Challenges for Network Service Providers on the yellow brick road to unregulated revenues

May 15, 2016 by Marchment Hill
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Network Service Providers (NSPs) are increasingly pursuing unregulated revenue opportunities to offset recent reductions in the growth of their regulated business. However, efforts by regulators to ensure that any unregulated activities are appropriately ring-fenced are creating an increasingly complex operating environment for NSPs.

Reductions in the level of peak demand in the NEM(1) and the AER’s strong moves to reduce network costs for consumers by constraining OPEX and CAPEX expenditure have meant NSPs will be hard pressed to find significant growth paths for their regulated business.

This has resulted in NSPs seeking alternative methods to leverage their existing competencies to realise future revenue growth. Many have already considered or implemented organisational restructures designed to protect their regulated business and grow revenue in unregulated market places. These restructures have focused on creating stand-alone businesses, business units and/or functions focused on unregulated revenue creation. Unregulated revenue pursuits have included:

  • Building network infrastructure outside of a NSPs jurisdiction (e.g. TransGrid’s construction of the Deer Park sub-station in Victoria)
  • Providing operations and maintenance services (e.g. Powercor Network Services)
  • Providing other competitive network services such as metering (e.g. AusNet Services’ Select Solutions)
  • Selling solar and battery solutions direct to customers (e.g. Powercor CitiPower)
  • Branching out to provide services and offerings in industries such as telecommunications (e.g. TransGrid)
  • Providing contestable connection services (construction, operation and maintenance of the connection assets located on the customer’s side of the connection point)

NSPs operating in contestable markets are currently doing so in accordance with existing jurisdictional ring-fencing arrangements, which vary greatly across the NEM. These arrangements will soon be replaced by a national ring-fencing guideline.

AER preliminary position for Electricity Ring-Fencing Guidelines

The AER recently published the Electricity Ring-Fencing Guideline – Preliminary Position paper which provides commentary on the regulator’s future aspirations for the competitive energy services market.

Today, ring-fencing arrangements are developed and managed by jurisdictional regulators. These arrangements are inconsistent across jurisdictional borders and too narrowly defined to cover the emergence of distributed energy resources (DER). In 2012, the AER investigated the potential for a national ring-fencing guideline and now, due to reforms introduced by the AEMC(2), must prepare a national ring-fencing guideline by the end of 2016.

The ring-fencing guidelines are a vitally important document for NSPs either participating in or planning to participate in contestable markets. In this preliminary position paper, the AER states that “in order to give confidence to third parties looking to compete with NSPs in contestable markets, the ring-fencing regime must be robust”. This guideline will have long-term implication for NSPs and the development of a competitive energy services market place.

The ring-fencing obligations state the degree of separation required for NSPs wishing to compete in ring-fenced network services. The AER does not have the power to request structural separation (full ownership separation) as an obligation. Although, as stated in the NER, legal separation, accounting separation, cost allocation and restrictions on information flows are all options the AER may impose in line with the ring-fencing guidelines. Under the proposed obligations, NSPs must:

  • Not carry on a ring-fenced service unless it is within a separate legal entity to the NSP
  • Not locate a ring-fenced service at the same physical location as the NSP
  • Not share staff between the ring-fenced entity and the NSP
  • Establish and maintain separate accounts that clearly identify the extent and nature of transactions between the NSP and the ring-fenced entity
  • Ensure there is no cross subsidy between the ring-fenced entity and the NSP
  • Protect information provided by a customer or prospective customer and ensure its use is only for the purpose for which that information was provided
  • Ensure that information provided to a ring-fenced entity is also available to third parties on an equal basis
  • Ensure information obtained by the NSP is not disclosed to any party without the informed approval of the customer or prospective customer to whom it pertains.

On the face of it, these obligations appear to be a significant strengthening of the current jurisdictional obligations. For example, the current approach to account for the proportion of time spent by a shared resource on non-regulated revenue activities via complex cost allocation methodology (CAM) may be redundant under the obligation to “not share staff”. These obligations may also impact organisational design requirements and influence the business model and costs of NSPs attempting to diversifying revenues in unregulated network and energy services.

Storage case study

AER’s preliminary positions paper offers a number of case studies. Of significant interest is the ‘NSP energy storage devices’ case study. Energy storage devices have the ability to provide more than one service. These multiple value streams can be particularly beneficial to support the storage-as-a-service business model assessed by MHC (see QSI article: Why isn’t there more talk about network storage as a service? published in July 2015).

However, under the proposed obligations, if an NSP owns a storage asset (as part of its RAB), it can only be used for the provision of regulated standard control network services (such as peak smoothing to defer network augmentation). If it is used for any service offered in the contestable market (e.g. electricity price arbitrage for a solar PV customer), the complete asset and its operations need to be ring-fenced. In this instance, the ring-fenced entity would then offer the network service to the NSP who could buy the service using part of their OPEX allowance.

The challenge created in this scenario for the uptake and use of storage on the grid is that, under the current incentive regime, an NSP would much prefer to spend CAPEX than OPEX. While the ring-fencing rules may be sensible and reasonable, this approach may unintentionally limit the uptake and use of storage by networks to improve the efficiency of the electricity delivery system.

The optimal outcome for NSPs, energy service companies and consumers may require consideration for a broader range of adjustments in the regulatory framework to ensure NSPs are neutral in their choice between CAPEX and OPEX expenditure when it comes to maintaining a safe, secure, reliable and affordable network. Options for regulatory reform to better align the incentives of NSPs with consumers was discussed in our QSI article, Barriers to storage and some bold ideas to overcome them, in February 2016.

Ring-fencing waivers

The preliminary position paper also includes suggested guidelines for ‘ring-fencing waivers’. Ring-fencing waivers are designed to offer the AER flexibility in regards to these ring-fencing obligations. For example, should an NSP make a case that the costs of ring-fencing for a particular service exceed the benefits, then the AER may concede that it may be more beneficial in the long-term interests of consumers to grant a waiver for this service. Other considerations include safety issues that require service provision being restricted to an NSP.

The final guideline is set to be published on or before 30th November 2016, and NSPs and interested stakeholders have opportunities to respond in the short term. With much at stake in the battle for non-regulated revenues, this is sure to be a hot topic of debate through 2016.

For more information regarding submissions and workshops, see: Electricity ring-fencing guideline 2016.

Footnotes
(1) Demand peaked in the NEM in 2008-09 at around 35.8GW and while it reached 35.6GW in 2010-11 the 2015-16 YTD NEM maximum demand currently sits at about 32.9GW. Source: https://www.aer.gov.au/wholesale-markets/wholesale-statistics/generation-capacity-and-peak-demand accessed on 13/5/16.
(2) http://www.aemc.gov.au/Major-Pages/Power-of-choice

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