AUSTRALIAN COMPETITION TRIBUNAL

Application by ATCO Gas Australia Pty Ltd [2016] ACompT 10

IN THE AUSTRALIAN COMPETITION TRIBUNAL

THE TRIBUNAL DETERMINES THAT:

1.    Pursuant to s 259(2)(c) of the National Gas Access (Western Australia) Law (‘NGL’), the Final Decision on Proposed Revisions to the Access Arrangement Decision for the Mid-West and South-West Gas Distribution System, including appendices published on 10 September 2015 (‘Amended Final Decision’), and the Economic Regulation Authority’s Revised Access Arrangement Decision for the Mid-West and South-West Gas Distribution System’, including appendices (‘Access Arrangement Decision’), are set aside and remitted to the Economic Regulation Authority (‘ERA’) to make the decisions again in accordance with the following directions:

(a)    the ERA is to decide the constituent components of the Amended Final Decision and Access Arrangement Decision that involve the estimated cost of corporate income tax (gamma) by reference to a gamma of 0.25; and

(b)    the ERA is to consider, and to the extent appropriate, to vary interrelated constituent components of the Amended Final Decision and Access Arrangement Decision, having regard to s 28(1)(b)(iii) of the NGL, where necessary in light of variations made to the Amended Final Decision and Access Arrangement Decision by reason of sub-para (a) above.

REASONS FOR DETERMINATION

THE TRIBUNAL:

INTRODUCTION

1    This is an application by ATCO Gas Australia Pty Ltd (‘ATCO’), pursuant to s 245 of the National Gas Access (Western Australia) Law (‘NGL’), for review of a full access arrangement decision made by the Economic Regulation Authority (Western Australia) (‘ERA’).

2    Section 7 of the National Gas Access (WA) Act 2009 (WA) (the ‘Act’) provides that the NGL, as set out in the Schedule to the National Gas (South Australia) Act 2008 (SA) and modified by Sch 1 to the Act, applies as a law of Western Australia. Section 26 of the NGL in turn, gives the National Gas Rules (‘NGR’) the force of law in Western Australia.

Background

3    ATCO owns approximately 14,400 km of natural gas distribution networks in Western Australia, servicing approximately 720,000 consumers in the Perth greater metropolitan area and regional centres including Geraldton, Bunbury and Kalgoorlie and an LPG network in Albany. ATCO’s application for review under s 245 of the NGL (‘Review Application’) relates to ATCO’s Mid-West and South-West Gas Distribution Systems network, which comprises approximately 13,700 km of pipeline delivering gas to approximately 700,000 customers in the Geraldton, Perth metropolitan, Bunbury, Capel and Busselton areas (‘ATCO gas distribution network’).

4    ATCO is a “service provider” within the meaning of s 8 of the NGL, in that it owns, controls or operates a scheme pipeline. The NGL defines a “scheme pipeline” to include a “covered pipeline”. The ATCO gas distribution network is a “covered pipeline” within the meaning of the NGL.

5    The “regulator” is defined in s 9 of the Act to mean the ERA “in relation to an ERA pipeline”. The ATCO gas distribution network is an ERA pipeline.

6    Section 27 of the NGL prescribes the functions and powers of the ERA. The ERA is responsible for the economic regulation of pipeline services provided by service providers, including ATCO, by means of or in connection with a scheme pipeline. In particular, under Pt 9 of the NGR, the ERA is responsible for determining the total revenue for ATCO for each regulatory year of an access arrangement period for the provision by ATCO of pipeline services through the ATCO gas distribution network.

Decision under review

7    On 17 March 2014, ATCO submitted for consideration by the ERA an access arrangement revision proposal for the access arrangement period AA4, being 1 July 2014 to 31 December 2019 (‘AA Revision Proposal’). On 14 October 2014, the ERA published a draft decision on ATCO’s AA Revision Proposal (‘Draft Decision’). The Draft Decision indicated that the ERA would publish its own revised access arrangement and access arrangement information.

8    The Draft Decision included a statement of reasons for the decision and set out 45 amendments to the proposed revised access arrangement that would be required before the ERA would be prepared to approve the AA Revision Proposal.

9    In response to the Draft Decision, ATCO submitted additions and amendments to its AA Revision Proposal and a revised access arrangement proposal on 27 November 2014 (‘Amended AA Revision Proposal’).

10    On 1 July 2015, the ERA published its access arrangement final decision entitled ‘Final Decision on Proposed Revisions to the Access Arrangement for the Mid-West and South-West Gas Distribution System’ (‘Final Decision’). In its Final Decision, the ERA refused to approve ATCO’s Amended AA Revision Proposal and indicated that it would publish its own revised access arrangement and access arrangement information.

11    Following, and in response to the ERA’s publication of its Final Decision, ATCO made further submissions and provided further information to the ERA.

12    On 10 September 2015, the ERA published:

(1)    an amended Final Decision entitled ‘Final Decision on Proposed Revisions to the Access Arrangement Decision for the Mid-West and South-West Gas Distribution System’ (‘Amended Final Decision’), in which the ERA again refused to approve the Amended AA Revision Proposal submitted by ATCO; and

(2)    a further decision entitled ‘Economic Regulation Authority’s Revised Access Arrangement Decision for the Mid-West and South-West Gas Distribution System’ for the ATCO distribution network (‘Access Arrangement Decision’), in which the ERA decided to approve the access arrangement drafted by the ERA (‘ERA Access Arrangement’).

13    The decision that is the subject of ATCO’s Review Application is the Access Arrangement Decision.

14    On 29 September 2015, the ERA published minor corrections to the ERA Access Arrangement.

Application for leave and review

15    On 1 October 2015, ATCO filed its application for leave to review and its Review Application, pursuant to s 245 of the NGL. In support of its Review Application, ATCO also filed the affidavit of Simon Harvey Byrne, sworn 1 October 2015 and the supplementary affidavit of Simon Harvey Byrne, sworn 5 November 2015.

16    On 1 December 2015, the Tribunal granted leave to ATCO to apply for a review of the Access Arrangement Decision made by the ERA, being satisfied of the relevant criteria in s 248 and s 249(2) of the NGL: Application by ATCO Gas Australia Pty Ltd [2015] ACompT 7.

