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Court decision to have major impact on electricity network revenue

3 mins Justin Oliver, Mark Carkeet, Katrina Groshinski
The Full Court of the Federal Court of Australia has today handed down its decision in relation to the revenue that can be earned by electricity distribution networks in NSW and the ACT.

The Full Court of the Federal Court of Australia has today handed down its decision in relation to the revenue that can be earned by electricity distribution networks in NSW and the ACT.

In 2015, the Australian Energy Regulator (AER) made determinations for each of the NSW and ACT networks (Ausgrid, Endeavour Energy, Essential Energy and ActewAGL Distribution). These determinations would have significantly reduced the revenue that could be earned by the networks (and therefore the prices they could charge) between 2014 and 2019.

In 2016, the Australian Competition Tribunal upheld an appeal by the networks, overturning the AER's decision in several important respects. The AER appealed against the Tribunal's decision to the Full Court of the Federal Court. In summary, the Full Court dismissed the AER's appeal with respect to operating expenditure and cost of debt, and allowed the AER's appeal with respect to gamma.

Operating expenditure

In its original determination, the AER developed and used a benchmarking technique to determine what it considered to be a reasonable allowance for forecasting operating expenditure for each of the networks. In the case of some of the networks, this would have resulted in very large cuts to allowable revenue. The Tribunal overturned the AER's decision on the basis that the AER placed too much weight on a benchmarking methodology which had several important limitations. The Full Court dismissed the AER's appeal against the Tribunal's decision.

Cost of debt

In its original determination, the AER set out a method for determining the benchmark cost of debt for a network using a 10 year 'trailing average' approach. The networks appealed to the Tribunal, arguing that the AER should have allowed them to transition between different methods for determining the cost of debt. The Tribunal agreed, requiring the AER to reconsider its decision. The Full Court dismissed the AER's appeal against the Tribunal's decision.

Gamma

'Gamma' is the value of imputation credits assumed by the AER for the purpose of working out how much revenue a network service provider should be allowed to earn to cover company tax obligations. While the calculation of gamma is a very technical exercise, it has major revenue implications for networks.

In its original determination, the AER arrived at a value of 0.4 for gamma. The Tribunal found that the AER's methodology did not satisfy the requirements of the National Electricity Rules and substituted a value of 0.25. The Full Court has upheld the AER's appeal, finding that the Tribunal erred in its interpretation of the National Electricity Rules, and that the AER's decision should be reinstated. 

Implications

This is an important decision for investors and consumers alike.

The Full Court has rejected the AER's appeal on cost of debt and operating expenditure. This means that the revenue for the NSW and ACT networks will need to increase for additional amounts which, according to the Tribunal, they should have been allowed to earn between 2014 and 2019. The networks have proposed a rule change (which the AEMC is supporting in a draft decision) that would allow the price impact of this decision to be spread over the next regulatory period.

The Full Court's decision on benchmarking will also require the AER to review and refine its methodology for assessing forecast operating expenditure. This will have significant implications for the revenue which can be earned by electricity networks throughout Australia.

The Tribunal has endorsed the AER's approach to gamma. This will have significant revenue implications for electricity networks, in particular those in NSW which have recently been privatised or soon will be.

Any further appeals in this matter will require special leave to appeal to the High Court. In the meantime, it will be interesting to see if the price impact of this decision becomes an issue that will be considered by the ACCC as part of its inquiry into retail electricity prices. 

Please contact us if you have any questions about the decision.

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