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A comparison [of the state of regulation] across electricity, gas and telecommunications sectors. Presented to the 11th Annual National Power Conference, 8 August 2000, Crown Towers, Melbourne by the Chairman, Australian Competition and Consumer Commission.

11th Annual National Power Conference 8 August 2000 Crown Towers Melbourne

 

A comparison across electricity, gas and telecommunications sectors

 

18 August 2000 Canberra

 

Professor Allan Fels

 

Chairman Australian Competition and Consumer Commission

 

1. Introduction  

 

Today I have been asked to provide a comparison of the state of regulation in a number of sectors. The Commission is involved in the regulation of energy and telecommunications as well as some other areas including transport. Water regulation is undertaken at the state level so I will restrict my comments to gas, electricity and telecommunications. 

 

I would like to comment on a number of things. 

• First, I would like to make some comments on the regulatory framework in these sectors 

• On why we regulate and the potential effects on owners of facilities and consumers; and 

• The approach to regulation in our federal structure.

 

2. The Commission's role in regulation: the legislative framework  

 

The basis of the Commission's regulatory role can be found in the legislation and industry codes in the electricity, gas and telecommunications industries. While the starting point and framework of each of the industries differs there are many similarities in the approaches adopted by the Commission.

 

Telecommunications  

 

Part XIC of the Trade Practices Act 1974 (the Act) sets out the legislative criteria by which the Commission is required to regulate carriage services. It provides that the Commission must have regard to the long term interest of end users, by establishing the rights of third parties to gain access to services which are necessary for competitive services to be supplied to end users. This aims to promote the long-term interests of end users by achieving the following objectives: 

• Promoting competition in markets for listed services; 

• Achieving any to any connectivity in relation to carriage services; and 

• Encourage the economically efficient use of, and investment in, infrastructure.

 

Electricity

 

The framework that governs the operation of the national electricity market is somewhat different from that operating in gas and telecommunications. In electricity the establishment of a wholesale market for power is set out in an industry code that prescribes the operation of the market, establishment of market institutions, rules of participation and the arrangements for access to and pricing of wires business services. These set of market rules has been evaluated under the Commission's powers of authorisation, is enabled under state law and the access arrangements under pinned by Part IIIA of the Trade Practices Act. Another interesting difference with telecommunications and gas therefore is electricity's use of a compulsory auction market, where by all power is sold through a physical market and contracts for that power are settled outside the market.

 

The national electricity market code sets out the criteria that the Commission uses for its regulatory functions. As with telecommunications there is a focus of efficient investment as well as a need to balance the interests of transmission owners and the users of the service.

 

Gas  

 

The National Third Party Access Code for Natural Gas Pipeline Systems (the Code) establishes the rights and obligations of pipeline operators and users in relation to access to the transmission and distribution of natural gas. Each jurisdiction applies to the National Competition Council to have its legislative access regime (implementing the National Gas Code) certified as effective under Part IIIA of the Trade Practices Act. Once the regime is certified, covered pipelines under the Code would be exempt from declaration under Part IIIA.  

 

Under the Gas Pipelines Access Law, the ACCC is the relevant regulator for access to services provided by transmission pipelines in all States and Territories except Western Australia. Access to services provided by distribution networks will be regulated by independent State-based regulators, except in the Northern Territory, which has requested the ACCC to regulate both its transmission and distribution pipelines.  

 

The Commission has made a number of decisions and authorisations in respect of transmission pipelines covered by the Code. 

 

3. Why Regulate?  

 

One initial question might be "why regulate in the first place" to which the usual answer is that where competition is not feasible, robust and independent regulation becomes necessary. In network industries there are few situations where competition alone provides a sustaining discipline. Without supervision the monopoly or bottleneck elements in the market can both extract rents and distort the character of investment upstream and downstream of the infrastructure.  

 

In the electricity, gas and telecommunications industries the Commission plays an important role as the facilitator of competition by providing the regulatory discipline of the network industry concerned. In our role as regulator, the Commission aims to adopt a regulatory process, which contains monopoly pricing, provides a fair rate of return to network owners; and creates incentives for managers to pursue ongoing efficiency gains through cost reductions, without compromising the needs of consumers. 

 

4. Differences and similarities in regulation  

 

One common feature of this regulation is that it attempts to redress the imbalance in market power. The objectives of the competition reforms are to achieve benefits through structural separation and the encouragement of competition. Where competition is not possible, in those bottleneck services such as electricity transmission, or gas pipelines, regulation is necessary.  

Without it the owners of those facilities could capture the benefits of competition upstream and downstream and distort output and investment in those related market. 

 

In doing this it is important to establish efficient costs of the regulated industries. This has been controversial in some quarters. However, as industries became regulated for the first time it was necessary to scrutinise costs to ensure efficiencies are passed on to users. 