17    ATCO applied for review in respect of the following grounds:

(1)    Sustaining capital expenditure: the decision by the ERA, in assessing ATCO’s forecast conforming capital expenditure (‘capex’) for the current access arrangement period pursuant to r 79 of the NGR for use in the calculation of the projected capital base pursuant to r 78 of the NGR, not to allow the costs of three sustaining capex projects in forecast conforming capex;

(2)    Depreciation: the decision by the ERA, in determining the depreciation schedule pursuant to r 89, to reject ATCO’s proposed depreciation schedule and underlying depreciation approach for the current and subsequent access arrangement periods, and instead to adopt an indexed straight line approach to depreciation of the capital base;

(3)    Corporate support costs operating expenditure: the decision by the ERA, in assessing ATCO’s forecast operating expenditure (‘opex’) pursuant to r 91 of the NGR, not to allow any access arrangement preparation costs for 2015;

(4)    Reference tariffs and the reference tariff variation mechanism: the decisions by the ERA:

(a)    to use forecast (rather than actual) revenue of ATCO for July to December 2014 in the calculation of the reference tariffs for the remainder of the access arrangement period after 1 October 2015; and

(b)    not to include in the access arrangement a cost pass through event pursuant to r 97 in relation to certain regulatory and licence fees;

(5)    The allowed rate of return on equity: the decision by the ERA, in determining the rate of return pursuant to r 87 of the NGR, to:

(a)    estimate the return on equity by use of a single model, the Sharpe-Lintner Capital Asset Pricing Model (‘S-L CAPM’); and

(b)    adopt an estimate of equity beta of 0.7;

(6)    The value of imputation credits: the decision by the ERA, in determining the estimated cost of corporate income tax pursuant to r 87A of the NGR, to adopt a value of imputation credits (theta) of 0.4.

The grounds will be considered below according to the order above.

Statutory Scheme for Review

18    Section 259(4a) of the NGL provides that, in a case where the decision under review is a “designated reviewable regulatory decision”, the Tribunal may only make a determination to vary the designated reviewable regulatory decision (under s 259(2)(b)), or to set aside the designated reviewable regulatory decision and remit the matter back to the ERA (under s 259(2)(c)), if:

(1)    the Tribunal is satisfied that to do so will, or is likely to, result in a decision that is materially preferable to the designated reviewable regulatory decision in making a contribution to the achievement of the national gas objective set out in s 23 of the NGL (‘NGO’) (a ‘materially preferable designated NGO decision’); and

(2)    in the case of a determination to vary the designated reviewable regulatory decision, the Tribunal is satisfied that to do so will not require the Tribunal to undertake an assessment of such complexity that the preferable course of action would be to set aside the decision and remit the matter to the ERA to make the decision again.

19    The Access Arrangement Decision that is the subject of this Review Application falls within the definition of “designated reviewable regulatory decision”.

20    In connection with the operation of s 259(4a), s 259(4b) of the NGL requires the Tribunal to:

(1)    consider how the constituent components of the designated reviewable regulatory decision interrelate with each other and with the matters raised as a ground for review; and

(2)    take into account the Revenue and Pricing Principles (‘RPP’) set out in s 24 of the NGL (in the same manner in which the ERA is to take into account the RPP under s 28 of the NGL);

(3)    in assessing the extent of contribution to the achievement of the NGO, consider the designated reviewable regulatory decision as a whole; and

(4)    not allow the following matters, in themselves, to determine the question about whether a materially preferable designated NGO decision exists:

(a)    the establishment of a ground for review under s 246(1);

(b)    the consequences for, or impacts on, the average annual regulated revenue of a covered pipeline service provider; or

(c)    that the amount that is specified in or derived from the designated reviewable regulatory decision exceeds the amount specified in s 249(2).

21    It is important to note at the outset that the Tribunal may perform all the functions and exercise all the powers of the ERA under the NGL and the NGR for the purposes of making a determination: s 259(3) of the NGL. However, the Tribunal’s function is not to substitute a decision which the Tribunal may prefer to make on the material before the ERA, but to consider the review-related material in order to determine whether a reviewable error has been established: see Application by WA Gas Networks (No 3) [2012] ACompT 12 at [22]; Application by ActewAGL Distribution [2010] ACompT 4 at [28]; Application by ElectraNet Pty Limited (No 3) [2008] ACompT 3 (‘ElectraNet (No 3)’) at [64] and [69].

22    It follows that, if no reviewable error under s 246(1) of the NGL is made out, the Tribunal must affirm the decision under review: see ElectraNet (No 3) at [64].

The National Gas Objective and the Revenue and Pricing Principles

23    Section 28(1)(a) of the NGL requires the ERA to make the Access Arrangement Decision in a manner that will or is likely to contribute to the achievement of the NGO.

24    The NGO is defined in s 23 of the NGL, which provides:

The objective of this Law is to promote efficient investment in, and efficient operation and use of, natural gas services for the long term interests of consumers of natural gas with respect to price, quality, safety, reliability and security of supply of natural gas.

25    The NGO is the overarching objective for economic regulation under the NGL. It requires the regulator to seek – in its decisions – to achieve “efficient investment in, and efficient operation and use of, natural gas services for the long term interests of consumers”.

26    Additionally, when making those parts of the Access Arrangement Decision relating to a reference tariff, the ERA is required to take into account the RPP. The ERA is also permitted to take into account the RPP when performing or exercising any other “[ERA] economic regulatory function or power” if the ERA considers it appropriate to do so.

27    The RPP set out at s 24 of the NGL are as follows:

24 – Revenue and Pricing Principles

(1)    The revenue and pricing principles are the principles set out in subsections (2) to (7).

(2)    A service provider should be provided with a reasonable opportunity to recover at least the efficient costs the service provider incurs in—

(a)    providing reference services; and

(b)    complying with a regulatory obligation or requirement or making a regulatory payment.

(3)    A service provider should be provided with effective incentives in order to promote economic efficiency with respect to reference services the service provider provides. The economic efficiency that should be promoted includes—

(a)    efficient investment in, or in connection with, a pipeline with which the service provider provides reference services; and

(b)    the efficient provision of pipeline services; and

(c)    the efficient use of the pipeline.

(4)    Regard should be had to the capital base with respect to a pipeline adopted—

(a)    in any previous—

(i)    full access arrangement decision; or

(ii)    decision of a relevant Regulator under section 2 of the Gas Code;

(b)    in the Rules.

(5)    A reference tariff should allow for a return commensurate with the regulatory and commercial risks involved in providing the reference service to which that tariff relates.

