The NECA Review of Transmission and Distribution Pricing
A Submission from the IPART Secretariat
1. Introduction
The Independent Pricing and Regulatory Tribunal (IPART) was established
initially in 1992 as the Government Pricing Tribunal to regulate the prices of
government monopoly services. Following substantial amendments to the
Tribunal's legislation in January 1996, the Tribunal was given an expanded
role and renamed the Independent Pricing and Regulatory Tribunal.
In carrying out its current role the Tribunal:
 sets maximum prices and undertakes pricing reviews of monopoly
services supplied by government agencies in NSW;

regulates natural gas pricing and third party access to gas networks in
NSW;

undertakes general reviews of industry, pricing or competition; and

registers agreements for access to public infrastructure assets and
arbitrates disputes about such agreements.
IPART is not subject to the control or direction of the Government in respect
of any determination or recommendation.
IPART’s practical experience, relevant to the NECA review, includes
determination of: the price of access to AGL gas pipelines in NSW; the price of
electricity transmission and distribution services in NSW; principles for the
calculation of connection charges for embedded generators; and principles for
negotiation between customers and service providers. IPART is about to
commence its next review of NSW electricity distributors’ prices.
A distinction should be drawn between the Secretariat to IPART, and the
members of the Tribunal. The Secretariat to IPART conducts analysis and
provides advice to the Tribunal to aid it in its decisions. This submission
encompasses the views of the Secretariat, not necessarily those of the
Tribunal.
NECA is to consider the current pricing arrangements outlined in chapter 6 of
the National Electricity Code (NEC). In particularly NECA, in consultation
with various parties, is to consider the merits, and the net benefit of
modifying the:
 pricing requirements set out in Part C of Chapter 6 of the NEC; and
 the methodologies and regulatory principles set out in Part E of Chapter 6
of the NEC.
NECA is to conduct the review given the broad pricing objective is to achieve
economic efficiency and equity.
The networks seem to have argued in the past against revisiting the
arrangements in the code on the basis that:
 the issues are complex and have been discussed at length without
resolution;
 transmission network prices based on CRNP, should approximate long
run marginal cost, which will deliver economic efficiency;
 the proposed arrangements may not be ideal but they are a start; and
 the arrangements should be put in place so that a national market can
begin, and they will improve over time.
While the IPART Secretariat agrees that a practical solution is required, it has
reservations that the arrangements in the code will deliver economic
efficiency. This stems from a theoretical basis, the Secretariat’s own practical
experience and its research of overseas experience.
Initially the Tribunal commissioned Dr Stephen King in 1995 to review and
comment on the pricing arrangements proposed by the NGMC. He
concluded that “ [t]he NGMC proposals may … be interpreted as supporting
a pricing structure that is potentially highly inefficient.” 1
The Secretariat’s practical experience with the CRNP approach supports this
view. In March 1996, the Tribunal released its determination on electricity
prices. An averaged CRNP approach was adopted to determine transmission
prices. This was because a pure CRNP allocation resulted in significant price
disparities at each bulk supply point without economic merit.
Recent international experience suggests that it is possible to introduce a more
effective solution than is currently proposed. The Secretariat is aware of a
number of alternative pricing arrangements proposed or in place in the UK,
US, Scandinavia and New Zealand. A Secretariat research paper is attached
(Appendix 1) which briefly outlines the experience in a number of countries.
The IPART Secretariat thought it would be most useful to NECA, if the
Secretariat used this submission to share its experience in implementing the
pricing arrangements in the (then draft) NEC, rather than giving detailed
information about alternative pricing arrangements, or providing a
comprehensive discussion of the issues raised in the NECA issues paper.
For this reason the Secretariat, in this submission, has focussed on:
 the NEC’s pricing objectives and their implications for network prices; and
 the likelihood that current arrangements will deliver the desired
objectives.
1
King S, 1995 p5
2
2. Pricing Objectives
Pricing principles and objectives are set out in sections 6.2.2, 6.10.3 and 6.10.4
of the NEC. The objectives of the arrangements, as stated in the code, may be
summarised as being to:
 foster an efficient level of investment in the industry,
 foster efficient O&M practices,
 foster efficient use of infrastructure,
 promote competition in upstream and downstream markets
 prevent monopoly rent being earned by the network service provider
 provide a balance of interests between the public and the network service
provider.
