Application by ActewAGL Distribution [2015] ACompT 3

AUSTRALIAN COMPETITION TRIBUNAL

Application by ActewAGL Distribution [2015] ACompT 3 Citation: Application by ActewAGL Distribution [2015] ACompT 3

Review from: Australian Energy Regulator

File number: ACT 5 of 2015

Tribunal: MANSFIELD J, PRESIDENT MR R DAVEY, MEMBER DR D ABRAHAM, MEMBER

Date of decision: 17 July 2015

Catchwords: CONSUMER LAW – application for leave to review regulatory determination of Australian Energy Regulator – consideration of criteria for leave in s 71E of National Electricity Law – consideration of whether serious issue or issues to be heard and determined – consideration of whether asserted grounds of review, if made out, would, or would be likely to, result in a materially preferable NEO (National Electricity Objective) decision – consideration of adequacy of identification of grounds of review in s 71C of National Electricity Law as specified in application

Legislation: National Electricity Law

Cases cited: Applications by Public Interest Advocacy Centre, Ausgrid, Endeavour Energy and Essential Energy [2015] ACompT 2

Date of hearing: 1 and 2 July 2015

Place: Adelaide (heard in Sydney)

Category: Catchwords

Number of paragraphs: 43

Counsel for ActewAGL Distribution: A McClelland and S Goubran C Moore QC and C Dermody (certain issues)

Solicitor for ActewAGL Distribution: DLA Piper

Counsel for the Australian Energy Regulator: S Balafoutis and T Phillips

Solicitor for the Australian Energy Regulator: Corrs Chambers Westgarth

AUSTRALIAN COMPETITION TRIBUNAL ACT 5 of 2015

re: APPLICATION UNDER S 71B OF THE NATIONAL ELECTRICITY LAW FOR A REVIEW OF A DISTRIBUTION DETERMINATION MADE BY THE AUSTRALIAN ENERGY REGULATOR IN RELATION TO ACTEWAGL DISTRIBUTION PURSUANT TO CLAUSES 6.11.1 AND 11.56.4 OF THE NATIONAL ELECTRICITY RULES

BY: ACTEWAGL DISTRIBUTION

Applicant

tribunal: MANSFIELD J, MR R DAVEY AND DR D ABRAHAM DATE OF ORDER: 17 JULY 2015 WHERE MADE: ADELAIDE (HEARD IN SYDNEY)

THE TRIBUNAL GIVES LEAVE TO:

1. ActewAGL Distribution to apply for review of the Final Determination of the Australian Energy Regulator published on 30 April 2015 in respect of the matters identified in its application and on the grounds it has specified in its application.

IN THE AUSTRALIAN COMPETITION TRIBUNAL ACT 5 of 2015

re: APPLICATION UNDER S 71B OF THE NATIONAL ELECTRICITY LAW FOR A REVIEW OF A DISTRIBUTION DETERMINATION MADE BY THE AUSTRALIAN ENERGY REGULATOR IN RELATION TO ACTEWGL DISTRIBUTION PURSUANT TO CLAUSES 6.11.1 AND 11.56.4 OF THE NATIONAL ELECTRICITY RULES

by: aCTEWagl distribution

Applicant

tribunal: MANSFIELD J, president

MR R DAVEY, member

DR D ABRAHAM, member

DATE: 17 JULY 2015 PLACE: ADELAIDE (HEARD IN SYDNEY)

