The AER’s assessment approach for incentive mechanisms is set out in its draft decision. See attachment 7 of the draft decision for a detailed explanation of the assessment approach.786
The Victorian Minister for Energy and Resources' written submission on Envestra's revised access arrangement commented on the revised proposal for incentive mechanisms. The AER took this submission into account in forming its final decision on Envestra's proposed incentive mechanisms.
Reasons for decision
Carryover from the 2008–12 access arrangement period
The AER approves the proposed zero carryover from the 2008-12 regulatory period because there is no provision under the Gas Code that allows for the application of negative carryovers.
Under clause 5(1)(a) of the NGR transitional provisions, the AER must take into account the operation of an incentive mechanism approved 'under section 8.44 of the Gas Code and ensure, in particular, that revenue calculations made for the next access arrangement period properly reflect increments or decrements resulting from the operation of the incentive mechanism'.
The AER therefore applied the decrements accrued by Envestra Victoria and Envestra Albury in the 2008–12 access arrangement period in its draft decision.787 However, Envestra objected to this approach in its revised proposals on the basis that an ESCV appeal panel decision in 2008 had broader application than recognised by the AER in its draft decisions.788 Multinet also raised the same objection in its revised proposal.789
In that appeal, Envestra Albury objected to the application of a negative carryover it accrued during its 2003–2008 access arrangement period.790 Its access arrangement was approved by the ESCV under the Gas Code. The Essential Services Commission Appeal Panel upheld the appeal and varied the carryover to zero on the basis that there is 'no power or discretion' provided by the Gas Code, under section 8.44 or other of the Gas Code provisions, which enabled the ESCV to make provision for negative carryovers in Envestra Albury’s access arrangement.791 Section 8.44 of the Gas Code provides:
The Reference Tariff Policy should, wherever the Relevant Regulator considers appropriate, contain a mechanism (an Incentive Mechanism) that permits the Service Provider to retain all, or any share of, any returns to the Service Provider from the sale of the Reference Service:
(a) during an Access Arrangement Period, that exceed the level of returns expected for that Access Arrangement Period; or
(b) during a period (commencing at the start of an Access Arrangement and including two or more Access Arrangement Periods) approved by the Relevant Regulator, that exceed the level of returns expected for that period, particularly where the Relevant Regulator is of the view that the additional returns are attributable (at least in part), to the efforts of the Service Provider. Such additional returns may result, amongst other things, from lower Non Capital Costs or greater sales of Services than forecast.
The ESCV Appeal Panel held that section 8.44 was limited to sharing extra returns resulting from reduced costs but did not extend to imposing penalties for efficiency losses.792
On review, the AER accepts the position submitted by Envestra as to the broader application of the ESCV Appeal Panel Decision specifically its findings that 'only positive incentive mechanisms were contemplated and intended by the Code'.793
For this reason, the AER considers Envestra Victoria's and Envestra Albury's carryovers should be revised to zero.
Incentive mechanism to apply in the 2013–17 access arrangement period
Opex incentive mechanism
The AER does not approve the opex incentive mechanism in Envestra's revised proposal.
Revision 7.3 of the AER's draft decision required Envestra to include a table in its access arrangement specifying the forecast opex amounts to be used in calculating efficiency gains (losses). Clause 11 of the incentive mechanism required by the AER's draft decision stated the opex forecasts in this table be used as the basis for measuring efficiencies under the scheme. The purpose of this revision was to remove any potential uncertainty as to which values should be used when efficiency gains (losses) are calculated at the end of the access arrangement period.
Envestra did not include clause 11 or the table in its revised proposal.
The AER considers clarifying the values to be used to calculate efficiency gains will encourage efficiency in the provision of services by Envestra794 and will provide more effective incentives in order to promote economic efficiency with respect to those services.795
Capex incentive mechanism
The AER does not accept Envestra's revised proposal to retain the current capex incentive mechanism for the 2013–17 access arrangement period. As noted in its draft decision, the AER considers the current capex incentive scheme provides inappropriate incentives to inefficiently defer capex that is not volume adjusted.796 Further, the lack of an adequate service standard incentive as a counter balance leads to the potential for under-investment and over-utilisation of the pipeline. This is inconsistent with an incentive mechanism that encourages efficiency in the provision of services by the service provider,797 and the RPP.798
Deferral of capex
The AER noted in its draft decision that cumulative efficiency carryover schemes applied to capex can deliver incentives to defer capex to a later access arrangement period even when it is not efficient to do so.799 These comments related only to those schemes that are not volume adjusted.