(6)    Regard should be had to the economic costs and risks of the potential for under and over investment by a service provider in a pipeline with which the service provider provides pipeline services.

(7)    Regard should be had to the economic costs and risks of the potential for under and over utilisation of a pipeline with which a service provider provides pipeline services.

28    As a result of amendments made to the NGL following the enactment of the Statutes Amendment (National Electricity and Gas Laws – Limited Merits Review) Act 2013 (SA) (the ‘LMR Act’), the ERA is required by s 28(1)(b) of the NGL:

(1)    to ensure that ATCO, users or prospective users of the pipeline services, and any user or consumer associations or interest groups that the ERA considers have an interest in the matter are informed of the material issues under consideration by the ERA and are given a reasonable opportunity to make submissions in respect of the decision before it is made;

(2)    to specify:

(a)    the manner in which the constituent components of the decision relate to each other; and

(b)    the manner in which that interrelationship has been taken into account in the making of the decision;

(3)    if there are two or more possible designated reviewable regulatory decisions that will or are likely to contribute to the achievement of the NGO:

(a)    to make the decision that the ERA is satisfied will or is likely to contribute to the achievement of the NGO (the ‘preferable designated reviewable regulatory decision’); and

(b)    to specify reasons as to the basis on which the ERA is satisfied that the decision is the preferable designated reviewable regulatory decision.

29    In Applications by Public Interest Advocacy Centre Ltd and Ausgrid [2016] ACompT 1 (‘PIAC and Ausgrid’), the Tribunal (differently constituted) recently made the following pertinent comments (at [77]) on the role of the NGO (and the National Electricity Objective, as relevant in that proceeding):

The ultimate objective reflected in the NEO and NGO is to direct the manner in which the national electricity market and the national natural gas market are regulated, that is, in the long term interests of consumers of electricity and natural gas respectively with respect to the matters specified. The provisions proceed on the legislative premise that their long term interests are served through the promotion of efficient investment in, and efficient operation and use of, electricity and natural gas services. This promotion is to be done “for” the long term interests of consumers. It does not involve a balance as between efficient investment, operation and use on the one hand and the long term interest of consumers on the other. Rather, the necessary legislative premise is that the long term interests of consumers will be served by regulation that advances economic efficiency.

Community Consultation

30    The LMR Act also introduced a new process in s 261(1)(b) of the NGL such that the Tribunal must, before making a determination that relates to a designated reviewable regulatory decision, take reasonable steps to consult, in such manner as the Tribunal thinks appropriate, with:

(1)    users and prospective users of the pipeline services; and

(2)    any user or consumer associations or user or consumer interest groups that the Tribunal considers have an interest in the determination, other than a user or consumer association or a user or consumer interest group that is a party to the review.

31    The consultation process is an additional procedural step which the Tribunal must take and, ideally, is to be accommodated within the target time prescribed by s 260 of the NGL.

32    The Tribunal notified the public of the consultation both via the Australian Competition Tribunal website and newspaper advertisement.

33    The consultation took place at the Federal Court of Australia in Perth on 2 December 2015.

34    To ensure a satisfactory process, the Tribunal issued a consultation agenda under which it provided for those who wished to speak to the Tribunal on that occasion either personally or on behalf of an organisation, to do so. In addition, opportunity was given to those who wished to make written submissions to submit them for consideration by the Tribunal following the consultation.

35    In this application, no member of the community sought to make any submissions to the Tribunal.

GROUNDS FOR REVIEW

Nature and scope of the grounds for review under s 246

36    Section 246(1) of the NGL provides that applications for merits review under s 245(1) may only be made on one or more of the following grounds:

(1)    the original decision maker made an error of fact in the decision maker’s findings of facts, and that error of fact was material to the making of the decision (s 246(1)(a) of the NGL);

(2)    the original decision maker made more than one error of fact in the decision maker’s findings of facts, and those errors of fact, in combination, were material to the making of the decision (s 246(1)(b) of the NGL);

(3)    the exercise of the original decision maker’s discretion was incorrect, having regard to all the circumstances (s 246(1)(c) of the NGL); or

(4)    the original decision maker’s decision was unreasonable, having regard to all the circumstances (s 246(1)(d) of the NGL).

Error of fact

37    In order to determine whether the ERA made an error of fact for the purposes of s 246(1)(a) and (b) of the NGL, the Tribunal must:

(1)    ascertain the precise conclusion of fact made by the ERA;

(2)    determine whether, within that conclusion, there is a finding of fact (or facts) that can properly be said to be erroneous (or erroneous in combination); and

(3)    if the finding of fact (or combination of facts) was erroneous, determine whether the error was material to the making of the decision.

Incorrect exercise of discretion

38    A discretionary decision making process requires the decision maker to weigh up relevant considerations. Some of the circumstances in which an incorrect exercise of discretion will occur are set out in the following paragraphs.

39    A decision which is not determined by reference to the applicable criteria in the NGL or the NGR is likely to have involved an incorrect exercise of discretion. Similarly, an incorrect exercise of discretion may occur where the exercise of the discretion is:

(1)    based upon a misconstruction or misapplication of relevant principles, methodologies or factors required to be considered by the NGL or NGR;

(2)    affected by a failure to have regard to a mandatory relevant factor prescribed by the NGL or the NGR;

(3)    affected by the regulator taking into account factors which are extraneous to those relevant under the NGL or NGR; or

(4)    affected by a failure to take into account a relevant submission.

40    If the reasons for a decision contain a logical error or an unexplained discretionary choice made in reaching a conclusion, then the decision is likely to have involved an incorrect exercise of discretion (and is also likely to be unreasonable). If factual error is made out and the exercise of discretion is based upon it, the exercise of discretion is incorrect.

41    However, the ground for review is not available merely because the Tribunal would exercise the discretion in a different way. If the ERA has exercised its discretion correctly, in accordance with correct principles, and if the particular exercise of discretion was open to it within the framework of the NGL, then it is not for the Tribunal to substitute a decision which it might prefer on the material before the decision maker.

Unreasonableness

42    The ground for review in s 246(1)(d) of the NGL requires that the decision under review is itself unreasonable.

43    For the unreasonableness ground in s 246(1)(d) of the NGL to be established, it must involve logical error or irrationality in the decision, and the decision must not be justified by reference to its stated reasons. A decision will be unreasonable if there is an absence of reason to explain the discretionary choices made by the ERA in arriving at its conclusions.

