'Gold-plating': NSW's skewed electricity market and the fight over rising bills

A federal court decision this week represents a possible end to a two-year battle that will see New South Wales households charged an extra $3bn on their collective energy bill and put upward pressure on bills in other states too.

The ruling comes after a complex legal stoush between three parties and highlights what some say is a failed regulatory framework where huge monopoly businesses can game the system to gouge consumers for essential services.

One party is the Australian Energy Regulator, which ruled that networks were exploiting their monopoly status and charging billions of dollars more than was necessary by over-investing in (or “gold-plating”) their networks and passing the costs on to consumers.

Another is a small consumer legal group, the Public Interest Advocacy Centre (Piac). It has argued the regulator did not go far enough and was letting the network companies get away with too much.

And finally there are the giant network businesses. They have attacked the regulator’s ruling, saying their spending was efficient and they should be allowed to pass the cost on to consumers.

But the battle was being played out on a field that is widely agreed to be slanted in favour of the huge network businesses. The federal environment and energy minister, Josh Frydenberg, says the existing regulatory framework allows the networks to “game” the system and push up prices – a view mostly shared by both Piac and the Coag energy council.

Underlying the whole issue is a messy set of problems and half fixes: a market that’s not really a market; a regulator that can have its rulings picked over by networks and challenged in very selective ways; and a legal process that benefits parties with more resources – and the networks out-resource both the regulator and consumers.

Monopoly hardwired

Since it would be hugely inefficient to have multiple network companies competing – operating parallel sets of poles and wires – the network companies are natural monopolies. You can’t choose who delivers electricity to your house.

In an attempt to avoid those monopolies charging consumers whatever they like, the Australian Energy Regulator can calculate how much an efficient business operating in a real market would charge and impose that limitation on the networks.

Between 2007 and 2013, the costs passed on to consumers for operating the poles and wires doubled, and rose to make up between 30% and 60% of household bills, a Senate inquiry heard.

In an unusual move, the AER ruled in 2015 that NSW and ACT electricity and gas networks had been spending more on their infrastructure than an efficient business operating in a market would, and slashed the amount they were allowed to recover from consumers. That resulted in a drop in energy bills of between $100 and $300 a year.

Endeavour Energy, Essential Energy and Ausgrid challenged the decision, saying their costs were more than $5bn higher than the regulator estimated.

Meanwhile, Piac, representing consumers, also appealed the decision, saying the regulator had overestimated the allowable costs by more than $2bn.

The slanted battlefield

That initial fight was heard by the Australian competition tribunal in what’s called a “limited merits review”.

In one corner was Piac, with a couple of lawyers, funded by donations. In another corner was the regulator, with its own lawyers, and limited resources. In the third corner were the network businesses – 12 in total – represented by dozens of lawyers.

“Networks have demonstrated that they can spend millions and millions and millions of dollars challenging decisions of the Australian Energy Regulator,” says Craig Memery, from Piac.

“The networks are not only better resourced than the consumers but they’re better resourced than the regulator. When they take the regulator to the tribunal, they have the power of information and resources behind them.”

Not only is there a funding asymmetry but, according to many groups, the very nature of the allowable challenge skews the decisions in favour of the networks.

The networks, or consumers, can challenge the regulator’s decision in what’s called a “limited merits review”.

In doing that, the regulator’s decision isn’t analysed from scratch but, rather, individual bits can be appealed against.

In a press release after this week’s federal court decision, Frydenberg said: “The [limited merits review] process is the root cause of today’s decision, which will see consumers paying more through higher electricity prices.”

Frydenberg said the process allowed the networks to “game” the system.

“Network businesses only appeal against the decision of the AER if they want to slug consumers more,” he said.

Memery agrees the networks can engage in a type of gaming. The regulator’s decision on how much networks can charge involves a complex modelling process in order to determine what an efficient business would do.

“It can’t be 100% accurate on all counts,” Memery says. “It’s reasonable to assume that because the regulator has given a lot of thought to a lot of issues, that there will be swings and roundabouts.”

He says some parts of the decision will probably be too generous to the networks and others will be too onerous. But since the networks can appeal individual parts of the decision the networks can “pick the eyes out of a decision”, appealing against just those parts they think they can make a buck on.

“There’s very little downside risk in the outcomes,” Memery says.

What to do about the limited merits review process is a matter of ongoing debate.

The Turnbull government has sought to eliminate it altogether, saying the regulator is best placed to make these decisions.

Piac says the limited merits review system should stay but it should be reformed so that consumers and the industry are on an equal footing. They argue the regulator should be given greater resources to engage with consumers and network access to review process should be limited in various ways.

The system is under review, and although the federal government failed to get agreement from the states to eliminate the process entirely, the Coag energy council did agree to various reforms, many of which align with Piac’s recommendations.

But on the existing skewed battleground, the consumers and the regulator lost the fight in the tribunal last year, and this week they lost their appeal in the federal court.

Where now?

However, this particular battle over “gold-plating” may not be over yet.

Paula Conboy, the chairwoman of the AER, described the federal court decision as “disappointing” and said it would consider the judgment and next steps. Appealing to the high court is still an option.

The network businesses welcomed the decision. “Today’s decision will allow us to fund and operate a safe and sustainable electricity supply for our customers, while providing a fair return to our shareholders,” Ausgrid said in a statement.

If the decision stands, consumers will be slugged with increases in their bills. Compared with what consumers would have paid if the regulator’s initial ruling were in place, NSW households will pay about $100 extra on their yearly electricity bills, Piac says.

And increases in other states will follow too, since it sets a legal principle for how the regulator can impose limitations on the network charges nationwide.