Independent Review into the Future Security of the National Electricity Market Blueprint for the Future, Jun 2017

6.5 Rewarding network providers for avoiding costs

Until recently, the role of networks was to transport electricity from large generators to consumers. Networks will continue to deliver this service, but it will only be one of a number that consumers want. In a network that makes efficient use of DER, the network connection is the access point for users who want to both consume and produce energy and related services.

Network businesses should be rewarded for providing the services that consumers want. Currently, there are concerns that the regulatory framework favours capital investments, resulting in too much expenditure on network assets and too little expenditure on non-network alternatives. The regulatory framework should encourage network businesses to utilise new technologies where they are cheaper than building poles and wires. Such ‘non-network’ solutions could include purchasing services provided by DER or utilising individual power systems³²⁹ or microgrids³³⁰ as alternatives to a traditional grid connection.

The AER is currently developing a demand management incentive scheme to provide an additional incentive for demand-side projects, and an innovation allowance for research and development into non-network solutions that have the potential to reduce long-term network costs.

Electricity networks are natural monopolies and are regulated accordingly. Even with advances in technology, it is unlikely to be economically efficient for a competitor to duplicate the assets needed to provide the service. Economic regulation is important for the uptake of demand-side resources because it shapes the incentives and obligations on networks to provide services to consumers.

Network incentives

There is a long-standing question about the ‘power’ of the underlying incentives in network regulation. The power of an incentive refers to its financial impact on a business, for example the extent to which it leads to greater profits. A number of submissions argued that the power of the incentive to undertake capital expenditure (capex), which goes into the regulatory asset base and earns a regulated rate of return, is greater than incentives to undertake operating expenditure (opex) on non-network options such as embedded generation or demand management programs. If this is true, it would be a powerful influence on network business behaviour, leading to a preference to select capex options over alternatives that rely more on opex, even if the opex options would result in lower long-term prices for consumers.

The relative power of the financial incentives in network regulation should be an empirical question. It is recommended that the Energy Council or the AEMC commission financial modelling to assess the relative power of the incentives in distribution network regulation. If this modelling shows that there is a bias in favour of capex, in spite of reforms like the new capital expenditure sharing scheme and demand management incentive scheme, this would signal a need to look at alternative models of economic regulation for network service providers. To deliver the network services that consumers will want in future at the lowest cost, distribution network businesses should be indifferent to spending opex or capex.

The Energy Council has already begun work on some of these issues. The Energy Council has asked the AEMC to monitor developments in the electricity market, including decentralised energy, and the need for any changes to the regulatory approach.³³¹ In December 2015, the Energy Council agreed to undertake work on optimising network incentives and considering the merits of different approaches to incentivising efficient network investment, but no documents have yet been published on this work. It should be completed as a priority or transferred to the AEMC.

The AEMC is also considering some of these issues as part of the current rule change request on the contestability of energy services, including whether there would be merit in moving to a regime where network businesses’ revenues are based on a single estimate of their efficient total expenditure (totex) rather than having separate treatment of capex and opex.³³²

Recommendation 6.8

By mid-2018, the COAG Energy Council or the Australian Energy Market Commission should commission financial modelling of the incentives for investments by distribution network businesses, to test if there is a preference for capital investments in network assets over operational expenditure on demand-side measures.

If this work demonstrates that there is a bias towards capital expenditure, the COAG Energy Council should direct the Australian Energy Market Commission to assess alternative models for network incentives and revenue-setting, including a total expenditure approach. This should be completed by end-2019.

Networks as platforms

In a ‘platform’ model of network service provision, network businesses are provided with revenue for delivering a platform for consumers to trade energy and other services between each other and with networks, retailers and other market participants.

International jurisdictions are testing different approaches to a platform model of network regulation. For example, New York’s Reforming the Energy Vision approach overlays a Distributed System Platform Provider, which makes use of the distribution network’s assets.³³³ The Distributed System Platform Provider earns revenue by coordinating distributed resources to provide services to the electricity network. Utilities also continue to earn revenue to provide the underlying assets, but there is an expectation that over time the Distributed System Platform Provider revenues would expand to the point that they can replace the traditional capex and opex revenue requirements.

Preliminary work has begun to consider these issues in the NEM, including Energy Networks Australia and CSIRO’s Electricity Network Transformation Roadmap³³⁴ and the AEMC’s ongoing Distribution Market Model project.³³⁵

A key part of networks’ role as a platform provider will be to provide clear signals about the location of network constraints and the amount that networks are willing to pay consumers, retailers or other providers of services that can avoid or defer those network constraints.

Electricity networks have good information about the costs of providing services and the value of non-network investments, but it can be difficult for consumers and service providers to get this information. There is information about emerging constraints in network planning reports, but this does not clearly show the value of avoiding network investments. Information about value is revealed in the Regulatory Investment Tests, but these happen on timeframes that make it difficult for service providers to plan ahead.

Service providers are starting to overcome these barriers. For example, in response to a Regulatory Investment Test for Distribution, Greensync has contracted with United Energy to provide a demand-side solution to a network constraint on the Mornington Peninsula in Victoria, including resources dispatched from United Energy’s control centre.

New AEMC rules introduced in 2016 require all distribution businesses to publish an annual system limitations report that shows the location of network constraints and information to help providers of non-network solutions estimate the amount that network businesses would be willing to pay for a non-network solution that removes the constraint, such as by reducing network peak demand at that location. This information must be published in a common format determined by the AER.³³⁶ These new reports will be published by 31 December 2017 and will go some way to improving access to this information. In addition, several maps of network opportunities and constraints have been developed, as discussed in Chapter 5.

Increased adoption of open platforms for signalling network value are likely to lower transaction costs for energy service providers seeking to mediate between consumers and the electricity market.

New technologies as an alternative to traditional grid connections

Individual power systems and microgrids using technologies such as solar photovoltaic and storage have the potential to provide more reliable and lower cost alternatives to a traditional connection to the interconnected distribution network. However, a number of submissions identified current regulatory barriers that prevent the adoption of these technologies. Individual power systems and microgrids are not currently regulated under the national frameworks and are subject to separate state and territory legislation, with significant gaps in regulation in some jurisdictions.

Figure 6.3: How microgrids and individual power systems are currently regulated³³⁷

Modelling conducted by Energeia for the Electricity Network Transformation Roadmap found that new regulatory arrangements would be required to allow innovative service delivery options for up to 27,000 new rural connections between now and 2050. Almost $700 million could be saved by supplying these connections, usually farms, with an individual power system, but current regulations would require the use of a more expensive conventional grid connected service.³³⁸

The Energy Council’s Energy Market Transformation Project Team published a consultation paper in August 2016 on how these systems could be regulated and whether there is value in regulating them under the National Electricity Rules and National Energy Retail Rules.³³⁹

The AEMC is also currently considering a rule change request from Western Power that seeks to remove some of the barriers to distribution network businesses using individual power systems as an alternative to a grid connection, particularly in rural areas.³⁴⁰

Recommendation 6.9

By mid-2018, the COAG Energy Council should direct the Australian Energy Market Commission to undertake a review of the regulation of individual power systems and microgrids so that these systems can be used where it is efficient to do so while retaining appropriate consumer protections.

The Australian Energy Market Commission should draft a proposed rule change to support this recommendation.