Australia is moving apace to meet its net zero target by 2050. The country’s policymakers and regulators are extensively reviewing the existing regulatory framework to make sure it is flexible enough to support the ongoing energy transition. Since transmission is an important enabler in this process, the Australian Energy Market Commission (AEMC) recently published its recommendations in its draft report on ‘Transmission Planning and Investment Review (Stage 2).’ It recognises that the existing regulatory framework was developed to support incremental growth of the power system and not the steep growth as envisaged in Australian Energy Market Operator’s (AEMO) 20-year Integrated System Plan (ISP) for National Electricity Market (NEM) development. AEMC has therefore identified certain issues that may hamper transmission development in future and given its draft recommendations to address them. The regulator has also sought feedback from stakeholders by July 14, 2022.
Future financeability challenges
AEMC believes that there is a risk that transmission projects may face financeability challenges in the future given the scale of investment requirement as well as commissioning timelines. While currently investors do not have any financiability concerns with specific projects, such issues may arise owing to the changing power market dynamics and delay transmission investments.
The current framework gives adequate opportunity to the transmission network service providers (TNSPs) to recover returns corresponding to the regulatory and commercial risks involved in providing transmission services and making new system investment. While the existing framework may still return efficient costs to investors over the longer term, there may be a short-term disincentive to invest if credit ratings were negatively impacted. Investors often support their investments in transmission infrastructure by adjusting capital structures to ensure creditworthiness, the impact on cash flow of multiple major investments may hamper the ability of investors to deploy capital in future.
AEMC, therefore, considers it important to ensure that the Australian Energy Regulator (AER) has sufficient flexibility to address this risk on a case-by-case basis, including the ability to shape cash flow for specific projects to enable them to recover costs over time in an efficient way as well as incentivise new transmission investment in a timely manner. AEMC is not in favour of adjusting the rate of return (RoR) for all businesses to address this issue but rather recommends adopting a bespoke approach wherein AER has the discretion to adjust flows of specific projects, i.e., actionable ISP projects identified by AEMO as being critical to addressing cost, security and reliability issues in the grid.
The draft report identifies two ways of shaping cash flows – by adjusting the return on capital (through RoR instrument) or adjusting the return of capital (through depreciation). AEMC believes that changes to the depreciation profile is a more proportionate approach for a single project or business. This is because shaping cash flow while keeping the asset life the same increases cash flow in the short term, while tapering off in the longer term, and keeping changes net present value (NPV)-neutral for the TNSP. This would help TNSP’s financial metrics, while ensuring consumers as a whole pay the same over the project term. For this, the regulator may provide greater flexibility within existing arrangements for setting depreciation or introduce a specific financeability/commercial viability test that can trigger the ability to shape depreciation. AEMC recommends the former approach as creating and applying a specific test for all revenue determinations would impose a disproportionate administrative burden on AER and TNSPs.
Building social licence
Another issue pertains to building social licence for timely implementation of transmission projects. In the current review, social licence refers to activities that are required under the National Electricity Rules (NER), and which help build a level of community acceptance for major transmission projects. There are many stakeholders as well as regulatory structures that affect social licence outcomes. The two main issues within NER ambit are cost recovery of a range of activities undertaken to build community acceptance such as stakeholder engagement or compensation (to landowners or communities) and community engagement activities.
The draft review notes that existing NER cost recovery mechanisms are well equipped to allow TNSPs to recover costs associated with social licence activities in an efficient manner. TNSPs can include these costs in the forecast expenditure for preparatory activities – sought via the regulatory investment test for transmission (RIT-T) and then recovered via the contingent project application (CPA) process.
Cost recovery of planning activities
Another issue relates to the cost recovery of TNSPs’ planning activities. Presently, TNSPs spend funds on two kinds of project planning activities – those to identify and select the preferred option to meet an identified need; and those to further refine and deliver the preferred option. NER provides separate cost recovery arrangements for different kinds of planning activity expenditures. Typically, costs associated with preparatory activities to identify and select preferred options are adjusted within TNSPs’ expenditure allowances while the costs associated with substantive project delivery activities are recovered through the CPA process. However, planning activities are referred to in different ways in NER and regulatory documents. For instance, NER clearly defines ‘preparatory activities’ while early work is only specified in AER and AEMO documents and therefore it is necessary to clarify these provisions.
The draft review recommends that planning activities should be clearly distinguished based on whether they relate to the selection or delivery of a preferred option. This can be based on cost magnitude or the purpose of the expenditure. AEMC suggests that the purpose of expenditure is a better way to make this distinction. This would require amendments in NER as well as AER and AEMO documentation.
Workability of feedback loop
Feedback loop that was introduced as part of the actionable ISP reforms provides an important safeguard for consumers. It aims to ensure that only investments that are in their long-term interests are eligible for regulatory funding, and that the level of regulatory funding does not exceed the efficient investment level. However, its functioning has been affected by implementation challenges. Feedback loops must be assessed against the most recent optimal development path, which under the actionable ISP framework refers to the latest final ISP or ISP update. As per AEMC, feedback loop functioning can be improved by aligning it with the publication of a draft or final ISP. This will also enable AEMO to consider the available information from the latest inputs, assumptions and scenarios report in its assessment.
AEMC has taken a proactive step to identify issues that could arise in the future and hamper transmission system development. Further stakeholder consultations and finalisation of the changes proposed by AEMC are expected to bring in greater regulatory certainty among investors, which is crucial for future transmission network expansion.