The Australian Energy Regulator

Expenditure Forecast Assessment Guidelines

Category analysis – Overheads and accounting issues

16 May 2013

Agenda9:00 - Introductions and objectives9:15 - Context and framework considerations9:30 - Overheads10:30 - Break10:45 - Accounting issues12:15 - Summary & next steps

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Where are we today?• Issues paper20 Dec 2012• Initial Roundtable12 Feb 2013• Category selection28 Feb 2013

• Replacement/Demand7/8 Mar 2013• Connection/Customer driven capex19/20 Mar 2013• Repex/Augex models, demand forecasting27 Mar 2013• Opex category assessment11 Apr 2013• Base-step-trend/Productivity change8 May 2013• Overheads, Cost allocation and accounting16 May 2013• Expenditure setting processTBC (~mid June)

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Objectives for todayProvide context for overheads assessmentTest potential assessment methods and

data requirements:◦Expenditure categorisations◦Normalisations◦cost drivers

Explore cost comparability issues:◦Cost allocation◦Capitalisation◦Other NSP reporting inconsistencies

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Context for todayOverheads, accounting and the incentive

framework:◦Opex (including overheads) may be set using

revealed cost◦Consistency in ex post/ ex ante capex

assessments Dealing with changes to capitalisation policies Reporting of related party margins

AER will compare overhead costs anyway:◦Opex activities in benchmarking reports◦Benchmarking of capex (including overheads)◦Capex/ opex category trade-offs

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Overheads expenditures

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Overheads – what’s in/ out“Overheads” = anything not yet covered in

workshops“direct” overheads

◦functions that are focussed on the management and general operation of the network

◦e.g. Network planning and operations“Indirect” overheads

◦corporate functions that are standard to almost all large businesses

◦e.g. CEO, HR, licence feesNon-system capex, capitalised overheads

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Lice

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capex

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augex

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Non-system

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8

Opex breakdown, all NSPs

9Source: Latest RIN data

55%

14%

28%

3% "direct" opex (repairs, maintenance)

network operating costs

other opex (metering, customer service)

opex overheads (where listed)

Capex breakdown, all NSPs

10Source: Latest RIN data

89%

4%

1%2%

2%

2%

11%

system capex

IT Systems and communications

Land

Buildings

vehicles

other

Previous AER approachesIn opex trends, recognition of:

◦Correlation to network growth◦economies of scale/ presence of fixed costs

Detailed expert reviewNSP justifications

◦bottom up e.g. CBA◦non-bottom up/ modelling

Some benchmarking (e.g. NSW reset)Limited consistency and transparency in

reported categories

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Ofgem’s general approachDirect overheads = “closely associated

indirects”◦11 sub-categories, eg network design, project

management, control, call centre, training◦Grouped according to normalisation “metrics”

MEAV Total network investment Total direct costs Drivers for the associated direct cost Combination of the above

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Ofgem’s general approachCorporate / Indirect overheads =

“business support costs”Eg HR, CEO, Finance, Property

◦External benchmarking (ie with other, unregulated businesses)

◦NSPs to provide evidence of insourcing/ outsourcing decisions/ business models

◦Metrics (not drivers) – employee numbers, revenue, end users (eg IT clients)

◦Expert review – IT and land

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Ofgem’s general approachBoundary issues in direct vs indirectTreatment of once-off costs, use of averages for

lumpy costsBenchmarking before and after allocations, to

services as well as DNOs in a groupChoice of metrics & transparency of

assessment◦Use of (direct) expenditures as a driver/ metric

potentially rewards inefficient behaviour◦“Metrics/ scale factors should be stable over time,

outside the DNO’s control, not collinear with other measures”

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Direct overheads (opex)Potential categorisations:

◦Asset/Network Management◦Network operations◦“other” - Customer service, metering, billing?

Potential drivers - network size/ value?◦Undepreciated RAB/ MEAV◦Revenue◦Customer numbers

Impact of any “uncontrollable” factors as per direct capex/opex?