REASONS FOR DECISION

INTRODUCTION 1 This application by ActewAGL Distribution (ActewAGL) is for leave to apply to review a decision by the Australian Energy Regulator (AER) given on 30 April 2015. The AER decision is entitled Final Decision ActewAGL Distribution Determination 2015/16-2018/19 (Final Determination) and was made under the National Electricity Law (NEL) and the National Electricity Rules (NER). The Final Determination of the AER was published at the same time as it published decisions relating to each of Ausgrid, Endeavour Energy and Essential Energy (together, Networks NSW). They have also applied for leave to review the decisions which affect them. 2 Each of the applications of ActewAGL and Networks NSW (in relation to each of which the Public Interest Advocacy Centre Ltd (PIAC) has also made an application under s 71B of the NEL) has been heard together and, if leave to apply is given, it is intended that they should continue to be heard together. 3 The relevant background, and legislative provisions are set out in the decision of the Tribunal in Applications by Public Interest Advocacy Centre Ltd, Ausgrid, Endeavour Energy and Essential Energy [2015] ACompT 2 (PIAC/Networks NSW Decision) given at the same time as this decision. It is not necessary to repeat that material. 4 Similarly, the task confronting the Tribunal under s 71E of the NEL in deciding whether to grant leave to apply to ActewAGL, as with the other applications of Networks NSW and PIAC, is discussed at some length in that decision. It is not necessary to repeat that. The matters which the Tribunal has generally considered in relation to this application are the same, and it has proceeded upon the basis of its consideration as discussed in that decision. 5 There is no issue that ActewAGL is entitled to apply for leave to review the Final Determination, or that the issues which it seeks to raise satisfy the threshold requirement of s 71F and there are no factors which might be enlivened under ss 71G or 71H so as to disentitle it from being given leave to apply for review. Nor, at present, does any issue arise under s 71O of the NEL, although the AER has expressly reserved its position in relation to that provision in the event that leave to apply for review is given. 6 For the reasons which are set out below, the Tribunal is satisfied of the matters in respect of which ActewAGL complains, so that it appears that each gives rise to a serious issue to be heard and determined as to whether a ground or grounds of review set out in s 71C(1) exists under s 71E(a). It also appears to the Tribunal that there is a prima facie case that any determination made by the Tribunal varying the Final Determination or setting it aside so that a fresh decision may be made by the AER upon remittal to it, on the basis of one or more of those grounds, either separately or collectively, would, or would be likely to, result in a materially preferable National Electricity Objective (NEO) decision as required by s 71E(b). Consequently, the Tribunal considers that it is appropriate to grant leave to ActewAGL to apply to review the Final Determination in respect of the issues which it has identified, based upon the errors which it asserts in its application and the grounds which it relies upon. 7 The particular matters which, it contends, give rise to a serious issue to be heard and determined are: (1) operating expenditure (opex) allowance; (2) Service Target Performance Incentive Scheme (STPIS); (3) alternative control metering services annual charges (annual metering services opex); (4) classification of metering services; (5) return on equity; (6) return on debt; and (7) value of imputation credits (gamma). 8 There is a significant overlap except in relation to issues (1), (5), (6) and (7) with those issues each arising in relation to the Networks NSW applications, and also in respect of the opex allowance and the return on debt in the PIAC applications. The Tribunal's reasons for granting leave to apply in this matter are somewhat abridged, except in respect of the distinctly separate issues (2), (3) and (4), because they may be read together with the PIAC/Networks NSW Decision. The commonality is demonstrated by the fact that both ActewAGL and Networks NSW were represented by the same senior counsel in relation to the issues of the return on equity and the return on debt (together: rate of return) and gamma. 9 As with the Networks NSW applications, ActewAGL raises each of the four grounds specified in s 71C(1) of the NEL in relation to each of the matters (1)-(7) listed in [7] above. It says that having regard to all the circumstances, the exercise of the AER's discretion was incorrect, that the Final Determination was unreasonable and that the AER made an error or errors of fact that were material to the making of the Final Determination in respect of each of the matters listed in [7] above. 10 The AER opposes the granting of leave to apply for review in relation to each of the grounds advanced by ActewAGL. 11 The Tribunal has considered the detailed written and oral submissions of ActewAGL and the AER. As noted above, counsel for Networks NSW represented ActewAGL in relation to rate of return and gamma. Counsel for ActewAGL also adopted certain oral submissions made by Networks NSW at the hearing. Consequently, the Tribunal has also considered the relevant oral submissions of Networks NSW in support of ActewAGL's application for leave to apply to that extent.

