AUSTRALIAN COMPETITION TRIBUNAL

 

Application by East Australian Pipeline Limited [2004] ACompT 8

 

 

TRADE PRACTICES – access to gas pipelines – review of decision of Australian Competition and Consumer Commission as to draft access arrangement – Moomba to Sydney Pipeline System – calculation of reference tariff – whether decision incorrect or unreasonable – calculation of initial capital base (ICB) – calculation of optimised replacement cost (ORC) and depreciated optimised replacement cost (DORC) – benchmark credit rating for purpose of calculating rate of return on capital

 

ADMINISTRATIVE LAW – appeal body empowered by statute to review decisions of regulator – scope of review power where regulator is granted large area of discretion

 

Gas Pipelines Access (South Australia) Act 1997, ss 38, 39

National Third Party Access Code for Natural Gas Pipeline Systems, ss 8.1, 8.2, 8.4, 8.10

 

Application by Epic Energy South Australia Pty Ltd [2002] ACompT 4 applied

Application by Epic Energy South Australia Pty Ltd [2003] ACompT 5 applied

Federal Commissioner of Taxation v St Helens Farm (ACT) Pty Ltd (1980–1981) 146 CLR 336 cited

Melwood Units Pty Ltd v Commissioner of Main Roads [1979] AC 426 (PC) cited

Re Michael Ex parte Epic Energy (WA) Nominees Pty Ltd (2002) 25 WAR 511 considered

 

 

 

 

 

 

 

 

 

 

 

 

 

APPLICATION UNDER S 39(1) OF THE GAS PIPELINE ACCESS LAW FOR REVIEW OF THE DECISION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION ON 8 DECEMBER 2003 TO APPROVE ITS OWN ACCESS ARRANGEMENT PURSUANT TO THE PROVISIONS OF THE NATIONAL THIRD PARTY ACCESS CODE FOR NATURAL GAS PIPELINE SYSTEMS AND THE GAS PIPELINE ACCESS LAW

NO 8 OF 2003

GYLES J (Deputy President), MR RC DAVEY and MISS MM STARRS

8 JULY 2004

SYDNEY

 

 

IN THE AUSTRALIAN COMPETITION TRIBUNAL

NO 8 OF 2003

 

RE:	APPLICATION UNDER S 39(1) OF THE GAS PIPELINE ACCESS LAW FOR REVIEW OF THE DECISION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION ON 8 DECEMBER 2003 TO APPROVE ITS OWN ACCESS ARRANGEMENT PURSUANT TO THE PROVISIONS OF THE NATIONAL THIRD PARTY ACCESS CODE FOR NATURAL GAS PIPELINE SYSTEMS AND THE GAS PIPELINE ACCESS LAW
BY:	EAST AUSTRALIAN PIPELINE LIMITED APPLICANT
THE TRIBUNAL:	GYLES J (Deputy President) MR RC DAVEY MISS MM STARRS
DATE:	8 JULY 2004
PLACE:	SYDNEY

 

 

 

THE TRIBUNAL ORDERS THAT:

 

The matter stand adjourned to enable the parties to consider the Tribunal’s reasons and propose orders to give effect to them.

 

 

IN THE AUSTRALIAN COMPETITION TRIBUNAL

NO 8 OF 2003

 

RE:	APPLICATION UNDER S 39(1) OF THE GAS PIPELINE ACCESS LAW FOR REVIEW OF THE DECISION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION ON 8 DECEMBER 2003 TO APPROVE ITS OWN ACCESS ARRANGEMENT PURSUANT TO THE PROVISIONS OF THE NATIONAL THIRD PARTY ACCESS CODE FOR NATURAL GAS PIPELINE SYSTEMS AND THE GAS PIPELINE ACCESS LAW
BY:	EAST AUSTRALIAN PIPELINE LIMITED APPLICANT
THE TRIBUNAL:	GYLES J (Deputy President) MR RC DAVEY MISS MM STARRS
DATE:	8 JULY 2004
PLACE:	SYDNEY

 

REASONS FOR DECISION

1                     On 8 December 2003 the Australian Competition and Consumer Commission (ACCC) made a decision not to approve a revised access arrangement submitted by East Australian Pipeline Limited (EAPL) pursuant to the National Third Party Access Code for Natural Gas Pipeline Systems (the Code) and drafted and approved its own access arrangement for the Moomba to Sydney Pipeline (MSP) pursuant to s 2.20(a) of the Code (the Final Approval). The MSP traverses parts of South Australia, Queensland and New South Wales and a lateral extends to the Australian Capital Territory. It is unnecessary in this matter to explore any complications arising out of that geography. The existence of a national scheme has enabled the argument to proceed on the basis that the South Australian legislation is applicable. EAPL applies to the Tribunal under s 39(1) of the Gas Pipelines Access (South Australia) Act 1997 (the Gas Law) for review of the Final Approval. It is the owner and operator of the MSP. The MSP is listed in Schedule A to the Code and thus was a Covered Pipeline at the commencement of the Code.

2                     An abbreviated history of the matter is as follows. On 5 May 1999 EAPL submitted a proposed access arrangement together with applicable access arrangement information to the ACCC. On 19 December 2000 the ACCC released a draft decision in which it proposed not to approve the access arrangement submitted by EAPL (the Draft Decision). On 30 April 2002 EAPL submitted a revised access arrangement to the ACCC and, later, further revisions of that arrangement. On 2 October 2003, the ACCC released a decision (the Final Decision) in which it did not approve the revised access arrangement. On 23 October 2003 EAPL submitted a further revised access arrangement to the ACCC which led to the Final Approval on 8 December 2003.

3                     At the time of the Final Decision, the whole of the MSP was Covered and EAPL’s revised access arrangement which was submitted on 23 October 2003 reflected that. On 19 November 2003, the Minister for Industry Tourism, and Resources decided to revoke coverage in relation to that part of the MSP which runs between Moomba and Marsden and to otherwise maintain coverage. That decision was to take effect on 11 December 2003. The ACCC considered that the approval process which commenced in 1999 applied equally to the MSP as it was to be configured once the Minister’s decision was to take effect. It assessed the revised access arrangement and proceeded to issue the Final Approval accordingly. Both the access arrangement proposed by EAPL and the ACCC’s access arrangement were drafted to accommodate a partial revocation of coverage. The ACCC took the view that the access arrangement would continue to apply to such parts of the MSP as continue to be covered once the Minister’s decision took effect. The Minister’s decision was challenged, but, in the course of proceedings in the Tribunal, the challenge was discontinued. Consequently, partial coverage is the status quo, surprising as that may seem.

4                     The limited nature of the application to the Tribunal appears from s 39(2) and s 39(5) of the Gas Law:

‘39(2) An application under this section—

(a) may be made only on the grounds, to be established by the applicant—

(i)                 of an error in the relevant Regulator’s finding of facts; or

(ii)               that the exercise of the relevant Regulator’s discretion was incorrect or was unreasonable having regard to all the circumstances; or

(iii)             that the occasion for exercising the discretion did not arise; and

(b) in the case of an application under subsection (1), may not raise any matter that was not raised in submissions to the relevant Regulator before the decision was made.

…

(5) The relevant appeals body, in reviewing a decision under this section must not consider any matter other than—

(a)       the application for review and submissions in support of the application (other than, in the case of an application under subsection (1), any matter not raised in submissions to the relevant Regulator before the decision was made);

(ab) the relevant access arrangement or proposed access arrangement or revision or proposed revision of an access arrangement, together with any related access arrangement information or proposed access arrangement information;

(ac) in the case of an application under subsection (1a)—any notice of a proposed variation of Reference Tariff within an Access Arrangement Period given by the service provider to the relevant Regulator under the Code;

(ad) any written submissions made to the relevant Regulator before the decision was made;

(c) any reports relied on by the relevant Regulator before the decision was made;

(d)       any draft decision, and submissions on any draft decision made to the relevant Regulator;

(e)       the decision of the relevant Regulator and the written record of it and any written reasons for it;

(f)        the transcript (if any) of any hearing conducted by the relevant Regulator.’

5                     However, by virtue of s 38(8) and s 38(9) and s 38(10):

‘38.(8) The relevant appeals body may require the relevant Regulator to give information and other assistance, and to make reports, as specified by the appeals body.

(9) In proceedings under this section, the relevant appeals body may make an order affirming, or setting aside or varying immediately or as from a specified future date, the decision under review and, for the purposes of the review, may exercise the same powers with respect to the subject matter of the decision as may be exercised with respect to that subject matter by the person who made the decision.