15

16

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

network ops

17

y = 88.398x + 2E+06R² = 0.1793

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

10,000,000

0 10000 20000 30000 40000 50000 60000

network ops per RAB

18

y = 0.7476x - 3859.1R² = 0.4987

-10,000

0

10,000

20,000

30,000

40,000

50,000

60,000

0 10000 20000 30000 40000 50000

network ops per MEAV

19

y = 0.6905x + 656762R² = 0.0083

0

200000

400000

600000

800000

1000000

1200000

1400000

1600000

1800000

0 50000 100000 150000 200000

"other" opex per customer numbers

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y = 7.471x + 255940R² = 0.632

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

2,000,000

0 50000 100000 150000 200000

"other" opex per revenue

Non-system capexPotential high level categories:

◦IT◦Communications◦Vehicles◦Land◦Buildings◦Furniture, plant and equipment◦Other

Drivers - network size, employees?Isolating recurrent from irregular costs

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Non-system capexIT – subcategories and supporting data:

◦recurrent vs one-off◦Leased vs purchased◦Fixed vs variable◦Cost per end user or employee?

Communications - similar points to IT◦Hardware vs software◦Data vs oral communications◦Cost per end user or employee?

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23

0

0.05

0.1

0.15

0.2

0.25

0.3

1 2 3 4 5 6 7 8 9 10 11 12 13 14

IT & comms (5 year average) per customer

Source: NSP RIN data

Non-system capexVehicles – subcategories and supporting

data:◦Leased vs purchased◦Cost and number of vehicles for:

Heavy/ light Passenger/ commercial

◦Impact of network area, km of line, employees, direct capex/ opex “workload”, number of jobs?

◦Utilisation data – kms, days used?

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25

0

1

2

3

4

5

6

1 2 3 4 5 6 7 8

Vehicles (5 year average) per km of line

26

0

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.09

0.1

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Vehicles per total capex (5 year averages)

Indirect overheadsTypical inclusions: CEO, Legal and

secretariat, HR, Finance, TreasuryNot visible in existing reportingExpect these costs to be largely fixed,

otherwise by FTEs?May reflect uncontrollable jurisdictional/

regulatory differencesComparable with competitive firms?Expensed and capitalisedCost allocation issues

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28

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 2 3 4 5 6 7 8

% direct opex

% opex overheads

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 2 3 4 5 6 7 8

% direct capex

% capex overheads

Accounting & reporting issues

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“Accounting issues”Things which detract from like-for-like

comparisons◦Capitalisation◦CAMs and cost allocation◦Related party margins/ fees◦Service classifications◦Standard voltage differences◦Different reporting years (calendar vs financial)

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CapitalisationWhat’s the problem?

◦ Accounting rules/ discretion in expensing/ capitalising◦ Policy not currently disclosed/explained by NSPs◦ Lack of comparability, e.g. in capitalised labour,

overheadsWhat AER/ stakeholders previously said

◦ Issues paper canvassed possible AER prescription◦ No support for this (ENA)

Considerations for discussion◦ If no prescription, what is “transparency”?◦ New Rules require accounting for capitalisation policy

changes in RAB roll-forward – how to do this?

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Cost allocation issuesWhat’s the problem?

◦Allocation between services and within standard control categories

◦Assessment of allocated/ shared costs but also preserving comparisons of directly attributable costs

What AER/ stakeholders previously said◦Issues paper canvassed possible AER prescription◦Responses – NSPs do not support single approach

Considerations for discussion◦If no prescription, what is “transparency”?◦Full visibility (calculations) of overheads allocation◦Reconciliation to statutory accounts

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Related-party marginsWhat’s the problem?o Margins currently assessed through specific efficiency

testo Require ongoing visibility of amounts

What AER/ stakeholders previously said◦Issues paper identified existing approach, noted

potential overlap with capex incentives/ ex post reviews

Considerations for discussion◦Ongoing need for transparency◦Differences between ex ante and potential ex post

assessment?

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Service classificationsWhat’s the problem?

◦Differing classifications mainly due to previous classification under earlier legislation

◦New services, e.g. AMI in Victoria (from 2016)Considerations for discussion

◦Materiality of problem◦Visibility and treatment of material differences◦CAM issues - visibility of allocations between

services

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Jurisdictional voltage variationWhat’s the problem?

◦Differing operating voltages may affect cost benchmarking

◦Voltage identified previously as a potential cost driver e.g. capex

Considerations for discussion◦Consideration of capex categories that capture

differences◦Recognition of materially different conditions

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Reporting year variationsWhat’s the problem?

◦Different regulatory reporting years may inhibit comparison of expenditures

What AER/ stakeholders previously said◦Issues paper suggested long term alignment◦Responses questioned materiality in context of

other benchmarking issuesConsiderations for discussion

◦Recognition of lags in some annual reporting/ benchmarking information

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Summary and next steps

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