More generally, the principles or objectives of utility regulation can be
grouped as:
 economic efficiency
 equity
 revenue sufficiency and
 efficient regulation.
These objectives may often be incompatible, although economic efficiency
seems to have had particular emphasis placed on it in the code.
Many submissions will discuss pricing options in terms of economic
efficiency and cross subsidy, but may use these terms differently. In assessing
the options, it is important to have a clear understanding of both economic
efficiency and cross subsidies as they set important benchmarks for pricing.
Economic Efficiency
Economic efficiency is a term that is often referred to but rarely defined.
Resources are allocated2, via prices, through the interaction of demand and
supply between consumers and producers. Efficient prices are those which
lead to the best allocation of resources and the highest level of aggregate
welfare among consumers and producers. Economic efficiency has three
components:
 allocative efficiency
 technical or productive efficiency and
 dynamic efficiency
2
It should be noted here that resources may be allocated administratively rather than always through
prices eg in the case of hospitals.
3
Allocative Efficiency
Allocative efficiency implies that prices of goods and services should reflect
the economic costs of producing the good or service so that resources are
distributed to where they are most valued. This means for allocative
efficiency, prices should be free of cross subsidies and any element of
monopoly pricing. The starting point for economically efficient prices is the
marginal cost of production.
The marginal costs of transmission are the changes in the future costs
transmission for a small but measurable change (either up or down)
demand over a defined period. This highlights three critical features
marginal costs:
 future costs count, not past or sunk costs
 marginal costs depend on the size of the change modelled
 marginal costs will vary with the time period over which the change
costs is measured.
of
in
of
in
In the short run the operating and maintenance costs of the network are
unlikely to vary with output. Hence, the short run marginal costs of a
marginal increase in demand may be:
 the associated marginal energy losses
 when system congestion is reached, price necessary to equate demand to
supply (ie the capacity rationing price). The adjustment to supply and
demand may have two components: a supply adjustment and a demand
adjustment.
The capacity rationing price effectively puts a value on the transmission
constraint based on the costs of the alternative actions it induces. Where there
is generation on both sides of the constraint, generation may be able to be
rescheduled.
The differences in the costs of generation due to the
rescheduling places a cap on the maximum price or value of the constrained
network. Demand can also respond to price changes. It is the combined
responses of demand and supply which would set the short run capacity
rationing price for the network.3
Importantly, in an optimally dispatched system the SRMC of transmission
between two points A and B is equal to the difference in the marginal costs of
generation at points A and B. If this were not to hold, the market operator
would be able to alter the dispatch of the generators to reduce costs of energy
supply.
In an ideal world, individual prices would be set for each customer at the
short run marginal cost of providing the service. However, such a pure
3
To some extent pool prices also act to ration demand eg inter-regional trading.
4
approach is not always practical, particularly in the case of pricing
transmission and distribution services. This is because:

price stability is important. Prices based on short run marginal cost can be
erratic, depending on system capacity. A more stable option may be to
charge according to long run marginal cost. Long run marginal pricing
has often been used in regulatory practice. However it has been subject to
criticism due to the dependency on planning assumptions.

the total cost of service exhibits economies of scale, ie transmission and
distribution businesses are categorised by long lived, expensive fixed
assets, and decreasing average costs. In this case, prices set at short run
marginal cost would only recover energy losses and other variable costs of
production such as labour and materials (except where the network is
subject to congestion). This would mean that fixed costs (past or present)
are not recovered, thereby giving the network service provider little
incentive to maintain and invest in the network.
A “second best” solution would be to adopt a two-part tariff4, or for the
network service provider to recover the difference between total costs and
revenue collected from pricing at marginal cost via government subsidy.
The dominate view, firstly argued by Coase (1946), is that it is much less
distortionary to recover the revenue residual through prices rather than
subsidy.

the total cost of service exhibits economies of scope, ie there is a large
proportion of joint or common costs incurred to serve customers 5. In this
case, if total costs (fixed and variable) are to be recovered through prices, it
is difficult to determine the total cost of serving an individual customer.
