Understanding past and future trends in investment is an important part of the Commerce Commission’s role for a number of reasons, including that we need to ensure that businesses have appropriate incentives to efficiently invest.
Why distributors are required to disclose information
One of the aims of information disclosures is to promote a greater understanding of the choices electricity distribution businesses are making in their investments. All electricity distribution businesses are subject to information disclosure regulation. This means that they have to prepare and publish financial and non-financial information that stakeholders can use to assess the performance of these businesses.
Making performance data and analysis available to stakeholders will over time help them understand whether the outcomes produced are desirable or whether performance could be improved.
Among the information electricity distributors disclose is information and commentary (as part of their asset management plans) of actual and forecast capital expenditure.
Past and forecast capital expenditure can provide insight into broad trends in the electricity distribution industry’s investment needs and characteristics.
Actual capital expenditure on the network has flattened out in recent years
Figure 1 below shows actual network capital expenditure from 2005 to 2012.[1]
Actual network capital expenditure for the electricity distribution industry overall was flat over the last four years [2], following several years of steady growth. The level of capital expenditure fluctuates over time. There is a range of possible reasons for this. For example, large projects could have come to an end, or demand may have levelled off due to economic conditions and led to changes in the timing of investments.
Following the Canterbury earthquakes in 2010 and 2011 actual expenditure from Orion is not yet available and we show Orion’s data separately where it is available to indicate the expenditure trend excluding the Orion network.
Figure 1: Network capital expenditure by electricity distributors from 2005 to 2012 ($m)
Source: Commission analysis based on data from electricity distributors’ information disclosures. Note: All figures are expressed in 2012 dollars
Distributors' forecasts of capital expenditure change significantly over time
Figure 2 below replicates the industry wide capital expenditure shown in Figure 1 and adds industry wide forecast capital expenditure (built up from the forecasts each distributor made from 2009 to 2012). All forecasts exclude forecasts for Orion’s network.
To help understand how closely forecast expenditure matches actual expenditure, Figure 3 shows in more detail the differences between actual and forecast network capital expenditure for the industry overall.
Figure 2: Actual and forecast network capital expenditure by electricity distributors ($m)
Source: Commission analysis based on data from electricity distributors’ information disclosures. Note: All figures are expressed in 2012 dollars
Figure 3: Difference between actual and forecast network capital expenditure ($m)
Source: Commission analysis based on data from electricity distributors’ information disclosures. Note: All figures are expressed in 2012 dollars
Forecast industry capital expenditure has increased and tails off over time
The profiles of the overall industry forecasts made in 2010, 2011 and 2012 are hump-shaped.[3] The 2010 and 2011 shapes are similar. The forecast made in 2012 peaks earlier in the forecast period and then declines more rapidly, potentially due to the scheduling of some individual large projects. The 2012 forecast suggests a significant increase in expenditure requirement, both when compared with forecasts made in previous years and previous actual expenditure.
The level of investment needed to maintain, renew and enhance a distribution network depends on a range of factors, including the size of the network, the condition of assets, the growth in new connections and the geographic characteristics of the region the network covers.
Each electricity distribution business is responsible for choosing and delivering the investments in its distribution network. In doing so they need to consider what service customers want from their distribution network given it is these customers who ultimately pay for any investment.
The forecast profile could reflect a number of factors and may include some of the following:
- the industry could be anticipating increased demand growth and/or consumers demanding improvements in reliability which distributors plan to meet by increasing capacity over the next few years
- the industry may be planning to catch up on investment that was deferred following weak demand during the global financial crisis
- asset management practices may have improved in recent years and the forecasts may reflect more closely the actual needs of the network; the industry could be anticipating increased need to replace assets over the next few years
- distributors may have changed their attitude to risk (for example, due to recent earthquakes) and may have decided to increase investment to improve the resilience of their networks
- investment may have been deferred until after the Commission set the starting prices for 16 of the 29 electricity distributors in the end of 2012[4]
- the Commission’s use of distributors’ own forecasts in setting starting prices for default price-quality paths may have incentivised electricity distribution businesses to change the way they forecast capital expenditure (in particular in their 2012 forecast).
Forecast expenditure tends to be different from actual expenditure
The comparison of actuals and forecasts shown in Figure 3 shows that while in some years forecast expenditure is close to actual expenditure, there is a significant difference in some years. There is also significant variability in forecasts between years.
There is a range of reasons why forecasts may turn out to be different from actuals. For example, projects may be finished earlier or later than planned, projects may be deferred, the scope of projects may change, the cost of projects may change, external assumptions change over time (eg, demand forecasts could affect need for or timing of investment), or the quality of forecasts could be improved.
Robust asset management planning is an important part of an asset intensive industry like the electricity distribution industry. We hope that the asset management information we require distributors to disclose, and that the new asset management maturity assessment tool we have developed in collaboration with the industry will not just be used for regulatory purposes. We hope they will be part of electricity distribution businesses' internal asset management planning and will also be used to drive electricity distributors’ engagement with their customers. [5]
Industry wide assessments have limitations as they hide variation
The conclusions in this article apply to the industry overall but mask the wide variation at the supplier specific level.
- While the industry overall forecasts made in 2010 and 2011 are very similar (ie, the lines in Figure 2 overlap), individual distributors changed their forecasts between 2010 and 2011, some of them significantly. The similar overall level and shape of forecast capital expenditure therefore appears to be a coincidence.
- More than half of businesses in the industry have hump-shaped capital expenditure forecasts, but a number have different profiles (such as upward trending forecasts or very lumpy profiles that may reflect individual large planned projects).
- Some distributors more closely forecast their investment requirements than others.
We consider that there are a number of areas relating to investment and asset management where developing a better understanding would benefit stakeholders. Developing a better understanding of the drivers of capital expenditure across different distribution networks is one of those areas.
Further reading
The article builds on our recently published report which examined electricity distributors’ performance from 2008 to 2011. ‘Electricity distributors’ performance from 2008 to 2011’ looks at a wider range of performance indicators in the electricity distribution industry.
Footnotes
[1] Some capital expenditure relates to expenditure on assets that do not form part of the distribution network, eg office buildings or motor vehicles. This expenditure is typically 10% or less of a distributor’s spending in a given year and distributors currently do not forecast non-network capital expenditure. We have therefore limited the discussion in this article to capital expenditure on the network.
[2] This paper deals solely with Electricity distribution and does not include capital expenditure for Transpower (New Zealand's electricity transmission business).
[3] We do not know why the shape for the 2009 profile (which is trending upwards) might be different from those in the following years.
[4] For details of the electricity distribution price reset refer to the 2010-2015 Default Price-Quality Path page.
[5] We developed the ‘asset management maturity assessment tool’ to identify the maturity of current asset management practices distributors use when compared with an objective standard based on good asset management practices. For details, refer to Commerce Commission, Information Disclosure for Electricity Distribution Businesses and Gas Pipeline Businesses: Final Reasons Paper, 1 October 2012, paragraphs 5.37 to 5.41 and Attachment H.
