Economic Society of Australia Business Symposium University of Sydney 30 September 2004

1. Economic Society of Australia Business SymposiumUniversity of Sydney30 September 2004 Infrastructure Investment in Australia - Is there an Emerging Crisis? Implications for Economic Regulation of Future Infrastructure Investment John Tamblyn Chairperson Essential Services Commission, Victoria 1

2. Overview • Is there an infrastructure investment crisis? • Economic regulation and long term investment • Conclusions of recent policy reviews • Recent Victorian regulatory experience • Observations on the regulation/investment debate • Implications for economic regulation

3. Is there an infrastructure investment crisis? • Popular view of major infrastructure under investment • transport, water, energy sectors • needed to meet future demand/sustain growth • support efficiency, reliability, sustainability goals • Policy view of infrastructure under investment • COAG/MCE etc communiqués – Parer/PC reports • supporting analysis of extent/causes is qualitative, anecdotal and fragmented • AUSCID infrastructure report card/modelling • underlying analysis superficial and unconvincing • blames market, regulatory, policy failure • Clearly a significant problem for economy/community • BUT: weak analysis of scope, causes, solutions

4. Economic regulation and L.T. investment • 10 years of access regulation experience • Part IIIA/CP Agt – energy, transport, telecom regimes • Focus was on natural monopoly NW industries • but application to partially contestable sectors • Regulation has sought more efficient outcomes by: • imposing CPI-X price caps using BB approach to; • encourage more efficient costs and prices; and • prevent misuse of monopoly power • Have the costs of regulatory failure exceeded those of market failure thro: • regulatory errors in setting price caps • intrusive/costly regulatory methods • discouraging L.T. infrastructure investment

5. Conclusions of recent PC reviews • PC Part 111A and Gas Code reviews concluded: • coverage wrongly applied to contestable markets • regulation has been costly and intrusive • too much focus on S.T. cost/price efficiencies • regulation has discouraged L.T. investment • Particular investment incentive concerns: • coverage risk  whether asset covered or not • regulatory risk  uncertainty about regulatory decisions • asymmetric truncation  cap upside returns not downside • PCs ‘Gas Code recommendations include: • binding no-coverage rulings pre-construction • existing Code options (eg fixed principles/extended periods) • But had difficulty addressing truncation issue

6. Recent Victorian regulatory experience • 2000 electricity distribution price review • BB approach, post tax WACC, tariff basket control • cost/service efficiency c/o incentives • reductions in proposed OPEX and CAPEX programs • significant Po price reductions (9.1 – 18.4%) • vocal industry concerns about profit/investment impact • 2002 gas distribution price decision • improvements on EDPR BB approach • modest Po reductions • significant allowances for replacement CAPEX investment • ESC concern about delivery of capital program • Difficult to deal with L.T. capital proposals under the BB price cap approach

7. Electricity experience to date (1) • Revenue tracking above forecast • Demand growth • S-factor/efficiency carryover All DB Revenue Forecast v Actual M$ 1999 Forecast Actual

8. Capex & opex expenditure tracking below forecast What is the reason? Excessive forecasts/regulatory gaming Deferral of necessary expenditure Efficiency improvements Other Electricity experience to date (2) Forecast ($m real 1999) Actual ($m real 1999)

9. Service standards are improving & exceeding targets, although capex / opex below benchmark But is medium-term reliability at risk? Electricity experience to date (3)

10. Observations on the regulation/investment debate • Accept that under-investment more costly than higher S.T. prices • cost of NW reliability failures • loss of dynamic competition potential • Limited empirical analysis showing under investment • PC uses first principles reasoning and anecdotal evidence • significant investment since regulation introduced • has it been too little/too late or about right? • PC concludes regulation has discouraged/deferred efficient investment BUT … • regulation can cause over or under investment • have outcomes been biased against investors or users

11. Observations on the regulation/investment debate (2) • Must distinguish “deferred” and “efficient” investment • more or earlier investment not necessarily efficient • delaying investment sound if demand/viability uncertain • Regulatory innovation can reduce regulatory/investment risk • revenue/loss sharing mechanisms (but PC concerns) • treat investment to meet D growth as efficient • pre-investment rulings for small town gas extensions

12. Implications for economic regulation • L.T. investment/reliability clearly a priority for regulation/regulators • Useful policy options proposed by PC • adopt a single Code objective of “efficiency” • regulated prices to satisfy pricing principles • focus price cap regulation on natural monopoly infrastructure businesses • permit lighter-handed regulation models where competition is emerging • allow binding no-coverage rulings • allow price cap methods other than BB

13. Implications for economic regulation (2) • Regulatory measures under access rules • regulatory consultation/guidelines/precedents • fixed principles on parameter methods/values • extended access periods (eg 10 or 15 years) • flexible depreciation schedules/capitalisation of losses • pre-construction approval of access prices/conditions • provider initiated reviews w.i. Period • Regulators must be pro active/transparent in applying these measures to reduce investment risk • BUT: assessing CAPEX/network augmentation requirements remains a difficulty for regulators • balancing cost efficiency incentives/L.T. reliability risks