(10) The relevant appeals body may make such orders (if any) as to costs in respect of a proceeding as it thinks fit.’

6                     The limited role of the Tribunal pursuant to s 39 was examined in Application by Epic Energy South Australia Pty Ltd [2002] ACompT 4 at [20]–[30] and Application by Epic Energy South Australia Pty Ltd [2003] ACompT 5 at [10]–[16].

7                     The parties have very sensibly reached agreement on most of the issues that have arisen in the course of the process, and have agreed upon particular issues to be determined. The material that was received between May 1999 and December 2003 by the ACCC in its consideration of the issues that remain was considerable. The material received by it from EAPL alone could be so described. All of that is before us. We have received comprehensive written submissions from both parties and have had the benefit of detailed oral submissions from counsel representing both parties. Much of the material is technical in nature. We will not endeavour to summarise the effect of all of the material or all of the arguments presented. We shall confine ourselves to deciding the necessary issues, explaining as succinctly as possible why we have so decided. We shall assume a general familiarity with the regulatory scheme and with the underlying facts.

8                     The setting of a tariff for a monopoly service provider, whether for gas, electricity or other services, is a difficult matter that has vexed regulators, service providers, producers and consumers in various parts of the world. Different solutions have been found in different places and in different industries. This complicates the process of deducing coherent theories and principles of general application. The field tends to be specific to particular regulators. Nonetheless, a corpus of economic theory has developed and, as will be seen, its existence is taken for granted by the form of the Code.

Initial Capital Base

9                     The first issue to be determined relates to the fixing of the Initial Capital Base (ICB) pursuant to s 8.10 and s 8.11 of the Code. In our opinion, much of the mystery surrounding the establishment of an ICB for an existing pipeline disappears if there is concentration upon the terms of the Code, with the assistance of the Overviews where appropriate (see s 10.4 and s 10.5). Part 2 of the Code relates to access arrangements generally and Part 3 deals with the content of an access arrangement. Sections 3.3, 3.4 and 3.5 are as follows:

‘3.3 An Access Arrangement must include a Reference Tariff for:

(a)               at least one Service that is likely to be sought by a significant part of the market; and

(b)               each Service that is likely to be sought by a significant part of the market and for which the Relevant Regulator considers a Reference Tariff should be included.

3.4              Unless a Reference Tariff has been determined through a competitive tender process as outlined in sections 3.21 to 3.36, an Access Arrangement and any Reference Tariff included in an Access Arrangement must, in the Relevant Regulator’s opinion, comply with the Reference Tariff Principles described in section 8.

3.5 An Access Arrangement must also include a policy describing the principles that are to be used to determine a Reference Tariff (a Reference Tariff Policy). A Reference Tariff Policy must, in the Relevant Regulator’s opinion, comply with the Reference Tariff Principles described in section 8.’

 

10                  The Reference Tariff and Reference Tariff Policy are aspects of an access arrangement. It is worth setting out the objectives of the Code in relation to those aspects:

‘8.1 A Reference Tariff and Reference Tariff Policy should be designed with a view to achieving the following objectives:

(a)         providing the Service Provider with the opportunity to earn a stream of revenue that recovers the efficient costs of delivering the Reference Service over the expected life of the assets used in delivering that Service;

(b)         replicating the outcome of a competitive market;

(c)          ensuring the safe and reliable operation of the Pipeline;

(d)         not distorting investment decisions in Pipeline transportation systems or in upstream and downstream industries;

(e)          efficiency in the level and structure of the Reference Tariff; and

(f)           providing an incentive to the Service Provider to reduce costs and to develop the market for Reference and other Services.

To the extent that any of these objectives conflict in their application to a particular Reference Tariff determination, the Relevant Regulator may determine the manner in which they can best be reconciled or which of them should prevail.

11                  The ICB for the MSP is a significant integer in the formula which arrives at the Reference Tariff. The relevant provisions are as follows:

‘Initial Capital Base – Existing Pipelines

8.10 When a Reference Tariff is first proposed for a Reference Service provided by a Covered Pipeline that was in existence at the commencement of the Code, the following factors should be considered in establishing the initial Capital Base for that Pipeline:

(a)         the value that would result from taking the actual capital cost of the Covered Pipeline and subtracting the accumulated depreciation for those assets charged to Users (or thought to have been charged to Users) prior to the commencement of the Code;

(b)         the value that would result from applying the “depreciated optimised replacement cost” methodology in valuing the Covered Pipeline;

(c)          the value that would result from applying other well recognised asset valuation methodologies in valuing the Covered Pipeline;

(d)         the advantages and disadvantages of each valuation methodology applied under paragraphs (a), (b) and (c);

(e)          international best practice of Pipelines in comparable situations and the impact on the international competitiveness of energy consuming industries;

(f)           the basis on which Tariffs have been (or appear to have been) set in the past, the economic depreciation of the Covered Pipeline, and the historical returns to the Service Provider from the Covered Pipeline;

(g)         the reasonable expectations of persons under the regulatory regime that applied to the Pipeline prior to the commencement of the Code;

(h)         the impact on the economically efficient utilisation of gas resources;

(i)           the comparability with the cost structure of new Pipelines that may compete with the Pipeline in question (for example, a Pipeline that may by-pass some or all of the Pipeline in question);

(j)           the price paid for any asset recently purchased by the Service Provider and the circumstances of that purchase; and

(k)         any other factors the Relevant Regulator considers relevant.

8.11          The initial Capital Base for Covered Pipelines that were in existence at the commencement of the Code normally should not fall outside the range of values determined under paragraphs (a) and (b) of section 8.10.

Initial Capital Base – New Pipelines

8.12          When a Reference Tariff is first proposed for a Reference Service provided by a Covered Pipeline that has come into existence after the commencement of the Code, the initial Capital Base for the Covered Pipeline is, subject to section 8.13, the actual capital cost of those assets at the time they first enter service. A new Pipeline does not need to pass the tests described in section 8.16.

8.13          If the period between the time the Covered Pipeline first enters service and the time the Reference Tariff is proposed is such as reasonably to warrant adjustment to the actual capital cost in establishing the initial Capital Base, then that cost should be adjusted to account for New Facilities Investment or the Recoverable Portion (whichever is relevant), Depreciation and Redundant Capital incurred or identified during that period (as described in section 8.9).

Initial Capital Base – After the Expiry of an Access Arrangement

8.14          Where an Access Arrangement has expired, the initial Capital Base at the time a new Access Arrangement is approved is the Capital Base applying at the expiry of the previous Access Arrangement adjusted to account for the New Facilities Investment or the Recoverable Portion (whichever is relevant), Depreciation and Redundant Capital (as described in section 8.9) as if the previous Access Arrangement had remained in force.

New Facilities Investment

…

8.16         The amount by which the Capital Base may be increased is the amount of the actual capital cost incurred (New Facilities Investment) provided that:

(a)               that amount does not exceed the amount that would be invested by a prudent Service Provider acting efficiently, in accordance with accepted good industry practice, and to achieve the lowest sustainable cost of delivering Services; and

(b)               one of the following conditions is satisfied:

(i)                 the Anticipated Incremental Revenue generated by the New Facility exceeds the New Facilities Investment; or

(ii)               the Service Provider and/or Users satisfy the Relevant Regulator that the New Facility has system-wide benefits that, in the Relevant Regulator’s opinion, justify the approval of a higher Reference Tariff for all Users; or

(iii)             the New Facility is necessary to maintain the safety, integrity or Contracted Capacity of Services.’

12                  The method referred to in s 8.10(a) is generally known as the Depreciated Actual Cost (DAC) whilst that referred to in s 8.10(b) is Depreciated Optimised Replacement Cost (DORC). The latter method involves fixing the Optimised Replacement Cost or ORC and then depreciating it.

13                  The ICB is entirely a creature of the Code and what it is and what it does is defined by the Code. It is one integer in a complex of integers used to arrive at an appropriate Reference Tariff. Whilst there is a considerable amount of discretion built into the system for both the operator and the ACCC, each of them, and the Tribunal, is bound by the Code.

14                  The first point to be noted is that by virtue of s 8.12 the actual capital cost of a new pipeline at the time it first enters service is the ICB for that pipeline. There is no need to pass any tests administered by the regulator such as those in s 8.16. It is assumed that the operator will build the pipeline in the most cost efficient manner.

