The gas transition: What do gorillas have to do with it?

The gas transition poses an unavoidable challenge: what to do with the potential for billions of dollars of stranded assets. Current approaches, such as accelerated depreciation, are fixes that Professorial Fellow at Monash University and energy expert Ron Ben-David argues will risk triggering both political and financial crises.聽

In Ben-David's recent paper 鈥淭he 500lb gorilla of the gas transition鈥� he offers a novel, market-based solution that he claims transforms the Regulated Asset Base (RAB) into a manageable financial obligation, in that the RAB is a financial asset which can be decoupled from the physical gas network, and securitised. Ben-David鈥檚 approach is not entirely without precedent, but its application to a gas RAB and the specific mechanism of inter-sector cost reallocation (to electricity networks) is innovative and he argues can be purposed to tackle Australia鈥檚 looming gas transition.

And Ron Ben David is clear that his conceptual blueprint will require further design work, political negotiation, and regulatory adaptation but nonetheless still tackles one of the hard questions of the energy transition.聽 We take a dive and examine the issues therein.

Making a manageable financial obligation by decoupling the Regulated Asset Base (RAB) from the physical gas network.聽

There are two problems as Ron Ben-David sees it:

1. The Central Problem 鈥� The Regulatory Asset Base (RAB)

• The RAB of gas networks is a financial obstacle to the energy transition.
• As customers leave the gas network, remaining customers face higher prices, triggering a death spiral of further disconnections and rising costs.
• The current regulatory framework (from the 1990s) was built to promote gas growth, not manage decline.

2. The Problem with the Existing Solution - Accelerated Depreciation Is Not Sustainable

• Networks seek accelerated depreciation to recover their RAB sooner, raising prices on remaining customers.
• This adds 鈥渇uel to the fire鈥� of the death spiral.
• While some (and Energy Consumers Australia is highlighted in his paper) accept this as a necessary tool, Ben-David argues it鈥檚 politically and economically unsustainable.

Accelerated Depreciation

Accelerated depreciation allows the gas distribution businesses to recoup investments in their infrastructure faster than usual, as their asset lives are reduced by the transition to renewable energy (electrical) sources.聽 Accelerated depreciation is intended to mitigate the risk of stranded assets, the gas distribution infrastructure that becomes obsolete due to declining gas demand, by shifting the financial burden proportionally onto current consumers rather than future ones.聽

Is there a real need to steeply accelerate depreciation now?聽聽 It is probably useful to examine Victoria when discussing gas connection abolishments, because even with the recent softening of policies the State still has the most aggressive gas exit approach.聽 In Victoria there are over 2 million homes and businesses connected to the gas network, and around 80 per cent of Victorian homes use gas for cooking, heating and hot water.聽 Even with its generous subsidy of electric for gas replacement, only somewhere between 24,000-34,000 Victorian homes have so far changed to electric heating and hot water, though many may still retain a gas connection.聽 So well under 2 per cent so far, and the national figure is below that.

We note Ben-Davids comments on the Energy Consumers Australia (ECA) rule change and their perceived support for accelerated depreciation as the regulatory tool.聽 To be fair, it鈥檚 not only the ECA (highlighted above) that accept the accelerated depreciation as a necessary, though unwelcome, tool.聽 The AER toolkit is limited, and they have so far taken a cautious approach to determining the quantum of accelerated depreciation in the current regulatory periods, rejecting the quantum put forward by the gas distributors.聽 And we at the Australian Energy Council have also not contested accelerated depreciation as a way of addressing both the risk of stranded assets either.聽 We need approaches that make sure that the networks continue making the efficient and necessary investments required to maintain safe and reliable gas distribution services.聽

What is contested is that accelerated depreciation allowances sought by the gas network owners are excessively fast and will likely not reflect the actual abolishments and that accelerated depreciation and capex expenditure growth appearing alongside each other in regulatory proposals might present an internal consistency problem.聽 New capital expenditure must now be heavily scrutinised and limited to avoid worsening the RAB problem. 聽However, for the current regulatory period there doesn鈥檛 seem to be another practical alternative to accelerated depreciation and nor is one perhaps necessary right now.

That said, Ben-David identifies an alternative.聽 He accepts that it might not be an easily workable alternative, but then as he points out neither is accelerated depreciation. He proposes decoupling the RAB from Physical Assets.聽 And the idea is worth exploring.

3. Decoupling the RAB from Physical Assets

• Ben-David contends the RAB is fundamentally a financial instrument (an IOU from consumers to investors), that is not tied inherently to the physical gas network.
• And he proposes decoupling the RAB from the physical infrastructure, transforming the RAB into securitised financial instruments (鈥渄elta assets鈥�).

The Boring but Important Part

Now put on your De Bono thinking hats and consider the Ten-Point Plan for Resolving the RAB Problem put forward by Ben David, and then keep reading:

1. Revalue each network鈥檚 RAB periodically based on declining gas throughput.

2. Record the reduction in a new financial instrument (鈥渄elta asset鈥�).

3. Recognise delta assets separately in regulatory models.

4. Structure delta assets as marketable financial instruments with secure income streams.

5. Sell delta assets to the market, likely at lower cost of capital than the regulated WACC.

6. Transfer proceeds to the gas networks; void the delta asset in regulatory accounts.

7. Treat the remaining RAB as 鈥渘ormal鈥� 鈥� no accelerated depreciation needed.

8. Repeat the process every few years to manage transition.

9. Electricity distribution networks underwrite the income stream of delta assets.

10. Costs are recovered through electricity tariffs, spreading the burden more broadly, but extending it to those who have never benefitted from a gas network connection.

