NEW SOUTH WALES (IPART) 5
1. provides an equitable allocation between Distribution Network Users and Distribution Network Owners of efficiency gains reasonably
156. In addition, section 6.10.2 of the Code describes the objectives of the regulatory regime:
The distribution service pricing regulatory regime to be administered under Part D of the Code must seek to achieve the following outcomes:
a) an efficient and cost-effective regulatory environment;
b) an incentive-based regulatory regime which:
1. provides an equitable allocation between Distribution Network Users and Distribution Network Owners of efficiency gains reasonably expected by the Jurisdictional Regulators to be achievable by the Distribution Network Owners;
2. provides for, on a prospective basis, a sustainable commercial revenue stream which includes a fair and reasonable rate of return to Distribution
Network Owners on efficient investment, given efficient operating and maintenance practices of the Distribution Network Owners;
…
c) prevention of monopoly rent extraction by Network Owners;
d) an environment which fosters an efficient level of investment within the distribution sector, and upstream and downstream of the distribution sector;
e) an environment which fosters efficient operating and maintenance practices within the distribution sector;
…
i. reasonable regulatory accountability through transparency and public disclosure of regulatory processes and the basis of regulatory decisions;
j. reasonable certainty and consistency over time of the outcomes of regulatory processes, recognising the adaptive capacities of Code Participants in the provision and use of distribution network assets;
k. reasonable and well defined regulatory discretion which permits an acceptable balancing of the interests of Distribution Network Owners, Distribution Network Users and the public interest.
157. Thus there are a number of Code provisions which relate to how IPART should review the service provider’s cost forecasts, although none are prescriptive.
158. As we document below, IPART’s approach to reviewing the service provider’s cost forecasts in the two sectors was very similar.
5.3 THE PRICE DETERMINATION PROCESS
Form and Timing
159. IPART uses a “building blocks” approach to determining the required revenue in the up-coming period. All of the building blocks, including the cost of capital, are considered together within the same process.
160. There are no formal requirements as to timing of IPART’s decision making processes. The Sydney Water draft determination was published in March 2012, and a final decision is expected in June 2012 (to set water prices for July 2012). IPART published an issues paper in June 2011, and the formal application from Sydney Water was received in September 2011. The process is thus 12 months overall, and nine months from the receipt of the application.
161. The electricity determination setting prices for July 2004 was published in June 2004, and the DNSP submissions were published in April 2003. The first IPART issues paper was
published in November 2002, and IPART also began requesting information from the DNSPs at that time.91 Thus the electricity process took 19 months overall, and 14 months from the submission of formal applications by the DNSPs.
162. IPART’s process begins with an “issues paper”, to which the service provider’s
“application” is a response. In this way, IPART is able to signal the type of information that the service provider should submit.
Use of Consultants
163. IPART commissioned technical advice from engineering consultants on the proposed capex/opex allowances in both the Sydney Water92 and electricity distribution93 reviews. In both cases, the consultants were asked to review the prudence of past expenditure and the efficiency of the company’s forecasts.
Interaction with Stakeholders During the Review Process
164. During the review process, IPART has formal consultation on an issues paper, and a draft decision, and the service providers and other stakeholders respond to these consultations.
165. IPART and its technical consultants correspond with the service providers in order to obtain additional information, and the technical consultants conduct interviews. IPART’s preference is for as much of the interaction as possible to be on a written basis, because this aids transparency.
166. IPART holds regular meetings at senior level with service providers, including Sydney Water. However, these meetings do not take place during the determination process. Because it has other roles in addition to determining maximum prices (such as licensing), IPART collects information from water service providers on a regular basis.
This information is helpful because it helps IPART understand the service provider’s business, including drivers of cost, and it means that IPART has a good picture of historical spending.
91 See timetable as set out in Regulatory arrangements for the NSW Distribution Network Service Providers from 2004, Issues paper, IPART (November 2002).
92 See Final Report Detailed Review of Sydney Water Corporation’s Operating and Capital Expenditure, WS Atkins in association with Cardno (November 2011).
