Review into the Transmission Ring-Fencing Guideline
Fast Facts
The AER commenced a review into the ring-fencing arrangements for TNSPs in November 2019, after becoming aware that, when the National Electricity Rules (NER) were amended to introduce Chapter 6A, these changes did not include provisions to transition the 2005 Transmission Guidelines.
The AER plans to use the outcome of the review to develop an amended Electricity Transmission Ring-fencing Guideline (Final Guideline).
In April 2022, the AER recommenced its review into the ring-fencing arrangements for TNSPs after a project pause in light of the COVID-19 pandemic. As an interim measure, an interim Guideline was released in April 2022, substantively re-issuing the existing 2005 Guideline.
On 31 May 2022, the AER released an Issues Paper on the development of the Final Guideline providing initial views on:
The services able to be provided by TNSPs (e.g. via technologies such as batteries);
The benefits and costs of strengthening any functional separation requirements, and
The strengthening of reporting and compliance requirements.
Submissions on the Issues Paper close 22 July 2022, with a Draft Guideline expected in November 2022. This is in preparation for the release of the Final Guideline early in 2023.
Background
Ring-fencing refers to the separation of regulated services provided by a TNSP (e.g. the installation and/or maintenance of poles and wires) from the contestable services conducted by a TNSP or through an affiliated entity (e.g. participation in the provision of generation, participation in retail services etc). Clause 6.17A of the NER sets out the requirements for the ring-fencing of TNSPs.
What is Ring-Fencing for Transmission?
To meet the underlying objectives of ring-fencing, the 2005 Guidelines require a TNSP to avoid cross-subsidisation and discriminatory behaviour by requiring TNSPs to put in place controls relating to legal and accounting separation; functional separation; non-discrimination, location, branding, information access and service providers; waivers; and compliance and reporting. Effectively, these measures segregate regulated transmission services from other competitive services in a bid to ensure effective separation from inherent monopoly power.
Why the change?
The original transmission ring-fencing Guidelines were developed at a time when there were few unregulated services being offered by TNSPs. For this reason, they have historically attracted little attention. However, it has been well known for some time amongst market participants that a update to existing guidance was necessary given the increasingly competitive nature of transmission connections in particular, but also the changes in the overall system as a consequence of the gradual exit of coal. These changes have been significant, for example:
An influx of renewables is requiring an abundant amount of new transmission installation (the Step Change scenario from the Draft 2022 ISP contemplates nearly 10,000km to connect 122GW of new VRE, and $12.5 billion worth of actionable projects);
An increase in the deployment of assets such as batteries and synchronous condensers used across both regulated and contestable services, is blurring the distinctions across these markets (which has recently been seen in REZ development, which may increase commercial interest in transmission; and generation businesses combining under common ownership structures);
The role of TNSPs in the transition to net-zero is ever evolving and remains subject to future change and developments, making it clear that there is a need for strong, effective and robust arrangements to ensure flexibility to accommodate any future arrangements; and
Recent reforms, particularly the implementation of the new Distribution Ring-Fencing Guideline, have highlighted a need for a refresh and fit-for-purpose TSNP arrangements within the same context.
Submissions Made to the 2019 Discussion Paper
During the consultation process for the 2019 Discussion Paper, a number of TNSPs (e.g. TasNetworks, TransGrid) made submissions that indicated support for a light-handed regime of ring-fencing. These submissions include views that:
There is no justification for any extra costs associated with more stringent regulation, on the basis that no evidence exists of sufficient harm, especially as it might relate to more heavy handed legal or functional separation requirements;
The current 5% threshold that allows TNSPs to provide other competitive services is sufficient and appropriate;
A relaxation on TNSPs conducting distribution activities should be considered; and
Any amendments to the Guidelines need to be consistent with the ISP or any other national developments or frameworks.
Other parties, which included consumer interest groups, noted that the more recent DNSP Ring-fencing Guidelines are an appropriate model upon which to base the TNSP guidance, and that stronger provisions are needed to promote competition for transmission connections.
Consultation on the Issues Paper is likely to lend itself to increased interest and commentary from a number of additional parties.
Key Issues
The AER’s starting point appears to reflect a desire to strengthen the current arrangements to reflect the evolution of the NEM. Relevant markets have changed significantly since the 2005 Guideline, and TNSPs are operating with broader scope and with more diversified equity ownership than ever before.
Cross-subsidisation
The current Guidelines are relatively light handed in how they regulate TNSP activity outside of prescribed services, particularly when compared to the ring-fencing arrangements for DNSP’s.
The AER’s initial views within the Issues Paper focus on strengthen these arrangements through a series of amendments aimed to improve the transparency over how costs should be allocated between services. The mechanisms considered are twofold - accounting and transactional separation, and legal separation.
Regarding accounting and transactional separation, the AER has snoted its intention to make separation measures clearer. In particular, the AER has sought feedback on an update to guidance reflect the difference between “services” and “activities”, which it considers will corroborate and reflect concepts within the NEL and NER – and provide consistency with the DNSP Guideline.
