Envestra's revised proposal for the Victorian network forecasts total operating expenditure of $328.0 million ($2011) for the 2013–17 access arrangement period. This is a reduction of $36.7 million ($2011) from Envestra's initial proposal of $364.8 million ($2011).
Envestra's revised proposal for the Albury network forecasts total operating expenditure of $10.91 million ($2011) for the 2013–17 access arrangement period. This is a reduction of $1.42 million ($2011) from Envestra's initial proposal of $12.33 million ($2011).
Envestra's revised proposal:
adopted the majority of the AER's draft decision amendments to base year opex with the exception of the treatment of movement in provisions
adopted the AER's draft decision approach to labour cost escalation and materials cost escalation with the exception of the source of the labour cost escalation forecast
included fourteen step changes for the Victorian network.642 Four of these step changes adopts the AER's draft decision
included seven step changes for the Albury network.643 Three of these step changes adopts the AER's draft decision
adopts the AER's draft decision on the forecast cost of ancillary reference services
includes a revised forecast for the cost of the Network Management Fee and for debt raising costs
Assessment approach
The AER’s assessment approach for opex is set out in attachment 6 of the AER’s draft decision.644
The AER also considered submissions to inform its final decision on opex. The AER received submissions on opex from the Energy Users Coalition of Victoria (EUCV) and the Victorian Minister for Energy and Resources.
The EUCV provided a submission setting out its concerns regarding the Victorian distribution businesses' proposals.645 The EUCV considers the outcome of the AER's draft decision analysis is consistent with the long term growth in opex and has resulted in an appropriate outcome. The EUCV considers that Envestra' revised opex claim is not justifiable but notes that because much of the information is confidential, its assessment is limited to an assessment of the information Envestra made public. It also agrees with the approach taken by the AER in the draft decision in relation to step changes. The EUCV considers that unless an exogenous change has occurred, then it cannot be classed as a step change.646
The Victorian Minister for Energy and Resources provided a submission supporting the AER's approach to assessing the Victorian distribution businesses' opex proposals. It notes that the assessment of step changes in operating expenditure tends to be focused on increases in expenditure and not on decreases in expenditure. As there are variations in expenditure from year to year, the Minister notes the AER needs to consider the extent to which small increases in expenditure will be offset by small decreases in expenditure that have not been forecast.647
The AER's consideration of specific comments made by the EUCV and the Minister are discussed in the relevant section of this chapter.
Where the AER considered additional material to inform this final decision, this is noted in its reasons for this decision.
In forming its views the AER has also considered advice from Deloitte Access Economics (DAE) on labour cost escalators.648
Reasons for decision
The AER's final decision is not to approve Envestra's forecast opex for the Victorian and Albury networks.
The AER accepts Envestra's proposal that its opex forecast be based on a base year roll forward method, using 2011 as the base year, consistent with its initial proposal and the AER's draft decision.
Using this method, historical expenditure, and particularly 2011 expenditure, plays a key role in forecasting and assessing efficient opex.
The importance of 2011 expenditure is partly due to the efficiency sharing mechanism in Envestra's existing access arrangement. The efficiency sharing mechanism recognises the incentive to reduce opex is driven by both the ex ante opex allowance and carryover amounts.649 The use of actual opex in determining the opex allowance for the following access arrangement period is a key factor in whether the mechanism will achieve its stated objective. This is to allow Envestra to retain the reward associated with efficiency improving initiatives for five years. For the mechanism to achieve this objective, opex must be forecast based on actual expenditure in the penultimate year of the preceding access arrangement period, in this instance 2011.
If external benchmarks, or a bottom up forecast, were used to set opex allowances, Envestra's opex allowance would not reflect revealed costs, and revealed efficiencies would not be clawed back.650 Consequently, Envestra would be rewarded twice, once in the ex ante opex allowance, and a second time in the carryover amounts under the mechanism. Therefore, it is important actual expenditure in 2011 be used as the basis for setting opex forecasts for the 2013–17 access arrangement period, where an efficiency sharing mechanism exists.
However, there are a number of reasons why efficient opex in the 2013–17 access arrangement period will be different from actual expenditure in 2011. It is necessary to take these into account to ensure Envestra retains the reward associated with efficiency improving initiatives for five years.
First, increased demands for Envestra's outputs may require it to expand its network. It is reasonable that an efficient service provider will require more inputs, and thus greater opex, to deliver more output. It therefore is reasonable to assume it needs an allowance for network growth.
Second, it is reasonable to assume that the cost of inputs for an efficient firm to produce the same level of output may not change at the same rate as CPI. Consequently it is reasonable to account for real cost changes in Envestra's inputs. However, to the extent the cost of inputs change, the input mix which minimises costs will also likely change. Thus, to apply input cost escalation while assuming a constant input mix will provide at least the efficient costs of a prudent service provider.
Third, there may be other reasons beyond Envestra's control that will increase or decrease its costs. For example, regulatory obligations may change requiring Envestra to increase expenditure to meet those new obligations. For this reason the AER allows for other incremental increases above base year opex (often referred to as step changes). Generally step changes should only be provided for cost increases beyond the service provider's control. Otherwise the step change would represent an increase in costs to produce the same level of output and thus a loss in efficiency.
While the AER agrees that Envestra’s opex in the 2013–17 access arrangement period will need to differ from the opex it incurred it 2011, the AER does not agree that Envestra’s proposed adjustments to its base year opex comply with the opex criteria or the criteria with forecasts and estimates.
The adjustments to base year opex proposed by the AER in its final decision include additional allowances for Envestra above its base year opex for:
an escalation in labour costs
an increased Energy Safe Victoria (ESV) levy
opex related to Envestra’s network expansion (network growth escalation, meter station charges, new extensions, opex for regional SCADA)
new incentive payments that are likely to result in new connections and/or increased gas load for which Envestra would not otherwise be compensated for (network development expenditure)
new vegetation management costs that the AER expects a prudent service provider would incur to meet its regulatory obligations (easement vegetation management)
a material non-recurrent program to comply with regulatory requirements relating to pipeline safety which the AER agrees is prudent to commence in the 2013–17 access arrangement period (pipeline integrity remediation works)
administration of the carbon tax
a new safety program that responds to recent concerns identified by the ESV and WorkSafe Victoria (gas pipes in drains)
meter reading services previously provided for Envestra by the Australian Energy Market Operator (AEMO) (interval meter data management)
forecast Network Management Fee payments and the forecast cost of ancillary reference services not included in Envestra's base year estimate
forecast debt raising costs
In general, the AER has not made adjustments to Envestra’s base year opex where it does not agree there needs to be an incremental increase in Envestra’s total opex to implement the program, or where Envestra’s proposed increase in expenditure relates to circumstances within Envestra’s control. For some adjustments, the AER does not propose the adjustment to base year opex made by Envestra but considers some increase above base year opex is required.
The AER’s final decision is discussed in further detail in this section under the following headings:
forecasting base year opex
network growth
escalation of base year opex
step changes
Network Management Fee and ancillary reference services
debt raising costs and liquidity costs
Further reasoning about the AER’s final decision on real cost escalation is provided in appendix A.
Where Envestra’s position in its revised proposal is the same as the position as the AER adopted in the draft decision, this is noted in the relevant section. Refer to attachment 6 of the draft decision for these reasons.
