2020 Inflation Review Technical workshop 13 August 2020 Jonathan - - PowerPoint PPT Presentation

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2020 Inflation Review Technical workshop 13 August 2020 Jonathan - - PowerPoint PPT Presentation

Apr 05, 2024 280 likes •610 views

2020 Inflation Review Technical workshop 13 August 2020 Jonathan Seymour, Assistant Director Robyn Pickering, Director Warwick Anderson, General Manager, Networks Finance & Reporting aer.gov.au 1 Workshop purpose Opportunity to

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2020 Inflation Review

13 August 2020 Jonathan Seymour, Assistant Director

Robyn Pickering, Director Warwick Anderson, General Manager, Networks Finance & Reporting

Technical workshop

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Workshop purpose

  • Opportunity to model a range of scenarios

presented in stakeholder submissions on the treatment of inflation in the regulatory framework.

  • Focus discussions on:

– Outcomes of scenario – Impacts on consumers, NSPs and investors – Transitional matters – Rule change requirements.

  • Workshop in no way pre-empts the AER’s draft
  • position. This will be released on 30 September.
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Agenda

  • Process for change
  • Modelling of alternatives

– Base assumptions – Estimation approaches (model change) – Alternate targets (framework change)

  • Questions and issues
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Model change or Rule change

  • Change to estimation method requires change

to PTRM.

  • Framework change (change of target) requires

change to NER (and possibly NGR). – Amount of rules requiring change depends on the change and how it is applied.

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Base scenario

  • Current approach to RFM, PTRM and pricing
  • PTRM:

– Nominal rate of return applied to RAB indexed for expected inflation – Expected inflation of RAB removed from depreciation – Real expected rate of return (nominal less expected inflation) drives revenues.

  • RFM:

– Updates the RAB for actual capex and actual inflation. – Closing RAB forms the base for revenues in PTRM.

  • Pricing:

– Applies CPI-X in each year except first – i.e. Real expected revenue updated for actual inflation.

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Current approach

  • If expected inflation 2.25% and actual inflation

was 1.5%

310.0 320.0 330.0 340.0 350.0 360.0 370.0 380.0 390.0 400.0 410.0 420.0 5700.0 5800.0 5900.0 6000.0 6100.0 6200.0 6300.0 6400.0 6500.0 6600.0 6700.0 1 2 3 4 5 Forecast RAB - at decision (RHS) Actual RAB - after roll forward (LHS) Expected revenue - at decision (RHS) Actual revenue - after pricing (LHS)

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Alternative approaches modelled

  • Estimation methods:

– 5 year estimate (2 years SMP + mid-point) – Glide path (linear from year 2 to year 6) – Glide path + 5 year (2y SMP, glide to 2.5 at y5) – Market estimate (BBIR/ZCIR)

  • Framework/target:

– Hybrid target (nominal RoD, real RoE):

  • Weighted CPI in Pricing and RFM

– Nominal target

  • Annual update/true-up (no expectation)
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Assumptions

  • Opening RAB = $6 billion
  • Capex to offset depreciation (constant $real

RAB)

  • No Opex
  • Tax lives = RAB lives
  • Return on Debt = 4.30% all years
  • Return on Equity = 5.00%
  • Return on Capital = 4.58% (60% gearing)
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Estimation methods

  • Below shows the outcomes of applying different

RBA-based methods to estimate expected inflation.

  • 10y inflation swaps and 5yr glide both around

1.80%

Year Estimate Source Outcome Year Estimate Source Outcome Year Estimate Source Outcome Year Estimate Source Outcome 1 1.00% RBA SMP 2.25% 1 1.00% RBA SMP 2.00% 1 1.00% RBA SMP 2.10% 1 1.00% RBA SMP 1.80% 2 1.50% RBA SMP 2 1.50% RBA SMP 2 1.50% RBA SMP 2 1.50% RBA SMP 3 2.50% RBA mid-band 3 2.50% RBA mid-band 3 1.75% glide 3 1.83% glide 4 2.50% RBA mid-band 4 2.50% RBA mid-band 4 2.00% glide 4 2.17% glide 5 2.50% RBA mid-band 5 2.50% RBA mid-band 5 2.25% glide 5 2.50% RBA mid-band 6 2.50% RBA mid-band 6 2.50% RBA mid-band 7 2.50% RBA mid-band 7 2.50% RBA mid-band 8 2.50% RBA mid-band 8 2.50% RBA mid-band 9 2.50% RBA mid-band 9 2.50% RBA mid-band 10 2.50% RBA mid-band 10 2.50% RBA mid-band Ex-ante rate of return = 2.28% Ex-ante rate of return = 2.53% Ex-ante rate of return = 2.43% Ex-ante rate of return = 2.73% 5 year + glide/swaps Linear glide path (2.5 @y6) Current AER estimation approach 5 year RBA approach