93 See Review of Capital and Operating Expenditure of the NSW Electricity Distribution Network Service Providers – Final Report, Meritec (September 2003).
Prudence
167. Both for water and electricity distribution service providers, IPART reviews the prudence of historical investment. There is no automatic roll-in of investment into the opening asset base for the new control period.
5.4 THE SERVICE PROVIDER’S APPLICATION
168. The service provider submits forecasts of capex and opex. It also submits its views on the other building blocks of the overall revenue requirement, and it provides information on actually-incurred historical costs.
169. There are no specific requirements on the precise form of Sydney Water’s forecast.
However, the forecast comes in response to an IPART issues paper.
170. The forecasts are broken down into major elements or programs for opex, and major projects for capex. As part of the opex forecast, Sydney Water identified “efficiency savings”, which represent elements of opex that are forecast to decline over time relative to the current level. The capex forecast includes a discussion of the major drivers (growth in customer numbers).
5.5 RULES FOR HOW THE REGULATOR’S ANALYSIS IS TO BE CONDUCTED
171. Section 15 of the IPART Act gives no guidance to IPART on how the service provider’s cost forecasts should be assessed.
172. In electricity there were no prescriptions in the National Electricity Code, but several provisions that seem to have been generally relevant to the assessment of the service providers’ forecasts. IPART was required “to have regard for [its] reasonable judgment of the potential for efficiency gains to be realised by the Network Owner in expected operating, maintenance and capital costs”.94 In addition, an objective of the Code was that it
“provides an equitable allocation between Distribution Network Users and Distribution Network Owners of efficiency gains reasonably expected by [IPART] to be achievable by the Distribution Network Owners”.95 Another objective was “reasonable and well defined
94 Section 6.10.5d(4).
95 Section 6.10.2b(1).
regulatory discretion which permits an acceptable balancing of the interests of Distribution Network Owners, Distribution Network Users and the public interest”.96
5.6 ANALYTICAL TOOLS USED BY THE REGULATOR
173. IPART both commissions technical advice from engineering consultants and conducts its own analysis. There is no restriction on the type of analysis that can be undertaken. In practice, IPART and its consultants have used a range of tools, as described in the consultants’ reports and IPART’s decisions.
174. IPART examines historical expenditure relative to the authorized amounts in addition to capex/opex forecasts.
175. A sampling approach was used for Sydney Water’s capex program. The consultants were asked to review 10% of projects costing more than $5m (for both the projects in the prior period and forecast projects).
176. IPART examines both the forecasts themselves and the service providers’ planning processes that were used to produce the forecasts.
177. IPART’s consultants undertook some benchmarking of Sydney Water relative to other water service providers. Inevitably, however, the final recommendations of the engineering consultants were based in part on professional judgement.97
178. When it had responsibility for regulating distribution network service providers, IPART undertook detailed statistical benchmarking analyses aimed at estimating the efficiency of the NSW service providers relative to other distributors in Australia and elsewhere.98 Some of this analysis involved total factor productivity assessment, but not for the purpose of setting rates or an “X-factor”. IPART undertook this research in the run up to the 1999 price determination, but it was not used in the 2004 determination.
5.7 COMMENTARY ON THE APPROACH
179. In determining the maximum prices for Sydney Water, IPART suggested that the interaction they have with the company by virtue of IPART’s licensing function was
96 Section 6.10.2k.
97 For example: “On the basis of what we have seen, our view of prudent expenditure is a judgement which takes into account the decision making process and the impact of those decisions. We have assumed that 15% of expenditure above the 2008 Determination was not prudent.” (WS Atkins report, p. 137).
98 See Pricing for Electricity Networks and Retail Supply Volume 1, IPART (June 1999).
particularly helpful. It meant that IPART already had access to detailed information about the company’s operational and financial performance on an on-going basis.
180. IPART appears to maintain a constructive relationship with the entities it regulates, which facilitates information disclosure. It was also suggested to us that some incentives for information disclosure and efficiency derive from the risk that IPART may (and does) disallow expenditures when warranted.
181. There is an appeals process for IPART’s decisions, but it has not been used to date, perhaps because the entities being regulated are state-owned enterprises.