Long run marginal cost (LRMC) estimates have an important role to play when it comes to wastewater recycling, stormwater harvesting and water conservation. LRMC helps ensure we understand the long-term cost of supplying water or managing wastewater, and the value from integrated water cycle management and water conservation. 
 
However, while they are central to a range of decisions, deriving estimates of the LRMC of water and wastewater is not without its challenges. 
 
Our economists Matthew Edgerton and Alexandra Humphrey Cifuentes spoke with the Water Services Association of Australia (WSAA) regarding the importance and challenges of understanding the LRMC of supply and its role in promoting efficient investment and consumption in the water sector. 
 

“LRMC estimates ... ideally underpin everything from usage prices, to wholesale & access prices, & to decisions about investment in supply or demand-side measures” (IPART - Independent Pricing and Regulatory Tribunal 2019, Review of pricing arrangements for recycled water and related services)

The session covered:

• the importance of using LRMC as a reference point in setting usage prices to promote efficient consumption,
• the role of LRMC estimates in assessing avoided costs when evaluating water recycling and/or water conservation measures, and
• key considerations in developing and applying LRMC estimates, to ensure they are robustly derived and appropriately applied.

For more information on this topic or a copy of the full presentation, please contact Matthew or Alexandra, or anyone from our urban and rural water team. 

 

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How are you measuring your impact on nature?

At the recent World Economic Forum Annual Meeting, a session titled “Putting a Price on Nature” piqued our interest as it’s an area of growth for us at Frontier Economics.  

More and more clients, and projects, are centred around the economics of natural capital and biodiversity. Below, we highlight key points, and provide further insights on this important topic: 

Quantifying nature’s contribution to our economic wellbeing   

While the first principles of accounting were developed in 1494, finance has only really learnt to rigorously quantify risk in the last 50 years or so. Only after advances in science provided the necessary mathematical and computational capacity.  

In the same vein, better ecological science detailing the relationships between nature and the economy is now providing the foundations for new tools. To equip us to incorporate nature into financial decision making. 

At the macro-economic level, the panel discussed a selection of major economies experimenting with the development of a new measure called ‘Gross Ecosystem Product (GEP)’. GEP measures the total value of final ecosystem goods and services supplied by nature to us.   

Incorporating the value of nature into decision making

Scientific research has become more focused on human activity’s impacts to, and dependencies on, nature, as climate change and economic activity place increasingly un-ignorable pressures on the environment.   

A headline from the influential 2021 Dasgupta Review is that while produced capital per person has more than doubled in the last three decades, natural capital per person has declined by nearly 40%. This reflects what one panellist called a “fatal flaw” of capitalism: 

 

Nature is invisible in most decision making.  

  

Against this, economists are being asked to think about how to make nature visible to investors, consumers, and other decision makers.  

But sending sufficient economic signals to protect and regenerate nature might not require a valuation of nature in all its economic, social, cultural and ethical dimensions, at least at first.  

Instead, the immediate task might be to use ecosystem services valuation techniques. As a tool to align the incentives to regenerate nature up and down the value chain, and across national borders.   

A starting point: agriculture and food system value chains

A key place to start is global agriculture. Panellists shared that 85% of the threats to nature come from global food systems.  

While science has demonstrated that regenerative agriculture can both improve agricultural productivity and environmental outcomes, the economics tends to require landholders to capitalise on the related climate and nature premiums – or, in other words, money needs to move up the value chain to the farm gate where the investment in regeneration occurs.  

Regenerative agricultural practices represent a big opportunity for farmers – especially in Australasia - to continue to improve productivity, protect country, and grow and diversify their incomes.   

Most encouragingly, panellists suggested that:

We can afford to make this change.

It’s about structuring markets and incentives across the value chain to create the right conditions for rational, sustainable investment.   

A final note on nature and culture

The panel noted that Indigenous people protect 80% of global biodiversity. Sharing the idea that the intrinsic value of nature is invaluable:

There’s no cost that can be assigned to it, to say, "let’s negotiate".