15                  The second point to note is that the ICB, once established, is not thereafter altered or ‘reset’, save for particular adjustments which are provided for by the Code such as the new facilities investment (ss 8.15–8.19), capital contributions (ss 8.23–8.24) and capital redundancy (ss 8.27–8.29). The general basis of adjustment is explained in s 8.9. The ICB remains the same amount once established although the capital base as such may be adjusted from time to time in accordance with the provisions of ss 8.14–8.29.

16                  There is no indication in the Code that there is to be discrimination in principle between the operators of existing as opposed to new pipelines. As it is fundamental that the ICB is the actual cost of a new pipeline, it can be assumed that the objective of the Code in relation to an existing pipeline is to attribute to it a value that would be consistent with that principle. Given the manner of fixing the ICB in relation to the new pipeline, it cannot be suggested that the Code contemplates either a subsidy of consumers by fixing an artificially low figure or a bonus to operators by providing an artificially high figure. It can be assumed that the same would flow through to an existing pipeline. The problem, of course, in relation to an existing pipeline is that it is not equivalent to a new pipeline – it has been utilised for some time, it may not have the same future life and it may not be as efficient.

17                  The next feature of the Code to which attention needs to be directed is s 8.11. This is a direction that s 8.10(a) and (b) will normally set the range of values within which a value pursuant to s 8.10 is to be selected. DAC is a deduction from actual experience. It looks back. There are great difficulties in calculating a satisfactory DAC in circumstances such as the present where the owner at the time of Coverage is not the first owner of the pipeline and where the previous (government) owner did not charge enough to recover a necessary return of the value of the asset. There are questions as to how s 8.10(a) is to be applied, leaving aside the complication of more than one owner. ‘Depreciation’ in that section is not a capitalised defined term. It is reasonably clear from the balance of the Code (particularly ss 8.32–8.35) that normally the depreciation to which reference is made is the economic concept of depreciation rather than the accounting concept of depreciation, but that does not necessarily apply in this context. There are also questions as to how DAC should be adjusted to take account of time and currency.

18                  DORC arrives at an hypothetical value and looks forward. The starting point to ascertain DORC is to arrive at the ORC (which costs the hypothetical optimised replacement of the pipeline) and then depreciates that amount to what might be called a second hand value, principally because the optimised pipeline would last longer than the existing pipeline. The critical issue in this case is as to how the depreciation is to be calculated.

19                  The next point to be noted is that it follows from s 8.10(c) and (d) that it is necessary to consider other well-recognised asset valuation methodologies and then to compare the advantages and disadvantages of each valuation methodology applied under subparagraphs (a), (b) and (c) before turning to the other subparagraphs. Those other subparagraphs are considered in the light of the analysis of recognised valuation methods which the section assumes already to have taken place. The factors to which those other subparagraphs direct attention could assist in the choice between methods, or lead to some adjustment of the result of the chosen method. Those factors would not normally (and perhaps would never) permit recognised valuation methods to be put to one side. In particular, those factors do not warrant departing from a quest for value and entering upon a quest for some form of justice or equity. If the Reference Tariff is capable of being ‘tweaked’ in that way, that is not to be done by tampering with the ICB. In unusual circumstances, one or more of those factors may have a significant effect upon the assessment of value.

20                  In one way, the decision of the Supreme Court of Western Australia in Re Michael Ex parte Epic Energy (WA) Nominees Pty Ltd (2002) 25 WAR 511 (which had an influence upon the decision-making of the ACCC in this matter) is such a case. Whilst not binding upon us, it is entitled to considerable respect. It is necessary to read that decision bearing the facts steadily in mind. In March 1998 Epic purchased the Dampier to Bunbury Natural Gas Pipeline from the state-owned Gas Corporation for $2.407 billion. The sale was by competitive public tender, conducted in accordance with the process specifically set out in the Dampier to Bunbury Pipeline Act 1997 (WA). The pipeline subsequently became Covered. The Independent Gas Pipelines Regulator adopted an ICB of approximately $1.234 billion for the purpose of calculating the Reference Tariff – ie approximately 50 per cent of the actual purchase price. The result was a Reference Tariff which would seriously affect Epic’s financial return from its investment. This, in effect, wasted capital in excess of $1.2 billion by a stroke of the pen. The reasons of Parker J (with whom the other members of the Court agreed) make a case for concluding that the exercise of that regulator’s discretion was incorrect or unreasonable having regard to all the circumstances. The difficulty was that the Western Australian Supreme Court had no jurisdiction to intervene on that basis. It was necessary to find error sufficient to enable intervention in accordance with the principles of judicial review of administrative decisions. That was not easy where the Code gives the regulator a large area of discretion. That caused some straining of the construction of the Code and the result should be confined to the facts of the case. In our opinion the facts in that case are too far removed from the present facts to make the reasoning of any real value in resolving this case. The lengthy discussion of the Code provisions in the particular factual setting that arose in that case is no substitute for reading the text of the Code itself, together with the explanatory material related to it, in the light of the present facts. If a principle is to be drawn from the decision, it may be that a result obtained by the operation of market forces (such as the tender in that case) is more reliable than a deduced theoretical result. It may also be seen as a case in which a comparable market transaction should have been considered as a well-recognised asset valuation methodology.

21                  It is necessary to refer to the facts in greater detail before examining how the ACCC applied s 8.10 in this case and the criticisms advanced by EAPL in that regard. This is conveniently achieved by reference to the chronology of events agreed between the parties and annexed to these reasons.

22                  The decision by the ACCC as to the ICB needs to be understood in context. In May 1999 EAPL proposed a value for the ICB of $666.7 million which was EAPL’s then DORC calculation using straight line depreciation of an ORC of $1055.6 million. That was based upon an assumed life of 60 years for the Moomba to Wilton pipeline segment and 80 years for other segments. In August 2000 Agility Management Pty Ltd (Agility) provided a report which proposed a net present value (NPV) method of depreciating ORC rather than the straight line method. This was later combined with a revised estimate of the life of the MSP of at least 80 years, assuming that there was refurbishment of some 250 km between 2033 and 2056, to provide for DORC in the order of $940 million. The ACCC accepted the proposed ORC, save for the inclusion of a contingency factor of $82 million. That issue still remains to be decided. In the Draft Decision, the ACCC determined what it called DORC of $539.5 million based upon an asset life of 50 years and straight line depreciation. That conclusion was based in part upon the purchase price of the MSP paid by EAPL in 1994. The ACCC proposed an ICB of $502.081 million which was equivalent to its assessment of DORC of $539.5 million when other adjustments were taken into account.

23                  EAPL criticised that proposal on various bases and put forward various alternative proposals in the period leading up to the Final Decision. These included DORC of between $768 million and $972 million (the higher being based upon the Agility approach) and a value of between $784 million and $998 million based upon its ‘reasonable expectations’ pursuant to s 8.10(g) of the Code. In the Final Decision the ACCC maintained the preference for straight line depreciation. It accepted that DORC should be the product of the expected useful life of the pipeline looking forward which it accepted as 80 years. It calculated a DORC value of $715.1 million. However, it rejected DORC as the measure of value. It adopted a value for the ICB of $559 million based upon adjusting ORC according to the useful asset life assumed in the past (50 years) coupled with future depreciation on the current assumed life (80 years). In each case straight line depreciation was utilised, but the overall result has been described as ‘kinked’. The life of 50 years was principally based upon the financial accounts of EAPL. The ACCC said that it placed weight upon s 8.10(f) as to past depreciation and the entry into service of the Eastern Gas Pipeline (EGP), and upon the application of a hypothetical new entrant test (HNET) pursuant to s 8.10(k). As to the purchase price, the ACCC said:

‘While the Commission does not consider that the price paid by EAPL in 1994 should form the basis of the ICB, the value of the ICB determined by the Commission will provide EAPL with the opportunity to recover the price it paid (after taking account of depreciation and capital expenditure to date).’

 

24                  The EAPL criticised that reasoning on various bases, but it was maintained by the ACCC in the Final Approval, the only difference being that the ICB value was fixed at $545.4 million (real July 2003 dollars) which excluded the amount previously attributed to the Interconnect.

25                  The reasoning of the ACCC as to the ICB in the Final Decision and the Final Approval has been subjected to a number of detailed criticisms which were responded to in corresponding detail. However, it was contended that it was a fundamental error in principle for the ACCC to put aside known valuation methodologies and devise a methodology of its own which adjusted ORC in a novel fashion. It was submitted that this had no support in the Code or the material on the subject received by the ACCC and is properly described as idiosyncratic. In our opinion that submission is correct.