 

For regulation of the telecommunications industry, the Commission uses a cost-based pricing approach. That is, the price of a service should not exceed the minimum costs an efficient firm will incur in the long run in providing the service. The Commission's Access Pricing Principles Guidelines for telecommunications sets out the Commission approach to regulation and states that, in relation to certain services, access price should be based on the total service long-run incremental cost of providing the service (TSLRIC). TSLRIC is the incremental or additional cost the firm incurs in the long term in providing the service. It is the cost the firm would avoid in the long run if it ceased to provide the service. This approach encourages: 

• Competition in telecommunications markets by promoting efficient entry and exit in dependent markets;  

• Economically efficient investment in infrastructure;  

• Long term efficient use of existing infrastructure 

• Access providers to minimise the cost of providing access 

• Enable efficient access providers to fully recover costs; and 

• Protects the interests of persons who have rights to use declared services.

 

As in the regulation of the telecommunications industry, the Commission's approach in the regulation of both electricity and gas transmission networks uses an estimation of the efficient cost of providing the service . In electricity, the principles setting out the Commission's role as transmission network regulator are set out in Part C of chapter 6 of the National Electricity Code. 

Chapter 6 provides that the Commission is required to set a revenue cap using a CPI-X regime, or some variant.  

 

The Commission has elaborated on this approach in the Draft Regulatory Principles. The regulatory principles utilises the building block methodology, and is based on forecasts of the cost of service over the regulatory period, calculating total revenues as the sum of: 

• The return on capital,  

• The return of capital; and  

• Operating and maintenance expenditure.

 

As the Commission moves towards finalising its approach to some important regulatory issues we have been busy engaging industry and the public, by providing the opportunity for them to comment on our proposals. We have had forums ton discuss various valuation techniques for existing assets, depreciation and cost of capital issues.

 

5. Regulation in a Federation  

 

We have also seen a proliferation of regulators. Responsibilities have in general been passed on to the Commission for transmission in gas and electricity while distribution has been retained at the state level. In contrast in telecommunications and indeed in airports the Commission is the sole competition regulator. 

 

We are conscious of the costs of dealing with multiple regulators and have been doing what we can to ameliorate the situation administratively. 

 

The Commission has been pro-active in promoting a nationally consistent approach to regulation across the gas and electricity industries through the establishment of the Energy Committee and our sponsorship of and participation in the regulators' forum. The Energy Committee, which sits as a committee of the Commission, includes various jurisdictional regulators and deals with energy regulatory matters. The regulators' forum is an association of all state regulators and the Commission and meets regularly to discuss regulatory issues of common interest and provides a means to promote consistency among regulators.  

 

6. Ensuring continued benefits  

 

The range of challenges before us in the utility sectors is significant. Some relate to the nature of regulation and others go to more fundamental questions of market structure and the on-going commitment to the reform process. For example, In the telecommunications industry, the Commission is charged with the responsibility of arbitrating disputes between access providers and access seekers. However, the number of disputes brought to the Commission under Part XIC of the Act for arbitration has been of some concern to us. We have received far more arbitrations than were ever envisaged when these provisions were introduced. Complex pricing arbitrations take time to complete. We expect the negotiation/arbitration model to become more effective as competition increases in the market and as we finalise our core work on access pricing which will provide further guidance to industry on appropriate pricing benchmarks. 

 

The Commission has been very active in ensuring that arbitrations are handled as speedily as possible. We have made a number of interim determinations and are close to final determinations in a number of arbitrations. We are also using a variety of dispute resolution options to speed the processes and to assist parties in resolving disputes themselves wherever possible.  

 

In gas sector many of the issues of reform are linked with the history of the industry and the approach to reform. This is not often recognised and there has been a degree of criticism of the regulatory framework that I believe is not supported by the facts of the reform process.  

Australia's natural gas industry developed as separate, State-based markets, often with a high degree of vertical integration, with monopolies operating in production, distribution and retailing market segments. 

 

The Council of Australian Governments (COAG) decided to address the problems of gas industry fragmentation and monopoly power by developing nationally integrated and competitive markets. In 1997, the Commonwealth, State and Territory Governments developed the National Third Party Access Code for Natural Gas Pipelines Systems (The National Gas Code). Each government committed to passing legislation to bring the National Gas Code into force in its jurisdiction.  

 

Jurisdictions also committed to have their legislative access regime (implementing the National Gas Code) certified as effective under Part IIIA of the Trade Practices Act. Once the regime is certified, covered pipelines under the National Gas Code would be exempt from declaration under Part IIIA. These applications are considered by the NCC, which makes a recommendation to the Commonwealth Minister. 

 

Under the Gas Pipelines Access Law, the ACCC was appointed as the relevant regulator for access to services provided by transmission networks in all States and Territories except Western Australia.  

 

The 1997 inter-governmental agreement listed a number of pipelines that were deemed to be Covered under the National Gas Code. For all other pipelines, including new pipelines, parties can apply to the NCC to have them covered. The NCC makes this assessment in accordance with the criteria set out in the National Gas Code. The NCC then makes a recommendation to the relevant Minister. 