From this perspective, you can’t put a price on the destruction of our most precious resources, and instead we should align ourselves to create a new system to preserve its wellbeing for all.  

At Frontier Economics we’ve worked on projects to consider not only the physical impacts of nature destruction but the social, cultural and ethical implications – especially on indigenous communities. 

It’s an area of growing importance to corporates and governments, and we’re excited to be supporting and informing society through economics.

WATCH WEF "PUTTING A PRICE ON NATURE" SESSION

The Australian Competition and Consumer Commission (ACCC) is continuing its inquiry into the electricity supply market within the National Electricity Market (NEM). As part of their latest Electricity Market Inquiry Report, Frontier Economics was asked to explore the evolving contracts market in this sector. This is particularly important given the rapid push towards renewable energy and associated changes in government policy.

Utilising interviews with key industry stakeholders, and our own analysis, the report is focused on how the electricity hedging market might evolve over the next 10-15 years. This is a period the electricity market will be in transition. A particular emphasis is placed on how retailers, especially those without generation assets, will be able to manage risk.  

Key findings: Electricity risk management and market evolution 

The report outlines several key findings.  

Firstly, an efficient hedging market is crucial for risk management, reducing energy costs, and ensuring a competitive retail market that benefits consumers. There are several tools that retailers can use to manage the risk of fixed consumer prices with the more volatile wholesale electricity market. These tools include financial contracting, vertical integration, or demand response strategies. 

Secondly, the energy market transition, driven by government policy for a low carbon economy, is affecting electricity markets in complex ways. It is expected to reduce dispatchable capacity, such as thermal generation. The replacement to this will be renewable generation, where most of this output is dependent on whether conditions. This impacts on the ability for this supply to offer the firm base load swap contracts that have traditionally been sold by baseload coalfired generators, or cap contracts sold by gas peaking plants.  

We have also identified several potential challenges for retailer risk management evolving from the transition to more intermittent generation. These include: 

• Increased spot price volatility, which could challenge the ability for independent retailers to manage risk. 
• Traditional contracts and futures may not meet the evolving risk profile of retailers, with a likelihood that more bespoke contracting will become increasingly necessary. This may have implications for trading exchanges, such as the ASX, to offer products that retailers need. 
• The availability of financially firm contracts is expected to reduce, making it harder for retailers to rely on contracting to source efficiently priced financially firm contracts. Drivers for this include the retirement of dispatchable generation sources, but also the potential that government supported generators have a reduced incentive to make contracts available to the market. 
• If vertical integration becomes necessary to effectively manage risk, this may foreclose on opportunities for smaller new entrant retailers.  

Strategies and options to assist future retailer risk management 

Our report sets out several strategies for the ACCC and Government to explore to improve outcomes for retailers in the future given the expected challenges they will face. These are: 

• Given governments currently fund the majority of new supply technologies in one form or another, we consider the ACCC, and the Government should identify if there are ways that these government funded generation/storage projects could be used to support qualifying small retailers with access to a quantity of hedges.  
• The Government may wish to also investigate underwriting new products on futures exchanges. The intent being to support the development and availability of these products until sufficient liquidity emerges.  

Importantly, our report advocates against market interventions, such as market design changes, to manage risk for retailers. Reducing risk through market mechanisms, such as reducing the market price cap, would likely reduce the incentive for retailers to contract, and in doing so, reduce the incentive for new investment in essential dispatchable capacity.  

Read further by downloading the report below, or on the ACCC website. The ACCC’s Electricity Market Enquiry can be found here.  

More information about our work in the energy and renewables sector is found here.  

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A report we produced in 2022 has been unjustly discredited recently in regard to the Murray-Darling Basin Plan and Water Amendment (Restoring Our Rivers) Bill 2023. Below we clarify the report’s use and findings and discuss the concerns of parties opposing the report. To read the full report, please download it below.  