26                  The ACCC received a number of expert opinions as to the appropriate methodology to be used – some commissioned by EAPL and some by the ACCC. These in turn referred to other expert sources and to ACCC decisions in other cases. On 27 May 1999 the ACCC had issued a Draft Statement of Principles for the Regulation of Transmission Revenues (Draft Statement of Principles) which had canvassed appropriate methodologies. The ACCC did not cite any of that material in support of the reasoning behind its decision as to the ICB. That is not surprising. ORC is only utilised in this field as the starting point from which to deduce DORC. These are forward looking concepts and the ‘depreciation’ concerned is economic depreciation. There is no support for ORC to be adjusted to take account of past events particularly based upon accounting concepts of depreciation, and to do so is wrong in principle.

27                  The terms of s 8.10 and s 8.11 give considerable latitude to the ACCC in assessing the ICB, and we have already mentioned the limits to the Tribunal’s power to interfere. Valuation is far from an exact science and there is considerable room for choice and discretion in the task. It will nearly always have aspects of estimation and approximation (Federal Commissioner of Taxation v St Helens Farm (ACT) Pty Ltd (1980–1981) 146 CLR 336 per Mason J at 381). However, an error in principle can always be reviewed (Melwood Units Pty Ltd v Commissioner of Main Roads [1979] AC 426 (PC) at 432D). It was incorrect and unreasonable to adopt a methodology which does not reflect the terms of the Code and which is not supportable in principle. We are satisfied that the ICB fixed by the Final Approval cannot stand and must be set aside. Before considering what course should be followed in view of this conclusion, we should deal with some of the points argued.

28                  It is implicit in what we have said that we cannot see any reasonable basis upon which reference to s 8.10(f) could justify the method of adjusting ORC that was chosen by the ACCC. The Final Decision in relation to this factor dealt with three matters. The first was to reject a value based upon the economic depreciation of the MSP which would be somewhere between $1291 million calculated by the ACCC in its Draft Decision and $1700 million as claimed by EAPL in its updated value. That rejection (even if correct) provides no independent support for the choice made. The second was a conclusion that a 50 year asset life had been assumed in the past. It is not clear how this fits with s 8.10(f). The most that could be deduced from the material before the ACCC was that the tariffs set for non-AGL customers post 1994 may have been calculated on the basis of a 50 year asset life consistently with certain of the financial accounting records. However, the setting of that market tariff cannot be assumed to have been calculated on a basis in any way comparable with the way in which the Code sets a regulated tariff. There is no logical or rational link between the accounting treatment of depreciation in the past on the one hand and the true estimate of the life of the pipeline in relation to the forward looking deduction of DORC from ORC on the other. The third matter referred to is the loss of market share to the EGP. Again, the link with s 8.10(f) is difficult to detect. Furthermore, there is no logical or rational connection between the actual and potential loss of market share to EGP on the one hand and the calculation of DORC from ORC on the other. As we have pointed out, for present purposes ORC is a concept which only has relevance in relation to that exercise. Furthermore, it is not demonstrated that there is any competition between the operators of the EGP and the MSP as such, although there may well be competition between the producers of gas in the respective basins.

29                  Indeed, it seems to us that the ACCC has misconstrued s 8.10(f) of the Code. When the factors in that section are considered together, they point to a set of circumstances in which the combined effect of past history is such as to require a modification of normal valuation methods which may have thrown up an unreasonably high ICB that would cause an unreasonably high tariff. The ACCC did not apply that reasoning in the present case. There appears to be no proper basis for doing so. When the past history of the operation of the MSP is considered as a whole, it is plain that the operation has been, and remains, seriously in debit which will never be recovered. Thus the users of the MSP have been subsidised at the expense of the operator of the pipeline. The tariff that was set following acquisition of the pipeline by EAPL can be assumed to be set at a more realistic level and is indeed at a level in excess of that proposed by the ACCC. Thus there would be no tariff ‘shock’ if the EAPL proposal were accepted. It is not possible to draw the conclusion that the few years of operation of the MSP by EAPL has caused such a gross over-recovery of depreciation as to require offset in setting the ICB under the regulatory regime.

30                  Counsel for the ACCC sought to suggest that it would be permissible for it to take account of these matters under s 8.10(k) if it were not entitled to do so under s 8.10(f). It is not possible to reconstruct reasoning in that way. It is the decision of the ACCC which is in issue, not the arguments of counsel. Even if it were permissible to do so, the difficulty remains that there is no logical or rational connection between the arguments advanced on the one hand and the adjustment of ORC as proposed by the ACCC on the other.

31                  The matter of substance that was dealt with by the ACCC pursuant to s 8.10(k) was the HNET. It is clear that the ACCC did not purport to derive, and could not derive, the ICB from the HNET. Furthermore, it is clear that the ACCC did not derive reference tariffs from the HNET. It took the view that the tariff proposed by it was consistent with the HNET tariff that was derived by National Economics Research Associates (NERA). Thus, on no view could that approach be a substitute for deriving the ICB in accordance with clauses s 8.10 and s 8.11. It should also be noted that the principle underlying use of the HNET is effectively the same principle as underlies the use of DORC and is also the principle underlying s 8.10(i).

32                  Counsel for EAPL submitted that it can be concluded from the various decisions that the ACCC has consistently reasoned to produce a predetermined result as to the ICB, namely that which would reflect the price paid for the MSP by EAPL in 1994, on the basis that to allow a greater ICB would be to give a ‘windfall’ to the purchaser of the privatised asset. That reasoning was certainly an important strand of the Draft Decision. It is not stretching things too far to see it as an explanation for depreciating ORC to DORC on a clearly incorrect basis in that Decision but upon a basis which arrived at a result in line with the ACCC’s assessment of the adjusted purchase price. In the Final Decision (carried through to the Final Approval) the error in the basis of deducing DORC from ORC in the Draft Decision was acknowledged and the reasoning based upon the purchase price was also omitted. However, DORC was abandoned as the appropriate valuation methodology and adjustments were made to ORC on no reasonable basis to arrive at a comparable figure to that in the Draft Decision, expressly noting that the figure chosen would permit recovery of the purchase price. It was also submitted that the conclusion of predetermination is supported by the reasoning of the ACCC on other aspects of the Final Decision, which was arbitrary and not in accordance with principle. It will be apparent from these reasons that there is some substance in that submission.

33                  As the decision in relation to the ICB must be set aside in any event, it is not necessary for the purposes of this decision to come to any conclusion in relation to the contention put on behalf of EAPL that the ACCC was reasoning towards a predetermined conclusion. It would, of course, be wrong of a regulator to justify a decision taken for a particular reason by reference to other reasons. A regulator in the position of the ACCC has a delicate task. It must be conscious of the interests of parties other than the proponent of the access arrangement and is bound to scrutinise carefully the information provided in support of it. On the other hand, it must have regard to the legitimate business interests of the proponent and should not put itself in an adversary position in relation to the proponent so that it may be perceived as a champion of other interests such as those of consumers.

34                  For the sake of completeness we should add that, for reasons explained in the Draft Decision, if the purchase by EAPL had been an arm’s length transaction effected before the regulatory regime came into force, then the price paid might well have been a reliable guide to the ‘second-hand’ value of the existing pipeline as a relatively recent market transaction. Taking account of that price would have been another well-recognised asset valuation methodology within the meaning of s 8.10(c). However, the purchase by EAPL was not an arm’s length transaction in that sense. The arrangements involving, and the interests of, AGL meant that the price paid was an unreliable guide to the true value of the MSP at that time. The lack of an open and unconditional tender almost certainly meant that full capital value was not realised. In that sense, EAPL may be seen to have received a bargain or a windfall. However, as our earlier discussion of the Code shows, the primary quest is for a proper contemporaneous value from which to deduce a tariff that will replicate a hypothetical competitive market. It is not to provide subsidies to customers. Pricing below a tariff based upon true value would not replicate a competitive market. It is no doubt for that reason that the ACCC does not now purport to rely upon the 1994 purchase price for the purpose of fixing the ICB.

