New merits review regime commences

In brief

Major changes to the merits review regime applying to regulated revenue and price determinations that the Australian Energy Regulator makes for electricity and gas networks have now come into operation. Partner Grant Anderson reports.

Background

The Australian Energy Regulator (the AER) is responsible for making periodic distribution and transmission determinations that regulate the revenue or prices that may be earned or charged by electricity network service providers, and for approving access arrangements that regulate the revenue or prices that may be earned or charged by gas network service providers. These regulatory determinations may be appealed by the network service provider or users (including consumers) to the Australian Competition Tribunal (the ACT),¹ which is charged with reviewing the merits of the determination. Specifically, if the ACT is satisfied that the AER has made a material error of fact or incorrectly exercised a discretion, or that the AER's decision on a matter is unreasonable, then (subject to certain quantitative and qualitative thresholds being satisfied) the ACT may itself vary the determination, or else set the determination aside and remit the matter back to the AER to remake the determination according to the ACT's directions or recommendations.² Following an analysis of this merits review regime by an independent expert panel, and the adoption of some of the panel's recommendations by the Standing Council on Energy and Resources, the South Australian Parliament, as the lead legislator for the National Electricity Law (NEL) and National Gas Law (NGL), passed amendments to those laws, which came into operation on 19 December 2013.

These amendments are largely intended to address two deficiencies identified in relation to the current merits review regime – namely:

• its tendency to focus on specific aspects of a regulatory determination (ie on 'error correction'), rather than on the overall outcome represented by the regulatory determination; and
• the absence of any requirement to assess the regulatory determination against the long-term interests of electricity or gas consumers – this concept is embodied in the national electricity and national gas objectives, which are to promote efficient investment in, and efficient operation and use of, electricity and natural gas services for the long-term interests of consumers with respect to price, quality, safety, reliability and security of electricity and natural gas supply³

Amendments to merits review regime

The recently passed amendments make a number of significant changes to the merits review regime.

The first change is to emphasise the need to fulfil the national electricity/gas objective to the fullest possible extent. This position is implemented through the following amendments:

• the AER's regulatory determination must be the one that the AER is satisfied is likely to 'contribute to the achievement of the national [electricity/gas] objective to the greatest degree';⁴
• the ACT may only grant leave to apply for a review of a regulatory determination if the ACT is satisfied that the applicant for leave has established a prima facie case that, on the basis of the grounds for review advanced by the applicant, there is likely to be an alternative regulatory determination that is 'materially preferable' in making a contribution to the achievement of the national electricity/gas objective – this is in addition to the requirement for the applicant to establish that a ground of review (material error of fact, incorrect exercise of discretion or unreasonable decision) exists;⁵ and
• the ACT may only vary a regulatory determination, or set a regulatory determination aside and remit it to the AER for remaking, if the ACT is satisfied that to do so is likely to result in a regulatory determination that is 'materially preferable' in making a contribution to the achievement of the national electricity/gas objective⁶ – for these purposes, the ACT is required to consider how the constituent components of the regulatory determination (ie the component decisions) interrelate with each other and the grounds for review, as well as the regulatory determination as a whole. That is, the ACT is not to restrict its focus to the grounds for review but must consider the operation of the determination more broadly.⁷

An intended consequence of these amendments is to reduce the number of successful merits reviews, and so restrict increases in regulated revenues and tariffs as a result of such reviews⁸ (from 2008 to 2012, 22 regulatory determinations were appealed, resulting in regulated revenues increasing by around $3.3 billion). This is consistent with the express intent of the relatively recent changes to the economic regulation of network service providers under the National Electricity and National Gas Rules, which confer increased discretion on the AER in its determination of matters such as the weighted average cost of capital and, to that extent, reduce the prospects of a successful challenge to the AER's determination of those matters.⁹

Consonant with the emphasis on the overall outcome of a regulatory determination, the second change introduced by the amendments is to permit the AER, in a merits review, not only to respond to matters raised by the applicant (or an intervener), but also to raise any other matter that relates to:

• a ground for review or a matter raised in support of a ground for review; or
• an alternative materially preferable decision, the interrelationship of the constituent components of the regulatory determination or the achievement of the national electricity/gas objective.¹⁰

