Draft decision2011-16 Access Arrangements for

Envestra (SA)

Andrew ReevesChairman, AER

2 March 2011Public forum

Housekeeping matters

• Please sign the attendance sheet

• A record of this meeting will be made

2

Purpose of the forum

• Present the main features of the AER’s draft decision on the access arrangement proposal submitted by Envestra

• inform parties intending to make submissions on the AER’s draft decision

3

Submissions

• Submissions on the AER’s draft decision can be sent to QLDSAgas@aer.gov.au, until 21 April

• The AER’s access arrangement guideline provides guidance on making submissions– available at www.AER.gov.au

• Timeframes under the NGL and NGR limit the AER’s ability to accept late submissions

4

Revenues & Prices

• The AER has determined lower revenues & prices than those proposed by Envestra.

• The main reductions are to the proposed WACC, forecast capex, forecast opex and the opening capital base as at 1 July 2011.

• Tariffs for haulage services are expected to rise in real terms by about 5.5 per cent per annum (on average) over the AA period.

• The tariffs for ancillary services were revised and will increase each year only by the rate of change in CPI.

5

Haulage Tariffs Real price index starts at $1 in 2005-06

$0.90

$1.00

$1.10

$1.20

$1.30

$1.40

$1.50

$1.60

$1.70

$1.80

2006

-07

2007

-08

2008

-09

2009

-10

2001

0-11

2011

-12

2012

-13

2013

-14

2014

-15

2015

-16

Envestra SA - Actual

Envestra SA - Proposed

Envestra SA - AER DD

6

Total revenues (including ancillary services)

7

020406080

100120140160180200

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

2014

-15

2015

-16

$m

(2

01

0-1

1)

Key drivers of results

• Key drivers are:– Return on capital (asset base * cost of capital) – Return of capital (depreciation)– Capital expenditure forecasts – Operating expenditure forecasts– Demand forecasts - for converting revenues

to prices.

8

Breakdown of revenues (2011-16)

9

Return on capital60%

Other11%

Opex29%

Cost of capital (WACC)

• The nominal cost of capital has increased significantly (see following table)

• Debt risk premium, more than tripled since the earlier AA period.

• The cost of equity has decreased, due mostly to a reduction in the equity beta.

• The AER has set the market risk premium to its pre-GFC level of 6%.

10

WACC parameters

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Parameters (%) Earlier AA period Envestra proposalAER draft decision

Nominal risk free rate 5.8 5.3 5.7

Inflation forecast 3.2 2.6 2.5

Cost of equity 11.2 13.0 10.5

Equity beta 0.8-1.0 0.8-1.1 0.8

Market risk premium 6 6.5-8.0 6

Cost of debt 6.9 8.7 9.6

Debt risk premium 1.1 3.4 3.9

Gearing (Debt/Equity) 60 55 60

Nominal cost of capital 8.6 10.6 10.0

Revenues under different WACCs

12

0.0

50.0

100.0

150.0

200.0

250.0

2011-12 2012-13 2013-14 2014-15 2015-16

$m (

no

min

al)

Envestra SA - Proposed

Envestra SA - AER DD

Envestra SA - Earlier AA

Regulatory asset base

0

200

400

600

800

1000

1200

1400

1600

1800

As a

t 30 J

un

e (

$m

, n

om

inal)

Proposed

AER approved

13

Capital expenditure• Envestra proposed a 157% real increase in

capex compare to the earlier AA period. • The largest component of Envestra’s forecast

capex was for mains replacement. • The AER accepted most of the forecast capex.

Adjustments for:– contingency allowances – overheads and – real cost escalators.

• In addition, forecast capex for a number of specific projects has not been adequately justified.

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Total capex

0

20

40

60

80

100

2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16

Rea

l $'m

201

0

Actual Estimate ESCOSA allow ance Envestra forecast AER Allow ance

15

Capex by purposeCapital expenditure by purpose

0

10

20

30

40

50

60

2006-07 2007-08 2008-09 2009-10(estimate)

2010-11(estimate)

2011-12 2012-13 2013-14 2014-15 2015-16

Mains replacement

Grow th Assets

Other capital expenditure

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Mains replacement capex

Mai

ns re

plac

ed

(km

)

0

50

100

150

200

250

300

1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16

Actual Approved Forecast

Year

17

Return of capital

• Envestra proposed shorter asset lives than had been used previously.

• The AER has accepted these asset lives– increased the rate of depreciation.

• Return of capital has increased significantly.

• The following graph shows the trend in regulatory depreciation.

18

Regulatory depreciation

19

-10.0

-5.0

0.0

5.0

10.0

15.0

20.020

06-0

7

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

2014

-15

2015

-16

$m (

2010

-11)

Operating expenditure• Envestra proposed a 20% real increase in opex compare to

the earlier AA period, principally due to:– expenditures not undertaken in earlier AA period due to financial

pressures– increased UAG costs, and – one off costs & step changes compared to earlier AA period.

• The AER amendments, including:– input cost escalation– reductions in network development – reductions in UAG expenditure and – amendments to several of the proposed step changes.

• The AER’s draft decision results in a 9% real decrease in opex compared to the earlier AA period.

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Total opex Envestra SA opex

0

10

20

30

40

50

60

70

80

2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16

Rea

l $

'm

2010

-11

Actual Estimate ESCOSA allowance AER allowance Envestra's forecast

21

Opex by purpose

Earlier AA period Next AA period(actual) (as proposed)

22

Operating and Maintenance

(O&M)55%

Admin & General

14%

UAFG19%

Network Marketing

12%

Operating and Maintenance

(O&M)56%

Admin & General

13%

UAFG18%

Network Marketing

8%

FRC5%

Demand forecasts

• For the most part, the proposed demand forecasts are reasonable.

• AER adjustments:– average gas usage for residential customers– economic outlook used for business demand

forecasts was overly pessimistic.

• The AER revised upward the demand forecasts based on historic trends and SA state treasury forecasts on the SA economy.

23

Residential customer numbers forecast

Residential customer numbers

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16

Actual Envestra proposal AER draft decision

24

Residential average consumption forecast

Average residential consumption (weather normalised) - GJ

0

5

10

15

20

25

30

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

2012-13

2013-14

2014-15

2015-16

GJ

Actual AER draft decsion Envestra proposal

25

Volume customer consumption forecast

Residential and small business consumption (weather normalised) - TJ

0

2,000

4,000

6,000

8,000

10,000

12,000

2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16

TJ

Actual ESCOSA approved Envestra proposal AER draft decision

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Terms and conditions

• Submissions:– overall terms and conditions were weighted

too much in favour of Envestra.• The AER accepts most of proposed terms

and conditions.• However, changes are required to provide

a better balance between Envestra and customers

27

Consultants

• Cost of capital: Professor Kevin Davis

• Opex and capex forecasts: Wilson Cook

• Labour cost growth: Access Economics

• Demand forecasts: ACIL Tasman

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Timeline

Release of draft decisions 17 February 2011

Public forum on draft decisions 2 March 2011

Revised proposals to be submitted 23 March 2011

Submissions on draft decisions due 21 April 2011

Release of final decisions Late May 2011

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