Gas pipeline regulation in Australia Is it fit-for-purpose? - PowerPoint PPT Presentation

Gas pipeline regulation in Australia Is it fit-for-purpose? Presentation to the 2019 ACCC / AER Regulatory Conference, Brisbane, 1 August 2019 Jeff Balchin Managing Director

Contents • How did we get here? • Is the current regime working? What improvements could be made? • What about the RAB – is one required? 2

Gas reforms and early trends • At time of mid 1990s reforms, a (relatively) simple industry structure – Single sources of supply linked to major markets via a single pipeline – Obvious monopoly elements – ex ante price control imposed generally • But clear potential for competition existed – Ability to contract capacity makes pipeline competition feasible – Clear that governments had held back the sector – A different path taken to electricity – capacity to test the need for regulation • Reforms followed by substantial development of the pipeline network and new supply sources – Creation of a pipeline “grid” with substantial benefits, including reliability – Increased competition between pipelines and basins – Removal / avoidance of price control for a number of pipelines – Light-handed regulatory option introduced – applied to a number of pipelines 3

East Australia gas pipeline network Early-mid 1990s Now Ex ante price control Light regulation Unregulated (now Part 23) Under development (on Schedule A) Major supply source Major demand centre 4

Subsequent trends • Continued evolution of the gas markets (new sources of demand and supply and risk) – and a substantial increase in (delivered) prices – Caused an examination of all parts of the supply chain – ACCC concluded there is evidence of pipelines making “monopoly rents” • Problems identified with the pipeline regulatory regime – De-regulation has proven easier than regulation / re-regulation  Concerns about whether the test for coverage is appropriate – The “light-handed” alternative did not prove effective 5

Response to emerging issues – current regime Two principal changes • Introduction of a default form Full regulation of regulation that covers Best way of controlling the Ex ante price control Form of regulation test almost all pipelines market power? – Information disclosure Light regulation – Capacity for commercial arbitration Negotiate - arbitrate (AEMC proposed cost-based) Is competition promoted in a Information disclosure (AEMC proposed regulator to set initial RAB) • Enhancements to “light Coverage test Regulator as arbitrator related market? regulation” – Part 23 regulation Information disclosure Negotiate - arbitrate – Improvements to negotiation and Information disclosure (self-reported asset values) dispute resolution processes Commercial arbitrator – Proposed requirement to apply the standard cost-based principles – Proposed AER to determine initial RABs 6

Assessment of current regime Some very good elements to the recent reforms • Focus on information disclosure and effective dispute resolution • Proposal for additional guidance for “light regulation” arbitration, including that the AER set the initial RAB But shortcomings exist • Potential for both over-regulation and a bias against increased regulation – Side-stepped rather than tackled the “coverage” concerns • The need for flexibility in the default regime brings uncertainty – Contains few protections against “expropriation” • Arbitrations framed as "commercial” and not precedent setting 7

Possible reform options Current regime Option 1 – no coverage test Full regulation Full regulation Best way of controlling the Ex ante price control Form of regulation test Ex ante price control Best way of controlling the market market power? Form of regulation test Light regulation Light regulation Negotiate - arbitrate (AEMC proposed cost-based) Negotiate - arbitrate (AEMC proposed cost-based) power? Is competition promoted in a Information disclosure (AEMC proposed regulator to set initial RAB) Information disclosure (AEMC proposed regulator to set initial RAB) Coverage test Regulator as arbitrator Regulator as arbitrator related market? Part 23 regulation Part 23 regulation Negotiate - arbitrate Negotiate - arbitrate Information disclosure (self-reported asset values) Information disclosure (self-reported asset values) Commercial arbitrator Commercial arbitrator • Recognition that the test of coverage has been made redundant • Removes the bias against increased regulation • But the potential for over-regulation would continue 8

Possible reform options (II) Current regime Option 2 – enhanced coverage test Full regulation Full regulation Best way of controlling the market Best way of controlling the Ex ante price control Form of regulation test Ex ante price control Form of regulation test market power? power? Light regulation Light regulation Negotiate - arbitrate (AEMC proposed cost-based) Negotiate - arbitrate (AEMC proposed cost-based) Is competition promoted in a Information disclosure (AEMC proposed regulator to set initial RAB) Sufficient market power Information disclosure (AEMC proposed regulator to set initial RAB) Coverage test Regulator as arbitrator Coverage test Regulator as arbitrator related market? to regulate? Part 23 regulation Part 23 regulation Information disclosure (self-reported asset values) Negotiate - arbitrate Information disclosure (self-reported asset values) Commercial arbitrator • Adopts the enhancements of the new default regime, but tackles the original issue – the coverage test • Removes the bias against increased regulation and the potential for over-regulation • Provides the protections against “expropriation” offered to full regulation pipelines • Retaining information disclosure as the default is low risk, and may reduce regulation 9

Possible alternative test for coverage … 15—Pipeline coverage criteria The pipeline coverage criteria are: (a) that the pipeline services provided by means of the pipeline are supplied in a market where there is both— (i) little or no competition; and (ii) little or no likelihood of a substantial increase in competition; and (b) there is scope for the exercise of substantial market power in relation to the pipeline services, taking into account the effectiveness of existing regulation or arrangements (including ownership arrangements); and (c) the benefits of regulating the pipeline services in meeting the national gas objective materially exceed the costs of regulation. 10

Role of the RAB in regulation • Whether and why “a RAB” is linked to the objective of regulation – Cost is the most feasible test of whether prices are reasonable  Minimum required for continued investment, and widely seen as fair  Overall benchmarking of prices is seldom feasible for infrastructure – Embedded cost (i.e., actual cost less cost already recovered) is the most feasible standard  Lower risk / potential for dispute than alternative of a hypothetical new entrant’s cost  Incentive issues can be addressed through incentive schemes and supervision • But setting an initial RAB is inherently contentious – Limited guidance from economic principles – a wide range – “Unrecovered cost” is difficult to measure, may have perverse effects and may be unfair – “Competitive market” value is not synonymous with “efficiency” – Ultimate target – an “objectively reasonable” value 11

Role of the RAB in regulation (II) • Effectiveness of a light-handed regime – like “light regulation” – improved by (i) requiring calculation / disclosure of a RAB, and (ii) setting of the initial RAB – Whilst an upfront cost, benefits from lower prospect of disputes – Although careful rules are required over carrying-forward the RAB to avoid future disputes • Experience in other sectors suggest the combination of an initial RAB, rules for carrying-forward and transparency have created a clear discipline on behaviour – E.g., airports in Australia and NZ • But there are clear limits to using “cost” to test the reasonableness of prices – Standard regulatory methods assume away “downside” risk – quantifying stranded asset risk is difficult – Hence, as you get further away from a perfect monopoly, then it becomes harder to draw inferences from measures of embedded cost – a component of which is the RAB 12

Thank you Contact the presenter: Telephone: +61 3 8514 5119 / +61 412 388 372 Email: jeff.balchin@incenta.com.au Website: www.incenta.com.au