Leading economist Professor Ross Garnaut has called for the write-downs in the values of regulated electricity networks’ assets. In a recent speech (available here), Garnaut said:
“The falling costs of decentralised power and storage open up the possibility of reducing costs of power supply to users of power throughout the State. But only if the pricing of network infrastructure allows economically efficient use of the existing grid, and provides incentives for efficient allocation of investment between centralised and decentralised power in future. The first step towards rational pricing is to write down the value of redundant grid capacity – of some investments that have been made redundant by technological and economic change, and others that were redundant when they were made. This is what the market
economy forces in other sectors of the economy where there has been investment in supply capacity beyond demand”.
The reinforces the call that I made in my article in the ACCC’s Network journal last July (available here) to abandon the standard “regulated asset base” (RAB) approach to economic regulation in Australia and adopt a market-driven approach. A few snippets from that article are quoted below:
“The intent of economic regulation of monopolies is to best serve the long-term interests of end-consumers. However, current regulatory practice falls well short of this intent. While some of the shortfall is inevitable, much is not….The biggest problem of current regulatory practice is that it focuses on by-products of competitive markets – asset values and normal rates of return – rather than on how to deliver efficient outcomes,,,,The first and single biggest reason [why RAB-based prices are very inefficient] is that revenue allowances (and therefore prices) are set largely on the basis of an irrelevant factor (RAB). Depreciation and cost of capital allowances based on RAB values typically account for around 70 per cent of total revenue allowances. Yet historic costs of past investments have no bearing on efficient prices…..Casting RAB values in stone ensures that price flexibility in response to market conditions is minimal. Indeed, it can be perverse. Supposed demand turns out to be permanently lower than expected. In competitive markets, prices would generally fall (at least in the short-run), although revenues per unit may rise under take-or-pay contracts; as a by-product of the price drops, asset values would fall. In contrast, under RAB-based regulation, network revenues per unit would rise….[Under the RAB approach] assets cannot become stranded due to changes in market conditions. This encourages overinvestment. For example, [if we adopted a market based approach under which rights to use network capacity would be auctioned],, if network users expected that compact, low-cost in-home solar and battery storage systems could become pervasive within the next five-to-ten years, capacity rights prices ten-to-fifteen years out would be low, and this would send a powerful signal to think very carefully before investing in assets that typically have lives for 40+ years. In contrast, our RAB-based system gives networks no incentive to consider those risks. Insulating networks from many risks that competitive suppliers bear, distorts investment decisions and promotes overinvestment”.
Reforming our regulatory approach can deliver substantial net benefits. It should rank very high on any list of Federal government economic reform priorities.