140409 TransGrid consumer advisory workshop presentation

Consumer Advisory Workshop
Held 9 April 2014 in Alexandria
This TransGrid event brought together a broad cross section of consumer
representatives to discuss our Revenue Proposal and Five Year Business Plan
Some small changes have been made to the following slide pack as details will continue to
change as we take feedback from our consultation process. All details were correct at time of
publication.

2
All figures are for consultation purposes and may change prior
to submission of TransGrid‟s Full Revenue Proposal
Welcome
Your input today is what counts

3
Workshop objectives
• Open, informative and transparent update on TransGrid‟s planned
revenue proposal and five year plan for 2014 to 2019
• Feedback and input from attendees on this revenue proposal,
including changes since our November forums
• Deeper discussion on topics raised by participants, including:
 Demand management innovation strategy
 Replacement capital program
 Transmission pricing
 Return on capital (WACC)
• Feedback on TransGrid‟s strategy to continue to engage you
and the broader public on this revenue proposal, and future topics

4
Workshop agenda
9.30am Welcome, workshop objectives and introductions
10.00am Conversation covering:
- Key changes in our Full Proposal from the Transitional Proposal;
- AER determination on Transitional proposal
- Your feedback incorporated in our future plans
11.15am Demand management innovation strategy
12.00pm Lunch
12.45pm Site tour of Beaconsfield substation and replacement capital discussion
2.15pm Transmission pricing consultation
3.00pm Afternoon tea
3.10pm Ongoing partnership discussion and conclusion
3.40pm Optional: Return on capital (WACC)
4.30pm Close

5
Introductions

7
Revenue determination timeline
31 Jan 2014
Placeholder
revenue
proposal for
2014-15
31 May 2014
Full revenue
proposal for
2014-19
2014 2015
31 Mar 2014
Placeholder
revenue
determination
for 2014-15
30 Nov 2015
Draft revenue
determination
for 2014-19
30 Apr 2015
Final revenue
determination
for 2014-19
 Consumers can make
submissions to the Australian
Energy Regulator at each
stage of the process
31 Jan 2014
Framework &
approach
paper to
guide content
of the
proposal
Australian
Energy
Regulator
TransGrid

8
Draft five year plan overview
500
550
600
650
700
750
800
850
900
950
1,000
2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19
$m(2013/14)
Maximum Allowed Revenue

9
Draft five year plan overview
1,624
Regulatory Asset
Base ($m)
172
Annual Allowed
Revenue ($m)
Proposed capital
investment (5 years)
Capital invested
historically
Tax & depreciation
Operating expense
Return on proposed
capital investment
Return on capital
invested historically

10
Five year capital expenditure
Replacement
1,339
Augmentation
137
Market Benefits
220
Other
200
November Draft
($1,896m)
Replacement
1,259
Augmentation
103
Other
262
April Draft
($1,624m)
• Beryl substation deferred
• Tamworth to Gunnedah
transmission line deferred
• Low span remediation
prioritised over 10 years
rather than 5 years
• Transmission line
replacement being
reviewed
• Queensland to NSW
interconnector upgrade
deferred
• Southern transmission
line upgrade contingent
• Strategic property
acquisition added
Changes

11
Benchmarking results
Benchmark Studies Undertaken Outcome
Cost estimating trials PB, Aurecon, SKM Average or slightly lower cost
Estimating database rate review SKM Average or slightly lower cost

12
Proactive network support

13
Proactive network support
0
40
80
120
160
200
240
2015 2016 2017 2018 2019 2020 2021 2022
MW
Proposed Network Support - Powering Sydney's Future
Network Support Required Network Support withPre-emptiveBuild Up

14
Annual operating expenditure
Maintain
74
Plan & Manage
Assets 22
Operate 9
Support the
Business
63
November Draft
($168m)
April Draft
($173m)
Changes
Maintain
74
Plan & Manage
Assets 25
Operate 9
Support the
Business
65
• Increase of demand
management innovation
allowance ($2.6m)
• Addition of consumer
engagement strategy
($2.2m)

