Keynote address, Infrastructure Partnerships Australia Energy Symposium, Clare Savage, AER Chair.
Good morning everyone.
I wish to acknowledge the traditional owners and custodians of the land we are meeting on, the unceded lands of the Gadigal people of the Eora Nation. I pay my respects to Elders past and present and acknowledge their continuing culture and contribution.
Thank you for the opportunity to be part of this Energy Symposium.
It feels trite to say this but Australia’s energy market is currently in a period of enormous change.
It is undergoing major technological, structural, policy and regulatory transformation.
There is no part of the energy sector that is immune from these changes, all of which require careful navigation to ensure that the market delivers the best possible outcomes for consumers.
This period of change brings challenges. But it also brings opportunity.
So today, I’d like to discuss three key areas:
- regulatory balance
- flexibility and
- innovation – and what these three areas look like in a transitioning energy market.
AER role overview
Before I begin, I’d like to provide a brief overview of our work at the Australian Energy Regulator.
The AER exists so that energy consumers are better off, now and in the future.
Our functions relate to energy markets in eastern and southern Australia where we regulate wholesale and retail energy markets, and energy networks, under national energy legislation and rules.
The AER regulates 30 gas and electricity network businesses with a combined asset base of over $115 billion. Our primary role is setting the maximum amount of revenue these businesses can earn, and the price they can charge for providing regulated services.
And the NSW Government has appointed the AER as the regulator for the state’s Renewable Energy Zones.
Our market monitoring, reporting, compliance and enforcement work is the cornerstone on which we build trust with the community.
In the wholesale gas and electricity markets, we monitor participant bidding and rebidding, market dispatch and prices, network constraints and outages, demand forecasts and forecasts of production and capacity.
Our role has also recently expanded after being appointed as regulator by the NSW government in relation to their coal market interventions.
Through this role we will ensure compliance with the directions and monitor and advise on the ongoing impacts of the recent gas and coal policies on the wholesale market.
We recently released our Wholesale Market Performance Report for Quarter 4 2022. That report showed that while wholesale energy prices eased during the period from the record highs experienced in the middle of 2022, they were still at historically high levels.
Record low electricity demand in the NEM as a result of a mild start to summer and strong rooftop solar output, together with high output from large-scale solar and wind generators, contributed to the easing of wholesale electricity prices.
Our observations of the wholesale market since the price interventions were announced also indicated that spot prices for both electricity and gas were lower during December 2022 and January 2023.
However, there were a number of factors unrelated to the interventions which contributed to this e.g. low demand, good renewables output, mild temperatures and lower gas prices.
However, there are two notable changes we can see in the market since the announcement of the intervention:
- A significant fall in electricity contract prices for 23-24 during December with a small increase in January. Important because contract markets are driven more by future expectations than spot markets.
- A reduction in the price at which significant portions of capacity are offered to the spot market by some the power stations that may be impacted by the coal caps as a result of their coal procurement circumstances.
By 31 December, futures prices had fallen 41-55% compared to October highs. But they are still higher than at the start of 2022.
These future electricity contract prices are a direct input to setting the Default Market Offer – which protects consumers in SA, NSW and south-east QLD from unjustifiably high prices. We’ll publish our draft determination in mid-March.
The AER also has a key role in enabling consumers to make informed choices about their energy supplier.
We manage the free and independent energy comparison website Energy Made Easy that allows consumers to simply compare energy offers that best suit them.
The Better Bills Guideline, which retailers must put in place by 30 September this year, is aimed at simplifying retail energy bills and making them easier to understand.
Last October, the AER launched its first-ever consumer vulnerability strategy – “Towards energy equity – a strategy for an inclusive energy market.”
As you can see, our role as regulator spans many areas.
Setting the scene
Significant infrastructure investment is required to support Australia’s energy transition.
According to AEMO’s Integrated System Plan (ISP) - investment will need to:
- Meet significantly increased demand (DOUBLE) as homes, vehicles and industrial applications switch to electricity from existing energy sources.
- This will require a nine-fold increase in utility-scale variable renewable energy (VRE) capacity, and a near five-fold increase in distributed solar photovoltaics (PV),
- Treble the firming capacity that can respond to a dispatch signal, including utility-scale batteries, hydro storage, gas-fired
generation, and smart behind-the-meter “virtual power plants” (VPPs),
- Adapt complex networks and markets for two-way electricity flow, and
- Efficiently install more than 10,000 km of new transmission, to connect geographically disperse and technologically diverse, low- cost generation and firming with the consumers who rely on it.
This scale of transformation will not be achieved in the timeframes required without the support of the communities who will host these investments.
Establishing and retaining social licence for the transition is critical. The AER is currently considering what prudent and efficient costs an electricity network might incur in meeting their social licence expectations.
Individual jurisdictions are also undertaking work in this area and are developing their own frameworks. The AER will be required to take these into account in future decisions in relevant jurisdictions.
