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Proposed changes to the ‘cost pass through mechanism’ where an electricity retailer has become insolvent

The past few years have seen important developments in the regulation of the national energy market, with amendments to the National Electricity Rules (NER) seeking to improve regulation.

One such request, made on 20 March 2014, by the Council of Australian Governments Energy Council (COAG Energy Council), is to amend the rules relating to retailer insolvency.

The COAG Energy Council has requested the Australian Energy Market Commissioner (AEMC) to amend the rules to allow Distribution Network Service Providers (DNSPs) to recover lost revenue where they have provided a ‘direct control service’ to a consumer, but the cost remains unpaid by the retailer, due to the retailer becoming insolvent.

A direct control service is defined in the National Electricity Law (NEL) as a service which is regulated in terms of either its price or the revenue which can be earned from it.

Although DNSPs can currently pass this additional cost on to consumers via the existing ‘cost pass through mechanism’, the rule change would see this mechanism amended to make it more accessible to DNSPs.

How does the current cost pass through mechanism operate?

In its current form, the ‘cost pass through mechanism’ allows DNSPs to increase the cost of services for consumers in order to meet their increased operating costs where the increase is the result of an event outside of the DNSPs’ reasonable control.

The DNSP must apply to the Australian Energy Regulator (AER) and be given approval before increasing their costs. There is currently a ‘materiality threshold’ which needs to be met before a cost pass through can be approved. The increase in the DNSPs’ operating costs as a result of the event must be greater than one per cent of their annual revenue in order for the AER to grant approval.

What is proposed to change under the new rules?

The proposed rule change would remove the materiality threshold. The effect of this would be that where a retailer has become insolvent and the DNSP cannot recover the funds owing in full, the lost revenue could be collected from across the customer base without the one per cent materiality threshold needing to be met.

The change would require two key amendments to legislation:

  • insert a definition of ‘Retailer Insolvency Costs’ into Chapter 10 of the NER which would allow costs arising from retailer insolvency events to be passed through to consumers
  • insert a new limb into the definition of ‘Positive Change Event’ in Chapter 10 of the NER to include a ‘Retailer Insolvency Event’. Events which are defined as a ‘Positive Change Event’ are not subject to the materiality threshold.

If passed, the amended rules would operate to allow the AER to approve cost pass through applications from DNSPs once they have provided evidence of the retailer insolvency and the cost impact they have experienced. Once approved, the DNSP will be able to pass on the costs they have actually incurred, even where they are less than one per cent of their annual revenue.

If passed, the amended rule will allow for the recovery of lost revenue, whereas in its’ current form, it only allows for the recovery of the increased cost of operating.

Rationale for rule change

The rule change has been requested for several reasons. These include:

  • Correcting drafting errors – the rules were intended to be amended as part of the National Energy Customer Framework (NECF) Amendment, effective from 1 July 2012, but were erroneously omitted. The NECF was initiated by the Standing Committee on Energy Resources (SCER) to promote efficiency and consistency in the energy market on a national scale. The SCER contended, in its current form, the cost pass through mechanism does not operate in the manner that was originally contemplated.
  • Distribution of costs in a fairer way – best practice regulation favours the allocation of risk to the party who has the most control over it. Yet, in the event of retailer insolvency, neither the DNSP nor the customer base have any effective control. Given neither party has control, the proposed change intends to spread the cost over a large customer base, where it will have a comparatively smaller impact.
  • Improved risk management for DNSPs – the operation of the NER limits the ways in which DNSPs can manage risk. The NER imposes an obligation on DNSPs to provide direct control services to any person who requests these services but removes the ability of DNSPs to effectively manage credit risk through pricing, as price caps are in place.
  • Compliance with NEO – in assessing rule change requests, the AEMC must consider whether a rule is consistent with the NEO, which seeks to promote the efficient investment in and use and operation of energy services. The inability to effectively manage risk can pose a significant barrier to participation in the energy market, especially for smaller and mid-sized retailers. Enabling DNSPs to better manage risk has the purpose of improving competition and promoting investment in the energy market.

Status of the rule change

The requested rule change is currently before the AEMC for assessment, including consideration of the issues raised in response to the consultation paper released by the AEMC in October 2014 seeking input on the proposed rule change. The AEMC has undertaken to make a draft rule determination for this request by 18 February 2016.

If passed, the rule change will only be effective in jurisdictions which have implemented the NECF. This currently includes NSW, ACT, SA and Tas and will include Qld from 1 July 2015 and Vic from 31 December 2015.

In deciding whether to allow the rule change, the AEMC will need to balance the competing needs and interests of DNSPs and their customers. Implementing the rule change will have the benefit of providing protection to DNSPs, although this could also mean higher costs to consumers for energy services.

