<mark>on the cost and performance of battery storage, which is changing rapidly (Australian Energy Market Commission, 2015). At current storage costs, most consumers will continue to benefit from grid connection both as a source to cover peak supply, a market for excess power production, and a back-up when solar resources are inadequate. As long as they remain connected to the grid, these customers could potentially provide value to the distribution grid, by allowing deferral of upgrades, relieving network congestion, and</mark> providing other ancillary services.

<mark>Incentives to adopt distributed generation depend critically on retail tariff structures as well as the design of net metering or feed-in-tariff arrangements as well as any compensation for ancillary services. The higher the share of variable charges in retail energy bills, the greater the extent of cross-subsidy among customer groups, and the more generous the provisions for resale of power into the network, the stronger will be the incentive for retail customers to invest in distributed generation. Without careful design of these pricing structures, there is a risk that distributed generation could undermine the basis for recovery of the fixed costs of the local distribution network. It is also likely that over time distributed generation may undermine the basis for cross-subsidy in retail</mark> electricity tariffs, which have long been a mainstay of social policy in the sector.

<mark>Turning next to the structure of costs, the general direction of all the recent technology</mark> and climatic trends is towards increasing the capital intensity of the energy sector.

<mark>The transition to a clean energy future will involve higher levels of investment in the sector, increasing the level of capital intensity. Enhancing energy efficiency, including through the adoption of smart grid infrastructure, invariably involves upfront capital investments that reduce the running costs of the system over time. Renewable energy is more capital intensive than conventional alternatives, but avoids the major operating expenditures associated with fuel purchase. Moreover, the dispersed character of renewable energy resources calls for substantial transmission upgrades that need to be carefully coordinated with investments in generation. At the same time, the growing threat posed by extreme weather events arising from climate change may require significant investments to upgrade power infrastructure or make new infrastructure more resilient (for example by burying overhead cables), particularly in the most vulnerable geographies. Responding to the impact of disasters will also create the need for unpredictable and lumpy investments in rehabilitation of damaged infrastructure (Alexander and Harris 2005). Finally, the rapid pace of technological change risks creating stranded assets as conventional technologies become redundant before the end of their</mark> useful lives.

<mark>Historical experience highlights that capital expenditure poses much greater challenges for regulation than operating expenditure. In particular, information asymmetries between regulators and utilities are much greater in the case of capital expenditures, due to the site specific and customized nature of investments. At the same time, the context described above indicates that investments could be unpredictable and not always in the</mark> 11