CONSIDERATION

Opex Allowance 12 In its determination of the appropriate opex allowance, the AER was required to accept ActewAGL's forecast operating expenditure provided that the AER was satisfied that forecast operating expenditure reasonably reflects the operating expenditure criteria set out in r 6.5.6(c) of the NER. As the AER was not satisfied that ActewAGL's forecast operating expenditure reflected those criteria, the AER was required to provide an estimate of ActewAGL's operating expenditure and to set out its reasons for doing so: r 6.12.1(4) of the NER. 13 The AER relied on a benchmarking model developed in a report prepared by its consultant, Economic Insights (EI), technically referred to as a Cobb-Douglas Stochastic Frontier Analysis Operating Expenditure Cost Function Model and in the Networks NSW submissions called the EI Model. Relevantly, the four variables in this model which determine opex are: customer numbers, circuit length (not circuit route), ratcheted maximum demand and share of underground cables. The AER relied on this benchmarking model as a starting point to assess the efficient amount of opex for ActewAGL, and then modified this amount to take into account the average opex efficiency of what the AER considered to be the most efficient service providers ("the efficiency frontier") and other operating environment factors (OEFs). 14 ActewAGL's submissions raise three broad areas of deficiency in the AER's decision about its opex allowance: the benchmarking methodology by which the AER determined ActewAGL's opex allowance; the presumptive limitation of considerations relevant to determining whether ActewAGL's forecast opex reasonably reflects the efficient costs of an objectively prudent provider to exogenous considerations; and the AER's compliance with the NER. 15 ActewAGL submits that the AER erred in its use of the EI model and the data input used in the model. ActewAGL says that the data input used in the model is inappropriate because there was insufficient Australian data available. Consequently, the 19% of the data relied upon from Australian companies was insufficient to provide a proper basis for modelling. The AER proceeded on that basis, and so sought external data. That data was sourced from companies operating in Ontario and New Zealand. ActewAGL argued that such data was not appropriate to be used because those entities face vastly different operating conditions (such as the geographic area covered and climate) and market conditions (such as number of consumers). In addition, ActewAGL submits that the model is inappropriate because it fails to take account of key variables (such as the physical environment within which the network operates); it is highly sensitive to change; it establishes a false frontier by using average over time; and it does not allow for critical operating differences across the companies. Further, ActewAGL submits that, consequently, there is evidence that the type of model relied upon produces arbitrary outcomes and that other analysis does not corroborate the conclusion. 16 Consequently, ActewAGL submitted that the AER's benchmarking methodology has such serious technical deficiencies that it had no value as a means of assessing ActewAGL's efficient costs, and ought not to have played any part in the AER's decisions and it was in error to use it under rr 6.5.6(c) and 6.12.1(4) of the NER. 17 ActewAGL also submitted that the AER had made a number of errors in the modifications it made to the opex allowance based on the benchmarking model. In particular, the AER erred in law and in fact by presumptively limiting the OEFs to exogenous considerations beyond the control of ActewAGL and failing to consider the consequences of previous business decisions which impact upon ActewAGL's ability to deliver safe and reliable supplies of electricity. ActewAGL also submitted that the AER's decision to adjust the opex allowance based on a calculation of the 'efficiency frontier' using the lowest of the efficiency scores in the top quartile of possible scores was arbitrary. 18 Finally, ActewAGL submitted that the methodology by which the AER approached its task of making decisions about ActewAGL's opex allowance was inconsistent with the methodology prescribed by clauses 6.5.6(c) and 6.12.1(4) of the NER, and was therefore contrary to law. This is because the AER did not "start" with ActewAGL's forecast opex, but that it constructed its own forecast which was lower than ActewAGL's, and not being satisfied that there was an explanation for the difference, it rejected ActewAGL's forecast and adopted its own as the appropriate allowance. 19 Without pointing to specific errors or errors, ActewAGL points out that the Final Determination represents a very significant reduction from the opex that ActewAGL considers it requires to meet the opex objectives in r 6.5.6 or the NER. It says that level of opex was last achieved by ActewAGL 15 years ago in the context of ActewAGL serving 40% fewer customers and maintaining an asset base that has a value that is 40% less than the asset base that it currently maintains. Hence, it says, the Final Determination can be seen to be unreasonable. 20 The AER responded to these submissions in some detail. As this is an application for leave to apply for review which is being granted, it is not necessary to outline these submissions in detail. It is appropriate to observe, however, that its responses also appear as cogent and forceful. It is not the role of the Tribunal at this point to determine whether they are correct, or more accurately to determine upon review and confined to the review related material, whether in the overall picture ActewAGL has demonstrated reviewable error on the part of the AER. 21 It appears to the Tribunal that there is a serious issue to be heard and determined as to whether, in relation to the opex allowance, the AER has made reviewable error. There is, at a factual and judgmental level, a serious question or questions to be determined in relation to the issues that ActewAGL has identified. As the general discussion in the Networks NSW/PIAC Decision indicates, any such error or errors – if accepted – may be a combination of error or errors of fact, wrongful exercise of discretion, and/or the outcome of an unreasonable decision. Because the characterisation of error or errors, if made out, will more clearly emerge in the course of considering the review related material and the submissions dealing with it, the Tribunal does not consider it appropriate or necessary to embark upon the careful textual analysis and criticism of the ActewAGL application at this point to describe the combination or permutation of alternative expressions of reviewable error in that application. In the event of an assertion that there is some unfairness to the AER in the conduct of the review, the Tribunal will further consider that issue. It also appears to the Tribunal that ActewAGL has established a prima facie case that a determination made by the Tribunal on the basis of one or more grounds raised in the application, either separately or collectively, would, or would be likely to, result in a materially preferable NEO decision. The reasons for that conclusion are apparent from the general observations in the PIAC/Networks NSW Decision.