15
Benchmarking results
Category Studies Undertaken Outcome
Maintenance ITOMS Lower than average cost (international)
Asset Management ITAMS Average effort (international)
IT KPMG, Mercer, UMS Lower than average cost (Australia)
Human Resources Mercer, UMS Average cost (Australia)
Payroll Administration Mercer, UMS Higher than average cost (Australia)
Training Mercer Slightly lower than average cost (Australia)
Work Health & Safety Mercer Higher than average cost (Australia)
Finance & Management Support UMS Average cost (Australia)
Property Management UMS Lower than average cost (Australia)
Fleet Management UMS Average cost (Australia)
Corporate Support UMS Higher than average cost (Australia)

16
Scenario of falling demand
0
20
40
60
80
100
120
140
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
MW
Tamworth 132/66kV Substation
Summer Peak Demand Winter Peak Demand Cyclic Firm Capacity Alternative Firm Capacity
$43.0m
$42.2m

17
Context of changing energy mix

18
Confidentiality
 Some information TransGrid provides to the AER will be
confidential
– Information affecting the security of the network
– Market sensitive cost information, that affects our ability to obtain
competitive prices
– Market intelligence, that would advantage our competitors for
competitive works
– Strategic information, that may affect our ability to negotiate fair
prices
– Personal information, which may raise privacy concerns
– Other, such as detailed third party intellectual property to which
TransGrid does not have access

19
Recent engagement activities
• Consumer advisory workshop
• Large energy user roundtable
• Direct briefings
Representative
groups
• Deliberative forums, focus groups
• Surveys, polls, quantitative feedback
• Customer service improvements
Direct consumer
consultations
• Websites, social media
• Traditional media, fact sheets
• Topic specific reports
Building public
awareness

20
Consumer feedback
 Review plans against scenario of falling demand
 Frame plans in the context of the changing energy mix
– Management of potential stranded assets
 Cost/reliability trade-off
 How to help consumers engage with the proposal
– Treatment of confidential information
 Demand management innovation value proposition
 Stakeholder engagement strategy
 Pricing methodology

21
Consumer engagement costs
• Consumer participation, education and expert input in business
planning, long-term network design and revenue reset application
 Forums, roundtables, workshops, surveys
 Submission and input tracking system
 Improvement to annual planning process and materials
 Conference participation, regional roadshows
• Community consultation on project need, options to defer capital
and community impact
 Powering Sydney‟s Future
 Project need consultation and options input
 Proactive support for non-build option applications
 Better systems to track impacted community issues
• Building consumer awareness and internal capabilities
 Advertorials, factsheets, communications collateral
 Skills to translate from technical to clearer, consumer-focused
 Website update and maintenance, including social media
$1.13m
$669k
$438k
$2.24m

22
Discussion
 What types of information do consumers need access to, in
order to understand and assess the substance of all issues
arising from the NSP's information?
– What level of detail?
– What are your thoughts on TransGrid‟s plans for
consumer engagement?

Demand management innovation
strategy
Mal Coble
Manager, Network Support and Consultations

24
Overview
Today TransGrid would like to discuss our draft demand
management innovation strategy with you.
We will cover:
? What is demand management?
 Our findings so far
 Our proposal
$ Value proposition for consumers
 Discussion

25
? What is demand management
Demand
management can
be an alternative
to investment in
the network
„Demand management‟ is any deliberate
change to the amount of electricity
demanded :
• demand response – a short-term decision
to reduce energy consumption; and
• energy efficiency – overall use of less
energy for the same activity or output
TransGrid has used demand
management as a „network support‟
alternative to network investment:
• 350 megawatts in Newcastle-Sydney-
Wollongong for summer 2008/09 to defer
network augmentation investment
• 40 megawatts in the Sydney CBD for
summer 2012/13 to mitigate network
operational risk.

26
The demand
management
ecosystem

27
Innovation is needed
to grow the demand
response market
The current low electricity demand
growth environment is a prime
opportunity to boost demand
management innovation and
procurement.

