisms and

ACCC Workshop on the DRP Incentive Mechanisms and Benchmarking 1

Structure of presentation • Observations on ACCC proposals on efficiency incentives and benefit sharing mechanisms • Proposed framework for assessing the most appropriate expenditure benchmarking approach • Way forward 2

ACCC Incentive Mechanism — Observations • Based on the ESC Scheme in Victoria developed for use on distribution companies expenditure. • Proposed incentive scheme seems a reasonable starting point for opex: – Delivers even incentives over time; – Simple to apply and administer; – Reasonable sharing ratios; and – Similar schemes successfully in operation elsewhere. 3

ACCC Incentive Mechanism — Observations • TNSP expenditures are more volatile (lumpy) than distribution expenditures • No reason is put forward for the less generous proposed treatment of capex efficiencies • For the successful implementation of a such a scheme for TNSPs the sharing mechanism itself will not be the key determinant • Rather, it will depend on how the benchmark for expenditure is set in the current period and in future periods 4

Framework for Suitable Benchmark Technique • Two important considerations when considering how to set expenditures for a regulated business • Degree of predictability with-in a 5 -year reset period – Types of cost exposures can be predictable or unpredictable with-in the reset period • Degree of variability from reset to reset – The quantum of expenditure can be variable or stable (including a consistent trend) from one five year period to the next (therefore, allows averaging of annual variability) 5

Expenditure characteristics matrix Unpredictable but Stable Unpredictable and Variable Predictable and Stable Predictable but Variable 6

Assessment of Expenditure in Framework • Types of expenditures can be assessed against these two factors and placed in one of the quadrants. For example: – Planned maintenance of the transmission network tends to be both highly predictable and stable from reset to reset; – Unplanned maintenance is, by its nature, unpredictable, however, is also relatively stable when averaged over a five year period; and – Replacement Capex is predictable for a given five year period , however, it is highly variable from one five year period to the next 7

How does this help? • By placing an expenditure type in its appropriate quadrant the TNSP and Regulator can strike a regulatory bargain on how expenditures are to be set both with-in the regulatory period and in future regulatory periods • This is helped by the fact that there is some broad agreement on the appropriate treatment to be used in each quadrant • This allows a reduction of regulatory risk by helping minimise arguments at the next revenue review 8

Setting ACCC Benchmarks (1) Unpredictable but Stable Unpredictable and Variable Predictable and Stable Predictable but Variable • Suitable for benchmarking against historical expenditure and possibly long term against industry averages 9

Setting ACCC Benchmarks (2) Unpredictable but Stable Unpredictable and Variable Predictable and Stable Predictable but Variable • Need for ex-ante review to set benchmarks for each reset period 10

Setting ACCC Benchmarks (3) Unpredictable but Stable Unpredictable and Variable Predictable and Stable Predictable but Variable • Should be excluded from the cap in case of capex • Should be handled via pass-through in case of opex 11

Possible Way Forward • This frame work allows this issue to separated into two questions: • What type of benchmark or revenue setting mechanism is appropriate for each quadrant? • What types of expenditure belongs in which quadrant? 12