The “Social and economic impacts of Basin Plan water recovery in Victoria 2022” report was produced for the Victorian State Government in 2022. We analysed the social and economic issues associated with water recovery for the environment in Victoria, under the Murray Darling Basin Plan. Our report provided a valuable evidence base to support robust decision-making on Basin Plan issues.  

Our scope was to build on and update the analysis undertaken for our 2017 socio-economic assessment report. The report explains the impacts being felt by communities in Northern Victoria in the 2022 context of water recovery for the environment under the Basin Plan. 

Future impacts of the Basin Plan 

One (of the thirteen) chapters considers the possible future impacts of the Basin Plan. The intent of this analysis was not to undertake detailed economic modelling to estimate the impact of further buybacks. Rather, we provide an indication of what is ‘at risk’ — in terms of the value of economic production and employment that is currently supported by the volumes of entitlements that could be recovered if the Commonwealth use buybacks to complete Basin Plan targets, for example the additional 450 GL. 

The report does not advocate for, or against, buybacks or alternative forms of water recovery.  

It documents the financial costs and socio-economic issues around each water recovery approach. It does seek to put into context the socio-economic value of water for agriculture with the aim of making government cognisant of the consequences removing this water through buybacks could have, so this can be considered when making decisions about water recovery and the support that would be needed to mitigate these impacts. 

Produced with updated available data  

Our report also brought significant new information to light, securing data from the Department of Climate Change, Energy, the Environment and Water (DCCEEW) regarding the type of infrastructure recovery (separating out on-farm and off-farm) that had previously not been released.  

Our work also secured data from the Commonwealth Environmental Water Holder (CEWH) regarding their holdings and behaviour that had not been previously made available. 

Academic judgement on the water report 

We note that the Murray-Darling Basin Authority (MDBA) commissioned a team from the University of Adelaide to conduct a literature review of 106 economic Murray-Darling Basin studies that are assessed and rated on a measure of ‘quality’ adapted from medical literature. This approach to assessment is not fit-for-purpose, for the range of studies considered.

Of the 65 studies that were deemed to relate to the influences of water recovery programs on economic outcomes (this report being one of them), 18 of the 28 applied studies are rated low-quality, with 10 of the 11 studies using descriptive statistics being rated low-quality. In fact, the review raises concerns with all the significant reviews in the area. 

The University of Adelaide reports that “The bulk of the large-scale reviews to date (e.g., EBC et al., 2011 [appointed by MDBA to consider community impact]; RMCG, 2016; Sefton et al., 2020 [which was an independent panel appointed DCCEEW]; Productivity Commission, 2018; Wentworth Group of Concerned Scientists, 2017; KPMG, 2016; 2018; TC&A & Frontier Economics, 2017; Frontier Economics & TC&A, 2022) have not managed to identify a causal relationship between water recovery and economic outcomes.” 

Furthermore, of the studies considered by the University of Adelaide team, many are not contemporary — suggesting that MDBA and DCCEEW need more evidence to support current policymaking.  

At Frontier Economics, we peer-review every report with a robust methodology built over our 25 years of economic consulting experience. Academic standard-peer reviews are not practical or common-practice in real-world industry cases, and using this basis to question the quality is, in our opinion, incorrectly measured. 

We invite any enquiries on this matter via contact@frontier-economics.com.au 

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We were recently asked by the Nature Conservation Council of NSW (NCC) to examine the financial and budgetary drivers behind the Victorian Government’s decision to accelerate the closure of its public native forest logging (NFL) business – and how comparable these drivers are in New South Wales and Tasmania. 

While the native forest logging businesses in NSW (Forestry Corporation of NSW - FCNSW) and Tasmania (Sustainable Timber Tasmania - STT) have not reached the same level of operational crisis and loss of keystone customers as Victoria, they share the fact that they have been a financial drag on taxpayers over a very long period. FCNSW’s hardwood division has a long history of poor financial returns and lost $30 million in the last two years. STT has also incurred operating cash losses over long periods. 