28
TransGrid’s demand
management
innovation
allowance for 2009
to 2014
• load reduction trials and research
projects in partnership with distribution
businesses
• implementation of the latest technology
in demand reduction solutions
• understanding industrial, commercial
and residential energy consumers

29
Targeting future
demand
management
innovation
activities
Attempts to procure network support, and innovation
projects undertaken from 2009 to 2014, indicate that:
• Consumers‟ lack of trust in the electricity industry is a
barrier to implementation of demand management
projects.
• Commercial businesses do not appear to be fully
exploiting energy efficiency opportunities because of
lack of understanding of technical opportunities and
mismatch in incentives acting on owners and
tenants.
• Early and clear information about network support
opportunities could contribute to greater uptake of
network support.
• Industry collaboration and a shared understanding
of the demand management market is needed, to allow
synergies to emerge and prevent duplication of efforts.
• TransGrid’s role in the demand management market is
different to that of the distribution businesses.

30
 Our proposal
Key objectives
contribute to facilitating a flexible demand
management marketplace
understand the electricity use of large consumers
and surface their potential to provide demand
management
develop and grow the demand management
market
test and apply large-scale demand management
tools and techniques
pinpoint key drivers of peak demand in NSW in
order to better source demand response
identify and leverage the transmission-specific
contribution to the demand management
ecosystem
Opportunity
test
Value test Execution Evaluation
TransGrid’s demand management
innovation proposal for 2014 to 2019

31
 Our DMIA proposal
• Market understanding and development
 Spatiotemporal integration of demand response and network constraints
 Primary data sourcing on demand management providers
 Understanding the peak, impact of variable generation
 Other market understanding and development
• Cross-industry market support
 Working groups to identify barriers to demand management, and develop
a plan to overcome them
 Support residential and consumer demand management education
 Develop and implement options to incentivise demand management
• Technology trailing
 Energy efficiency (auditing) with large consumers
 Large scale innovative demand management systems (eg iDemand and
microgrids)
 Energy storage selection, sizing, placement and operation
 Broad-based trials in partnership with distribution businesses
$1.5m
$420k
$680k
$2.6m

32
$ Value proposition for consumers
$
• cost-effective deferral or avoidance of
transmission network investment using
demand management allows reduced network
charges for consumers
• however benefits are also possible throughout
the electricity supply chain
• demand management can reduce the need for
investment in generation capacity and possibly
distribution network capacity.
Demand
management
presents a
compelling value
proposition for
electricity
consumers

33
Discussion
 What are your thoughts about our demand management
innovation strategy?

All figures are for consultation purposes and may change
prior to submission of TransGrid‟s Full Revenue Proposal
Transmission pricing consultation
Isaac Katz
Director – Harding Katz Energy Consultants

35
Objectives for transmission pricing
 To provide „cost reflective‟ or „efficient‟ price signals
 Efficient use of the network
 Encourage demand side response
 Efficient transmission investment– lower costs/better service to
customers
 To recover the maximum allowed revenue set by the AER
 To deliver „fair‟ outcomes to customers
 Manage price shocks
 Allocate costs to those that cause / benefit from the transmission network
 Reasonable price certainty for customers
 Are these the right objectives?

36
NSW summer demand

37
Pricing methodology regulation
 Pricing methodology must comply with National Electricity
Rules
 Rules require:
 Allocate revenue to 4 transmission services
 Price each service on a locational or postage stamp basis (or a
mix)
 AER approves methodology for a 5 year period
 TransGrid to submit revised methodology by 31 May 2014
for implementation from 1 July 2015
 Is the Rule-based process too inflexible?

38
Current pricing arrangements
1. Is 50% appropriate?
2. Is CRNP effective?
3. Apply to peak days only?
4. Apply postage stamp prices to
demand or energy?
5. Greater pricing certainty?

39
What have stakeholders said?
 Prices should be more cost reflective
 50% postage stamp component (not location based) is too
high
 Transmission pricing should be primarily or entirely
demand based, rather than energy based
 Transmission pricing should be based on system peak
demand
 Customers should have greater certainty on transmission
prices
 Need to think about linkages with distribution pricing
 Any other concerns?

40
What has our analysis found?
 No easy answer to „cost reflective‟ transmission pricing
 Concerns that method for determining location prices
(CRNP) may not be robust:
 Do not reflect future investment needs
 Vary across connection points that are geographically
and electrically similar
 Not stable over time - hence the need for the Rules 2%
side constraint
 CRNP methodology is a "black box", and it lacks the
transparency that customers value
We agree that pricing signals could be improved.