35                  Notwithstanding the foregoing, it must be recognised that in the second half of 2000 the ACCC was confronted with a most unusual circumstance, namely, the ‘discovery’ of a further 20 years’ life of the mainline to Wilton after Coverage and well after lodgement of the access arrangement, together with a new basis for deducing DORC from ORC. If the access arrangement had been proposed within 90 days of Coverage (as s 2.2 provides) and if it had been dealt with in a timely fashion, the ICB would have been established long before the ‘discovery’ in question. Indeed, there is a strong argument for the view that on the proper construction of the Code the ICB is to be established as at the commencement of the Code in the case of an existing pipeline. The language of clause s 8.10(a) is a pointer in that direction. It is also indicated by the manner in which s 8.12 and s 8.13 work. In the case of a pipeline that is already in service, the proxy for the time of entry of service of a new pipeline would be the time of Coverage, namely the commencement of the Code in the case of the MSP. Further, a ‘discovery’ such as this would not qualify for adjustment pursuant to s 8.13 if it occurred after entry for service. We do not need to come to a final view on that question of construction of the Code as, in our opinion, the ACCC was not and is not bound to accept an 80 year life for the existing mainline when reconsidering the assessment of DORC.

36                  The key to DORC is to compare the lifetime of the hypothetical optimised pipeline with the remaining life of the existing pipeline, not of some hypothetically partially optimised pipeline. It was and is open to the ACCC to take the view that the existing MSP was to be considered as it stood, not as it might stand at some indeterminate time in the future after the spending of an indeterminate amount of money on future refurbishment. A moment’s reflection would indicate that by the time that was to occur, technology might have again changed in various ways and the solution envisaged in 2000 might never occur. Furthermore, if there was such expenditure, to the extent that it might qualify as New Facilities Investment, there would be double counting of it in a manner not easy to eradicate. In our opinion it would be open to the ACCC to take the view that it would be appropriate to calculate DORC on the basis of the life for the pipeline as it stood (and stands) namely, 60 years as to part and 80 years as to part. Furthermore, that was the approach of EAPL up to the change in ownership in 2000.

37                  Our reading of the decisions of the ACCC in this case indicates that, if it were not for the issue caused by the claimed extended life, DORC would be the preferred method of fixing the ICB in this case. This is not surprising as it has been used in other cases by the ACCC and has been recommended by the ACCC in the Draft Statement of Principles. It is generally acknowledged that in the normal case DORC is the methodology most in keeping with the recovery of the efficient costs of delivering the Reference Service over the expected life of the assets used in delivering that Service which the Overview describes (in our opinion correctly) as ‘the over-arching requirement of the Tariff principles’, and is likely to directly meet s 8.10(i). It would also be consistent with the principles underlying HNET referred to in the Final Approval.

38                  If we were satisfied that straight line depreciation should be used to deduce DORC from ORC we would be inclined to avoid further delay in the matter and fix the ICB based upon DORC ourselves. However, in our opinion the theoretical underpinning of DORC has progressed over the years to the point where it can now be recognised that straight line depreciation is too crude a tool to be used where there is the opportunity for a more sophisticated analysis. In our opinion, the materials before the ACCC, including its own Draft Statement of Principles, recognise that a net present value (NPV) approach is required for the most reliable result to be achieved, albeit, in our opinion, based upon costs rather than revenue. We recognise that there will inevitably be differences of opinion as to how those principles apply in this particular factual situation. Resolution of those differences of opinion in the first instance is properly (and remains) the function of the ACCC rather than the Tribunal. It is not an adequate response to that responsibility to claim that the task is too difficult. When the matter is reconsidered, attention should be directed to the proper application of a NPV approach to depreciation in this case. Where the value attributed to the ICB will have a continuing effect for the balance of the life of the pipeline, it is appropriate that there be a serious effort made to arrive at the correct result.

39                  We have not overlooked the criticisms by counsel for EAPL of the reasons of the ACCC for rejecting the case made by EAPL pursuant to s 8.10(g). There is substance to those criticisms but we are not persuaded that there should be departure from the recognised methodology of a properly calculated DORC.

ORC

40                  It is necessary to resolve the issue as to whether a contingency of 10 per cent was properly included in the calculation of ORC. As a first step in applying the DORC methodology, EAPL obtained from Venton & Associates Pty Limited (Venton) an estimate of the MSP’s ORC.

41                  Venton’s 20 June 1999 report Optimised Design and Cost Estimate EAPL Pipeline Network (the Venton report) presents the results of the study it undertook for EAPL ‘… to determine the current cost of the existing pipeline network developed today using current technology and standards.’ The report’s summary states:

‘The proposed design is considered to be an “Optimised” design, and the capital cost estimates presented are considered to represent the present day cost of the Optimised design. The estimate accuracy is ± 20%.’

 

In its estimates of capital costs, the report states:

‘Allowance is made for notional quantities of rock trench, padding and other physical constraints of the pipeline route provided by EAPL. In some cases accurate lengths of these features were not available from EAPL, and the quantities allowed are based on judgement using experience and some knowledge of the routes by the author. The accuracy of the estimates is considered to be ±20%. The accuracy of the construction cost portion of the estimate is influenced by the assumptions made in relation to the ground conditions.’

…

A number of assumptions were made in developing the estimate. The extent to which these assumptions influence the overall cost of constructing the pipelines through undisturbed country is unknown. The assumptions are:

…

– A contingency of 10% is applied to the estimated cost, including Owners, EPCM and Interest charges.’ [EPCM being an abbreviation of ‘Engineering Project Construction Management’.]

 

42                  In deciding whether EAPL’s proposed access arrangement satisfied the Code, the ACCC had Kinhill Pty Ltd (Kinhill) review the Venton report. The executive summary to Kinhill’s January 2000 report Review of the Asset Valuation of the EAPL Pipeline Network (the Kinhill report) states:

‘Kinhill finds that the proposed optimised design is reasonable given the market complexities. The proposed system will handle the current loads with some compression, and can be upgraded effectively by adding compression if future loads eventuate.

 

While the capital cost estimates are at the high end of the historically achieved range of costs for Australian transmission pipelines, they are valid in the current climate due to the higher costs of managing land acquisition and approvals recently experienced with the construction of such pipelines.’

 

43                  Notwithstanding the Kinhill report, the Draft Decision stated:

‘Although it may be appropriate for a business to include a contingency factor in its estimates of the projected costs of constructing a new pipeline, this is not the case when determining the regulatory value of the initial capital base of an existing pipeline.’

 

The statement was repeated in the ACCC’s Final Decision and Final Approval.

44                  In elaborating on its exclusion of the contingency in its Final Decision, the ACCC stated:

‘The purpose of determining an estimate of ORC under the Code is to assist the regulator in establishing a value for the ICB for an existing pipeline. The Commission does not consider it necessary to replicate the cost estimations of a firm that is planning to construct a new pipeline. To make allowance for all contingencies that may occur and which produces a cost estimation at the high end of a feasible range is, in the Commission's view, contrary to the objectives in sections 8.1 (a) (efficient costs) and 8.1 (b) (replicating the outcomes of a competitive market) of the Code.’

 

The reference to s 8.1(a) and s 8.1(b) is misconceived in this factual context. The task is to fix an estimate of the cost of an optimised pipeline. The only issue in question was whether or not to include the contingency.

45                  In its Final Decision, the ACCC also stated in relation to the contingency:

‘A firm that is planning to construct a new asset may well include an allowance for contingencies that could increase the cost of construction. However, this does not mean that those contingencies will occur or that those costs will be incurred. It is equally likely that the project may cost less than was forecast. An ORC valuation seeks to estimate the actual cost of replacing the existing asset. To include in such a valuation an allowance for contingencies assumes that the replacement project would always suffer from the planned contingencies and would cost more than was forecast. This assumption is not justified.’

 

This explanation ignores Venton’s clarification, dated 12 May 2003, that:

‘The contingency allowance in the estimate was provided as an allowance for omissions based on an assessment by the pipeline estimator and myself, based on the knowledge of the limited detail behind the estimate.’ (emphasis added)

 

46                  Further explanation of the exclusion of the contingency was provided in the ACCC’s Final Decision as follows:

‘Furthermore, one of the reasons given in the Venton report for the contingency factor was that the 'attention of Government and Landowner/Landowner [sic]/Land Claimant Groups' may increase costs significantly. This argument assumed that the estimate of ORC was based on considerations of a greenfields pipeline. By implication, these particular costs would be less if consideration of the ORC estimate was based on a brownfields project.’

 

At most, this explanation goes only to the quantum of Venton’s estimate of the contingency. It does not explain the exclusion of the contingency in toto.