44    It is not possible to give an exhaustive definition of what constitutes an unreasonable decision. However, at one end of the spectrum, an arbitrary or capricious decision will be unreasonable, but at the other end of the spectrum, it is not sufficient merely to reach a different view to the original decision maker.

45    A decision which is not determined by reference to the applicable criteria in the NGL or the NGR is likely to be unreasonable in all the circumstances. A failure to take into account a matter which is required to be considered, or consideration of a matter which is irrelevant, may also constitute unreasonableness.

46    The unreasonableness ground in s 246(1)(d) and the incorrect exercise of discretion ground in s 246(1)(c) overlap to a certain extent. For example, if the reasons for a decision contain logical error or an unexplained discretionary choice made in reaching a conclusion, then the decision is likely to be unreasonable.

Interaction between the grounds

47    Notwithstanding the discussion above, and as noted by the Tribunal in Application by ATCO Gas Australia Pty Ltd [2015] ACompT 7, the Tribunal accepts that:

(1)    the line between the several available grounds for review is not necessarily always clear cut;

(2)    there is no clear line between factual error, opinion, and discretionary judgment, as one may feed into the other;

(3)    any such error or errors - if accepted by the Tribunal - may be a combination of error or errors of fact, wrongful exercise of discretion, and the outcome of an unreasonable decision.

See Application by ATCO Gas Australia Pty Ltd [2015] ACompT 7; Applications by Public Interest Advocacy Centre Ltd, Ausgrid, Endeavour Energy and Essential Energy [2015] ACompT 2; Application by ActewAGL Distribution [2015] ACompT 3.

48    In accordance with the legislative context, ATCO’s Review Application to the Tribunal is limited in that:

(1)    ATCO must establish that the ERA made an error of one of the four kinds described in s 246(1)(a)-(d) of the NGL;

(2)    where, as in the present application, the application relates to a “designated reviewable regulatory decision”, ATCO must identify how addressing any errors it establishes by varying or setting aside the decision would, or would be likely to, result in a materially preferable designated NGO decision;

(3)    ATCO may not raise any “matter” (by way of evidence or submissions) that it did not raise and maintain in submissions to the ERA before the decision was made; and

(4)    unless the Tribunal is satisfied that a ground of review has been made out, the Tribunal must not consider any material other than that specified in s 261(1) of the NGL, which material essentially comprises the material that was before the ERA and the parties’ submissions to the Tribunal.

Sustaining capital expenditure

Introduction

49    ATCO seeks a review of the ERA’s determination of ATCO’s forecast capex used to determine projected capital base over AA4.

50    Specifically, ATCO contended that the ERA was in error in not approving forecast sustaining capex relating to the following projects:

(1)    a proposed spur line from the existing Dampier to Bunbury transmission pipeline offtake at the Muchea gate station to Two Rocks and areas south of Two Rocks including Yanchep and Alkimos (‘Two Rocks project’);

(2)    a three stage project commencing with reinforcement from the Fairbridge gate station to Pinjarra, then two further stages extending a new spur line to Greenfields and Mandurah (‘Peel project’); and

(3)    a number of smaller interdependency projects to improve reliability and security of supply at certain points in the network (‘Interdependency project’) as well as metallic mains replacement.

Legislative framework

51    Under r 76(a) and r 76(b) of the NGR, two of the building blocks in determining ATCO’s total revenue for each regulatory year of the access arrangement period are a return on, and depreciation of, the projected capital base for the year.

52    The projected capital base is determined by adding to the opening capital base, forecast conforming capex for the period (less forecast depreciation and assets to be disposed of during the period): r 78.

53    Under r 79(1), conforming capex is capex that meets the following criteria:

(1)    the capex must be such as would be incurred by a prudent service provider acting efficiently, in accordance with accepted good industry practice, to achieve the lowest sustainable cost of providing services;

(2)    the capex must be justifiable on a ground stated in r 79(2).

54    Capex is justifiable under r 79(2) if:

(a)    the overall economic value of the expenditure is positive; or

(b)    the present value of the expected incremental revenue to be generated as a result of the expenditure exceeds the present value of the capex; or

(c)    the capex is necessary:

(i)    to maintain and improve the safety of services; or

(ii)    to maintain the integrity of services; or

(iii)    to comply with a regulatory obligation or requirement; or

(iv)    to maintain the service provider’s capacity to meet levels of demand for services existing at the time the capex is incurred (as distinct from projected demand that is dependent on an expansion of pipeline capacity); or

(d)    the capex is an aggregate amount divisible into two parts, one referable to incremental services and the other referable to a purpose referred to in paragraph (c), and the former is justifiable under paragraph (b) and the latter under paragraph (c).

55    ATCO contended that the capex in question is justified under one or more of the heads of justification in r 79(2)(c)(i)-(iii), namely that it is necessary to:

(1)    maintain and improve the safety of services: r 79(2)(c)(i); or

(2)    maintain the integrity of services: r 79(2)(c)(ii); or

(3)    comply with a regulatory obligation or requirement: r 79(2)(c)(iii).

56    Rule 74 addresses the basis on which a forecast (like forecast capex) is to be determined, and the information necessary to support it. Rule 74 provides:

(1)    Information in the nature of a forecast or estimate must be supported by a statement of the basis of the forecast or estimate.

(2)    A forecast or estimate:

(a)    must be arrived at on a reasonable basis; and

(b)    must represent the best forecast or estimate possible in the circumstances.

57    Rule 71 is also relevant to the ERA’s consideration of forecast capex, and provides:

(1)    In determining whether capital or operating expenditure is efficient and complies with other criteria prescribed by these rules, the [ERA] may, without embarking on a detailed investigation, infer compliance from the operation of an incentive mechanism or on any other basis the [ERA] considers appropriate.

(2)    The [ERA] must, however, consider, and give appropriate weight to, submissions and comments received when the question whether a relevant access arrangement proposal should be approved is submitted for public consultation.

58    The ERA’s discretion in approving conforming capex is limited: r 79(6). The consequence is that under r 40(2) of the NGR, the ERA may not withhold its approval to an element of an access arrangement proposal that is governed by the relevant provision if the ERA is satisfied that it:

(1)    complies with applicable requirements of the NGL and the NGR; and

(2)    is consistent with applicable criteria (if any) prescribed by the NGL and the NGR

59    This is in contrast to other provisions of the NGR where the ERA has no discretion or conversely full discretion: see r 40(1), r 40(3).