This means it is difficult to determine the relevant cost to reflect in prices.
This has implications for the measurement and removal of ‘cross
subsidies’ in prices (see discussion below).
Productive and Dynamic Efficiency
The remaining components of economic efficiency, productive and dynamic
efficiency, have implications for price regulation in the case of regulated
monopolies. Productive efficiency refers to minimising the input costs of
production and maximising productivity. Dynamic efficiency refers to the
achievement of continuous productivity improvements through innovation.
4
This involves setting a variable charge at the level of marginal cost, and a fixed component which
recovers residual costs.
5
Joint and common costs are costs that are incurred to serve a range of customers together, which
makes it difficult to assign costs to an individual customer for pricing purposes .
5
To achieve these, it is critical for price regulation to provide incentives for the
service provider to be efficient in production, and to be innovative. Critical to
this, is that within the regulatory framework the service provider should have
an opportunity to earn an appropriate return if they produce and invest
efficiently.
It should be noted, however, that the maximum value of the network is
determined by the relative costs of alternative generation options and
demand responses rather than the cost of the network assets. A substantial
reduction in the relative costs of small and large scale generation may restrict
the ability of the network owner to recover the cost of past investments. This
stems from some competitive pressure on network service providers (eg
embedded generation, fuel substitution or by-pass). These pressures also
provide an extra incentive for the network service provider to be productively
and dynamically efficient.
Cross Subsidies
“Cross subsidy” is also a frequently used, but often poorly defined term.
A subsidy is a payment or a financial commitment which usually results in consumers
paying prices below the cost of supply … [a] cross subsidy occurs when the subsidy to one
group of consumers is financed by a higher price [paid by] the other consumers supplied
by the same firm.6 (emphasis added)
The cost of supply is the key issue. As noted above, it is often difficult7 to
assign costs to an individual group of customers. This stems from the
presence of economies of scope, and therefore joint and common costs, in
network industries. It is the treatment of these joint and common costs that is
relevant to the measurement of cross subsidies.
While there is no universally accepted method, there are three indicators of a
cross subsidy that are commonly employed and discussed.
 prices under-recover incremental costs
 prices over-recover stand-alone costs
 prices either over or under-recover fully distributed costs
Each reflects an opinion of which costs comprise the relevant cost of supply.
There is increasing agreement that it is the incremental costs8 that are most
relevant to the economic measurement of a cross subsidy. Prices below
6
Australian and New Zealand Minerals and Energy Council, 1995, p 13.
It should be noted that this difficulty is often overstated. More costs are attributable (and measured)
over the short-run than the long-run. Also, activity based costing helps.
8
Incremental costs may be defined as the costs that would not be incurred if a group of customers is
not supplied. Incremental costs include any additional operating costs and capital costs incurred,
including a return on investment.
7
6
incremental costs suggest an under-recovery of the economic costs of
providing the service.9 This is discussed in Baumol and Sidak (1994)10:
A cross subsidy is present when the average incremental revenue contributed by a
product of a firm is insufficient to cover its average incremental cost, but the firm
nevertheless earns sufficient revenue from all its products to cover its cost of capital
together with its other outlays.
The measurement of an over-recovery of stand-alone costs11 in one market,
would present the same result as the measurement of an under-recovery of
incremental costs in the other market in a two product/customer market (say
A & B), as long as the firm was recovering its cost of capital (and no more
than that). This is due to the following identity:
Total costs of A and B = Stand-alone costs of A + Incremental costs of B
This leads to the concept of a range of prices that are subsidy-free. A set of
prices is said to be subsidy-free if the price for each service lies above average
long-run incremental cost and below average stand-alone cost.12 The basis for
these limits is usually discussed in terms of competitive pressures. Prices
above the stand-alone costs can only be sustained in the long run through the
existence of entry barriers or other restrictions that prevent bypass. Thus
prices above stand-alone costs require the exercise of market power. With
open entry a customer could not be charged more than the stand-alone cost of
supply, otherwise another business could enter the market and provide the
service at a cheaper price13. Conversely, the incremental costs represent a
minimum, since a business would not supply for long a customer that could
not pay at least the incremental cost of supply, since the business could
improve its profitability by not supplying that customer.14
The problem with this concept is that it can result in a wide range of ‘subsidyfree’ prices15. Furthermore the range is not as definitive as sometimes
presented. Stand-alone prices may not be sustainable in the absence of
market restrictions if customers have other self-supply options; or some of the
costs for other potential suppliers are common to other activities and can be
recovered from other customers. Indeed, depending on the cost of self
supply, fully distributed or even incremental costs may not be sustainable.