Author:
Adrienne Huggins 5cm 300ppi BW JPEG 2015Adrienne Huggins | Graduate Lawyer
61 3 9258 3531
Adrienne.huggins@maddocks.com.au

 

The past few years have seen important developments in the regulation of the national energy market, with amendments to the National Electricity Rules (NER) seeking to improve regulation.

One such request, made on 20 March 2014, by the Council of Australian Governments Energy Council (COAG Energy Council), is to amend the rules relating to retailer insolvency.

The COAG Energy Council has requested the Australian Energy Market Commissioner (AEMC) to amend the rules to allow Distribution Network Service Providers (DNSPs) to recover lost revenue where they have provided a ‘direct control service’ to a consumer, but the cost remains unpaid by the retailer, due to the retailer becoming insolvent.

A direct control service is defined in the National Electricity Law (NEL) as a service which is regulated in terms of either its price or the revenue which can be earned from it.

Although DNSPs can currently pass this additional cost on to consumers via the existing ‘cost pass through mechanism’, the rule change would see this mechanism amended to make it more accessible to DNSPs.

How does the current cost pass through mechanism operate?

In its current form, the ‘cost pass through mechanism’ allows DNSPs to increase the cost of services for consumers in order to meet their increased operating costs where the increase is the result of an event outside of the DNSPs’ reasonable control.

The DNSP must apply to the Australian Energy Regulator (AER) and be given approval before increasing their costs. There is currently a ‘materiality threshold’ which needs to be met before a cost pass through can be approved. The increase in the DNSPs’ operating costs as a result of the event must be greater than one per cent of their annual revenue in order for the AER to grant approval.

What is proposed to change under the new rules?

The proposed rule change would remove the materiality threshold. The effect of this would be that where a retailer has become insolvent and the DNSP cannot recover the funds owing in full, the lost revenue could be collected from across the customer base without the one per cent materiality threshold needing to be met.

The change would require two key amendments to legislation:

  • insert a definition of ‘Retailer Insolvency Costs’ into Chapter 10 of the NER which would allow costs arising from retailer insolvency events to be passed through to consumers
  • insert a new limb into the definition of ‘Positive Change Event’ in Chapter 10 of the NER to include a ‘Retailer Insolvency Event’. Events which are defined as a ‘Positive Change Event’ are not subject to the materiality threshold.

If passed, the amended rules would operate to allow the AER to approve cost pass through applications from DNSPs once they have provided evidence of the retailer insolvency and the cost impact they have experienced. Once approved, the DNSP will be able to pass on the costs they have actually incurred, even where they are less than one per cent of their annual revenue.

If passed, the amended rule will allow for the recovery of lost revenue, whereas in its’ current form, it only allows for the recovery of the increased cost of operating.

Rationale for rule change

The rule change has been requested for several reasons. These include:

  • Correcting drafting errors – the rules were intended to be amended as part of the National Energy Customer Framework (NECF) Amendment, effective from 1 July 2012, but were erroneously omitted. The NECF was initiated by the Standing Committee on Energy Resources (SCER) to promote efficiency and consistency in the energy market on a national scale. The SCER contended, in its current form, the cost pass through mechanism does not operate in the manner that was originally contemplated.
  • Distribution of costs in a fairer way – best practice regulation favours the allocation of risk to the party who has the most control over it. Yet, in the event of retailer insolvency, neither the DNSP nor the customer base have any effective control. Given neither party has control, the proposed change intends to spread the cost over a large customer base, where it will have a comparatively smaller impact.
  • Improved risk management for DNSPs – the operation of the NER limits the ways in which DNSPs can manage risk. The NER imposes an obligation on DNSPs to provide direct control services to any person who requests these services but removes the ability of DNSPs to effectively manage credit risk through pricing, as price caps are in place.
  • Compliance with NEO – in assessing rule change requests, the AEMC must consider whether a rule is consistent with the NEO, which seeks to promote the efficient investment in and use and operation of energy services. The inability to effectively manage risk can pose a significant barrier to participation in the energy market, especially for smaller and mid-sized retailers. Enabling DNSPs to better manage risk has the purpose of improving competition and promoting investment in the energy market.

Status of the rule change

The requested rule change is currently before the AEMC for assessment, including consideration of the issues raised in response to the consultation paper released by the AEMC in October 2014 seeking input on the proposed rule change. The AEMC has undertaken to make a draft rule determination for this request by 18 February 2016.

If passed, the rule change will only be effective in jurisdictions which have implemented the NECF. This currently includes NSW, ACT, SA and Tas and will include Qld from 1 July 2015 and Vic from 31 December 2015.

In deciding whether to allow the rule change, the AEMC will need to balance the competing needs and interests of DNSPs and their customers. Implementing the rule change will have the benefit of providing protection to DNSPs, although this could also mean higher costs to consumers for energy services.

Author:
Adrienne Huggins 5cm 300ppi BW JPEG 2015Adrienne Huggins | Graduate Lawyer
61 3 9258 3531
Adrienne.huggins@maddocks.com.au