41
Proposed changes within existing
Rules
1. Postage stamp prices to be based on maximum
demand (MVA), not energy
2. CRNP model to focus on 10 peak days
3. More flexibility to improve methodology during the
5 year period
4. Framework for negotiating fixed prices with all
transmission customers?
5. Transitional arrangements to manage any price
shocks

42
Rule change required?
 Case for Rule change to be developed with input from
customers and other stakeholders
 Opportunity for prices to reflect forward investment plans –
at present not allowed by Rules
 Case for recovering „postage stamp‟ costs on a locational
basis?
 Rule changes may be required to allow fixed prices to be
negotiated

43
Next steps
 Pricing methodology:
 Must be submitted to the AER by 30 May 2014.
 AER will then consult on the proposed methodology, so
all stakeholders will have further opportunity to
comment.
 Rule change proposal:
 To be considered by TransGrid, in consultation with
stakeholders over the coming months.
 Target submission of any Rule change proposal in the
third quarter of this year.

44
Discussion

The return on capital under the
new National Electricity Rules
Prof Stephen Gray
University of Queensland Business School

46
The building block approach
Operating
costs
Taxes
Depreciation
Return on
capital
Regulated
asset
Base (RAB)
Return on
capital Return to
shareholders
Interest to
lenders

47
The return on capital
Return to
shareholders
Interest to
lenders
rd
rate of interest
re
return to equity
60%
of financing
40%
of financing
Credit rating
Systematic risk
ed rrreturnAllowed 4.06.0

48
The implications of mis-estimation
 If the allowed return on equity is set too high (i.e., above
what investors actually require):
 Prices will be above efficient levels; and
 Regulated businesses will have an incentive to over-invest.
 If the allowed return on equity is set too low (i.e., below
what investors actually require):
 Prices will be below efficient levels;
 Regulated businesses will have an incentive to under-invest,
which affects reliability:
 Difficult to finance investments where allowed return is less
than the cost of capital; and
 Incentive for business to cut costs to provide required return
to investors.

The allowed return on debt

50
The return on debt
Previous rules New rules
Allowed
return
Prevailing BBB+ rate
at the beginning of the
regulatory period.
10-year trailing average
ending at the beginning
of the regulatory period.
Assumed
financing
practice
Refinance all debt at
the beginning of every
regulatory period.
Issue a staggered
portfolio of debt over a
10-year cycle.
Actual
financing
practice
Issue a staggered
10-year cycle.
Issue a staggered
10-year cycle.

51
The reason for the rule change
Current yield
Average yield
Yield
Time
10%
10% 10%
10%
10%
10%
10%
10%
10%
10%

52
TransGrid debt portfolio

53
The effects of the rule change:
matching and stability

54
Summary of return of debt issues
 User groups proposed the rule change due to
the divergence between:
 The allowed return on debt (based on the rate at the
beginning of the regulatory period); and
 Actual debt service costs (based on the average rate
over the last 10 years).
 Matching the allowed return to the observed
practice results in:
 The allowed return better reflecting the actual debt
service cost; and
 More stability in the allowed return on debt.

55
Transition arrangements
 AER proposes to phase in the new return on debt method
over 10 years:
 From the previous regulatory assumption of businesses
refinancing all of their debt requirements at the beginning of each
regulatory period;
 To the new regulatory assumption that debt is issued in a
staggered fashion over 10 years.
 However, TransGrid has always financed according to the
new regulatory assumption, so no transition is required.
 The transition simply means that the mis-match between
actual costs and the regulatory allowance, and the variability
of allowed returns, will continue for another 10 years.

The allowed return on equity

57
Return on equity under the
previous rules
2009 WACC Review
Approach
Sharpe-Lintner CAPM
exclusively.
Risk-free
rate
Contemporaneous yield on
10-year Commonwealth
Government bonds.
Beta
Regression analysis
applied to a small sample
of domestic firms,
producing a range of 0.4 to
0.7. Figure of 0.8 adopted.
MRP 6.5%.
MRPrr fe

58
A mechanistic implementation of
the CAPM
The global financial crisis
and its continuing impact
through the European
sovereign debt crisis have
highlighted the inherent
dangers in an overly rigid
approach to estimating a
rate of return in unstable
market conditions.
AEMC Rule Change Final Determination, p. 40.
Did the GFC really reduce the cost of equity??