The third change is to restrict the matters that may be raised by the appealing network service provider in a merits review¹¹ – specifically, such a network service provider may not raise 'any matter that was not raised and maintained by the provider in submissions to the AER before the [regulatory decision] was made'.¹² This addresses two issues that have been the subject of recent argument before the ACT and the Federal Court:

• it is not sufficient for a network service provider simply to raise a matter early on in the regulatory process (which commences after the lodgement of the regulatory proposal, in the case of electricity, and after the lodgement of the access arrangement (revision) proposal, in the case of gas)¹³ and either to abandon that matter expressly or not persist with it – instead, to preserve its merits review options, a network service provider must maintain its position right up until the final determination is made;¹⁴ and
• even though the AER's practice is to conduct the regulatory process for 'tranches' of electricity network service providers and to deliver the one set of reasons for each such tranche (albeit with separate regulatory determinations for each network service provider in the tranche), the network service providers in a tranche cannot rely (for merits review purposes) on matters raised by other providers in that tranche during the regulatory process but must specifically raise those matters itself – this is an unfortunate position, as it will simply encourage network service providers to adopt (or copy) each other's submissions, and may lead to inconsistent (and incongruent) outcomes where network service providers are treated differently in relation to the application of common parameters (eg cost of capital) because only some of them have raised issues with the determination of those parameters.¹⁵

The fourth change introduced by the amendments is to entitle any person who has made a submission during the regulatory process, as well as a Minister of a participating jurisdiction,¹⁶ to seek review of the regulatory determination (albeit subject to various restrictions)¹⁷ rather than merely to intervene in a review. This has the potential to increase the number of merits review applications that are made, not by affected network service providers but by consumer interests.

The fifth change is to require the ACT to take reasonable steps to consult with users, and consumer associations and interest groups who are not party to the review, before making a determination.¹⁸ Quite how this will be done in practice is likely to represent something of a challenge for the ACT.

The sixth change is that a network service provider is not permitted to pass through, or otherwise recover, the costs it incurs in respect of a review of the regulatory determination that applies to it (including where the review is sought by another party).¹⁹ This prohibition is at least in part intended to focus the attention of network service providers on whether it is likely to be cost-effective to seek merits review of a regulatory determination.²⁰

The final change is one that recognises the limitations of a judicial body such as the ACT in reviewing complex economic regulatory determinations that require a balancing of competing interests and the exercise of a significant degree of policy making. In this regard, the amendments require the ACT to remit a successfully challenged regulatory determination to the AER for remaking, rather than to vary the determination itself, unless the ACT is satisfied that, in varying the determination, the ACT will not become involved in undertaking an unduly complicated assessment.²¹

The role of the ACT in the limited merits review regime is to be reviewed during 2017.²² Among other things, this review will recommend whether (consistently with the expert panel's recommendations) a new review body should replace the ACT. This recognises that, despite minor changes having been made to the Competition and Consumer Regulations 2010 (Cth) to make the ACT's role in a merits review less formal and more investigative, a disadvantage of having a judge-led tribunal undertake the review function is that it will tend to operate in a relatively legalistic manner that may discourage consumer participation in the review process. The expert panel recommended that, instead of the ACT, the review body should take the form of a specially constituted panel of reviewers (comprising experts in regulation, energy markets, economics, finance and engineering) who would undertake the review of the contested regulatory determination in an investigative (rather than an adversarial and overly legalistic) manner. In the absence of increased consumer participation and engagement in the regulatory review process, and a clear demonstration that the ACT's decisions are justifiable by reference to the national electricity/gas objectives, it is quite conceivable that this next review of the merits review regime will lead to the replacement of the ACT by such a body.²³

Next steps

When approaching their forthcoming regulatory determinations, electricity and gas network service providers will need to bear in mind the changed merits review regime that will apply to them. The new requirements of this regime should influence the way in which they structure their regulatory proposals and submissions, so as to maximise the chances of a successful merits review outcome.

Allens assisted the Australian Energy Market Commission in drafting the major changes to the economic regulation of electricity and gas network service providers that came into effect on 29 November 2012. In addition, Allens has advised various network service providers on their merits review applications (including ENERGEX on its successful merits review application relating to the gamma value), and in preparing their regulatory proposals.

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