47                  Yet further explanation of why the contingency was excluded appears in the ACCC’s Final Decision as follows:

‘Finally, EAPL has provided little evidence to justify a level of 10 per cent for the contingency factor as opposed to some other value. The indicative nature of the 10 per cent level is demonstrated in Venton report of 20 May 2003 in which Venton stated that a more detailed analysis may produce a level of contingency lower than 10 per cent.’

 

Again, this explanation goes only to the quantum of Venton’s estimate of the contingency and does not explain its exclusion in toto.

48                  Another reason for excluding the contingency was given in the ACCC’s December Final Approval

‘…Venton provided only a few examples of areas which justify the inclusion of a contingency factor. These mainly related to the granting of easements and compensation to landowners. Much of Venton's arguments seem to rely on comparisons with the cost of constructing new pipelines, such as the EGP. However, Venton did also discuss the changing circumstances surrounding the MSP since its construction in 1974, which Venton argued justified the inclusion of a contingency factor.

 

The Commission notes that the ORC estimate submitted by Venton contained cost categories for these items under the headings 'Survey & Easement' and 'Environment'. The combined contribution to the ORC of these two categories is $44.3 million, 10 per cent of which is only $4.4 million of the total allowance for contingencies of $82 million.’

 

Like the explanations given in its Final Decision and quoted above, this statement of reasons only goes to quantum, not exclusion.

49                  The Final Approval also contains the following reason for excluding the contingency:

‘In other access arrangements that the Commission has assessed, the Commission has not allowed a separate allowance for contingencies.’

 

In this context, the Final Approval states:

‘The Commission further notes that all service providers have not proposed a contingency in the valuation of ORC.’

 

That other service providers have not included a contingency in their ORC is not relevant to the case in hand.

50                  The ACCC’s Final Approval concluded its consideration of the contingency as follows:

‘Despite the submissions of EAPL and Venton, the Commission does not consider that EAPL has sufficiently justified the inclusion of an across-the-board contingency factor amounting to $82 million to cover the costs of 'unspecified items which are anticipated but not itemised'. The exact costs of replacing an existing pipeline are unknown and can only be estimated. The uncertainty surrounding estimates of ORC is illustrated in the Venton report, in which Venton has allowed a plus or minus 20 per cent tolerance level in the estimate, in addition to the 10 per cent allowance for contingencies. The Commission considers that the value of ORC determined in the Final Decision is a reasonable estimate as an input factor in determining the regulated value of the ICB of the MSP.’

 

Once again, the conclusion goes to quantum, not exclusion. Also, it is wrong to infer that the 10 per cent contingency is an addition to a complete capital cost estimate. It was to cover omissions from that estimate. Venton included the contingency as part of its estimate, recognised that the estimate had an accuracy range of ± 20 per cent and arrived at an ultimate figure in the mid point of that range. There is no logical connection between an allowance for items of expenditure omitted altogether from the estimate on the one hand and the allowance for price variation up or down on the other.

51                  If, as defined and described by the ACCC, DORC is the price at which a potential new entrant making ‘a buy or build’ decision would value an existing asset, it is difficult to see why the ORC used to calculate the DORC of an existing pipeline (such as the MSP) should not include a contingency factor to cover omissions. Clearly, a prudent potential new entrant would allow for contingencies and include them in its calculation of its ORC to arrive at its ‘buy or build’ DORC value. We are of the opinion that the ACCC was wrong and unreasonable in finding that the contingency included in Venton’s estimate of ORC should be excluded in toto. We are of the view that it was appropriate to include a contingency factor in an estimate of ORC in this case to cover omissions.

52                  As there is material available as to quantum it is preferable that it be resolved by the Tribunal rather than sent back to the ACCC for reconsideration. It does not follow that the 10 per cent contingency originally claimed by EAPL should be allowed in full. Venton’s letter of 12 May 2003 referred to above recognises that:

‘While a detailed analysis of the estimate for omissions and cost accuracy was not undertaken at the time of the 1999 report, it was considered that 10% was reasonable. A more detailed analysis may show that 7.5% would have been a more appropriate allowance.’

 

Notwithstanding the changes in Venton’s ORC in the four and a half years that the access arrangement has been before the ACCC, in its submissions EAPL pressed that the Venton allowance of 10 per cent should be allowed or at worst reduced to 7.5 per cent. The ACCC’s submissions and its submissions in reply to EAPL’s further submissions are critical of EAPL for failing to itemise the $82 million 10 per cent contingency, but do not suggest an alternative percentage and there is no expert evidence on the point. The ACCC’s criticism ignores Venton’s clarification that the contingency is really an allowance for omissions. The $82 million is thus not appropriate for itemisation.

53                  In the absence of an alternative percentage being advanced by any other expert in the field, we are of the opinion that the ORC should include an allowance for contingencies of 7.5 per cent.

Credit Rating

54                  The parties are agreed that the Tribunal should determine whether the benchmark credit rating should be BBB or BBB+. Because of the manner in which the issue has developed in the successive ACCC decisions, we need to sketch the history of it in some detail.

55                  Section 8.2(a) of the Code provides that factors about which the ACCC must be satisfied in deciding to approve a Reference Tariff include that:

‘the revenue to be generated from the sales … of all Services over the Access Arrangement Period (the Total Revenue) should be established consistently with the principles and according to one of the methodologies contained in … section 8’

56                  Section 8.4 provides that the Total Revenue should be calculated according to one of the methodologies set out in the section. The methodology chosen by EAPL was the net present value (NPV) methodology described in s 8.4 as follows:

‘NPV: The Total Revenue will provide a forecast Net Present Value (NPV) for the Covered Pipeline equal to zero. The NPV should be calculated on the basis of a forecast of all costs to be incurred in providing such Services (including capital costs) during the Access Arrangement Period, and using a discount rate that would provide the Service Provider with a return consistent with the principles in sections 8.30 and 8.31.’

57                  Sections 8.30 and 8.31 provide:

‘8.30 The Rate of Return used in determining a Reference Tariff should provide a return which is commensurate with prevailing conditions in the market for funds and the risk involved in delivering the Reference Service (as reflected in the terms and conditions on which the Reference Service is offered and any other risk associated with delivering the Reference Service).

 

8.31 By way of example, the Rate of Return may be set on the basis of a weighted average of the return applicable to each source of funds (equity, debt and any other relevant source of funds). Such returns may be determined on the basis of a well accepted financial model, such as the Capital Asset Pricing Model. In general, the weighted average of the return on funds should be calculated by reference to a financing structure that reflects standard industry structures for a going concern and best practice. However, other approaches may be adopted where the Relevant Regulator is satisfied that to do so would be consistent with the objectives contained in section 8.1.’

 

58                  EAPL’s May 1999 access arrangement proposed, amongst other things:

(a) a weighted average cost of capital (WACC) with the return on equity component based on the Capital Asset Pricing Model (CAPM); and

(b) a range of 7.3 to 7.4 per cent for the cost of debt based on a margin of 1.3 to 1.4 per cent over the risk free rate which was claimed by EAPL to be consistent with the benchmark financing structure and investment grade rating.

59                  The ACCC’s December 2000 Draft Determination rejected EAPL’s proposed debt margin and, for reasons outlined in earlier decisions it had made in like matters, substituted a debt margin of 1.2 per cent.

60                  In its October 2003 Final Decision, the ACCC noted that:

‘… the debt margin operating in the economy fluctuates over time and that further data on the cost of debt (through which the debt margin can be deduced) has been published.’

 

The ACCC concluded that:

(a)                adhering to its assumption of 1.2 per cent would generate a result which would not, as required by s 8.30, reflect the prevailing conditions in the market for funds and would not, as required by s 8.2(e), represent best estimates arrived at on a reasonable basis; and

(b)               a debt margin arrived at by reference to current market data would better satisfy the requirements of the Code.

To that end, the ACCC applied the following methodology:

‘The benchmarking approach to establishing the debt margin requires the consideration of two distinct empirical questions: the appropriate benchmark credit rating of the service provider; and the market observed debt margin associated with the benchmark credit rating.

 

With regard to the benchmark credit rating of the service provider, the Commission considers that the relevant Code provisions (sections 8.30 and 8.2(e)) are best met by reference to Australian gas transmission companies. It is important for consistency with other parameter assumptions that these companies are stand alone entities and are devoid of government ownership. In addition, it is important that the gearing ratio of the entities used to calculate the debt margin are not significantly different from the gearing assumptions used to determine the WACC.²²⁹

 

The table below sets out the long term credit rating for four Australian transmission and distribution gas companies that meet the stand alone entity criteria and have been assigned a credit rating from ratings agency Standard and Poor's.²³⁰ As indicated, the average gearing ratio (debt/(debt+equity)) of these companies is 62.1 per cent, which is just slightly higher than the 60 per cent benchmark rate proposed by EAPL.