Envestra did not address this issue in its revised proposal.
External reviews of energy network regulation
Envestra considered the AER's draft decision was inconsistent with the findings of the Productivity Commission in its review of electricity network regulatory frameworks. In its draft report the Productivity Commission recommended:800
The Australian Energy Regulator should develop an efficiency benefit sharing scheme to apply to capital expenditure that provides consistent incentives to reduce capital expenditure, both over time and when compared with operating expenditure.
The AER agrees a consistent incentive to reduce capex expenditure is preferable to declining incentives. However, the capex incentive mechanism proposed by Envestra does not provide consistent incentives to reduce capex. While it does provide a constant incentive to reduce capex unit rates, it does not provide a constant incentive to reduce associated volumes. Consequently the capex incentive mechanism proposed does not provide a constant incentive to reduce capex.
Also, the capex incentive mechanism proposed does not provide balanced incentives between the different capex categories. That is, Envestra would have an incentive to shift capex from unadjusted categories to volume-adjusted categories. Envestra would thereby benefit from an efficiency gain achieved for unadjusted capex while avoiding any equivalent penalty in volume-adjusted capex (as a result of the benchmark adjustment mechanism). In this way it would have an incentive to overinvest up to the value of the carryover payment.801 Therefore, the AER considers the proposed mechanism does not provide effective incentives in order to promote economic efficiency.802
Envestra also noted the AEMC, in its Draft Decision on proposed changes to the National Electricity Rules, proposed the scope for the introduction of capital expenditure efficiency schemes be broadened.803 However, the conclusions from the AEMC's review of the economic regulation of electricity network service providers are not directly applicable to gas networks. The gas framework has stronger inherent capex incentives than the electricity framework at the time of the review, especially given the NGR allow for a review of the efficiency of a service providers' past capex. Further, the service standard incentives under the gas regime are less prescriptive than under the electricity regime.804 Applying additional capex incentives through the operation of the incentive mechanism may result in inappropriate incentives for the service provider to inefficiently reduce capex at the expense of maintaining or improving service standards.
The Victorian Minister for Energy and Resources noted the concerns raised by AER with the incentive arrangements that applied to capex previously. Given these concerns, the Minister considered a capex incentive mechanism should not be included in an access arrangement until the completion of the AER's review of expenditure incentives has been completed and guidelines released.805 This work will be completed by the end of 2013. The AER notes that its assessment is based on the current NGR and the information before it. The forthcoming review has not been a factor in its consideration of whether to apply a capex incentive mechanism or not in this final decision.
Service standards
The AER considers the proposed capex incentive scheme may provide incentives to inefficiently reduce capex at the expense of maintaining or improving service levels in the absence of any service standard incentive mechanism. Envestra, however, did not agree. It stated it had maintained high levels of service over the past 10 years despite a capital incentive existing in the efficiency carry over mechanism.
It stated that gas, unlike electricity, was a fuel of choice for customers. If it were to provide poor service, customers could shift their energy requirements away from gas to electricity. The potential loss of customers and demand motivates it to provide a safe and reliable service.806
However, the AER considers the proposed capex incentive scheme may provide incentives to inefficiently reduce capex at the expense of maintaining or improving service levels. While there is no evidence of a significant decline in service standards over the past two access arrangement periods, the impacts of reduced capex would likely take a number of years to be seen in service levels.
Conclusion
For the above reasons, the AER does not approve Envestra's proposal to include an incentive mechanism applying to capex in the 2013–17 access arrangement period. The AER considers such an incentive scheme would not encourage efficiency in the provision of services as required under r 98(1) of the NGR, nor is it consistent with the RPP and the NGO.807