60    There may appear to be some tension between these provisions in the NGR, and s 28(1)(b)(iii) of the NGL. However, putting aside any issues of the status of the NGR (which whilst they have the force of law in Western Australia are not elevated to have the same effect as the NGL), s 28(1)(b)(iii) is to be applied in contemplation of the operation of the NGR. So, for instance, if a provision of the NGR has mandatory effect (see, eg r 50) then the ERA must decide according to that direction. It could not rely on s 28(1)(b)(iii) to ignore the operation of a mandatory provision of the NGR, on the basis that there was a preferable designated reviewable regulatory decision. It is only when the ERA, in correctly applying the NGR, comes to the conclusion that there are two or more possible designated reviewable regulatory decisions, that the ERA needs to consider whether there is such a “preferable” decision. If the ERA has a limited discretion under the NGR, it must proceed accordingly, and not at large.

Factual background

Australian and New Zealand standards and their application

61    One justification for ATCO’s sustaining capex is its need to comply with a number of Australian standards. ATCO and the ERA had very different interpretations of what those standards required and how they should be applied. As much of the claimed sustaining capex turns on these standards, it is necessary to consider them in some detail.    

62    AS/NZS 4645.1:2008 Gas distribution networks Part 1: Network management (‘AS 4645’) applies to gas distribution networks. Appendix C of AS 4645 is headed “Qualitative risk assessment”. The opening paragraph of Appendix C headed “C1 General” provides:

This appendix provides guidance for qualitative risk assessment undertaken in accordance with AS/NZS 4360.

63    ATCO relied on the references to the expression “qualitative” in the heading to Appendix C and the above passage in support of its view that AS 4645 does not require (and relevantly did not require) a cost-benefit analysis. It consistently maintained that position.

64    The reference in Appendix C to “AS/NZS 4360” is a reference to the Australian and New Zealand risk management standard AS 4360 (‘AS 4360’). It is undisputed that AS 4360 was replaced by AS/NZS ISO 31000:2009 Risk Management – Principles and guidelines (‘AS 31000’) in November 2009. The preface to AS 31000 traces the development of the standard and the decision to move to an international standard on risk management.

65    The preface to AS 31000 also states that the process described for managing risk is identical to that in AS 4360. Much of AS 31000 is devoted to describing that process and what it requires. Some of the features of that process include:

    communication and consultation with external and internal stakeholders during all stages of the risk management process;

    the internal and external environment in which the organisation seeks to achieve its objectives is to be assessed;

    risk assessment is the overall process of risk identification, risk analysis and risk evaluation;

    risk treatment involves selecting one or more options for modifying risks, and implementing those options;

    there should be planned monitoring and review as part of the risk management process; and

    risk management activities should be traceable.

66    The risk analysis process under AS 31000 may be undertaken with varying degrees of detail, depending on the risk, the purpose of the analysis and the information, data and resources available. It is expressed that the analysis can be qualitative, semi-qualitative or quantitative, or a combination of these depending on the circumstances. Again, ATCO pointed to this passage in support of its view that a cost-benefit approach is not mandated.

67    The management process under AS 31000 also requires

[s]electing the most appropriate risk treatment option [which]involves balancing the costs and efforts of implementation against the benefits derived, with regard to legal, regulatory, and other requirements such as social responsibility and the protection of the natural environment.

68    The ERA relies on this passage (among others) in support of its view that a cost-benefit analysis is required.

69    AS 4360 and its replacement, AS 31000 are useful in setting the framework for the management of risks. However, those standards are necessarily general in nature as they are intended to apply to many industries, not just gas. For that reason, the parties acknowledged that AS 4645 is more relevant as it applies specifically to gas distribution networks, including the ATCO gas distribution network. Unsurprisingly, AS 4645 was the subject of much attention by the parties.

70    AS 4645 requires that all actions and activities not unduly expose personnel, the public or the environment to unacceptable risks. Measures to mitigate those risks are to be identified, reviewed and documented. The areas to be considered include:

    safety of the public (including consumers);

    safety of personnel working on the gas distribution network;

    integrity of the network;

    minimisation of environmental impacts; and

    protection of property.

71    AS 4645 requires that the risk assessment of threats be undertaken under AS 4360. AS 4645 further provides:

Appendix C provides the requirements for qualitative risk assessment and it provides a risk matrix that should be used in an AS/NZS 4360 qualitative risk assessment.

72    There are circumstances where risk estimation using qualitative methods is required to enable comparison of alternative mitigation measures as a basis for demonstration of ‘as low as reasonably practical’(‘ALARP’), and in some jurisdictions, to satisfy planning criteria.

73    Again, ATCO relied on the references to the expression ‘qualitative’ in support of its view that a qualitative approach, rather than a cost-benefit analysis is all that is required.

74    Appendix C of AS 4645 provides guidance for undertaking a qualitative risk assessment. That process first involves assessing the severity of the consequences of failure of each event. The consequences to be assessed include the potential for the following:

    Human injury or fatality

    Interruption to continuity of supply with economic impact

    Environmental damage

75    Other factors such as property damage and loss of reputation may also be considered.

76    A severity class is then assigned to each failure event based on the consequences at the location of the failure (‘consequence analysis’), using the class selected from the following Table C1:

77    A severity class is applied for each of the dimensions, people, supply and the environment, and a severity class assigned to each ranging from catastrophic to trivial (as seen across the top columns of Table C1) .

78    Second, a “frequency analysis” of each threat is to be assigned for each location where risk estimation is required. The frequency classes are those from the following Table C2:

79    The frequency classes range from “Frequent” (expected to occur once per year or more) to “Hypothetical” (theoretically possible but has never occurred on a similar gas distribution network).

80    Third, Table C3 below is then used to combine the results of the consequence analysis and frequency analysis to determine the risk rank:

81    For example, a severity class of “Catastrophic” with a frequency class of “Hypothetical” yields a risk ranking of “Intermediate” in Table C3.

82    Once the risk ranking is determined, action is to be taken to reduce the risk as set out in the following Table C4:

83    As can be seen from Table C4, any risk that is considered to be “Extreme” or “High” should be dealt with to reduce it to “Intermediate” or lower.