Our previous analysis “Comparing the value of alternative uses of native forests in Southern NSW” also shows that this unprofitable business also comes at a significant opportunity cost to the community. This is in terms of the loss of alternative higher valued uses of the standing forest, and the loss of environmental services. 

The poor financial position and budgetary burden posed by the publicly-owned NFL business is intensifying. Factors include the reducing log supply, increasing costs of production, and the increasing competition from alternative wood products that have dramatically reduced demand, including for structural timber from native forests.  

It is time to stem the cost to the community posed by the industry and to plan for an orderly exit from NFL. 

Additionally, the facts show that this would not materially disrupt downstream markets or increase illegally logged supply.  

Wood production by the NFL industry has already fallen by 60% since the early 2000s, so it is possible to see what the likely impacts will be. The data suggests the markets for sawn wood products have substantially switched to softwood timber and wood-based panels. The decline in Australian native woodchip supply has largely been filled with plantation woodchips, particularly from Vietnam. 

View the full report commissioned by Nature Conservation Council of New South Wales below.

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Whilst road pricing has been a hot topic in recent months in various states across Australia, the evolution of charging commuters for roads across Australia’s has been a long series of developments. With many challenges to defining how to charge commuters – including competing priorities and governance, and new technology such as EV’s, we unpack this topic below.

The challenges to tackling road pricing

Road pricing has made its way into the news recently for a number of different reasons.

Firstly, in 2021 the Victorian government introduced the Zero and Low Emission Vehicle (ZLEV) charge which levied electrical vehicle owners 2.8c for each kilometre they travelled. The intent was to charge EV users for the costs they impose on Victoria’s road network.

However, in October the High Court of Australia ruled the charge invalid, as it amounted to an excise duty, which under the Constitution, can only be levied by the Commonwealth.

Secondly, in the last year the NSW Government also announced the Independent Toll Review. This has come about because of emerging public concerns about the affordability of current tolls on Sydney motorways, particularly given the rising cost of living. Concerns have been accentuated by the inequities in tolling, whereby some motorists on their daily commute face quite significant charges, while other motorists in Sydney, pay very little.

The Independent Review has released a discussion paper which considers the efficiency and fairness of existing tolling arrangements that are set out in PPP contracts with road concessionaires.

The challenges posed by toll roads are merely a subset of the broader issues in road user charging. Whilst governments think that users should pay more directly for roads, developing a comprehensive set of road prices that applies across Australia’s road network is challenging.

Frontier Economics’ has been providing economic consulting advice in the transport sector – and on the development of road user charges – for many years. Here, we unpack the challenges of road pricing and discuss a possible path forward.

Why is pricing road use challenging?

Our Local, State and Federal governments are entering into a challenging space when it comes to the pricing roads. There are multiple reasons why pricing road use is challenging:

Firstly, there are multiple objectives to consider when pricing roads which are sometimes conflicting. Road charges can:

1. Fund the development or expansion of a new motorway – as is the case with tolls.
2. Be used to recover the ongoing costs of maintaining or operating the road network more generally – by accounting for the wear and tear vehicles impose on the road pavement, or
3. Help manage congestion and reduce emissions – by encouraging better decision making when it comes to reducing vehicle use; to limit these third-party costs.

The second reason is that we have Local, State and Federal Government roads. This creates challenges because you immediately have multiple governments involved, and we have motorists travelling, potentially in one trip, on multiple roads that are owned by different governments. The charging arrangements for that entire network therefore becomes far more complicated.

The final layer to this is that is that different governments have different powers in respect to vehicles, vehicle use and charging. The Federal Government has responsibility for the importation and design of new vehicles, and the power to levy the fuel excise, which is often argued to be the main mechanism for implicitly funding the road networks. The State Governments are far more confined in their ability to levy state-based road charges, however, they are in charge of things like registration. So, this limits the ability for any one government to create a comprehensive charging structure on its own.

