Proposed AER & EUC RULE CHANGEs

AEMC Public Forum 23.11.11 Proposed AER & EUC RULE CHANGEs Hugh Gleeson CEO United Energy & Multinet Gas

Today’s presentation High level view • Multiple drivers for rising prices • How have the rules performed to date • The regulatory framework we need Proposed changes to the • Opex and Capex methodology • Capex incentives • Cost of capital The United Energy & Multinet Gas perspective

High Level Perspective • Current rules put in place 5 years ago to give confidence for badly needed 40 year investments • 35 more years before those investors get their return - and more new investment is needed • Stability and predictability is essential • Significant change to the rules would need very strong justification – which we have not seen • Energy prices are rising • Customers are understandably concerned • But no evidence to suggest that flaws in the rules are the cause • Some of the drivers of energy price increases • Replacing aging assets • Growing peak demand • Increased funding costs (GFC) • Higher cost generation sources (and green subsidies) • Returning to long term investment (and price) levels after a low investment period • We want to ensure there is confidence in the price setting process

Electricity as a % of weekly earnings • Prices returning to the levels they have been at twice before • Prices have moved in cycles Note: Whilst this graph uses Qld data, the trends are similar nationally

Capital investment coming out of a trough • Historically peaks and troughs in investment • Significant increase in asset utilisation in 1990s allowed low spend – but this can only be temporary.

Growing peak demand a driver of costs Source: AEMO, Statement of Opportunities, 2011

How have the rules performed to date? • Capex and Opex submissions – assessments and allowances • Businesses have been required to provide high levels of verification / sign off for proposals • AER has received very large volumes of RIN information from NSP – no asymmetry • AER level of disallowance similar to previous regulators (higher for Opex, lower for Capex) • AER has been able to use benchmarking • AER has generally work well within the discretion allowed to it in the rules • Appeal findings do not show AER pushing boundaries of their Capex/Opex discretion • AER has not used the range of incentive mechanisms allowed/intended in the rules • Cost of Capital has been contentious. Not surprising given: • Return on capital is typically >40% of prices • Gives 100% of average return to shareholders • There has been a GFC • AER has been found to have made multiple errors • No evidence to show material problems with the rules • But acknowledge DRP has been problematic during GFC • The issue has been in bedding down regulatory practice, not the terms of the rules

The regulatory framework we need • The regulatory structure which separates the rule maker from the rule enforcer is an important design feature • We are very concerned about a lack of confidence in the price setting process – and make these proposals to address: • Drive for information symmetry: • Ensure that the AER has the capability to review/assess pricing submissions and understand the large volume of information they obtain through the RIN • Ensure consumer advocates are strong - resourced/funded • Ensure incentive based regulation (– as always intended) • Ensure that the Rules give incentives for efficiency • Ensure that the Rules give incentives for accurate (balanced) forecasting • We support the AER using robust benchmarking to support their assessment of efficiency/inefficiency

Comments on specific rule changes

Opex and Capex Process • No case for change • We disagree with AER assertions that it is overly constrained • The rules were designed to incentivise efficiency, and incentivise accurate forecasting • We believe the rules can achieve that • The AER has successfully used many of they discretions they seek, and had these assessments upheld in appeals • However, we are open to fine tuning of rules to ensure the intent can be achieved • The NSP’s plan and forecast must be the start point • The NSP is responsible for managing the network and delivering the service. • It must develop & own the plan that underpins the forecasts. • If the NSP’s plan is ignored – the AER will be taking over responsibility • NSPs need planning certainty (predictability) to manage the business.

Capex Incentive mechanisms • We support capex incentives • We note that the electricity distribution rules allow the AER to develop a capex incentive mechanism • But it has not chosen to take up this option • We do not believe that mechanism proposed by the AER in their rule change meets the NEO and Pricing Principles • Not symmetrical • Likely to create other anomalies

Cost of Capital • AER has not presented case for change • Their arguments appear mostly to relate to administrative ease • The existence of 3 different WACC processes does not mean 2 are wrong • The MCE/AEMC built the 3 sets of rules at the same time – recognising the importance consistency over time for investors in the 3 sectors • If the AEMC accepts the case for change – we put forward: • A WACC without merits review cannot be relied on to deliver efficient outcomes => would not meet the NEO and NGO • If the AEMC accepts the case for a 5 yearly review – we put forward: The process must: • Deliver against overarching principles – to give a market return at each NSP price revenue/ determination – in order to support ongoing investment • Be able to cater for changes in market conditions – inc. a GFC • Include a level of prescription in the rules sufficient to ensure predictability and stability for investors and customers • We acknowledge the problems with the current approach to cost of debt • Open to looking at alternative solutions

United Energy and Multinet Gas Specific issues for our businesses • Capex needs new debt and new equity – need stability & predictability • Multinet has not yet been through a review under current rules: • Yet the rules are being deemed a failure, and • The AER rule change would take away Multinet’s access to merits review Thinking that causes us great concern: - Thinking where the AER: • Believes it doesn’t have the NSP understanding to assess our plan/forecast • due to information asymmetry • Believes the rules give NSPs an incentive to inflate their forecasts • Therefore assumes that the NSPs do inflate their forecasts (without testing them) • Wishes to use new discretion to remove the premium that they assume. Concerned about the risk of: Broad discretion + Asymmetry (Lack of understanding) = Unstable outcomes

Proposed AER & EUC RULE CHANGEs