84    Continuing the example of a risk ranking of “Intermediate”, Table C4 specifies the actions required including repeating the evaluation process and where the risk is confirmed, modifying the threat, the frequency or the consequence to reduce the risk rank to “Low” or “Negligible”. Where the risk cannot be reduced to “Low” or “Negligible”, action is to be taken to:

    remove threats, reduce frequencies and/or reduce severity of consequences to the extent practicable; and

    demonstrate ALARP.

85    In relation to ALARP, AS 4645 provides:

A risk cannot be designated as ALARP until the following has been completed:

(a)    Analysis of the means of further reducing the risk, including an analysis of various options.

(b)    Review as to the reasons why these further means have not been adopted.

(c)    Substantiation that the cost of further risk reduction measures is grossly disproportionate to the benefit gained from the reduced risk that would result.

Options that shall be considered include –

(i)    relocation of the network components;

(ii)    modification of the design of network components;

(iii)    review of pressure levels;

(iv)    modification or enhancement of specific operations or maintenance procedures;

(v)    modification to gas distribution network marking; and

(vi)    threat treatment for operating gas distribution networks shall consider interim control measures (e.g. reduction in operating pressure, access restrictions) to allow time for the implementation of permanent control measures (e.g. repair).

86    Again, ATCO maintains that ALARP can be demonstrated without a cost-benefit analysis.

The ATCO risk matrix

87    ATCO developed a risk management matrix in April 2014. The matrix adopts the factors specified in AS 4645, namely the impact on people, the environment and supply and the severity classes for each ranging from “Catastrophic” to “Trivial”. However, the matrix applied different definitions of “Consequence” (severity) from that specified in AS 4645 – presumably reflecting ATCO’s specific risk appetite, as identified in the following table:

88    ATCO also developed the following frequency table:

89    As can be seen, ATCO modified the descriptors for both consequence (severity) and frequency from that listed in AS 4645. A comparison of the specific changes ATCO made to the supply category of risk is set out in Table 37 below:

90    Similarly, a comparison of the specific changes ATCO made to the people category of risk is set out in Table 36 below:

91    It is worth noting some specific differences between ATCO’s approach and that specified in AS 4645, as they are the subject of dispute. Relevantly for “Supply”:

    ATCO’s matrix defines a “Catastrophic” event as one involving the interruption of supply affecting more than 25,000 customers. AS 4645 defines it as a “Long term interruption of supply”.

    ATCO’s matrix defines a “Major” supply event as one involving the interruption or restriction of supply affecting greater than 5000 customers. AS 4645 defines it as a “Prolonged interruption or long- term restriction of supply”.

92    Relevantly, for “People”:

    ATCO’s matrix defines a “Catastrophic” event as more than two fatalities. AS 4645 defines it as “Multiple fatalities result”.

    The ATCO matrix defines a “Major” event as “Up to 2 fatalities: Several people with life threatening or permanently disabling injuries”. AS 4645 defines it as “Few fatalities, or several people with life threatening injuries”.

ATCO’s Safety Case

93    The Gas Standards (Gas Supply and System Safety) Regulations 2000 (‘Regulations’) are made under the Gas Standards Act 1972 (WA).

94    Regulation 27 requires that a network operator submit a safety case to the Director of Energy Safety (‘Director’) for the distribution system of the network operator. A “network operator” is defined in reg 3 to mean an undertaker who operates a distribution system. It was undisputed that reg 27 applies to ATCO.

95    Regulation 3 defines a “safety case” as relevantly a document that sets out the safety management and technical practices and procedures to be followed by a network operator in the operation of a distribution system.

96    Regulation 27(2) requires that the safety case comply with a number of standards including:

    AS 4645;

    AS 2885.1 - 2007 (Pipelines - Gas and liquid petroleum Part 1: Design and construction); and

    AS 2885.3 - 2001 (Pipelines - Gas and liquid petroleum Part 3: Operation and maintenance).

97    Regulation 31(1) requires that the safety case be accompanied by a certificate signed by a nominated auditor certifying that the safety case complies with a number of matters:

31.    Preliminary certification of safety case

(1)    A safety case submitted under regulation 27 is to be accompanied by a certificate signed by the nominated auditor certifying that —

(a)    the safety case complies with the requirements of this Division;

(b)    the safety case is appropriate having regard to the size and complexity of the distribution system and the possible risks; and

(c)    the safety case adequately identifies the measures necessary —

(i)    to prevent hazardous events identified in the safety case from occurring; and

(ii)    to protect consumers, the public, employees, plant, equipment and the environment, should such events occur;

(d)    the safety case adequately identifies the training and equipment requirements necessary for personnel to be able to implement the various procedures set out in it; and

(e)    the network operator has in place a plan (the “implementation plan”) for —

(i)    implementing the measures referred to in paragraph (c); and

(ii)    meeting the requirements referred to in paragraph (d)

98    Once submitted, the Director is required to assess the safety case: reg 32(1). The Director may approve the safety case for the purpose of certification under reg 33(1) or refuse approval and must notify the network operator: reg 32(2).

99    If a safety case is approved, reg 33(1) provides that a network operator may submit to the Director a certificate signed by the auditor certifying that the measures specified in reg 31(1)(c) have been implemented, and that the requirements in reg 31(1)(d) have been met. On receipt of that certificate the Director may accept the safety case or reject it: reg 34(1).

100    In 2011 ATCO, under previous ownership as WA Gas Networks Pty Ltd (‘WAGN’), submitted a safety case in relation to its gas distribution network to the Director under reg 27. In June 2011, EnergySafety approved the safety case for the purposes of certification.

101    In July 2011, WAGN submitted a revised and certified safety case, and acceptance of the safety case was notified by EnergySafety under reg 34(1).

102    The parties proceeded on the basis that the safety case as submitted by WAGN and accepted by EnergySafety (the ‘Safety Case’) now applied to ATCO. As indicated, the accepted Safety Case required ATCO to apply certain risk thresholds, and to then take prescribed actions based on those thresholds, under AS 4645 and AS 2885.

103    Regulation 37 requires that a “prescribed activity” comply with the accepted safety case:

37. Compliance with accepted safety case

If an accepted safety case has effect in relation to a distribution system, the network operator must ensure that a prescribed activity is carried out in such a way as to comply with—

(a)    any practice or procedure set out in the accepted safety case; and

(b)    any provision of a code, standard or specification compliance with which is required under the accepted safety case.