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Random inflation (around 2.4% on average)

  • Ex-ante and ex-post returns:

Rate of return Nominal ex-ante Nominal ex-post Real ex-ante Real ex-post Base (2.25%) 4.58% 4.70% 2.28% 2.25% 5 year (2.00%) 4.58% 4.94% 2.53% 2.48% 10y Glide (2.10%) 4.58% 4.84% 2.43% 2.38% Swaps (1.80%) 4.58% 5.13% 2.73% 2.66% Return to Equity Nominal ex-ante Nominal ex-post Real ex-ante Real ex-post Base (2.25%) 5.00% 5.32% 2.69% 2.84% 5 year (2.00%) 5.00% 5.94% 2.94% 3.43% 10y Glide (2.10%) 5.00% 5.69% 2.84% 3.20% Swaps (1.80%) 5.00% 6.43% 3.14% 3.90%

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Cash flows to debt and equity

  • Assuming random inflation:

50 100 150 200 250 300 350 400 450 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 Base case Interest payments Base case Cash flow to Equity 5 year Interest payments 5 year Cash flow to Equity Expected CF to Equity

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Random inflation (not so random)

  • Reflects actual inflation from 2002 (post-GST)

back then reversed, then forward.

0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71

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Consistently lower than expected inflation (1.5%)

  • Ex-ante and ex-post returns:

Rate of return Nominal ex-ante Nominal ex-post Real ex-ante Real ex-post Base (2.25%) 4.58% 3.87% 2.28% 2.34% 5 year (2.00%) 4.58% 4.11% 2.53% 2.57% 10y Glide (2.10%) 4.58% 4.02% 2.43% 2.48% Swaps (1.80%) 4.58% 4.30% 2.73% 2.76% Return to Equity Nominal ex-ante Nominal ex-post Real ex-ante Real ex-post Base (2.25%) 5.00% 3.24% 2.69% 1.71% 5 year (2.00%) 5.00% 3.83% 2.94% 2.29% 10y Glide (2.10%) 5.00% 3.59% 2.84% 2.06% Swaps (1.80%) 5.00% 4.30% 3.14% 2.75%

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Real returns to capital and equity (1.5% actual)

  • Ex-ante and ex-post real returns:

0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% Base case 5 year Glide path Swaps Real return to capital ex-ante Real return to capital ex-post Real return to equity ex-ante Real return to equity ex-post

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Cash flows to debt and equity

  • Assuming 1.5% inflation:

50 100 150 200 250 300 350 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 Base case Interest payments Base case Cash flow to Equity 5 year Interest payments 5 year Cash flow to Equity Expected CF to Equity

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Revenue profiles (1.5% actual)

  • Nominal revenues:

0.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 900.0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 Base case 5 year Glide path Swaps

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Bill impact (1.5% actual)

  • Profile of customer bill ($real)

1400 1500 1600 1700 1800 1900 2000 2100 2200 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 Base case 5 year Glide path Swaps

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Volatility (random inflation)

  • Inflation assumptions:
  • Real vs nominal revenue
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Impact of annual pricing

  • In all scenarios presented the approach to

pricing is unchanged (CPI-X).

  • First year set equal to PTRM, subsequent years

updated for actual inflation.

  • Short term actual cash flows therefore do not

reflect the PTRM estimate (unless actual = expected).

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Impact of Pricing

  • If CPI-X is not applied to annual pricing.
  • Impact on returns (1.5% inflation):

Rate of return Nominal Real Ex-ante Ex-post Ex-post No CPI-X Ex-ante Ex-post Ex-post No CPI-X Base (2.25%) 4.58% 3.87% 3.99% 2.28% 2.34% 2.46% 5 year (2.00%) 4.58% 4.11% 4.19% 2.53% 2.57% 2.65% Swaps (1.80%) 4.58% 4.30% 4.35% 2.73% 2.76% 2.81% Return to Equity Nominal Real Ex-ante Ex-post Ex-post No CPI-X Ex-ante Ex-post Ex-post No CPI-X Base (2.25%) 5.00% 3.24% 3.54% 2.69% 1.71% 2.01% 5 year (2.00%) 5.00% 3.83% 4.03% 2.94% 2.29% 2.49% Swaps (1.80%) 5.00% 4.30% 4.42% 3.14% 2.75% 2.88%

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Alternate targets

  • Hybrid target

– Nominal debt target – real equity – Can be achieved by applying weighted CPI in Pricing and RFM (60% exp | 40% actual). – CEG modelled only change to RFM

  • Hybrid + market measure

– ENA/APGA approach – Modelled with same RoD and RoE term.

