Total overheads Very High High Very High Total corporate overheads Comparable Comparable High Total network overheads Very High Comparable Comparable Maintenance High High Comparable Emergency response High High High Vegetation management High High Very High Source: AER analysis. Given the NSW service providers generally have high expenditure on category analysis for most categories of expenditure, we consider this supports the view that it is likely systemic issues exist across the service providers (particularly for Ausgrid and Essential Energy). The results of the labour and total overhead metrics (which are broader measures) tend to support this view as well. Detailed review Category analysis suggested labour and (for Essential Energy) vegetation management appeared to be significant drivers of costs. Accordingly, we have conducted more detailed analysis of these categories of expenditure. Labour Labour costs are the largest component of the NSW service providers' opex, accounting for more than 70 per cent of total opex. Given this magnitude, we engaged Deloitte to provide a review of the labour and workforce management practices of the NSW service providers. Deloitte found in respect of the labour costs incurred in delivering the capex program (labour-related capex), there is evidence to suggest that the expenditure and approach to resourcing the program was not consistent with that of a prudent or efficient service provider. In particular: All service providers seem to have relied too heavily on hiring permanent internal labour resources rather than using temporary external contractors to undertake the capex program In 2007, Ausgrid entered into an arrangement which appears to have driven its costs up, or at a minimum entrenched them at a relatively high level
Endogenous factors Capitalisation policy We are satisfied that it is not necessary to provide the NSW service providers with an operating environment adjustment for differences in capitalisation. An adjustment for differences in capitalisation policy between the NSW service providers and the comparison firms would not satisfy operating environment factor two. Differences in capitalisation policy will not lead to material differences in opex between the NSW service providers and the comparison service providers. The NSW service providers raised capitalisation as an issue that may affect benchmarking results. Capitalisation policies may affect the amount of opex recorded. Utilisation of capital will affect the amount of opex required. The relative efficiency of a service provider's opex and capex will also affect the opex to capex ratio, as will service providers' location in their asset replacement cycles. A high opex to capex ratio may simply reflect the efficient utilisation of opex and capital. For instance, SA Power Networks and United Energy, which are two of the best ranking service providers in our benchmarking results, have high opex to capex ratios. Where service providers are spending more on capex, we would also expect more overheads to be allocated to capex. We are satisfied that differences in capitalisation policies will not materially affect the NSW service providers' benchmarking results relative to the comparison service providers. This is because they expense a similar amount of their costs relative to most NEM service providers. However, the NSW service providers expense fewer costs, as a percentage of total expenditure, than all of the comparison service providers except for CitiPower. This is shown in Figure A.28 below. This suggests that it is likely that any operating environment adjustment to the NSW service providers' benchmarking results for capitalisation policies would be negative. Figure A.28 Average opex as a percentage of totex, 2006 to 2013 Source: Economic benchmarking RIN Risk appetite We are satisfied that it is not necessary to provide an operating environment adjustment for differences in the risk appetites of service providers' network owning corporations. Service providers choose their risk appetite.
Ausgrid's consultant Evans and Peck said differences in the risk appetites of service providers' network owning corporations may shape the costs of service providers and therefore impede like for like comparison. Evans and Peck did not provide any further explanation about how differences in risk appetite would impede comparisons. Part of the role of a corporation's management is to select the level of risk that they are willing to bear. The quality of a firm's management is an endogenous factor that does not require an adjustment. Work and operating procedures We are satisfied that it is not necessary to provide an adjustment for work and operating procedures. Work and operating procedures are under the direct control of service providers' management. Evans and Peck raised the issue of work and operating procedures as an operating environment factor in its report for Ausgrid. Evans and Peck indicate that differences work and operating procedures may affect both operating and capital cost drivers. It is the role of service providers' management to seek and implement ways to improve the effectiveness and efficiency of the service provider's work and operating procedures. Because the effectiveness and efficiency of a service providers' work and operating procedures are a result of the quality of a service providers management, they are endogenous to the business and we do not consider it appropriate to account for them when benchmarking. Work conditions We are satisfied that it is not necessary to provide an operating environment adjustment for differences in work conditions. Service providers' managements are able to negotiate the agreements that they make with their workers. Evans and Peck raised the issue of wage rates as an operating environment factor in its report for Ausgrid. Evans and Peck indicate that differences in wage rates and stand-down provisions in awards may affect both operating and capital cost drivers. The service providers in the NEM all have enterprise agreements. A service provider's management has discretion in reaching an agreement that it strikes with its workforce. The deal that it makes represents a trade-off. The agreement might provide for lower wage rates in return for higher non-salary conditions. Alternatively, it might provide higher wage rates in exchange for productivity improvements. This is a
network. The opex forecast has already been increased (from the base year) to account for forecast network growth. By applying the rate of change to the base year opex, we also adjust our opex forecast to account for real price increases. A step change should not double count price increases already compensated through this adjustment. Applying a step change for costs that are forecast to increase faster than CPI is likely to yield a biased forecast if we do not also apply a negative step change for costs that are increasing by less than CPI. A good example is insurance premiums. A step change is not required if insurance premiums are forecast to increase faster than CPI because within total opex there will be other categories whose price is forecast to increase by less than CPI. If we add a step change to account for higher insurance premiums we might provide a more accurate forecast for the insurance category in isolation; however, our forecast for total opex as a whole will be too high. Further to assessing whether step changes or change factors are captured in other elements of our opex forecast, we will assess the reasons for, and the efficient level of, the incremental costs (relative to that funded by base opex and the rate of change) that the service provider has proposed. In particular we have regard to: whether there is a change in circumstances that affects the service provider's efficient forecast expenditure what options were considered to respond to the change in circumstances whether the option selected was the most efficient option––that is, whether the service provider took appropriate steps to minimise its expected cost of compliance the efficient costs associated with making the step change and whether the proposal appropriately quantified all costs savings and benefits when this change event occurs and when it is efficient to incur expenditure, including whether it can be completed over the regulatory period whether the costs can be met from existing regulatory allowances or from other elements of the expenditure forecasts. One important consideration is whether each proposed step change or change factor is driven by an external obligation (such as new legislation or regulations) or an internal management decision (such as a decision to increase maintenance opex). Step changes should generally relate to a new obligation or some