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Financeability in revenue cap decisions for electricity distribution businesses

Home Insights Financeability in revenue cap decisions for electricity distribution businesses

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Contributed by: Michael Loan and Sophie Chester

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Published on: February 26, 2024


The relevance of financeability to the setting of regulated revenue caps continues to receive scrutiny as the Commerce Commission (Commission) and regulated electricity distribution businesses (EDBs) look ahead to the Commission's upcoming decision on the next default price-quality path (DPP4).

Last week the Commission released the Issues Paper on Financeability of electricity distribution services in the default price-quality path (Issues Paper). The default price-quality path (DPP) regulates the maximum revenues and the required quality standards for certain EDBs. 16 EDBs are subject to the DPP (or, where applicable, a customised price-quality path (CPP)), with a further 13 EDBs only subject to information disclosure regulation as they are deemed to be "consumer-owned" under the Commerce Act 1986. DPP4 must be set by 30 November and will apply over the next four or five years from 1 April 2025.

The DPP4 decision will be a critical milestone for regulated EDBs and their plans to significantly increase the level of investment in their networks, in the face of electrification-driven demand growth and an increasing focus on the need for more resilient networks. The Commission reports that the 16 EDBs are forecasting approximately $8.4 billion of investment between 2025 and 2030.

The Issues Paper focuses on the relevance of financeability to the Commission's upcoming decision to set DPP4. A broader consultation paper on the upcoming DPP4 decision was issued by the Commission in November last year, entitled "Issues Paper on Default price-quality paths for electricity distribution businesses". You can read more about this in our previous Insight here. In addition, in December last year the Commission issued its final decisions on input methodologies (IMs) for services regulated under Part 4 of the Commerce Act 1986, following its 2023 review. IMs set out how assets are to be valued and other key components of the regulatory regime and must be applied when the Commission sets each DPP.

During 2023 the Commission received a number of submissions calling for a prescriptive financeability test to be included in the IMs in the context of revenue caps for the 16 EDBs. The argument, broadly, was for a test (consistent with certain international regimes) to check that proposed revenue cap decisions would be sufficient to enable EDBs to be adequately funded and incentivised to invest. The Commission's final decision was not to include a financeability test in the IMs, primarily on the basis that it did not consider it necessary to have such a test in order to consider financeability. The Issues Paper now seeks to outline the Commission's view of how financeability may be relevant to its upcoming DPP4 decision.

Whilst the Commission describes itself as being very much "alive" to financeability concerns that have been raised, it has made it clear that financing significant new investment and capacity is the responsibility of the EDB through normal, efficient capital raising and management. To this end, the Commission notes that it is not its role to:

  1. resolve financeability issues caused by capital structure, dividend or other investment decisions made by the EDB that ultimately compromise its ability to finance expenditure on its network; or

  2. accelerate revenue recovery from existing customers in periods of high growth to provide funds for new investments.

Rather, it is for the owners of the EDB to resolve structural issues (through a restructure or a sale to another owner) and to fund new investments through new debt and/or equity.

That being said, the Commission proposes to consider financeability via a 'sense check'. This 'sense check' would involve the use of a notional analysis of whether a financeability issue would exist for a prudent and efficient supplier under the proposed price path. If an issue arises under this analysis, the Commission will then assess whether there was in fact likely to be a financeability issue for the particular EDB.

Whilst the Commission does not prescribe any particular outcomes from its proposed sense check, the Commission notes that the check will be important to their assessment of whether there is a real risk that financeability concerns may disincentivise investment or otherwise impact investment in a way that risks actual harm to the long-term benefit of consumers.

In addition to the 'sense check', the Issues Paper outlines certain specific decisions where financeability may be considered by the Commission (including where the Commission may make adjustments if its sense check identifies an issue for a particular EDB). The identified decisions are limited to those that affect the timing of cashflows.

Finally, the Issues Paper notes that, in the absence of any widespread financeability issue, the Commission may consider a customised price-quality path (CPP) mechanism to be a better option than the DPP to address an EDB's particular circumstances. CPPs involve a greater level of verification, consumer consultation and scrutiny for the EDB. In addition, the Commission notes that:

  1. the EDB would need to demonstrate the capital management steps they had already taken and provide evidence of a lack of access to equity; and

  2. where customers are in substance being asked to provide funding by paying higher prices in the short term (eg to enable a trust-owned EDB to remain trust-owned), the Commission would expect consumer consultation on the issue.

Submissions on the Issues Paper are due 15 March 2024, with cross-submissions due on 29 March 2024. The Commission intends to release a draft DPP4 decision for consultation in May 2024, with the final decision due in November 2024.

This article is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance on any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact one of the partners listed below.

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