On 17 May 2010, the State Treasurer asked the Economic Regulation Authority (ERA) to undertake an inquiry into the funding arrangements of Horizon Power.

The inquiry has been referred to the ERA under section 32(1) of the Economic Regulation Authority Act 2003, which provides for the Treasurer to refer to the ERA inquiries on matters relating to regulated industries. The inquiry is also in accordance with section 129E(1) of the Electricity Industry Act 2004, which provides for the Treasurer to seek advice from the ERA prior to making a determination on the level of the Tariff Equalisation Contribution payable to Horizon Power.

In accordance with the Terms of Reference, the ERA is to consider and develop findings on:

• the cost reflective retail tariffs that would apply in the areas of operation of Horizon Power, for the purpose of determining the efficient expenditure required to supply customers on regulated retail tariffs located in these areas;
• whether the area that Horizon Power operates in should be separated into sub-areas, given the different cost structures of the systems that Horizon Power operates, for the purpose of determining cost reflective retail tariffs;
• incentives for Horizon Power to develop and implement efficiency measures, such as gain sharing mechanisms between customers and Horizon Power;
• the efficiency of Horizon Power’s procurement processes; and
• the efficiency of Horizon Power’s operating and capital expenditure programmes, including opportunities for alternative arrangements for service delivery in remote regions.

When determining cost reflective tariffs the ERA must give consideration to:

• the efficient generation costs, taking into account the current and committed stock of generation;
• the efficient network costs, taking into account the current network infrastructure;
• the efficient level of retail costs and net retail margin;
• the efficient costs relating to the Mandatory Renewable Energy Target; and
• the efficient costs related to the proposed Carbon Pollution Reduction Scheme.

The ERA is to determine cost reflective retail tariffs:

• for the period 2009/10 to 2013/14; and
• for each of the retail tariffs currently provided by Horizon Power, being the A2, K2, L2, M2, N2, W2 and Streetlight tariffs.

In conducting the inquiry, the ERA has published:

• an issues paper on 4 June 2010 to help interested parties understand the matters under review and to facilitate public submissions. The submissions received in response to the issues paper are published on the ERA’s website; and
• a draft report on 16 December 2010 for further public consultation. The submissions received in response to the draft report are also published on the ERA’s website; and
• a final report for the inquiry has been produced that provides a set of recommendations concerning Horizon Power’s efficient levels of operating and capital expenditure.

The Authority developed the proposed efficient levels of operating and capital expenditure for Horizon Power in conjunction with advice from Parsons Brinckerhoff Australia Pty Ltd (PB) who reviewed the efficiency of Horizon Power’s operating and capital expenditure forecasts and procurement processes over the inquiry period and provided technical advice to the Authority. PB’s report on its review of Horizon Power is available on the ERA’s website.

For the purpose of calculating cost-reflective tariffs for Horizon Power, the Authority’s key final recommendations are as follows:

• an inflation-adjusted historical cost asset valuation of $388.7 million be used for Horizon Power’s capital base at 1 July 2009;
• a compounding efficiency target of one per cent per year be applied to the 2009/10 adjusted level of controllable operating costs per connection. This reduces Horizon Power’s total forecast operating costs by $72.6 million over the five year inquiry period from $1,646.7 million to $1,574.1 million;
• Horizon Power’s forecast capital expenditure programme be reduced by $43.4 million over the five year inquiry period, from $841.6 million to $798.2 million; and
• a real pre tax rate of return of 7.23 per cent be applied to Horizon Power’s capital base.

From these elements, the Authority calculated Horizon Power’s efficient annual cost to supply electricity to regional Western Australia and also the cost-reflective tariffs for Horizon Power’s 34 electricity supply networks. The cost-reflective tariffs produced in the final report range from $0.28 per kWh for Lake Argyle in East Kimberley to $1.47 for Menzies in the Mid West. The cost reflective tariff for the North West Interconnected System (NWIS) is $0.32 per kWh and $0.38 per kWh for Horizon Power as a whole. These compare to an equivalent figure of $0.19 per kWh for the South West Interconnected System (SWIS).

In the final report, the Authority has also made two recommendations that relate to the TEC. These are how the TEC should be funded and why and, if the TEC is to be retained in its current form, then how the TEC should be calculated. These recommendations are as follows:

• The TEC be funded by a Customer Service Obligation (CSO) payment direct to Horizon Power. This has the benefits of:
• lower distribution network tariffs in the SWIS;
• removing price distortion in the competitive markets that exist within the SWIS;
• an earlier timeframe to achieve full retain contestability in the SWIS;
• greater transparency around the overall level of subsidy for Horizon Power; and
• being consistent with how other utilities are subsidised.
• Should the Government continue to subsidise Horizon Power through a TEC payment funded by SWIS customers, the TEC should be calculated using a return on capital that reflects Horizon Power’s actual cost of debt. This will provide for the lower TEC to be passed through to lower distribution network tariffs in the SWIS. The Authority notes that using a lower return on capital to calculate TEC will result in a shortfall from the funding from the cost-reflective revenue requirement for Horizon Power and suggests that this shortfall be covered by an additional Government subsidy.

The Authority’s recommendations on the TEC result in a net present value saving of $44.5 million (for the period 2009/10 to 2011/12) compared to the TEC values published in the Government Gazette.

The Authority also recommended that another inquiry be undertaken in three years to enable a further review of Horizon Power’s actual costs and to set new efficiency targets.

This final report was delivered to the Treasurer on 18 March 2011 and the report was tabled in Parliament on 14 April 2011.

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