Electric Vehicles (EV) and road charges

It’s necessary for all governments to consider a reformed approach to road pricing now, because of the emergence of Electric Vehicles (EVs) – who don’t pay the fuel excise. And currently the main mechanism used to implicitly fund road development is this fuel excise. This funding is expected reduce over time, as more motorists take up EVs. Essentially, motorists will be using less fuel, and as we use less fuel, this funding source will disappear.

The time to deal with this is now. Solving this problem means moving away from current arrangements which is challenging. States, such as Victoria, have tried to go it alone by implementing road use charges for EV. But this approach has been struck down in the High Court Challenge. So, you can see states acting on their own isn’t really a great option.

What can be done to create fairer and more efficient road pricing

The first step is to acknowledge that road pricing is an issue across governments and one that might benefit from intergovernmental co-operation. An intergovernmental agreement could be developed, that sets out:

• Principles for pricing – what governments are hoping to achieve with different road use charges to deal with the problem of multiple objectives, and
• The role of different governments in this charging space. So, we don’t get competing actions – which tends to happen in part because different governments are all not empowered to act on their own.

Some pricing improvements for heavy vehicles have already been achieved. It’s been a slow process with incremental improvements but there is no reason why that process, which we have been heavily involved for the last 15 years with can’t be expanded.

Given the outcomes of the High Court Case, governments need to work together on this emerging issue, and a better, intergovernmental, solution is required if we are to create road charges that are more efficient and fair for all motorists across Australia.

Frontier Economics was an independent advisor to AustralianSuper, for Brookfield and EIG's Origin Energy takeover scheme. Our role was to review the assumptions used in the Independent Expert’s Report (IER) in Origin’s Scheme Booklet.

Using robust economic analysis and long-standing expertise in the energy sector, our advisors, engaged by AustralianSuper - a long-term shareholder in Origin - found that the assumptions used in the IER to derive a business valuation are unrealistically low.

We refer all enquires in regards to this takeover bid, and our economic advice on this matter, to AustralianSuper.

A copy of the full media release from AustralianSuper can be downloaded below.

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Frontier Economics' Tim McNamara, Mike Woolston and Dinesh Kumareswaran were commissioned by the Water Services Association of Australia (WSAA) to produce the report Understanding Efficiency to explain in "plain English" the concepts of economic efficiency and how they apply to the water sector. The report also illustrates what efficiency looks like under different scenarios using examples from the water sector and detailed case studies. Below is the Executive Summary of the report.

About this report

The aim of this report is to explain in ‘plain English’ the concepts of efficiency and how these are utilised within businesses, by economic regulators and others to assess service and expenditure proposals in pricing submissions and business cases.

Efficiency in the urban water sector

It is important for businesses to be able to understand and demonstrate efficiency, not just to get approval of pricing submissions from regulators – but also to demonstrate they are providing value for money to customers, owners, and other stakeholders.

Common or dictionary definitions of ‘efficiency’ tend to focus on the relationship between inputs and outputs of producing a good or service, but this narrow interpretation may lead to misconceptions. Minimising costs may not necessarily be consistent with providing customers’ desired service levels, maintenance and investment in asset capability and supply resilience, or delivering broader outcomes which are desired by customers or society.

Rather, economic efficiency can be seen as synonymous with value for money - providing the services customers want at the lowest long-term cost. The regulatory frameworks applied by most economic regulators do provide for broader ’value for money’ outcomes in assessing efficiency.

Some common misconceptions about efficiency

There are a number of common misconceptions about demonstrating efficiency in the urban water sector. These related misconceptions include:

1. Efficiency means prices need to be flat or declining
2. Efficiency is about cutting costs to the minimum
3. Efficiency is incurring lowest possible costs over the upcoming determination period
4. Efficiency means providing services at the lowest possible standards consistent with regulatory and other obligations
5. Efficiency is about deferring new investment as long as possible and running assets to fail
6. Efficiency means minimising costs even if this leads to higher risks
7. Efficiency means neutralising the impact of other drivers of expenditure (e.g. growth) so prices remain constant overall without having to disaggregate the drivers
8. Efficiency means demonstrating on a once-off basis that a business is efficient relative to the industry standard.

