Traditional frameworks for economic regulation of energy networks and pipelines are being fundamentally challenged by the transition to low carbon (or zero carbon) technologies.  

A central objective of these regulatory schemes has been (and remains) the promotion of economic efficiency. Both the National Electricity Law and the National Gas Law seek to promote efficient investment in, and efficient operation and use of, energy services for the long term interests of consumers.

In pursuit of this objective, regulators have generally focused on encouraging efficient utilisation of existing infrastructure, as well as creating incentives for efficient investment in renewal and augmentation works required to maintain reliable and secure energy supply.  In this context, greater use of energy services – including both natural gas and electricity services – has generally been seen as a positive.  Increased use generally leads to more efficient utilisation of existing capacity, which in turn means lower energy prices for consumers.

Decarbonisation objectives have not featured prominently in instruments of economic regulation.  When the National Electricity Law and the National Gas Law refer to the “long term interests of consumers” they speak of consumer interests with respect to price, quality, safety, reliability and security of supply.  Thus, the statutory objectives address two limbs of the energy trilemma, but are silent on the third limb – there is no reference to decarbonisation or other environmental goals which might be important to consumers.

Evolution or revolution in Australia’s energy laws?

Despite the absence of explicit decarbonisation objectives in our national energy laws, incremental changes continue to be made to the electricity and gas regulatory frameworks with these objectives squarely in mind.

Some examples of this evolutionary trend include:

1. Energy Ministers have recently agreed to make changes to the National Gas Law, National Energy Retail Law and subordinate instruments to bring hydrogen and other renewable gas blends within the ambit of the national regulatory framework.  These will potentially include changes to the technical definitions of key terms such as ‘natural gas’.
2. Over the past five years, a number of changes have been made to the transmission network planning framework (Chapter 5 of the National Electricity Rules) aimed at facilitating the development of transmission infrastructure required to support the energy system transition.  Chapter 5 now includes a separate investment test process for “actionable ISP projects”, which are projects identified in AEMO’s Integrated System Plan as forming part of the “optimal development path” for the system transition.
3. Individual states have also introduced their own schemes to prioritise the development of infrastructure to support renewable energy zones.  In some cases (NSW being one example) these schemes allow for explicit carveouts from the national regulatory framework for infrastructure within the designated zones(For example, regulations under section 41 of the Electricity Infrastructure Investment Act 2020 (NSW) may modify the application of, or disapply, a provision of the National Electricity Law or the National Electricity Rules to the extent reasonably necessary to achieve the objects of the Act and to enable a network operator to carry out a REZ network infrastructure project).
4. At the distribution level, various modifications have been made to the tariff rules and incentive frameworks, aimed at facilitating integration of (and providing appropriate charging mechanisms for) distributed energy resources such as rooftop solar.

However more fundamental questions are now being asked about the objectives of economic regulation, and whether these may come into conflict with decarbonisation policy.

In a recent paper focused on gas pipeline regulation, the Australian Energy Regulator (AER) asks whether decarbonisation policies aimed at reducing gas usage could soon come into conflict with the objectives of the national gas regulatory framework, which encourages more gas consumption to promote efficient utilisation of the gas network and to lower the prices paid by gas consumers.

The potential for conflict is most obvious and acute in the case of the gas pipeline regulatory framework, which applies to both transmission pipelines and distribution infrastructure.  While in time some pipeline infrastructure may be put to other uses – such as transporting hydrogen – in the near term it has no alternative use.  This means that reducing gas usage in pursuit of decarbonisation objectives is likely to mean increasing prices for use of this infrastructure, the cost of which is largely fixed.

In the case of electricity, decarbonisation objectives can be achieved through changes to the fuel mix rather than necessarily reducing usage.  Indeed, we may see usage of electricity networks increasing as more sectors of the economy are electrified, particularly transport.  However even changes to the fuel mix – as well as changes to the profile of usage – are likely to alter the economics of electricity networks, particularly if this comes with greater decentralisation and more usage moving behind the meter.

Revisiting the regulatory compact

The long-term regulatory compact with owners of essential network infrastructure has provided a degree of stability and certainty around recovery of long-lived sunk investments, in exchange for relatively low rates of return.  For so long as usage has remained stable (or has been growing), regulators have been able to maintain this compact with investors while also ensuring affordability for consumers.

However the prospect of declining usage creates challenges for regulators in maintaining this regulatory compact.  Regulators are likely to become increasingly concerned about increasing prices if usage patterns continue to change.  At one extreme, there is the prospect of a ‘last customer problem’ emerging for some network and pipeline assets.

From the perspective of investors and asset owners, a combination of changing usage patterns and uncertainty around the future regulatory framework creates heightened risk around new investment.  This in itself creates challenges for the energy market transition.  Perceptions of increased risk are likely to place upward pressure on required rates of return, and may lead to necessary investment being delayed or abandoned.

The debate about how to resolve these challenges has really only just begun. The Information Paper released by the AER in November is a step in the right direction.  The AER has squarely acknowledged the challenges facing the gas pipeline regulatory framework and canvassed a range of thorny questions which will need to be addressed.  However, for the moment, the AER has left many of these questions about the future direction of economic regulation unanswered.

The good news is that the energy sector is not the first to face these types of regulatory challenges.  Lessons can be drawn from other sectors that have faced similar disruptions, albeit on a different scale and from different sources.  For example, in the telecommunications sector, regulators have been forced to grapple with the implications of declining usage of legacy network infrastructure as services have migrated to next generation networks.

A key question is whether regulators in the energy sector can continue to navigate these challenges within existing legal frameworks, or with only incremental changes to those frameworks.  To date, our regulators and policy-makers have focused largely on adaptation.  However there are some signs that a broader regulatory revolution may be brewing.