59
The AEMC Rule changes
 At the end of its 18-month rule change process, the
AEMC:
 Criticised the mechanistic implementation of the
CAPM (and the Tribunal‟s endorsement of it);
 Introduced the allowed rate of return objective –
allowed return must be commensurate with the efficient
financing cost of the benchmark efficient entity;
 Required the regulator to have regard to relevant
methods, models, data and other evidence;
 Required the regulator to have regard to the prevailing
conditions in the market for equity funds.

60
The AEMC‟s criticism of regulatory
practice under the previous Rules
it is almost inherently contradictory then to say that the approach
or the model is not likely to produce a reliable output - assuming
that the inputs are appropriate – if that approach and that model
are well accepted.
ATCO Gas Reasons, Paragraph 63, Application by WA Gas Networks Pty Ltd (No 3) [2012] ACompT 12.
The Commission considered that this conclusion presupposes the
ability of a single model, by itself, to achieve all that is required by the
objective. The Commission is of the view that any relevant evidence
on estimation methods, including that from a range of financial
models, should be considered to determine whether the overall rate of
return objective is satisfied.
AEMC Final Determination, p. 48.

61
The allowed rate of return objective
the rate of return for a Transmission Network Service Provider is
to be commensurate the efficient financing costs of a benchmark
efficient entity with a similar degree of risk as that which applies to
the Transmission Network Service Provider in respect of the
provision of prescribed transmission services.
NER 6A.6.2(c).

62
The AEMC‟s criticism of regulatory
practice under the previous Rules
Achieving the NEO, the NGO, and the RPP requires the best
possible estimate of the benchmark efficient financing costs. The
Commission stated that this can only be achieved when the
estimation process is of the highest possible quality. The draft rule
determination stated that this meant that a range of estimation
methods, financial models, market data and other evidence must
be considered.

63
Matching allowed returns to the
prevailing conditions
If the allowed rate of return is not determined with
regard to the prevailing market conditions, it will either
be above or below the return that is required by capital
market investors at the time of the determination. The
Commission was of the view that neither of these
outcomes is efficient nor in the long term interest of
energy consumers.

64
Return on equity under the new
Rules
2009 WACC Review 2013 Guideline
Approach
Sharpe-Lintner CAPM
exclusively.
Sharpe-Lintner CAPM
exclusively.
Risk-free
rate
Government bonds
Government bonds
Beta
Regression analysis
applied to a small sample of
domestic firms, producing a
range of 0.4 to 0.7. Figure
of 0.8 adopted.
Regression analysis applied
to the same small sample of
domestic firms, producing a
range of 0.4 to 0.7. Figure of
0.7 adopted.
MRP 6.5%. 6.5%.

65
Industry proposes a simple
approach
 Industry has argued that the Rules require the
regulator to simply:
 Set out what it considers to be the relevant evidence;
and
 Apply weight to each piece of evidence according to
its relative strengths and weaknesses (e.g., reliability
and precision).

66
The AER‟s proposed “turducken”
approach

67
Main points of disagreement
Why filter all evidence through the Sharpe-Lintner CAPM?
Why not simply consider every model that is deemed to be relevant? What is
gained by using evidence from one model to inform the parameter estimates for
another?
When the CAPM was being developed Kennedy was the US president, the
Olympics were in Rome, and Psycho was the top rating movie. There have
been many developments in financial economics since that time.
Why have a hierarchy of evidence when estimating parameters?
When estimating a parameter, why not set out all evidence that is relevant to
the estimation of that parameter and give more reliable and precise evidence
more weight?
Why use one sub-set of evidence to constrain the range, so that other evidence
can only be used to select a point from within that range, even when all of the
other evidence suggests an estimate materially outside the initial range?

68
Main points of disagreement
Why not properly consider other relevant models?
The Fama-French model is well-known to provide a much better fit to the
observed data than does the Sharpe-Lintner CAPM. It is also used in practice
(e.g., required for CFA certification). Fama was awarded the Nobel prize in
2013.
The dividend discount model is widely used in practice, including use by other
regulators for the purpose of estimating the required return on equity.

Please visit yoursaytransgrid.com.au for more details
For further information on TransGrid or this presentation
please contact us on 02 9284 3361.

140409 TransGrid consumer advisory workshop presentation

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