104    “Prescribed activity” is defined in reg 3 to mean

anything related to the conveyance, control, supply or use of gas done by, for, or with the authority of, the network operator in the course of the construction, maintenance, repair or operation of any part of a distribution system

105    Regulation 37(a) requires ATCO, in the course of operating its gas distribution network to comply with any “practice or procedure” set out in the Safety Case. ATCO said this clearly includes the procedure of assessing risks and then, to the extent that the Safety Case prescribes a practice or procedure that must be followed, dealing with them in accordance with the Safety Case – which must comply with AS 4645.

106    Regulation 37(b) requires compliance with any provision of a code, standard or specification. ATCO submitted that the reference to ‘standard’ includes for example AS 4645, compliance with which is required under the Safety Case.

107    Clause 1 of ATCO’s Safety Case indicates, as required by reg 31(1)(c) and (d), that it is intended to adequately identify:

    the measures necessary to “prevent hazardous events identified in the safety case from occurring”;

    the measures necessary “to protect consumers, the public, employees, plant, equipment and the environment, should such events occur”; and

     “the training and equipment requirements necessary for personnel to be able to implement the various procedures set out in it”.

108    The Safety Case is also expressed to comply with AS 4645 and where applicable, also with:

    AS 2885.1 - 2007 (Pipelines – Gas and liquid petroleum Part 1: Design and construction); and

    AS 2885.3 - 2001 (Pipelines – Gas and liquid petroleum Part 3: Operation and maintenance),

as required by reg 27(2).

109    The Safety Case also obliges ATCO to undertake a Formal Safety Assessment (‘FSA’) where aspects of the management of the network are not in accordance with the means of compliance identified in AS 4645 to ensure the risk measures implemented result in an acceptable level of risk.

110    ATCO says it implemented its Safety Case in January 2013.

The Two Rocks, Peel and Interdependency projects

111    On 17 March 2014, ATCO submitted its AA Revision Proposal. It proposed sustaining capex for the Two Rocks project, the Peel project and the Interdependency project (the ‘Projects’). As will be seen, ATCO claimed that the capex on these Projects is required to comply with the Regulations, the Safety Case and AS 4645. To understand this argument it is useful to describe these projects in more detail.

The Two Rocks project

112    In 2013, ATCO prepared a document titled ‘Spurline – Two Rocks (Growth and Maintenance Capex) in relation to the Two Rocks project’ (‘Two Rocks project report’).

113    The Two Rocks project report is a high level assessment proposing to secure supply to the North Metro HP network in the event that the pressure reduction station (‘PRS’) at various points is unavailable. The report draws on Western Australian Department of Planning Report Directions 2031 (‘Directions 2031’) identifying potential developments in the North West region over the next 20 years.

114    The Two Rocks project report presents three options. One of these is a ‘do nothing’ option.

115    Another option is the construction of a 36 km steel pipeline to Two Rocks and areas south of Two Rocks including Yanchep and Alkimos from the existing DBP Muchea off take, along existing roads and the installation of a PRS. This option was said to “ensure continuity of gas supply to existing customers and capacity to provide gas to an additional 111,000 customers from the proposed Greenfield developments in the northern part of North West region in (sic) next 20 years”.

116    A further option involves constructing a 44 km 300mm steel pipeline with two PRSs, from the existing DBP Muchea off take, along existing roads with a further 5 km 200mm steel reinforcement in the next access arrangement period (‘AA5’). Its aim is also to ensure continuity of gas supply to existing customers and capacity to provide gas to an additional 111,000 customers from the proposed Greenfield developments in the northern part of North West region. This option is shown in the following map:

117    As indicated, this option includes a subsequent reinforcement line to be constructed in AA5 (shown bounded within a circle in the top left of the map). The Two Rocks project report recommended this option.

118    In ATCO’s Amended AA Revision Proposal, these options were discussed in Appendix 8.2 which specifically addressed aspects of the Draft Decision, including as it related to the Projects. It noted the decision to proceed with the construction of the 44 km steel pipeline as described in the diagram above.

119    In the Amended AA Revision Proposal, ATCO indicated that the option was chosen to provide greater security of supply to current and future customers including to over 60,000 existing customers in the northern networks.

120    ATCO indicated that the construction of a new pipeline was required to reduce the supply risk, which it considered “High” to an acceptable level, by introducing a secondary supply of gas of sufficient capacity to an area that is currently vulnerable due to its reliance on a single supply.

121    In addition to the loss of supply to domestic customers, there are 635 small commercial customers and 29 large commercial customers it considered would be affected.

122    Broadly, therefore, the option was considered as a risk reduction measure against the possibility of a loss of supply. As discussed below, ATCO’s classification of that risk as “High” is disputed by the ERA.

The Peel project

123    In a similar way to the Two Rocks project, in 2013 ATCO prepared the ‘Project Feasibility Study: Peel Region Long Term Growth Strategy’ in relation to the Peel project (‘Peel project report’). It noted that the Peel region is expecting a significant growth in new residential and commercial developments including in Austin Lakes. The report discussed the options to connect the proposed developments in Austin Lakes as well as the future developments in the Peel region.

124    It identified that the Greenfields developments noted in Directions 2031 are predominantly along Pinjarra road. It noted that “[t]he route of the proposed pipeline along Pinjarra Rd has been strategically selected to accommodate the Greenfields developments.... This will allow the new developments to easily connect to the gas network without extensive mains extension”. The ERA pointed to this statement in support of its view that the Peel project was in reality a growth project and not one directed at addressing security of supply.

125    The Peel project report canvassed three options. The Amended AA Revision Proposal indicates that the Peel project was proposed to address the loss of supply risk in the Peel region. This includes the loss of supply to over 34,000 customers in the Mandurah gas network. It also stated that in addition to the loss of supply to domestic customers there are 437 small commercial customers and eight large commercial customers affected.

126    The Amended AA Revision Proposal suggested that what was ultimately proposed was a three-stage project. It indicates that the project was selected after consideration of risks to reliability and security of supply identified in the Mandurah area and was ultimately proposed by ATCO in combination with the reinforcement of the existing spur line from the Fairbridge gate station supplying Pinjarra, and an extension of the line from Pinjarra in a north-westerly direction through Greenfields to Mandurah, where it would connect with the Rockingham High Pressure line.