Rate of return 22 The rate of return matters are common to ActewAGL and Networks NSW, with the one qualification that in the case of the three Networks NSW applications PIAC has itself made an application for leave to review the relevant AER decisions (confined to the opex allowance and the return on debt). 23 As the same submissions were put on behalf of ActewAGL and Networks NSW on these two topics (and largely on the opex allowance), it is not necessary to repeat what appears in relation to these two topics in the PIAC/Networks NSW Decision. Of course, the relevant numbers differ. 24 For the reasons there given, the Tribunal is satisfied of the two criteria for leave to apply for review on these two topics, and in relation to the grounds of review as expressed in its application.

Alternative Control Metering Services Annual Charges 25 The AER had a discretion to classify ActewAGL's metering services as "alternative control services" and to implement its own mechanism to control how those services were implemented: r 6.12.1 of the NER. In the final determination the AER classified ActewAGL's type 5 and 6 metering services as alternative control services and determined that in relation to those services, the control mechanism would be a cap on the prices of individual services. 26 ActewAGL contends that the AER made a mathematical error in the course of calculations used to determine that price cap. 27 During the course of the hearing, the AER indicated that it did not oppose the granting of leave in respect of this ground. 28 It is therefore, based on that acknowledgment, more readily concluded that it gives rise to a serious question to be heard and determined. The asserted error may be described as an error of fact or facts by reason of the asserted miscalculation (if the error is made out) or as the erroneous exercise of a discretion by the selection of the incorrect or inappropriate integer in the calculation process or (possibly) as leading to a decision which is in all the circumstances unreasonable. 29 Having regard to the terms of s 71E(b) discussed in the PIAC/Networks NSW Decision, and as the issue concerning opex (if made by reviewable error) has been found to give rise to the Tribunal being satisfied in terms of s 71E(b), this asserted error is to be taken in combination with the other errors which are found to give rise to serious issues to be heard and determined in relation to that conclusion. It therefore falls within that conclusion of the Tribunal. It is understandable that, at this point, that should be the case because, ultimately, the Tribunal may need to consider the interaction or interdependency of any established reviewable errors and the other elements of the Final Determination in deciding whether to make any order and to ensure any order it makes will result in a materially preferable NEO decision.