 

Table 2.6.7.3: Credit rating associated with stand alone energy companies

Source: Standard and Poor's, Australia and New Zealand CreditStats 2003, June 2003

______________________

229 All else being equal, the level of gearing effects the risk of lending to a company and thus may have an impact on the assigned credit rating.

230 A stand-alone entity is defined as an entity that does not have a parent company (a company that holds the majority of voting stock). With regard to the companies used to estimate the benchmark credit rating:

- approximately 19 per cent of Envestra Ltd is owned by Cheng Kong Infrastructure Holdings (Malaysia) Ltd and another 19 per cent is owned by Origin Energy Ltd (source: hn://www.envestra.com.au 04/08/03 data).

- 21 per cent of AlintaGas is owned by WA Gas Holdings Pty Ltd, which is jointly owned by Aquila Inc and United Energy Limited (source:http://www.alintagas.com.au).

- The largest shareholder of GasNet is National Nominees Ltd with 5.78 per cent of units (source: GasNet Annual Report 2002).

- The largest shareholder in AGL is JP Morgan Nominees Australia Limited with 9.58 per cent of issued shares (source: AGL concise Annual Report 2002).

- TXU Australia was not included in the benchmark as it is a wholly‑owned subsidiary of TXU North America.’

 

61                  Having applied that methodology, the ACCC concluded that ‘… a BBB+ credit rating represents an appropriate proxy credit rating for the benchmark company.’ A footnote to that conclusion stated:

‘Some of these companies also have non-regulated elements, which all else being equal, should lower the overall credit rating of the entity. Therefore, the rating for a 100 per cent regulated benchmark company would generally be higher than the benchmark determined above.’

 

62                  The ACCC’s Final Decision then determined a benchmark cost of debt by reference to the BBB+ proxy credit rating of 0.92 per cent.

63                  Relying on an October 2003 report by the Network Economics Consulting Group (NECG) EAPL challenged the ACCC’s choice of the BBB+ proxy credit rating in the Final Decision. The NECG report stated:

‘The benchmark credit rating applied by the ACCC (BBB+) is inconsistent with its own preferred methodology, namely benchmarking credit rating of gas transmission providers (which implies BBB).

…

The ACCC … assumes a benchmark credit rating of BBB+ by considering the average credit rating of AGL, AlintaGas, Envestra and GasNet – despite only one of these parties being a gas transmission company. The ACCC provides no explanation as to why AGL, AlintaGas and Envestra are appropriate comparators. Even in the case of GasNet its relatively higher gearing to that proposed for MSP and the lower risk faced suggests it may be more comparable to a distribution network than a gas transmission pipeline.

 

Given the greater exposure to competitive pressure, including stranding risk on MSP compared to the Victorian network, there would appear to be no clear case for assuming a credit rating above that of GasNet. However, given the paucity of gas transmission comparators we do not believe it is appropriate to rely on one comparator alone.

 

To complement such analysis, we believe that it is necessary to also estimate an appropriate credit rating by modelling the cash flows and interest-cover ratios under a range of plausible risk scenarios.

 

GasNet precedent, which is consistent with the ACCC’s own stated approach, supports a credit rating of BBB.’

 

64                  In its Final Approval the ACCC stated that it did not consider NECG’s arguments adequately addressed its position set out in the Final Decision and maintained a BBB+ benchmark. The ACCC’s Final Approval evaluated NECG’s arguments as follows:

‘First, NECG argued that the businesses used to establish the Commission's benchmark are inappropriate, given that only one of the four companies referenced is actually a gas transmission business. The Commission recognises the limited number of observations available for establishing a benchmark. There is currently only one Australian stand-alone gas transmission company which has an established credit rating – GasNet. In the Final Decision the Commission was reluctant to rely solely on CasNet's rating, particularly given the company's gearing ratio of 67 per cent which is higher than the 60 per cent benchmark assumption.65

 

In these circumstances the Commission considered it reasonable to establish the benchmark through reference not only to GasNet but to stand-alone listed gas distribution/retail companies (specifically, AlintaGas, Envestra and AGL). These companies share a number of broad characteristics with gas transmission companies (such as network characteristics and regulated returns) and provide the closest proxy available given limited data. The Commission maintains that the inclusion of these companies in the sample is appropriate and provides a more robust outcome than reliance on just one company as the basis of the benchmark.

 

This position is supported by NECG who recognised that it is not appropriate to rely on one comparator alone in the assessment of the benchmark credit rating.66 However, rather than referring to similar publicly traded entities, NECG suggested that it is necessary to undertake modelling of the cash flows and interest coverage ratios to determine a relevant benchmark. NECG and EAPL did not however engage in such an exercise or refer to any such tasks that had been completed in order to substantiate their claim.67

 

Third, NECG argued that the 'GasNet precedent, which is consistent with the ACCC's own stated approach, supports a credit rating of BBB’. This claim is factually incorrect. In the GasNet Final Decision, the Commission proposed a BBB+ benchmark based on the same sample used to establish the benchmark for the MSP in the Commission's Final Decision.68 This approach was accepted by GasNet in its revised access arrangement, not the benchmark of BBB as suggested by NECG.69 It is also of note that NT Gas Pty Ltd, of which 96 per cent is owned by APT, accepted a BBB+ credit rating benchmark in the 2002 Amadeus to Darwin Pipeline approval process.70 As previously noted APT raises debt jointly on behalf of all of its subsidiaries and then allocates these costs to the various pipelines, including both NT Gas and EAPL.71 It therefore appears inappropriate to approve a different debt margin methodology for these two access arrangements.

 

In light of the, above analysis, the Commission considers that the arguments raised by EAPL in response to the Final Decision do not address its reasons for requiring a BBB+ benchmark credit rating. The Commission has therefore maintained a bench mark debt margin of 0.92 per cent in the determination of regulated tariffs.

 

65 A high gearing ratio may have an adverse impact on the credit rating of the entity given the greater level of default risk for debt holders.

66 NECG, Key, contentions on WACC components of ACCC MSP decision, October 2003, p. 18.

67 The Commission is aware of one such cash flow analysis that was undertaken by UBS Warburg on behalf of SPI PowerNet (Letter from Nick Wade, Director, Credit Research, UBS Warburg, to Jim Larnborn, Treasurer, SPI PowerNet, 28 November 2001). While SPI PowerNet is not a gas transmission entity, the objective of this analysis was to determine an appropriate credit rating for an entity which is regulated; exhibited a gearing level of 60 per cent and a EBIT interest cover of 2.0x. Using these assumptions and standard ratios supplied by Standard and Poors, UBS Warburg concluded that 'standard regulated transmission or distribution business would be rated around BBB+'. It is notable that UBS Warburg did not distinguish between transmission and distribution. Further, UBS Warburg did not even distinguish between regulated gas and electricity entities, though the Commission's analysis in this case does not draw on data from the electricity industry.

68 ACCC, Final Decision: GasiNet Australia access arrangement revisions for the Principal Transmission System, 13 November 2002, pp. 90-91.

69 ACCC, Final Approval.. GasNet Australia access arrangement revisions for the Principal Transmission System, 17 January 2003 and GasNet Australia access arrangement, 17 January 2003.

70 ACCC, Final Approval: Access Arrangement proposed by NT Gas Pty Ltd for the Amadeus to Darwin Pipeline, 26 March 2003.

71 EAPL, Letter to the Commission, 10 June 2003, pp. 7‑8.’

 

65                  EAPL submitted that the ACCC was wrong and acted unreasonably in concluding that BBB+ was the appropriate proxy credit rating because:

(a) three of the four companies in the ACCC’s Table 2.6.7.3 quoted above have a BBB rating and one an A rating; and

(b) the only reasonable conclusion to be drawn from the table is that EAPL should have been assigned a BBB rating, not a BBB+ rating.

66                  We accept EAPL’s submission. The effect of the decision of the ACCC was to distribute part of the A rating of AGL to the other three members of the class in a crude averaging exercise. There is no logic or reason to that approach and there is no material to suggest it has any support in the theory or practice of statistics. If attention is directed to the chosen class, the only rational conclusion is that AGL was an ‘outrider’ out of line with the other members of the class and should properly be ignored. That conclusion is reinforced by the material which shows AGL to be of such a size and its business of such a nature as to be a poor proxy for a pipeline operator.

