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Ending the ‘arms race’ at the centre of utilities regulation


15 February 2016

Professor Joe Dimasi
Professor Joe Dimasi

by Joe Dimasi and Peter J. Lambert

Generators, retailers and consumers should be able to negotiate deals with energy, telecommunications and water network owners to keep the system honest, new research argues. Utilities regulators are hamstrung by legislation that allows utilities network owners to drag out decisions and pass on costs.

The length of regulatory decisions and associated documentation has grown by over 2000 per cent in some cases. Decisions regularly take several years to make and are also more complex and hence less transparent with no clear benefits to customers.

Legal battles appealing the regulators decisions have been especially frequent in energy and to a lesser extent in telecommunications. Energy network owners appealed the regulator’s decision 40 per cent of the time since 2006. Not only does this lead to costs and delays, it also has increased the businesses’ allowable revenue by an additional $3 billion.

An alternative approach is needed to deal with the complexities of utility regulation. An example of this is a system that puts users at the centre of the regulation. The available evidence from United States, Canada, and in Australia (the Hunter Valley decision) indicates that allowing negotiation between users and owners of these networks with regulatory backup can lead to quicker, simpler decision making as well as more prudent investment decisions and lower overall prices.

Generators and retailers are also likely to have a much better idea of what they need from the networks than the regulator. They are also much more likely to be knowledgeable about the optimal timing and nature of new investment in the network. They also have an incentive to keep these costs low.

The benefits of introducing competition and greater consumer choice are substantial. For example, the Productivity Commission’s 2005 review of National Competition Policyestimated gains to our national income from these reforms of 2.5%, adding roughly $40 billion annually.

The regulation of utilities is necessary because some of these networks, such as the networks of poles and wires in electricity, are well recognised monopolies. Legislation requires regulators such as the Australian Competition and Consumer Commission (ACCC) and the Australian Energy Regulator to establish an “efficient price” for utilities that reflects a competitive market.

However, such an approach to regulation is proving to be too difficult and expensive. The information and expertise needed by the regulator is just too great. Utilities network owners (with more information and knowledge than the regulator) have the incentive to get regulatory approval for higher costs. This in turn allows them to charge greater prices.

To capture higher prices, utility network owners can try to game the regulatory system in various ways. For example they can provide excessively lengthy and detailed information backed up by a range of experts, or they can provide it late in the regulatory process. Not only does this slow the whole process down; the regulator can risk being appealed if it does not adequately consider the information put to it as we have seen in the electricity sector.

The result can be an “arms race” of ever increasing use of experts and complexity and evermore resources used in the process.

A greater concern is that regulation appears to be contributing to a misapplication of resources in some sectors, particularly in energy and telecommunications.

For example, the asset base of electricity transmission and distribution companies has grown by 45 per cent and 120 per cent respectively in around a decade. The total increase in the asset base over this period sits at around $35 billion.

This increase cannot be explained by total electricity transmitted and distributed as this has declined since its peak in 2008. Nor can it be explained by number of customers or growth in peak demand. Some tightening of the reliability standards may have contributed to this expenditure but can hardly explain increased expenditure of this magnitude. Which begs the question – how can this cost be justified to users?

Requiring generators, retailers and consumer representatives to negotiate with network providers would not be without its challenges as they would have to actively engage with the regulated business in the first place. In the end, however, putting the primary stakeholders in control of their fate (and using regulators only as a backup to negotiations) will ensure decisions are made under the best possible incentives.

Professor Joe Dimasi and Mr Peter J. Lambert work in the Department of Economics at Monash University. 

This article appeared in The Conversation