Classification of Metering Services 30 Appendix A to the Overview to the AER's Final Determination for the distribution determination for ActewAGL includes a table of constituent decisions upon which the distribution determination is predicated. It reads as if the type 5 and type 6 unrecovered metering costs are defined as standard control services when the AER's reasons in Attachment 13 and Attachment 16 make it clear that standard control services do not include type 5 and 6 unrecovered metering costs. The existence of this error is not contentious and it is apparently now agreed between the parties as to how this error should be corrected. 31 ActewAGL submits that this error should be corrected by the Tribunal and that a failure to do so would frustrate the control mechanisms which regulate prices and affect ActewAGL's ability to recover its residual metering capital costs. The AER says that in circumstances where the AER has acknowledged the error and undertaken to correct it by adopting the proposed formulation of ActewAGL, that there is no serious question to be heard and determined. 32 During the course of the leave hearing, counsel for the AER indicated that the AER had undertaken to correct that aspect of its decision, but would not do so until the Tribunal's decision on this application for very sensible reasons. To revoke its existing Final Determination and to then substitute a fresh decision with that error corrected would or may mean that the present ActewAGL application would have no foundation. The Final Determination would have to be revoked. Then, ActewAGL would have to apply to the Tribunal in respect of its other grounds of review, at a later time, with the additional cost and delay that would involve. 33 That position by the AER is to be commended. However, at the point of the institution of this application, there was clearly a serious issue to be heard and determined as to this issue. The acknowledgement of particular error by the AER confirms that. Its acknowledgment does not remove that conclusion. Moreover, its preparedness to rectify the error may (not must) mean that the error, when corrected, will lead to a materially preferable NEO decision. That is a factor touching s 71E(b) in this instance, beyond the factors generally discussed above. 34 The AER says, understandably, that the Tribunal in its discretion should not make any order correcting the Final Determination when the AER has indicated that it will do so. If this were (or as events unfold, is) the only reviewable error, the Tribunal might well take that position. At present, it considers that it should give leave to apply for review on this topic. It should take little hearing time. Depending on whether any other errors on the part of the AER are made out, the consequences of this error may inform the Tribunal's consideration of whether it should make any order as a materially preferable NEO decision. This matter may be relevant to that. 35 Accordingly, it appears to the Tribunal that there is clearly a serious issue to be heard and determined in relation to the classification of metering services as both the AER and ActewAGL say that an error has been made. It is our view that ActewAGL has established a prima facie case that a determination made by the Tribunal on the basis of s 71C(1)(a) or (b) in the application, either separately or collectively, would, or would be likely to, result in a materially preferable NEO decision. In due course, the Tribunal will consider whether the terms of any proposed amended determination, may be made by the AER, or whether those terms would be relevant to it considering what might constitute a materially preferable NEO decision.

Value of Imputation Credits (Gamma) 36 This matter is also common to ActewAGL and Networks NSW. 37 As, in essence, the same submissions were put on behalf of ActewAGL and Networks NSW on this topic, it is not necessary to again refer to the submissions, including the responsive submissions of the AER, or the material referred to. 38 For the same reasons as given in the PIAC/Networks NSW Decision, it appears to the Tribunal that the two criteria for the grant of leave to apply for review on this topic are met, in relation to the grounds of review as expressed in its application, so leave to apply for review is given.

Service Target Performance Incentive Scheme (STPIS) 39 One of the constituent decisions by the AER relates to a decision on how the STPIS applies to ActewAGL. This scheme is designed to balance incentives to reduce expenditure, with the need to maintain or improve service quality. It achieves that by providing financial incentives to a distributor to maintain and improve performance and reliability. It imposes penalties on the distributor if it fails to maintain historical levels of reliability over the last five years. If those historical levels of reliability are exceeded, then ActewAGL gets a financial benefit. If it does not achieve those levels of historical liability, it suffers a penalty in terms of its revenue. 40 ActewAGL submits that the AER's opex allowance for ActewAGL is much lower than the opex that was used by ActewAGL to achieve those average levels of historical reliability. The reliability levels are the same, but the opex is now much lower. So the issue is how ActewAGL can be expected to maintain levels of reliability that it only achieved by incurring opex that was vastly in excess of "efficient opex". 41 The consequences are said to demonstrate that the AER has not, in reality, provided a meaningful STPIS, but has provided a system where the performance targets cannot be met if the existing opex allowance stands, but rather they will not be met and the consequential non-performance penalties will cumulatively adversely affect both ActewAGL financially, and the long term interests of consumers by its progressive inability to provide the levels of service and reliability to which consumers are entitled. 42 Of course, the issue is not clear cut. The AER submissions again provide cogent responses. This is one matter which clearly is interrelated with, and consequential upon, the opex allowance itself. It appears to the Tribunal that it gives rise to a serious issue or issues to be heard and determined, and that the criterion for leave in s 71E(b) is also met. The grounds of review may fall within the categories of error of complex fact (the level of opex allowance necessary to perform the service functions at an acceptable level) or "subfacts", that is dependent on more primary facts about how and why ActewAGL has in the past met and profited from the STPIS, to the AER's discretionary judgment about the appropriate "cut off" points for the incentive scheme to be meaningful, and (as ActewAGL says) to producing a decision which is unreasonable in all the circumstances.

CONCLUSION 43 For those reasons, the Tribunal gives leave to ActewAGL to apply to review the Final Determination in respect of the matters identified in its application and on the grounds it has specified in its application. I certify that the preceding forty-three (43) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Mansfield, Mr R Davey and Dr D Abraham.

Associate: Dated: 17 July 2015