67                  If AGL is put to one side, the only rational conclusion from the chosen class is that a rating of BBB is appropriate.

SUMMARY

68                  The proposed ICB is to be set aside. The ICB should accord with DORC calculated upon ORC which includes a 7.5 per cent contingency for omissions. Depreciation should assume a life for the MSP as it stands and be based upon NPV calculated in relation to cost. The credit rating to be attributed for the calculation of tariff should be BBB.

69                  The matter will stand adjourned to enable the parties to consider these reasons and propose orders to give effect to them.

I certify that the preceding sixty-nine (69) numbered paragraphs are a true copy of the Reasons for Ruling herein of the Tribunal.

 

Associate:

 

Dated: 8 July 2004

 

Counsel for EAPL:	JT Gleeson SC, N Manousaridis
Solicitor for EAPL:	Middletons
Counsel for the ACCC:	JBR Beach QC, MAC Painter
Solicitor for the ACCC:	Deacons
Dates of Hearing:	4 February, 29–31 March, 1, 20–22 April 2004
Date of Decision:	8 July 2004

 

EAST AUSTRALIA PIPELINE LIMITED v ACCC

 

CHRONOLOGY

 

DATE			EVENT
26-May-71			30 year Agreement between AGL and Cooper Basin producers; AGL lodges application to build and operate a transmission line from Moomba to Sydney.
1972			East Aust Pipeline Corporation Limited formed to construct the pipeline.
Dec-72			New Federal Government announces it will take over the project from AGL and build the pipeline.
1973			Pipeline Authority Act 1973 (Cth) establishes the Pipeline Authority.
1974			Construction of the Moomba – Sydney pipeline commences.
17-May-74			1974 Tri-partite Agreement between TPA, AGL and the Cooper Basin Gas Producers.
17-May-74			Haulage Agreement Between TPA and AGL details the initial arrangements between TPA and AGL for the carriage of AGL's gas.
1976			Moomba – Sydney pipeline completed at approximate cost of $240 million.
1981			Young - Wagga Wagga lateral commissioned at approximate cost of $21 million..
15-Jul-81			1981 Canberra Natural Gas Sale Agreement between TPA and AGL establishes the arrangements by which the TPA would construct a gas pipeline to Canberra from an off-take point near Dalton (NSW).
21-Aug-85			1985 Heads of Agreement between TPA and AGL renegotiating in part the 1974 Haulage Agreement. Was negotiated until 1990 but never executed.
1987			Young - Lithgow lateral commissioned at a cost of $35 million and associated Agreement entered between TPA and AGL.
Early 1990			Federal Government calls for expressins of interest from third parties to purchase the pipeline.
Aug-90			Task force on assets sale issues request for proposals to purchase Moomba - Sydney gas pipeline system.
	Nov-90			New South Wales Court of Appeal upholds AGL's contractual right of first refusal, [Special Leave to Appeal to the High Court refused]
	DATE			EVENT
	1990/1991			Legislation to increase the cost of haulage defeated in the Sente and the pipeline withdrawn from sale.
	1993			Junee - Griffith lateral commissioned
	1993			Interstate Gas Pipelines Bill (Cth) introduced into Federal Parliament.
	18-Nov-93			Moomba - Sydney pipeline 51% Sale Agreement.
	10-Jun-94			Moomba - Sydney pipeline System Sale Act
	30-Jun-94			EAPL pays the Commonwealth $534.3 million for the pipeline EAPL 51% owned by AGL and 49% owned by Gas Inverst Australia Pty Limited (a joint venture of Noval Corp International Inc of Canada and Petroliam Nasional Berhad of Malaysia).
	30-Jun-94			Gas Transportation Agreement (GTA) entered between EAPL and AGL Wholesale Gas Limited which regulates terms for the purchase of gas until the end of 2016.
	30-Jun-94			Compensation Deed entered between the Commonwealth, the Pipeline Authority and AGL.
	8-Jul-97			EAPL board meeting. This board meeting forms the basis for EAPL's reasonable expectations.
	7-Nov-97			Natural Gas Pipelines Access Agreement
	14-Aug-98			Gas Code comes into force in NSW.
	Jul-98			The Interconnect is completed linking the NSW and Victorian gas systems between Wagga Wagga and Barnawartha.
	1998 – 1999			EAPL enters agreements to supply gas to non-AGL parties on the MSP.
	5-May-99			EAPL Access Arrangement Information submitted.
	Dec-99			AGL increases interest in EAPL to 76%.
	28-Apr-00			EAPL submits its first application to the NCC for revocation of coverage of certain sections of the MSP
	5-May-00			Australian Pipeline Trust Offer document to acquire 7,000 kilometres of pipelines, including the Moomba - Sydney pipeline.
	13-Jun-00			Trading of units of APT on the Australian Stock Exchange commenced
	30-Jun-00			Gas Transportation Deed replaces the Gas Transportation Agreementt.
	DATE			EVENT
	11-Aug-00			APT advised ACCC that it had acquired all the shares in EAPL Foreshadows that it wished to revise the proposed access arrangement
	17-Aug-00			EGP commissioned by Duke
	18-Aug-00			Agility on behalf of APT proposes use of NPV of revenues to ascertain DORC. Produces a DORC in excessof $900 million.
	8-Sep-00			NCC recommends that coverage of the MSP not be revoked
	21-Sep-00			EAPL letter to the ACCC notes that life of the Moomba-Wilton section could be extended to 80 years through refurbishment by recoating the pipeline in certain areas.
	16-Oct-00			The Minister decides that coverage of the MSP should not be revoked. EAPL did not appeal this decision
	19-Dec-00			ACCC Draft Decision of EAPL proposed access arrangement.
	14-Mar-01			EAPL responds to the Draft Decision
	4-May-01			Tribunal rules the EGP not be covered.
	Jun-01			EAPL lodges a second application with the NCC for revocation of coverage of certain sectins of the MSP.
	14-Jun-01			EAPL requests the ACCC to delay release of its Final Decision pending resolution of the coverage matter.
	3-Jul-01			ACCC advises EAPL that it had agreed to request to delay release of the Final Decision subject to a review in six months.
	11-Jan-02			In responses to EAPL's request to delay the Final Decision further, ACCC advises EAPL that following the six months review it would not be in the public interest to delay again.
	30-Apr-02			EAPL submits revised access arrangement to ACCC.
	20-Jun-02			EAPL submits DORC value of $972.7 million based on the Agility approach.
	20-Jun-02			ACCC releases an issues paper inviting submissions on EAPL's revised access arrangement.
	23-Aug-02			Decision of Full Court of Supreme Court of Western Australia in Epic.
	5-Nov-02			EAPL makes a submission to ACCC following the WA 'Epic Decision'. Sumbits an estimated value for DORC between 4768 million and $972 million.
DATE		EVENT
11-Nov-02		ACCC releases issues paper inviting comments on EAPL's submission and implications of the 'Epic Decision'.
14-Nov-02		NCC recommends to the Minister that coverage of the MSP should not be revoked
4-Dec-02		EAPL revises estimated value of reasonable expectations to a range of $784 - $998 million.
18-Dec-02		AGL announced new gas supply portfolio
12-May-03		EAPL submits revised lower volume forecasts following an announcement by AGL in December 2002 to change its future gas supply contracts
12-May-03		EAPL submits a letter from Venton on the nature of "contingency".
23-May-03		EAPL submits a revised report on ORC following revised volume forecasts
7-Jul-03		EAPL provided further revised access arrangement information.
2-Oct-03		ACCC Final Decision. Requires EAPL submit revised access arrangement on 23 October 2003.
23-Oct-03		EAPL provides final revised access arrangement.
23 October to 1 November 2003		EAPL makes further submissions in response to the ACCC's Final Decision, including:
		·        Public submission in response to Final Decision
		·        Venton and Associates contingency in the ORC.
		·        NECG dicsussion on hypothetical new entrant test
		·        EAPL submission of partially revised access arrangement information
		·        Submission re NERA and Agility formulations of NPV
		·        Submission of NECG report on asymmetric risk
		Legal advice from Atanaskovic Hartnell
19-Nov-03		The Minister releases his decision that coverage of the Moomba to Marsden section of the MSP should be revoked (effective from 11 December 2003).
8-Dec-03		ACCC final approval and ACCC's own access arrangement.