A common thread underlying these misconceptions is that ‘efficiency’ is synonymous with cost minimisation. Not only is cost minimisation in itself not an appropriate objective - but it is not an appropriate interpretation of what it means to be ‘efficient’.

Minimising costs may not necessarily be consistent with:

• providing services at the level customers want
• maintaining and investing in asset capability and supply resilience
• delivering broader outcomes which are desired by customers or society.

How is efficiency measured and demonstrated?

While how best to demonstrate efficiency may depend on the audience, fundamentally it is about demonstrating that a proposal is in the long-term interests of customers.

The overarching approach of economic regulators in determining efficient levels of expenditure for regulated urban water businesses, which they then allow to be recovered in regulated prices, typically involves:

• Establishing the services to be provided to meet regulatory and other obligations and customers' preferences
• Establishing the minimum expenditure needed to efficiently deliver these services
• Setting prices which are forecast to enable the business to recover the total expenditure which the regulator has deemed to be 'prudent and efficient'.

Typically regulators adopt a ‘prudency and efficiency test’ to provide assurance that the businesses are (1) doing the right things; and (2) doing those things as efficiently as possible.

Regulators typically assess the prudency and efficiency of operating and capital expenditure individually, as well as the trade-off between these two types of expenditures:

• While both detailed ‘bottom up’ assessments of various operating expenditure items and broader ‘top down’ approaches which focus on broad categories of expenditure have been applied by regulators, the latter (particularly the base-step-trend approach) is becoming increasingly widespread.
• Approaches to assessing the efficiency of capital expenditure typically examine the business' capital governance frameworks, policies and procedures, and review a sample of the business's proposed capital expenditure projects. This generally requires reference to an identified need or cost driver, evidence that the business has considered alternate solutions including non-network solutions, and that the cost of the defined scope and standard of works is consistent with conditions prevailing in the relevant markets.

What lessons does recent regulatory experience provide?

We examined a number of recent regulatory reviews and decisions by state economic regulators. This provided a number of key insights and lessons that can be drawn upon for future periods.

• The Base Step Trend methodology is being adopted by a number of water regulators
• Capital projects exposed to uncertainty have the potential to be deferred to future periods
• Willingness to pay studies are helpful but should not be used in isolation to justify expenditure
• Consultation and analysis is required to demonstrate the prudency of projects
• The introduction of new services needs to predominately benefit customers
• Capital expenditure proposals should be supported by robust business cases
• Regulators often require alternative options to providing the service to be considered.

Guidance for demonstrating efficiency 

We have identified some overarching guiding principles that should be adopted to demonstrate the efficiency of expenditure proposals regardless of the context in which efficiency is being measured or demonstrated: 

• Adopt a business case (or cost-benefit analysis) approach to all expenditure proposals 
• Focus on the long-term interests of customers, considering factors including operating and capital expenditure trade-offs and the impact on service standards over time and supported by Net Present Value NPV (analysis)  
• Consider both prudency and efficiency of expenditure, including how cost proposals incorporate efficiency targets and continuing efficiencies (as would occur in a competitive market)
• Explain trends in operating and capital expenditure and key drivers of these trends  
• Develop a narrative that explains the link between expenditure and outcomes for customers 
• Conduct analysis that is proportionate to the size and impact of the potential expenditure. 

However, there is no single methodology or technique that is appropriate to use in all circumstances to measure and demonstrate efficiency. The appropriate approach may vary depending on factors such as the nature of the: 

• expenditure (i.e. operating vs capital expenditure or large ‘step’ in operating expenditure) 
• activity (discretionary vs non-discretionary expenditure). 