9
Changing market pressures can hold long-run prices below long-run incremental costs. In this case it
is not efficient to attempt to lift prices to long-run incremental levels. However, while the service may
continue to be offered in this short term, its long-run provision would not be commercially viable.
10
Baumol, WJ and Sidak, JG, 1994, p 62.
11
Stand-alone costs are incurred if a group of customers is supplied in isolation.
12
This is discussed, for example, in Baumol, WJ, Koehn, MF, and Willig, RD, 1987.
13
This assumes easy market entry.
14
It is worth noting that Baumol, WJ and Sidak, JG, 1994, apply the stand-alone/incremental cost
distinction to final prices, while in this case it is applied to the prices of an intermediate product.
15
However, as noted previously, a forward looking, long-term view can help, as can activity based
costing.
7
Subject to certain caveats, prices outside this range encourage inefficient use
of resources which may be detrimental to the community’s economic goals.
In contrast, the efficiency arguments for different price combinations within
this range is not clear cut.
A price based on fully distributed costs16 (FDC) will result in a price that will
usually lie somewhere within the stand-alone and incremental cost, subsidyfree bounds. Pricing arrangements in parts C and E of the Code are examples
of FDC approaches.
While the FDC approach has broad practical appeal, as it is seen to share the
benefits of economies of scope more widely, the weakness of the approach is
that the allocation of joint costs is arbitrary and subject to judgemental bias17.
This is noted in Baumol and Sidak (1994):
Usually the choice of an arbitrary rule for apportioning common costs profoundly affects
the magnitudes of the individual FDC figures that emerge from the calculation. Not
surprisingly, therefore, the selection made among the alternative rules has sparked bitter
and protracted disputes …18
So while a FDC approach may have some merit on equity grounds, it is not a
sound basis for producing economically efficient prices.
Summary: Implications of Economic Efficiency and Cross Subsidies for Pricing
Arguably the starting point for economically efficient pricing is either:
 short run marginal cost (SRMC) pricing. In areas/times of congestion the
price would be that to clear the market through demand or supply
responses.
 long run marginal costs (LRMC).
LRMC prices are more stable over time, but they are driven by planning
assumptions. The problem of the dependency of LRMC on planning
assumptions has seen increasing regulatory emphasis on SRMC approaches,
which has highlighted the tension between LRMC regulated prices and
market solutions.
In either case, but especially for SRMC, total revenues are unlikely to provide
a sufficient revenue stream for the network. Hence an additional component
of pricing is required. From an economic efficiency perspective, this
component should seek to have as little effect on behaviour as possible.
16
Fully distributed cost (FDC) is an allocation of the total costs of the business to each group of
customers using a chosen allocator.
17
This can be illustrated for example, by the wide range of AGL’s distribution cost estimates put to the
Tribunal. Cost allocations to the contract market using a FDC approach ranged from $5 million to $75
million. see IPART, AGL Determination, July 1997, p 37
18
Baumol, WJ, Sidak, JG, 1994, p 56.
8
Ideally it should not alter relative prices between locations or over time, and
should not vary with system usage. Because of the gap between SRMC and
average cost for networks there is a no guarantee that economically efficient
prices will be cross subsidy free. However given that by-pass is allowed,
prices which exceed standalone costs may encourage inefficient economic
network bypass.
So in summary, in the case of pricing transmission and distribution services,
there is no clear cut pricing rule to ensure both economic efficiency and the
absence of cross subsidies. However, a useful guide may be that:
 prices should be between the average standalone cost, and the average
long-run incremental cost; and
 prices should be structured to ensure that:
 variable charges reflect short run marginal cost
 fixed charges imposed on customers do not, as far as possible, change
behaviour, in that, a customer that would choose to connect to the
network at or above marginal cost, is not deterred by the imposition of
a high fixed charge and would not alter location in response to the
fixed component.
