graham shuttleworth - energy networks australia

Benchmarking, Regulation and AppealsWhy regulatory procedure matters

ENA, Brisbane QLD, Australia26 July 2017

Graham ShuttleworthAffiliated Consultant

1

“It is a truth universally acknowledged,…”

“…that a single utility in possession of a sunk cost must be in want of a price cut.” (with apologies to Jane Austen)

0 5 10 15 20 25 30 35 40Years

Operating Expenses (Opex)

$ millionper

annum

Capital Expenditure (Capex)

Allowed Revenues???

X (opportunism)

“…that a good regulatory process must provide a reasonable prospect of cost recovery”

2

Procedural Standard

Revenue Standard

Regulatory systems evolve defences against opportunism (or they fail)

Constitutional Defences against Regulatory Opportunism:

A Procedural Standard allows scrutiny of decisions and hence enforcement of the Revenue Standard

Good decision-making

The right value

3

Benchmarking persists where procedural standards are weak

Weaknesses in the benchmarking process:

Problems with UK procedures and appeals:

Residual

“Inefficiency”No agreed model;

selection by results

Widespread acceptance of

regulatory discretion

Appeals judged on plausibility, not on objectivity

No cross-examination to

expose subjectivity

“Efficient Costs”

Correct standard

UK regulation has a weak “evolutionary engine”, which allows bad methods to persist (until now….?)

4

(+ 3 procedural and accounting

issues with limited impact

on NPV)

GB: Appeals against poor process were more effective than disputing values

“Limited Merits” Appeals against RIIO-ED1 (2015):

Northern Power Grid (distribution network operator)re: own price control1. Real Price Effects – unit prices rising faster/slower than RPI2. Regional labour cost adjustment – used in benchmarking3. Smart grid – implementation targets were baseless

Centrica (retail supplier and network user)re: price controls for all “slow-tracked” DNOs4. Cost of debt – too high5. Interruption incentive – too generous6. IQI – calibrated without reference to Ofgem’s stated objectives

X

X

X

X

The British appeals panel accepted regulatory discretion, but rejected arbitrary procedures

5

2013: Dutch regulator adopted a European DEA model, but adapted it:– Replaced (European) Post-Tax WACC with (Dutch) Pre-Tax WACC; and – constrained weights on variables (to get “stable” results)

These changes lowered TenneT’s score from 100% to 85%.– Mostly due to use of Pre-Tax WACC (NERA Sensitivities for TenneT)

TenneT appealed to the regulatory tribunal (CBb), twice:

2015 Judgement:

Add a margin of error for model selection

2016 Judgement:

5% is not enough:sensitivities => 10%!

NL: Dutch national grid challenged use of only one benchmarking model

The Dutch court required the regulator to allow for equally valid, alternative approaches

Dutch Court rejects single-model benchmarking:

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Conclusion: Why regulatory procedure matters

Legal frameworks vary between jurisdictions, but in general regulatory appeals enforce the standards of good decision-making:

(1) Revenue Standards (if any); and (2) Procedural Standards

– Even in “Limited Merits Reviews”, (quasi-)judicial panels often focus on the procedures used to set values, not on the actual values

– Regulatory benchmarking overrides any Revenue Standard by ignoring the Procedural Standard, and only survives where procedural constraints are weak

Enforcing (“good”) regulatory procedure on individual choices prevents arbitrariness and opportunism (i.e. “bad” values)

Appeals over the Procedural Standard impose a useful discipline (good decisions), especially if the Revenue Standard

(the right value) is poorly defined

Annex: About Our Firm

The Company Overview

8

About Our Firm

For over half a century, NERA's economists have been creating strategies, studies, reports, expert testimony, and policy recommendations for government authorities and the world's leading law firms and corporations– We bring academic rigor, objectivity, and real world industry experience

to bear on issues arising from competition, regulation, public policy, strategy, finance, and litigation

Clients value our ability to apply and communicate state-of-the-art approaches clearly and convincingly, our commitment to deliver unbiased findings, and our reputation for quality and independence– Our clients rely on the integrity and skills of our unparalleled team of

economists and other experts backed by the resources and reliability of one of the world's largest economic consultancies

NERA Economic Consulting is a global firm of experts dedicated to applying economic, finance, and quantitative principles to complex business and legal challenges

9

Our Global Presence

Our global team of more than 500 professionals operates in more than 25 offices across North America, Europe, and Asia Pacific

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Our Connection to Marsh & McLennan Companies

NERA Economic Consulting is a unit of Oliver Wyman Group, part of Marsh & McLennan Companies

Marsh & McLennan Companies

Consulting

NERA Economic Consulting

Oliver Wyman Group

Mercer

Lippincott Oliver Wyman

Risk andInsurance Services

GuyCarpenter

Marsh

CONFIDENTIALITY Our clients’ industries are extremely competitive, and the maintenance of confidentiality with respect to our clients’ plans and data is critical. NERA rigorously applies internal confidentiality practices to protect the confidentiality of all client information.

Similarly, our industry is very competitive. We view our approaches and insights as proprietary and therefore look to our clients to protect our interests in our proposals, presentations, methodologies and analytical techniques. Under no circumstances should this material be shared with any third party without the prior written consent of NERA.

© 2017 NERA Economic Consulting

graham shuttleworth - energy networks australia

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