We also note the AER is providing input to the Australian Energy Market Commission’s Transmission Planning and Investment Review, which is considering the obligations on transmission networks businesses to build social licence for their projects. The AEMC is engaging with jurisdictions to promote coordination between jurisdictional processes and the National Electricity Rules on this issue.
Balance
Regulatory balance is important. It’s needed to attract investment and ensure consumers benefit.
A recent example of the balancing act required is our the Rate of Return Instrument decision (released last Friday).
The Rate of Return Instrument sets out what network service providers can recover for their capital investments.
The instrument is binding on network service providers and ourselves and will be used in regulatory decisions over the next four years.
Setting an appropriate rate of return requires the exercise of regulatory judgement.
Firstly, because it requires us to look towards the future. We are asking what rate of return is needed to attract an efficient level of investment in energy networks. We take the Goldilocks approach – not to high, not too low.
Secondly, the tools and data available to undertake this task are imperfect and experts can have different views about which models and approaches should be applied.
That’s why extensive consultation is essential and it’s why we started that work two years ahead of publishing the final instrument.
This instrument referred to as the 2022 Instrument is largely consistent with the 2018 Instrument but updated to reflect the latest data and market conditions.
The extensive process and exploration of all aspects of the rate of return found the 2018 Instrument continues to be supported by data and finance principles.
The overall rate of return is 5.75%, which is a 60:40 weighted average of debt and equity.
Key elements of our final decision:
- The estimate of equity beta will remain unchanged at 0.6.
- The market risk premium estimates have changed to 6.2%. As was the case for the 2018 decision this figure is fixed for the 2022 instrument. The methodological approach we’ve taken is also consistent with the approach we adopted in our 2018 decision. However, one change in the 2022 decision, is that we extended the timeframe of the data for historical excess returns used to estimate the market risk premium (MRP). This was in response to a review of the draft decision by an Independent Panel who recommended we seek expert advice on a potential bias in our estimate of the MRP based on historical excess return data out to the end of 2021, which it believed could be impacted by the low interest rates and quantitative easing that is now being unwound. Commonwealth Treasury suggested one method for reducing any potential bias was to extend the sample period to include the 2022 calendar year. After consultation on this advice we chose to extend the data used, which also required us to delay publication of our decision from December 2022 to last Friday.
- The cost of debt approach is the same. The return on debt is around 4.70% based on full transition trailing average estimates (or 6.52% based on ‘on-the-day’ estimates over December 2022). We continue our trailing average and use the same data sources and method for averaging. Any new network service provider will receive the on-the-day cost of debt, (6.52%), but existing service providers receive their ten-year trailing average. This difference is a natural outcome of our debt approach at times when interest rates change significantly over short periods.
The term of the return on equity is one of the areas that required careful judgement and balance of stakeholder views.
While our draft decision proposed a change to our term of equity to 5 years, after careful consideration and consultation, we decided to continue our current approach of a 10-year term into the final Instrument.
A strong case was made for there being a high bar for change; which we consider hasn’t been met at this time.
I thank those industry stakeholders who gave so much of their time and effort over the last two years to help us get the balance of this instrument right.
Flexibility
Regulatory flexibility can help the industry be agile, and responsive.
Flexibility that allows industry to progress, without compromising quality and due process, can best be demonstrated by our approach to two major infrastructure projects: Humelink and Project Energy Connect.
It is consumers who ultimately pay for big energy infrastructure projects like this, so the AER’s job is to ensure that the project costs are efficient.
With major infrastructure projects that require new investment and the use of land, we know that there are community and stakeholder concerns that need to be addressed before work can even begin. It takes time and money to do that engagement and to establish a social licence for the build to be accepted.
For staged actionable projects identified in AEMO’s Integrated System Plan, that’s where a flexible regulatory approach can be helpful.
Project Energy Connect
With Project Energy Connect, the interconnector running between South Australia and New South Wales, built by Electranet and Transgrid, the consideration of social licence as a legitimate cost of doing business was a critical issue.
Not only did we approve this $2.3b project relatively quickly (3 months) but we provided an additional $30 million to allow the networks to conduct the necessary and delicate negotiations with landholders along the route.
Humelink
For Humelink, the transmission upgrade connecting the Snowy Mountains Hydroelectric Scheme to Bannaby, we’re taking a two-stage approach.
For stage 1, Transgrid came to us with an application so that they could undertake the project design, community engagement and land-use planning work, prior to commencing construction.
They will then come back to us in the second stage, with an application for the remainder of the project, having fine-tuned the details.
This two-stage approach can help reduce project uncertainty, risks and potentially the overall cost of the project.
Ultimately this benefits consumers by providing greater transparency of costs and greater likelihood of keeping the project on schedule.
While Marinus Link, the proposed interconnector between Tasmania and Victoria, is not yet at the revenue approval stage, we anticipate they will use a similar 2-stage process, applying the lessons of Humelink and Project Energy Connect.