3. Comments on the NEC
Given the theoretical framework presented above, and drawing on its
practical pricing experience, the Secretariat has the following comments to
make on the current pricing arrangements in the NEC. The Secretariat
believes that from these perspectives, the arrangements may not be able to
meet the pricing objectives in the code, and consequently it may be of net
benefit to modify the arrangements.
Annual Revenue Requirement
While the Secretariat recognises that the determination of the revenue
requirement is not part of the NECA review, it does have implications for the
method in which the revenue requirement is allocated to customers, and into
final prices.
The Code specifies the determination of an annual revenue requirement using
a rate of return on a written down, current replacement cost of existing assets.
This has two issues associated with it. Firstly, it means that prices reflect a
return on sunk costs, and secondly, places emphasis on asset value and rate of
return. These may be contrary to the objectives of economic efficiency and
equity in the code, and are discussed in turn.
One view is that the inclusion of a return on sunk costs has no economic basis,
and may result in a revenue requirement that is too high. Stephen King
suggested this in his review of the NGMC proposal:
9
“Evaluating sunk costs and attempting to transform these into prices may be a useful
theoretical exercise but has little economic benefit. As these costs are sunk, any attempt
to recover them must reflect political rather than economic imperatives. … While it is
necessary to establish a regime of transmission prices that induces a desirable level of
ongoing investment, such a regime needs to be divorced from the valuation of existing
sunk costs. “19
However, a counter view is put forward on the grounds of commercial
reality: the network service provider needs to earn sufficient revenue for it to
maintain and invest in the network. There is therefore good reason to provide
a “commercial” revenue stream. However care needs to be taken in the
evaluation of such a stream. It is an area where there is no simple rule, as
discussed below.
Nevertheless, the relevant issue here is that the extraction of the “commercial
revenue” stream from users has implications for the allocation of costs and
efficient prices. As noted in section 2, to the extent that:
 there is a gap between revenues from marginal cost/congestion pricing
and a commercial revenue stream; and
 this gap is to be recovered through charges
the design process to extract this gap should seek to distort the behaviour of
users as little as possible. It should also have regard to the important practical
goals of transparency, administrative cost and simplicity, and equity. A
balanced consideration of these goals may suggest that the gap may best be
recovered through a relatively simple access component. However such
judgements are likely to depend upon specific circumstances. Hence care
should be taken to avoid mandating the use of a single approach.
The second issue is that undue emphasis is placed on asset values and rate of
returns. This may be inappropriate as:
 it may send inappropriate signals to asset owners for network
investment. It may encourage “gold plating”.
 there may be limitations on the regulator’s ability to verify asset values,
due to a problem of asymmetry of information.
To overcome these potential difficulties, the Tribunal has adopted cash flow
measures to assess the reasonableness of the revenue requirement. This
approach is outlined in the IPART’s September 1996 draft determination on
AGL access undertaking:
“The Tribunal wishes to stress that asset valuation assumes a diminished role in the
Tribunal's approach to revenue requirement determination. Due to the use of the "range
of indicators" approach, the rate of return on the regulatory asset base is but one of the
reference points against which users can conduct reasonableness tests of the price path
and revenue requirement. This contrasts sharply with the North American approach,
which utilises an apparent strict reliance on the rate base/rate of return model, in which
the asset base, in conjunction with the weighted average cost of capital, drives the
19
King S, 1995 p 3
10
determination of the revenue requirement. Strict application of this approach would
exclude the "reasonableness checks" allowed by reference to a broad set of cash-based
financial indicators.”20
This change of approach is evident in international regulatory experience, for
example in countries such as the UK, Norway and Chile.
Cost Allocation
As discussed in section 2, the cost allocation approaches in part C and E of the
code are FDC approaches and hence have little economic basis. The approach
may have some appeal on the grounds of equity, however this will depend on
circumstances as can be demonstrated from the Secretariat’s experience.