  • Nominal target

– Updates PTRM for actual inflation impact each year (no need for forecast).

  • Multitude of alternate modelling.
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Hybrid - Weighted CPI

  • If expected inflation is 2.5% and actual is 1.5%:

– Weighted CPI = 2.1% – Pricing applies this rate as CPI-X for each year – RFM applies this rate to indexation of entire RAB.

  • Issues:

– RAB not maintained in correct $real terms. – Gearing may diverge from 60% if average inflation =/= expected inflation.

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Nominal - Updated

  • PTRM updated each year (as per debt update) but also

for actual inflation for previous year.

  • No need to forecast inflation (other than for presentation
  • f nominal revenues).
  • Revenues move more year-to-year (may be mitigated

somewhat with revenue smoothing)

  • No need to apply CPI-X at pricing, just take revenues

from PTRM.

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Alternate targets - Random inflation

  • Ex-ante and ex-post returns:

Rate of return Nominal ex- ante Nominal ex- post Real ex-ante Real ex-post Base 4.58% 4.70% 2.28% 2.25% Hybrid (weighted) 4.58% 4.57% 2.28% 2.13% Hybrid + swaps 4.58% 4.84% 2.73% 2.38% Nominal -updated 4.58% 4.58% 1.56% 2.14% Return to Equity Nominal ex- ante Nominal ex- post Real ex-ante Real ex-post Base 5.00% 5.32% 2.69% 2.84% Hybrid (weighted) 5.00% 5.00% 2.69% 2.54% Hybrid + swaps 5.00% 5.61% 3.14% 3.12% Nominal -updated 5.00% 5.01% 1.96% 2.14%

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Alternate targets - low inflation (1.5%)

  • Ex-ante and ex-post returns:

Rate of return Nominal ex- ante Nominal ex- post Real ex-ante Real ex-post Base 4.58% 3.87% 2.28% 2.34% Hybrid (weighted) 4.58% 4.22% 2.28% 2.68% Hybrid + swaps 4.58% 4.42% 2.73% 2.88% Nominal -updated 4.58% 4.58% 3.03% 3.03% Return to Equity Nominal ex- ante Nominal ex- post Real ex-ante Real ex-post Base 5.00% 3.24% 2.69% 1.71% Hybrid (weighted) 5.00% 4.09% 2.69% 2.55% Hybrid + swaps 5.00% 4.61% 3.14% 3.06% Nominal -updated 5.00% 5.00% 3.45% 3.03%

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Alternate targets - real returns (1.5% inflation)

  • Ex-ante and ex-post real returns:
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Alternate targets – 1.5% inflation

  • Revenues:

0.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 900.0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 Base case Hybrid (weighted CPI) Hybrid + swaps Nominal (updated)

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Alternate targets - Bill impact

  • $real customer bill profile (1.5% actual)

1400 1500 1600 1700 1800 1900 2000 2100 2200 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 Base case Hybrid (weighted CPI) Hybrid + swaps Nominal (updated)

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Volatility (random inflation)

  • Inflation assumptions:
  • Real vs nominal revenue
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Volatility in bills

  • Nominal updated leads to volatility as all

revenue updated each year for actual inflation.

1400 1500 1600 1700 1800 1900 2000 2100 2200 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 Base case Hybrid (weighted CPI) Hybrid + swaps Nominal (updated)

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Questions?

  • Is a transition required if a change is made?
  • Should consumers pay for inflation risk premium (CEG)
  • We see ‘inflation risk’ as the impact on purchasing power
  • f returns and costs. Maintained under current real

target. – How does hybrid/nominal change this? – NSPs are already compensated for ‘cash flow inflation risk’. – How does change to hybrid/nominal change this? Is change to equity beta required as well?

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Other questions

  • Any follow up questions should be emailed to

Inflationreview2020@aer.gov.au.