A Brave New World

It would be a Brave New World, but have a think about what new mechanism is needed to actually reduce the RAB 鈥� not just stop it growing?聽 Here at the Australian Energy Council:

• We would agree that the ECA鈥檚 rule change proposals (limiting RAB growth and scrutinising new gas investments) are helpful, but incomplete.
• We also want an orderly, manageable transition that protects consumers.
• We agree that ignoring the problem risks disorderly network failure in the coming decades.
• And we haven鈥檛 had a better idea either鈥�

And so, we are interested in the delta asset proposal wherein it assumes that investors retain the right to recover the regulated value of their sunk investments鈥攂ut it changes the form and pathway of that recovery. 聽So, before you wander off and get that coffee, read on.聽 Because in the interests of comprehension by those like me who orbit outside the planet of arcane financial and asset regulation, I鈥檝e tried to get this in layman鈥檚 terms.

What are the Key Implications? (in Layman鈥檚 Terms):

• Well importantly, property rights are not extinguished: Investors still recover the promised value of their assets, but not necessarily via the traditional regulated tariffs on gas users.
• Financial structures are altered: Recovery occurs through securitised delta assets, which become tradable income-bearing financial instruments.
• Investors lose a direct link to the physical asset but they gain a new, often lower-risk, regulated financial entitlement.

Still confused? Get ready for More Layman:

Imagine you're a landlord, and (bear with me)鈥�:

• You buy a rental property for $1 million.
• You rent it out, and over the next 30 years, you recover your investment through rent payments.
• And for this exercise pretend the rent is set by a regulator (e.g., capped or indexed), and not by the free market.

This is how a gas network RAB works: the investor is guaranteed to recover their costs (if deemed efficient, we must remember the caveat) through regulated charges to customers, just like your rent as a landlord.

Here鈥檚 the Analogy

Now imagine this:

• The neighbourhood is emptying and tenants are moving out (like people electrifying and leaving gas).
• The rent can鈥檛 rise fast enough to cover your mortgage (death spiral).
• You still own the house, but no one's willing to rent it.
• You鈥檙e stuck with a still valuable asset (though declining in value through write downs), but no income.

Here鈥檚 where securitisation comes in.聽

Here鈥檚 the Solution: Securitise Your Future Rent.

• Instead of waiting for rent that may never come, you sell the rights to your future rental income (at a discount logically) to an investor.
• This buyer gives you cash now in exchange for a secure, predictable (though in real terms declining) income stream backed by someone else.

Back to gas.

In the case of gas this looks like:

• The delta asset is like selling the 鈥渇uture rent鈥� rights.
• The gas network operator keeps the property (pipes), but gives up the right to earn future income from part of the RAB.
• The buyer of the delta asset (investor) gets that income from a new payer: in this proposal electricity customers, and not gas customers.

But I鈥檓 a landlord, what are the Implications for Property Rights?

In this analogy:

• As noted above, property rights are retained.聽 The landlord doesn鈥檛 lose their house (pipes); they just monetise a part of the income stream.
• The landlord gets compensated fairly.
• The property right changes form, not value (now this can be hard to figure, and we are not talking about buying a house with Bitcoin).

There are always risks.聽

If the government forced the landlord to give up rent without payment, that would be akin to expropriation. So, things to watch out for that might flow from Ben-David's proposal for gas networks would include:

• Coercive transitions (such as forced RAB write-downs) which could trigger litigation.
• Changes to the AER鈥檚 regulatory treatment of returns, which could be interpreted as de facto expropriation if they reduce expected earnings.
• Any lack of clarity on the rights of delta asset holders which may affect their marketability or investor confidence.

But the risk is mitigated:

The proposal assumes the 鈥渞egulatory compact鈥� remains intact, i.e., investors are entitled to recover their full sunk investment.聽 There is a reference to not believing this is necessarily warranted as past overcompensation may justify investors bearing some loss. But let us assume the former. 聽

• The transfer is structured.
• The investor (landlord) is paid.

• A new 鈥渢enant鈥� (electricity network/consumers/government) underwrites the rent.

And operational rights remain unchanged.

• What changes is the source of cash flow: instead of earning through tariffs on gas users, part of the revenue now flows from a separate financial obligation (underwritten by electricity networks, or governments).

So we can conclude that, if done consensually via a negotiated asset swap or voluntary regulatory change or some mechanism I can鈥檛 think of, this is a restructure of financial rights, and not a taking.聽

Precedent and fat gorillas

Dr Ben-David鈥檚 approach is not entirely without precedent, but its application to the gas RAB and the specific mechanism of inter-sector cost reallocation (to electricity networks) is innovative and perhaps can be purposed to tackle Australia鈥檚 looming gas transition.聽 It鈥檚 a good thought piece.

And a side note, I did a quick look at how much a gorilla weighs.聽 Males can indeed weigh up to 500lb, but that tended to be the well fed ones that are kept in protected environments (not unlike a regulated gas distribution network).聽 Outside in the competitive world, the range is more between 300 to 500.聽 So presumably an 鈥渆fficient鈥� gorilla would weigh less than 500lb to start with鈥