The industry has continued to argue that a CRNP allocation will approximate
long-run marginal costs (LRMC), and therefore will result in economically
efficient prices. There appears to be no basis to support this position.
Firstly, the industry often refers to the NGMC’s estimation of LRMC to
support CRNP. Yet it seems that the only analysis conducted by the NGMC
was the estimation of LRMC for generation, which is different to the LRMC
for loads (use of the transmission network). The latter is equally relevant for
economically efficient transmission prices.
Secondly, from a theoretical viewpoint, it seems highly unlikely that the
CRNP allocation would approximate long-run marginal costs. This stems
from the fact that the revenue requirement on which prices are based, reflect a
return on sunk assets and hence reflect costs incurred in the past. This may
not be equivalent to future costs which should be the basis for determining
long-run marginal cost. As Stephen King noted:
“The CRNP “revenue based” approach attempts to do this [ie reflect long-run marginal
cost (LRMC)], but as noted above, it is based on sunk assets and may only roughly reflect
true LRMC in practice. The NGMC proposals may, then, be interpreted as supporting a
pricing structure that is potentially highly inefficient.”21
This theoretical perspective is consistent with IPART’s experience in the
regulation of electricity and gas network businesses.
For the IPART March 1996 Electricity Price Determination, while the
principles in the draft National Electricity Code were considered, an averaged
CRNP approach was adopted to determine the price of transmission. This
was because a pure CRNP allocation resulted in significant price disparities at
each bulk supply point. Such variations could have significant effects in some
communities and on remote or under-utilised assets with little benefit, or
possibly no benefit, to economic efficiency.
20
21
IPART draft Determination, September 1996, p 20.
King S, 1995, p 5
11
Results were such that, often prices were very high in areas with underutilised assets, and in areas with over-utilised assets, prices were low. If these
prices were adopted they would send perverse economic signals:
consumption and additional connections would be encouraged in areas where
the system is in urgent need of expansion, while in areas where there are
under-utilised assets, users would be discouraged to increase consumption or
connect. Congestion pricing, either for generation or transmission, would
remedy this somewhat, however it would be unlikely to resolve perverse
economic signals in all areas, such as the example given below.
An example the Secretariat encountered, is the case of the bulk supply point
at Drake in the north east of NSW. An abattoir had previously operated at the
site and had been the dominant load. With its closure, the load at the bulk
supply point was small and there was substantial excess capacity. Despite the
optimisation of the system, the CRNP price at Drake was among the highest
in the state. Yet the economic costs of meeting any additional demand at
Drake was very low (excluding losses). Perversely, CRNP charges would
create an incentive for a new load to locate in the nearby congested coastal
zone rather than Drake. Clearly prices in this case would not have sent
economically efficient signals. Attached is a table that further illustrates the
results of Transgrid and Secretariat CRNP analysis.
For this reason, IPART averaged the CRNP prices in each distributors
franchise area, resulting in a single transmission price for each distributor.
The resultant prices, while probably not economically ideal, were not
economically perverse, and did not generate price shocks for users.
IPART encountered similar issues in the determination of the price of access
to AGL’s gas pipelines. A “flow of molecules” approach was adopted to
allocate the revenue requirement into prices. The approach was adopted as it
was seen to minimise bypass opportunities, and more importantly that it was
endorsed by customers as an equitable approach.
“The new price structure “follows the molecules” through the system and reflects the
differing sunk costs of service based on the size and utilisation of pipes by customers.
This reduces bypass risk because most of the customers that would wish to bypass have
large loads and are served by large, well utilised pipes. Reflecting this in their transport
price reduces the difference between AGL’s transport price and a bypass price.” 22
However the “flow of molecules” approach does not eliminate incentives for
customers to bypass completely. The allocation is based on the existing
network, designed to serve all customers at current loads. This has two
implications. Firstly, the load on the system constantly changes, which means
that at every recalculation, prices could be very different, without any
economic basis. This could create incentives to bypass. Secondly, a customer
22
IPART, AGL Determination, July 1997, p60
12
could be very closely located to the supply source, however, because of the
design of the system, long lengths of pipe could be used to transport gas to
that customer, resulting in a high price. This could create a situation where
the resultant price is greater than the standalone cost of serving that customer
through a bypass pipeline, which could provide opportunities for cherry
picking.
