Monopoly regulation of electricity infrastructure must be replaced

Share this article:

Much has been written about the economic challenges facing the network infrastructure that serves the National Electricity Market (NEM). Recent contributions by the Grattan Institute and the Energy Networks Association (ENA) are good examples of this. And while these contributions could be interpreted as taking opposing positions, both offer a guide to the path ahead.

Australia’s electricity network infrastructure is oversized relative to the ‘utility’ it now provides customers, whose energy consumption is well below forecasts. This is caused by many things, including Australia’s receding manufacturing industrial base, but also reflects energy consumers taking a much more active role in their energy needs: installing photovoltaics, taking energy efficiency measures, and generally using less in response to increasing prices.

The Grattan Institute argues that this declining network ‘utility’ should be reflected in a downward asset revaluation. At face value, this could be seen as a reasonable consequence of falling customer demand, which investors in any industry ought to be prepared for.

Meanwhile the ENA’s paper argues that if network investments were exposed to a new level of regulatory risk, then investors would rightly seek to secure a higher return on their capital – which in turn would increase prices. Again, that is not an unfair expectation.

But how can these two points of view be reconciled?

In contrast to the observed declining network utility, there is in fact significant growth occurring in the electricity industry. It is occurring ‘niche-by-niche’, as can be seen by the diversity of approaches to solar power for example. Niche markets are inherently subject to market forces, nimble and quick to evolve – like an ecosystem. Participants in these niches are taking risks, in the pursuit of strong returns.

Networks have traditionally pursued economies of scale, and their omnibus business models are not naturally well equipped to be competitive in this new energy ecosystem. While some are trying to change and compete (and we applaud those efforts), the ability and willingness of the regulated industry players to participate in this growth has been patchy.

Networks are also externally constrained by regulation that curtails their freedom to respond to these competitive threats: the rapid cost reduction of competing technologies, emerging business model innovations, and the changing nature of consumer engagement with energy are perfectly contrasted to the near-glacial speed of regulatory evolution through the nation’s established processes.

Interestingly, the attributes which have made investment in large-scale network infrastructure historically attractive (reliable returns through the prevailing regulatory model, predictable growth without the need for a growth strategy, and a captive customer base without the need for a compelling value proposition) are now arguably putting that investment in jeopardy, or at least constraining its future.

The networks are already taking action to respond to these challenges, although more could always be done: avoiding putting any further capital at risk by minimising capital expenditure, and cutting operational costs. Investors may even consider a moratorium on network augmentation until the sovereign risk associated with assets which have a 40- to 50-year investment lifespan has been clarified.

Eventually, however, we wonder whether electricity networks can continue to be regulated as pure form monopolies. It is still true that their ‘poles and wires’ infrastructure cannot be replicated by any competitor, but their competitors have emerged anyway – with alternative energy provision models.

As networks face this competition, which is desirable from a consumer’s perspective, they must also face the risk of capital loss and have the prospects of higher returns, i.e. returns which match their risk profile. So, in this sense, both the Grattan Institute and the ENA are correct.

We are some way away from this future, but it is inevitable that networks will in time move toward a fee-for-service model, let go of the safety net of monopolistic regulation that once enabled but now constrains their traditional business models, and compete on a more even playing field as energy service providers.

It is easier to define the future role of network infrastructure in this way, than it is to agree a transition path of how and when these changes will happen, and who will pay for them – or explore the myriad of related considerations. There will be winners and losers but one thing seems certain: the longer we delay the difficult negotiations that will allow meaningful transition, the sharper the pain of adjustment will be.