Regarding legal separation, the AER once again is seeking to define and improve the Guidelines to insert an added layer of transparency and assurance to arrangements for the separation of services and entities, through the clear identification of arm’s length arrangements and bolstering of non-discrimination clauses. There are still questions to be raised, but the AER’s preliminary thoughts point towards a number of key areas for discussion, particularly:
What is the best way to clearly define a TNSPs scope of services? – where at a minimum, the AER has suggested identifying a scope of services that allows TNSPs to provide transmission services (including prescribed, negotiated and contestable services) within the same legal entity, albeit with the functional separation of staff, offices and branding. The AER asserts that focussing on “what services” a TNSP can provide will increase TNSP confidence in what their optimal mix of assets actually is;
What is the actual scope of services a TNSP can provide? – where the AER’s initial view is that the current Guideline should, to future-proof against market development, be amended to explicitly define:
What related services TNSPs can provide - which at this stage, will only include Distribution Services, and the exploration of the potential for emerging electricity services and non-electricity services; and
What cannot be provided - such as generation/retail services.
How will batteries be treated? – where the AER have proposed encouraging TNSPs to take advantage of underutilised assets, exploring the possibility of allowing TNSPs to lease any spare capacity, or provide some non-network services with appropriate regulatory oversight; and
What are the best-case Grandfathering arrangements? - where the AER has noted TNSP concerns, and is seeking feedback on both the tax impacts to TNSPs, and the likely effect of being required to establish new commercial agreements and adhere to new regulatory obligations.
Discrimination
Discrimination, in this context, means “favouring” an affiliate entity. Current guidance only considers discrimination in relation to prescribed services, and not contestable services – which the AER considers light-handed when compared to restrictions on DNSP’s. The AER is exploring potential avenues to limit a TNSPs ability to discriminate.
To do such, several options are being explored by the AER, including:
Insertion of a general obligation not to discriminate – which may be broad enough to apply to contestable electricity services, aligning with the DNSP Guidelines and recognising the ability of TNSPs to discriminate in favour of themselves or an affiliate;
The functional separations of offices, staff, branding, and cross promotions – where the appropriate balance between costs and division of staff will need to be met, particularly between prescribed and contestable/non-transmission services; and
Stringent frameworks on information access and disclosure – where the AER proposes alignment with the DNSP Guideline, and aligning the application of this with proposed obligations under the Transmission Connection and Planning Arrangements.
Compliance
Currently, the AER is of the position that current oversight of TNSP compliance is limited, with the idea of regular reporting being floated to potentially allow both the AER, and the broader market, greater transparency. Whether this will actually lead to the intended outcomes is being tested in the application of the DNSP Guideline (from which these provisions are duplicated). The AER is also consulting on the idea of the publication of a best practice manual, along with a template for breach reporting.
Our Insights
The AER’s review of ring-fencing for transmission is timely given the complexity of transitional issues at play that should be addressed now to provide market certainty, particularly in relation to the operation and ownership of battery assets, and affiliate business engagements in contestable delivery of transmission.
Ring-fencing settings may have significant implications for existing battery asset owners and potential future investors. TNSP network operation – particularly following the AEMC’s recent Efficient Management of System Strength on the Power System rule change – will continue to require the procurement of system strength services. There are instances where the most cost-effective method to provide such services will be through direct ownership of assets by incumbent TNSPs; however, we agree with the AER that there are significant risks for emerging markets associated with such ownership. Without sufficient regulation, the value pools associated with these assets could be diluted through direct engagement in markets by TNSPs and/or preferential contracting between TNSPs and affiliates. Market risks – even if only perceived – will reduce investment certainty and may result in some projects becoming unviable. Given the future storage requirements of the NEM, the AER should carefully consider ring-fencing settings. We encourage investors and asset owners to engage with the AER on these matters to provide a more rounded perspective of these risks.
Facilitating a competitive market for delivery of contestable transmission is becoming increasingly important in the NEM.
Firstly, if renewables are to be installed at pace, generation connections will need to be delivered quickly, and competitively. Recent connection-related rule changes introduced the concept of designated connection assets but retained the contestable ownership, design, and construction elements of 2017 arrangements (dedicated connection assets).
Secondly, there is potential for increased contestable delivery of Renewable Energy Zone (REZ) transmission by state governments: NSW has already established EnergyCo (a statutory authority) to facilitate the competitive tender processes for the design, construction and operation of Central-West Orana REZ network infrastructure. Other states may follow suite with contestable delivery models for this infrastructure. We note that Victoria has established VicGrid which has been tasked with co-ordinating the overarching planning and development of Victorian REZs – though the interaction with existing contestable arrangements in Victoria is uncertain.
Potential contestability reforms for general transmission are being considered by the AEMC as part of its continuing Transmission Planning and Investment Review.
This context makes the case for the AER to closely examine the advantages that affiliated businesses may obtain in contestable delivery of transmission. The AER’s initial views are to broaden the restrictions upon TNSPs related to contestable services to address discrimination in favour of affiliated businesses. This appears a sensible starting point, but the question of whether further functional separation is necessary is finely balanced. Allowing affiliated businesses to draw on the expertise of the TNSP regarding the ‘state of play’ may, in the short term, benefit consumers through reduced costs. However, over the long term, it may disincentivise new entrants coming into the market. Given the global requirement for network investment to increase substantially, thought should be given to how to make Australia as attractive as possible for competitive investment.
For more information, contact Matt Rennie at mrennie@renniepartners.com.au
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