It is worth noting here that bypass risks are different in electricity. Larger
risks may be local generation, cogeneration and local area networks. Local
generation and cogeneration costs do not depend on the costs of building
connections. Therefore, prices based on the recovery of sunk costs may
increase, rather than reduce these bypass risks.
IPART’s experience in gas and electricity shows that there is a danger in
applying a prescriptive FDC approach, such as CRNP, in the belief that it will
deliver economically efficient prices.
However a FDC approach may be acceptable on equity grounds, as was the
case in the regulation of AGL’s gas network. In this case, the approach was
seen to be equitable, despite having limitations in terms of economic
efficiency. The pricing distortions (the incentives for customers to proceed
with uneconomic bypass) were remedied by allowing negotiations between
customers and AGL.
Negotiation
The principle of negotiation, is a fundamental principle of Competition Policy
and COAG agreements. From this perspective, it is critical that customers are
given scope to negotiate with the service provider. To not include clear
guidelines to aid negotiation in the NEC, would be to go against the spirit of
the micro-economic reforms to date.
Furthermore, the ability for a customer to negotiate price and service is a
critical element of an effective network pricing arrangement. Negotiation can
supplement arrangements by providing an opportunity for pricing distortions
to be reduced.
As it stands, the provisions relating to a customers ability to negotiate, and a
network service providers obligation to negotiate, is minimal. It is critical that
these are strengthened to ensure parties’ obligations and rights are clear.
Jurisdictional regulatory powers in the NEC - information gathering and disclosure
13
The objectives of the distribution and transmission regulatory regimes set out
in 6.2.2 and 6.10.2 of the code requires the regulatory processes to be costeffective, and transparent. It is critical for the regulator be given effective
powers if these objectives are to be met.
Clearly, a regulated business will have more information about its business
than is available to the regulator or other interested parties. Due to this
problem of information asymmetry, it is vital that a regulator be given
effective information gathering and disclosure powers.
The Secretariat is concerned that the code, as it stands23, does not provide
sufficient powers in this regard to the jurisdictional regulators. A copy of a
letter sent to the ACCC outlining these concerns is attached. In brief the
Secretariat considers it unsatisfactory that the code:
 gives the regulator the power to collect only financial information;
 restricts the regulator on its use of the information; and
 restricts the regulator from disclosing any information collected.
23
The Secretariat understands that the ACCC has made a number of revisions to the code in this regard.
However, at the time of writing, these revisions had not been seen.
14
4. Conclusion
The objectives of the pricing arrangements in the code are to facilitate
economic efficiency and equity.
The CRNP methodology provided in Part C of chapter 6 of the code is very
prescriptive. It has been put forward by the industry on the grounds that it
will deliver economic efficiency, as it approximates long-run marginal cost.
Theory suggests however, that in fact the methodology is unlikely to result in
economically efficient prices. The experience of the Secretariat in using CRNP
supports this.
While the Secretariat notes that a FDC approach may have some merit in
terms of equity, as it is seen to share the benefits of economies of scope, this is
dependent on many variables such as the configuration of the network and
utilisation of assets. On this basis, it is necessary to evaluate whether the
approach is equitable on a case by case basis. This highlights a need for a
more flexible pricing arrangement than CRNP.
From this perspective, the Secretariat is of the view that CRNP is unlikely to
meet the pricing objectives in the code, and that a net benefit would result if
CRNP arrangements were modified.
Part E of chapter 6 is much less prescriptive. The current arrangements for
distribution pricing in NSW have been based on the code: the regulated
revenue cap is allocated to prices by the distribution business, and the
regulator checks the allocation method for reasonableness. This gives the
distributor the flexibility to manage risks such as bypass, and should allow
the business to retain a customer focus.
The ability for customers to negotiate is critical to an effective network pricing
arrangement. The arrangements in part C and E need to ensure that
customers are given sufficient powers to do so.
Finally, in order for regulatory objectives to be met the regulator needs
sufficient powers to collect and disclose information.
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