NSW Renewable Energy Zones
Yet another example of regulatory flexibility is what we’re seeing with NSW Renewable Energy Zones.
NSW REZ is a new space for us, and one which has in-built flexibility in its design.
In addition to making the traditional revenue determinations for the supply of services by non-contestable monopoly networks, we’re also having to consider what role we play where there is a contestable process for the delivery of infrastructure and supply of services.
Under a non-contestable process, a Network Operator is directly selected by the Infrastructure Planner to construct and operate the network infrastructure project. We use our more traditional building block approach to regulate such monopoly network assets.
For contestable projects though we are having to take a different approach to way we regulate. We look to assess the effectiveness of contestable processes for the delivery of infrastructure.
While this is a new role for us and challenges us to adopt a different method to regulating infrastructure, these contestable and competitive processes for the delivery of network services provides great opportunities for potential new participants with even more efficient costs.
Ultimately the regulatory framework in the NSW Renewable Energy Zones will provide us with important learnings.
Where appropriate we will look at how we could use these learnings to improve the way we regulate and consider where to apply these new approaches.
Innovation
Regulation and innovation are not words that you often hear together.
We’re conscious that regulation can often be seen as rigid, or an inhibitor to innovation.
But that doesn’t have to be the case.
And innovation doesn’t always have to be about technology, it could also be about innovative or different ways of working.
Laws passed last year mean the AER now has the power to grant rule waivers, and the AEMC has the power to make temporary rule changes, to enable trials of new products and services.
These, together with regulatory guidance, can be accessed via the Energy Innovation Toolkit website which is led by us and supported by our partners at AEMO, AEMC, Essential Services Commission of Victoria, and ARENA.
The Energy Innovation Toolkit website is designed to be a first stop shop for businesses and we’re already seeing lots of innovators coming in and looking at how they can improve the consumer experience, in a protected environment, but also a potentially modified rules environment.
We're seeing plenty of interest in things like virtual power plants, microgrids, electric vehicle charging, battery storage and connecting to the NEM.
We also have noticed that many applicants are not facing a particular regulatory barrier but are instead overwhelmed by the amount of confusing information out there and are simply in need of guidance to navigate it all, which we can provide.
One really interesting idea, that may help improve energy resilience and security in regional towns during natural disasters, is that of an islandable microgrid in the south-east NSW town of Cobargo.
Some of you might recall that Cobargo suffered devastating losses during the 2019-2020 bushfires.
The town was cut off from the national electricity grid and with no battery backup, the town’s residents were left with extended power outages that impacted water supply, sewerage, petrol pumps, and telephone and internet services.
As a result of this experience, the Cobargo and District Energy Transition group project hopes to build an electricity microgrid that would allow a portion of the town to continue to operate, using locally stored and generated electricity when the network connection to the National Electricity Market (NEM) is offline.
This is just one way where the Energy Innovation Toolkit has helped energy innovators receive targeted guidance as to what is possible under current energy regulations.
For a different take on innovation, I’d finally like to turn your attention to Transmission Access Reforms.
Getting transmission access right is something I’m quite passionate about because it’s consumers who will benefit in the long run from the investment in the transition.
The rapidly changing generation mix and the need to build the necessary infrastructure to transport the energy around the NEM is only going to increase.
It’s not enough for us just to stimulate investment in renewables. We need to stimulate investment in the right geographic locations so that renewable generation connects to the national system, and doesn’t just simply displace existing renewable generators.
If we don’t get it right, the costs could be higher, and the benefits of renewables and storage not realised. Worst case, we rebuild the grid twice.
Understandably it’s a very tricky area of policy to get right as there are a lot of strong views in the market.
But if we are to embrace innovation in a transitioning market, then reform needs to be on the table and we must get the co-optimisation of generation and transmission decision-making happening so the ISP comes together as planned.
Conclusion
I’d like to close by highlighting a few key points.
As a sector we all have a role in the energy transition, and in doing so building national resilience and energy security for all Australians.
Regulation helps to provide balance between stakeholder views. We won’t all agree, all of the time, and that’s ok.
There is flexibility inherent in the regulatory framework and we’re increasingly looking to use that flexibility to the long-term benefit of consumers in the way we approach issues and projects.
We’re calling on businesses to think outside the box and put forward ideas or consider different approaches. That’s how we’ll innovate and support the transition.
Just because something hasn’t been done before, or there’s not a previous regulatory determination on it, doesn’t mean there’s not a way forward.
There are potentially ways where things can be dealt within the rules, or through a rule change process where appropriate.
I said at the beginning that the AER exists so that energy consumers are better off, now and in the future.
Providing for the long-term interest of consumers is crucial, but their interests are only served if the necessary infrastructure is in place – when and where they need it.
Thank you
AER Chair, Clare Savage