 

If a Covered pipeline's circumstances change the Service Provider can apply to the NCC to have coverage revoked. 

 

The National Gas Code establishes minimum obligations, but allows service providers to structure a tariff package that best suits their business while providing effective access to users. 

The National Gas Code has been described as imposing rate of return regulation through a Cost of Service approach. In fact, the Code allows Service Providers to propose their preferred regulatory approach, so long as it achieves a number of broad objectives, including: 

• providing revenues that recover efficient costs; 

• replicating the outcomes of a competitive market; 

• not distorting investment decision; and 

• providing an incentive to reduce costs. 

The Commission has been criticised for providing lower rates of return in successive regulatory decisions. The facts are quite different. The nominal post-tax return to equity holders that the Commission has used in previous decisions has not been inadequate. In the Victorian gas decision the figure used was 13.2% in May 1998 while the Central West pipeline which is a newly built and riskier pipeline a forecast rate of return of 15.4% was used. 

 

As a basis for broader comparison the average annual return on equity from investing in shares on the stock market was 11.3% from June 1988 to June 1998.  

 

Whilst the industry is voicing concerns about regulation, this is to be expected. It is important to remember that this is the first time that these pipelines have been subject to independent economic regulation. In making its decision the Commission seeks to balance the competing interests of service providers and users. Maintaining appropriate incentives for future pipeline investment is a critical component of the Commission's regulatory assessment. 

 

The Commission also recognises the different risks inherent in greenfield projects. This is reflected in its recent decision regarding the Central West Pipeline Access Arrangement. In addition to a return on equity at the high end of a feasible range, this decision provided for losses to be carried forward for future recovery. The access arrangement review period was extended to 10 years to allow any upside from volumes above those forecast to be retained by the Service Provider. 

Clearly a lot of attention is being focused on midstream and downstream sectors of the gas supply chain. However the Commission believes that the full benefits of the gas reform process will not be realised without greater supply competition.  

 

In the Gas sector we are yet to see significant supply competition. In comparison, it was supply competition between generators that has driven a lot of the benefits arising from reform in the Electricity sector.  

 

Both the Gas Policy Forum and the Business Council of Australia recognised that the upstream sector is an important area for ongoing reform and review. The Commission would expect supply competition to develop in through new entry and Inter-basin competition via new pipelines. For example the Kipper field in the Gippsland Basin and the Eastern Gas pipeline both can facilitate greater competition.

 

In electricity, while the establishment of the national electricity market has been a significant achievement, one recognised around the world, there remain a number of challenges if we are to full realise the benefits of the reforms in electricity. Some of these challenges are rightly issues for state regulators and the ACCC to address. For instance, matters such as the approach to asset valuation and the treatment of easements are currently before regulators and ultimately there needs to be a consistent approach not only between regulators but also between the different regulated sectors. 

 

Other contentious issues for regulators are common across regulated industries, such as balancing the interests of the regulated entity and the broader interests of users. Also the approach to incentive regulation is evolving with greater emphasis now being placed on performance based regulation rather than one focussed only on costs.  

 

Finally, in electricity there is the ongoing review of the general network pricing provisions. As you may be aware, the National Code Administrator is proposing major changes to who pays for the transmission network. At the moment customers largely pay for network investment. However, in the future it may be that those who benefit from network investment will pay. This could see other market participants, such as generators, paying a proportion of network costs. If the market evolves towards nodal pricing then in the future the electricity market will look significantly different from what we see today. 

 

A significant amount has been achieved by the reforms in electricity. The gains by consumers of energy have been significant. Investment in the industry is now more market orientated, regulation increasingly focussed on incentives and the industry is seeing a greater degree of private sector investment and risk taking. However, I also detect some degree of reform fatigue on the part of governments. This is best illustrated by the use of derogations and government intervention in the national electricity market, whether by means of vesting contracts or the discouragement or encouragement of generation projects and interconnection. 

 

In my view these interventions detract from the likely benefits of reform and in some extreme situations can place those benefits at risk. Indeed any short-term transition gains are usually lost in the distortions to market behaviour, resulting in inefficient and undesirable outcomes. Having come this far the reform process, we have moved beyond the point of revisiting old commitments and therefore I would encourage all involved in the electricity reforms to focus on resolving the remaining regulatory and market reform issues.

 

7. Conclusion  

 

In telecommunications, opening the sector to competition along with the Commission's role in the regulation of listed carriage services has seen the benefits of upstream competition passed onto consumers through lower prices and an increased range of services. Similarly, in the energy industries, the regulation of transmission and distribution networks has passed benefits from upstream competition from electricity generation onto final consumer through lower prices. This has not been true in gas. The continued success of the reforms in utilities requires the encouragement of competition. Where this is not possible there must be effective regulation. Greater emphasis must be placed on continuing the reform momentum. Without this there is increasing risks that the benefits of the reforms to date will be stifled to the detriment of the market in general.