Friday, 7 September 2012

The Australian Energy Regulator's insurance dilemma with respect to SP Ausnet

In the last week we have seen a fair amount of controversy raised in Australia (and Victoria in particular) over the Australian Energy Regulator's (AER) proposal that SP Ausnet be able to recover funds that they have to pay out (above their insurance cover) to the Black Saturday bushfire victims through higher charges no the Victorian electricity network.

This is the way SP Ausnet (an ASX listed company 51% owned by Singapore Power) described the proposal by the AER:
This further draft decision deals with the insurance pass-through event, which had not been finally determined. Under the draft decision, there may be circumstances in which liability which exceeds insurance may be recovered by SP AusNet as regulated revenue. The AER’s consultation on this draft decision closes on 12 September 2012.
I admit when I read this I could not believe it - on first read it seemed like a private operator was getting immunity for harm that they cause and the burden would need to be borne by rate payers.  The media's response was particularly ferocious.  This article by Michael West of Fairfax Media is just one of a host of articles ridiculing the proposal.

The Victorian government has announced that they will also be opposing this proposal and will lodge a statement with the AER.  However I think this was only in response to community misunderstanding and the flames whipped up by the media.

However I do not think that the issue is as simple as the media makes it out to be

In fact I think that the media does not understand what this proposal is truly saying.  This is pretty ironic because they have, probably without knowing it, been beating the drum on both sides of this debate.

If you go back through the articles written by Michael West of Fairfax Media (the same author as above) you will find this article which expresses outrage at the high price that consumers have to pay for electricity because of the gold plating (over spending) on the networks which consumers then have to reimburse.  To be fair to the author - this was an excellent article which raised very valid considerations.  He does not seem to link this to the article that he wrote opposing the AER's decision though.

Victorian transmission networks have not been gold plated unlike other states and there has been limited overspend compared with states such as New South Wales and Queensland.  This is largely a function of the privatised nature of the Victorian distribution network.  When you 'over-spend' or 'gold plate' a network it means that you spending to get that last (expensive) 1% of network reliability.  To get this last 1% it is very expensive and as outlined in the article above, probably not worth it.

However this 1% also adds to things like safety of the network.  When you spend these excessive amounts of money the probability of an event like Black Saturday happening also decreases.  Regulators, governments and in the end consumers need to work out what is the appropriate balance and what risk (there is always risk) is acceptable.

To mitigate the consequences of this risk the regulator requires (and provides an allowance for) insurance to cover these events

In the regulatory determinations (you need to read a fair few to get the hang on them) the AER allows operators a certain amount to take out insurance to cover the risk of an event happening.  This is because, in an efficient system you can never have 100% reliability.

What the regulator is proposing in this case, which the media does not seem to grasp is that, if the operator (in this case SP Ausnet) has spent this insurance money efficiently and appropriately and this is still not enough (i.e. implicitly the regulator did not give them enough in the first place) then they should be reimbursed

This actually makes a lot of sense in the regulatory context.
 If you have given the operator a certain amount of money to spend on the network, and this is being done efficiently by the operator (including when they take out insurance) then they should not be penalised for the risks associated with an efficient network.

If an efficient network is 100% safe and reliable then consumers cannot complain about gold plating and high electricity prices.  Victorian consumers (and the media) are trying to have it both ways.  Unfortunately populist ideas seem to be winning out over common sense and the AER really does have a dilemma on it's hands.

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