Wage and price forecasts for Western Power’s access arrangement

The Issue

The framework for economic regulation of certain electricity networks in Western Australia, including Western Power’s South West Integrated System, is the Electricity Networks Access Code (the Access Code).

The objective of the Access Code is to promote the economically efficient investment in, and operation and use of, networks and services of networks in Western Australia, to promote competition.

Under the Access Code, Western Power is required to submit access arrangements for its electricity transmission and distribution networks. An access arrangement sets out the prices, terms and conditions that a network owner can charge its customers to use its infrastructure.

Synergies was engaged to assist Western Power in relation to the wage and CPI forecasts required for its proposed access arrangement for the 2022-27 regulatory period.
Our CPI forecasts were to be used in the roll-forward of Western Power’s regulatory asset base value and WPI forecasts used in the inflation-adjusted escalation of labour costs for its operating and capital expenditure forecasts.

Our Methodology

We developed forecasts in relation to

• CPI
• Nominal and real wage costs
• Opex productivity.

It is important to note that this was a particularly challenging time to develop price, labour and materials escalation forecasts given the economic effects of Covid-19, as well as the potential inflationary effects of significant government financial stimulus provided to the Australian economy in response to the pandemic.
Further, WA’s important iron ore sector had been experiencing strong economic conditions, reflected in record iron ore sale volumes and until recently prices, flowing through to strong employment growth. The income effect of this upturn in mining activity was likely to have a strong positive effect on WA economic growth in the next few years, which could result in a pick-up in wage and price inflation compared to relatively subdued growth over the AA4 period.

Our report

The basis of our cost escalation forecasts for the 2022-07 period was as follows:

• We applied what is generally known as the ‘break-even’ inflation forecasting method in accordance with the Economic Regulation Authority’s (ERA’s) Gas Rate of Return Guideline. This method reflects the difference between nominal and index-linked Australian Government long-term bond yields and provides a market-based forecast of inflation, which evidence suggests is more reliable than alternative methodologies used by Australian economic regulators.
• Our WPI forecasts for the WA EGWWS sector was based on estimating WA WPI for the regulatory period based on an average of published WA Treasury forecasts. We then estimate the premium (if any) of the historical EGWWS WPI growth over the Australian All Industries WPI, which we add to the WA WPI forecast to derive the nominal labour escalation forecast. We finally apply forecast CPI from the WA Treasury to our nominal EGWWS WPI forecast to derive the EGWWS WPI real labour cost escalation forecast.
• Our operating cost productivity forecast was based on analysis of National Electricity Market (NEM) electricity distributors’ opex productivity performance, including those we consider bear the closest resemblance to Western Power (noting that even these comparators are imperfect), which are South Australia Power Networks, Powercor, AusNet Services, Essential Energy and Ergon Energy.We developed our forecast using our Multilateral Total Factor Productivity (MTFP) model including 2019-20 data from the Australian Energy Regulator’s (AER’s) Regulatory Information Notice (RIN) data set.

Contact

To find out more about this project and how Synergies can assist you, send an email to: contactus@synergies.com.au