Table 1. Approach to demonstrating efficiency - a guide

Step	Type of expenditure	Evidence/  data required	Techniques	Example
Outline why the spending is in the long-term interest of customers	All	Link spending to specific outcomes for customers in terms of services and prices over the long term  Clear ‘golden thread’ narrative	Investment Logic Mapping	See section 4.2 and 5.5
Prudency: Link spending to non-discretionary obligation	Non-discretionary  opex & capex	Identify key drivers including relevant legislative or regulatory obligations	Understanding of non-discretionary service (and related) outcomes, including their timing	Central Coast Council (section 3.3.3)
Prudency: Demonstrate that customers want the proposed service/level or outcome	Discretionary opex & capex	Customer feedback	Surveys, customer forums	Case study 2
Prudency: Demonstrate that customers are willing to pay for this service	Discretionary opex & capex	WTP studies	Choice modelling	Case study 2
Analyse a range of options to produce the desired outcome	All	List of alternative options including capital vs recurrent solutions – ideally in business case	Cost-benefit analysis	Case study 3
Identify a preferred option	All	Business case or similar	Cost-benefit analysis (benefit -cost ratio, NPV etc)	Case study 3
Undertake sensitivity analysis to demonstrate the preferred option is robust	Capex/major opex step change	Business case or similar (preferred option is superior under a range of assumptions/scenarios)	Sensitivity analysis  Real options analysis  Scenario analysis	Case study 3, Sydney Water resilience expenditure (section 3.6.3)
Ensure/demonstrate the preferred option/proposed services will be delivered at the lowest cost	Opex	Historical expenditure   Productivity growth (continuing efficiency) forecasts  Market-tested estimates	Base-step-trend  Benchmarking	Case study 1
Ensure/demonstrate the preferred option/proposed services will be delivered at the lowest cost	Capex  Step jump in opex	Robust procurement process (e.g. market-testing or similar)  Detailed approach to managing delivery of project and associated risks  Proposed expenditure is within long-term context & strategy  Consideration of scope for application of continuing efficiency factor	Business case methodology	Powercor ICT investment (section 3.4.3)
Benefits realisation (ex pt)	All	Ex post assessment of benefits and costs	Post project review	See section 2.2

 

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Frontier Economics' Stephen Gray was commissioned by Vector to assess whether the draft Input Methodology decision by the New Zealand Commerce Commission will help or hinder the investment that’s needed to decarbonise the economy. The New Zealand Commerce Commission is currently developing a final decision over the key regulatory principles that bind the way electricity networks in Aotearoa New Zealand can operate and invest for the next seven years, and possibly longer (the Input Methodologies, or IMs).

In this video below, Stephen shares his view on how the IMs could support the network investments needed to deliver New Zealand’s energy transition to net zero by 2050.

Electrification is at the core of New Zealand’s decarbonisation strategy, and this will require extensive investment in transmission and distribution networks over a short period of time. Indeed, it will be impossible for New Zealand to meet its decarbonisation commitments without this extensive network investment.

Moreover, there is widespread agreement that investment in electricity networks today will secure long-term benefits for consumers. So it is important that New Zealand’s regulatory framework helps to facilitate the network investment that is required.  However, there is a real risk that the current regulatory framework will, in fact, hinder major network investment projects.

The key problem is that the regulatory cash flows tend to be back-ended, creating a risk that the cash flows in the early years of a project’s life are not sufficient to support the credit rating and gearing that the regulator has assumed. Where this happens, a project is not commercially viable and does not proceed. And, of course, no consumers receive any benefit from a project that does not proceed.

Our analysis found the draft Input Methodologies do not contain the sort of ‘financeability’ test that regulators in other markets employ. Nor do they provide potential investors with certainty about how a financeability issue would be addressed if it was identified.

A process to ensure that the regulatory cash flows are sufficient to support the credit rating and gearing that the regulator has assumed would remove a regulatory roadblock to the efficient investment that’s needed to meet the task of decarbonisation.

Extra for experts – a solution

A workable solution could be for the Input Methodologies to accelerate the allowed cash flows in a Net Present Value-neutral manner, as Stephen explains in this short video. The draft Input Methodologies decision canvassed several options to make this happen, of which the most promising was removing indexation of the Regulated Asset Base.

 

 

This excerpt was originally published in Vector's stakeholder newsletter.