127    The first stage is 3.2 km of high pressure main commencing with reinforcement from the Fairbridge gate station (GS011) to Pinjarra. The two further stages of 7 km and 15.6 km extend a new spur line to Greenfields and Mandurah. The location of the Peel project is shown in the following map:

128    ATCO considered that the growing Pinjarra area could not be adequately served by its present supply as the supply to Mandurah is currently largely dependent on a single spur line, originating at the Mandurah gate station (GS025) travelling west along Redheads Road to a point north of Mandurah. ATCO considered that the reliability and security of supply to the areas south of this spur line, including the Greenfields area, require improvement.

129    Therefore, like the Two Rocks Project, the Amended AA Revision Proposal indicated that the Peel Project was designed to address the possibility of the loss of supply, including to over 34,000 customers in the Mandurah gas network. In addition to the loss of supply to domestic customers, ATCO said that there are 437 small commercial customers and eight large commercial customers affected. Like Two Rocks, ATCO identified the risk of loss of supply to the Mandurah network as “High”. As discussed below, ATCO’s classification of that risk as “High” is disputed by the ERA.

Interdependency projects

130    As part of its annual asset management plan review, ATCO identified five interdependency projects it considered were necessary to reduce “High” loss of supply risk due to their relative size and location within the network and options to isolate in the event of interruption to supply. In Appendix 8.2 of the Amended AA Revision Proposal, ATCO pointed to three options, one of which is a ‘do nothing’ option.

131    One option involves constructing pipelines and regulating facilities which will reinforce isolated networks which have the potential to lose supply to over 25,000 customers for a long term period.

132    Another option involves increasing operational maintenance and third party damage mitigation initiatives by increased maintenance frequency of assets and increased frequency of patrols for third party interference.

133    ATCO’s classification of that risk as “High” is again disputed by the ERA.

134    In summary therefore, across the three Projects, ATCO identified aspects of the network that gave rise to a risk of supply interruption, in the event of pipeline failure, to more than 25,000 customers. This resulted in a risk, the consequence of which was “Catastrophic” according to ATCO’s risk matrix. ATCO then characterized the “Catastrophic” risk case having a “Remote” frequency. Therefore, under AS 4645 and its Risk Matrix, a “Catastrophic” risk with a “Remote” consequence resulted in the identification of a “High” risk ranking, for each of the Projects.

Regulatory decision

ATCO’s AA Revision Proposal and Amended AA Revision Proposal

135    In March 2014, ATCO submitted its AA Revision Proposal to the ERA.

136    In relation to the Two Rocks project and the Peel project, the following appeared in the “Asset performance and safety” section of the AA Revision Proposal:

Security of supply – HP spur lines

New high pressure spur lines and pipelines are primarily demand-related capital expenditure. However, the forecast investment also provides security of supply to new and existing customers. Therefore, a proportion of the infrastructure costs are allocated to network sustaining capital forecasts. These spur lines are discussed in detail in section 8.5.2(b) below.

137    In the “Growth capital forecast” section of the AA Revision Proposal, ATCO sought to provide justification for network growth capex. Section 8.5.2(b) was entitled “Demand related capital”. The first two “key demand related projects” ATCO identified were the Two Rocks and the Peel projects. In relation to the Two Rocks project, ATCO said:

To ensure continuity of gas supply, ATCO Gas Australia will construct a 44 km steel pipeline...The proposal will also accommodate potential consumers from developments in the North West Metropolitan region, predicted by the WA Department of Planning to be a high growth area over the next 20 years.

…

The construction of this pipeline in conjunction with the interdependency project described above will provide security of gas supply to North Metropolitan high pressure networks in accordance with AS/NZS 4645. It will also reduce the risk of loss of supply to as low as reasonably practicable in accordance the Safety Case. This option will also accommodate greenfield developments in the North West region.

138    In relation to the Peel project, ATCO said:

The Peel Region is expecting significant growth in greenfield residential and commercial developments. This pipeline is essential to economically grow the gas network and has the capacity to supply gas to future domestic and commercial developments in the Peel region. Directions 2031 forecasts the Peel region will grow by an additional 10,750 residential dwellings and several industrial sites in West Pinjarra, Greenlands and Waroona.

139    ATCO’s justification for these projects in the AA Revision Proposal was therefore broadly consistent with the reasons presented in the Two Rocks project report and the Peel project report.

140    Appendix 8.2 of the Amended AA Revision Proposal provided the ERA with further information in relation to ATCO’s requirement for the Interdependency, Two Rocks and Peel projects:

The requirement for the Interdependency, Two Rocks and Peel projects are to reduce risk from High for a loss of supply incident on high pressure infrastructure affecting greater than 25,000 customers. Currently the areas covered by the proposed projects have single source critical high pressure feeds, where the construction of secondary high pressure feeds reduces the assessed risks to an acceptable level.

To not address the High loss of supply risks would result in a breach of AS4645, the Safety Case and likely action from EnergySafety.

141    Although the Projects were expressed as a measure designed to address security of supply, clearly growth impacts also informed the decision:

When assessing the merit of individual projects, AGA considers the specific immediate and short term asset needs. However, to ensure that future growth investment is undertaken as efficiently as possible considerations of future needs are also taken in to account. Where it is efficient to do so, AGA will look to achieve both security of supply and future growth objectives.

In designing Two Rocks and Peel spur line projects to meet security of supply requirements, AGA has considered growth factors in the area and where possible increased the scope of the security of supply projects to ensure future growth can be accommodated to avoid higher future costs of supporting future growth through an additional standalone project.

142    The ERA argued that these statements indicate that the Projects were in fact growth projects not security of supply projects. While ATCO did not deny that the Projects had a growth element, it proposed to deal with the dual nature of the costs attributable to them in the following way:

In the AAI, where a project achieved both security and future growth objectives, the costs were allocated to the sustaining and growth investment categories on the basis of an NPV assessment. AGA conducted an NPV assessment of the project costs and future load and allocated the total amount of the project that enabled a neutral NPV value to growth. AGA considered that this provided a higher threshold test when considering projects against NGR 79 (2). The balance of the forecast expenditure for these projects was included in the sustaining capital expenditure category to be assessed in accordance with NGR 79 (2) (c).

Although AGA considers that its approach to categorising expenditure on shared objective projects remains appropriate, the following sections provide the stand alone security project assessments.

These assessments demonstrate that the cost of undertaking discrete projects to achieve the security and growth objectives is greater than the projects costs proposed by AGA. An alternative method of allocation might include adopting the stand alone security project costs as the costs to be allocated to sustaining capital expenditure and only allocate the incremental cost of a joint project to the growth project. This increases the NPV for the costs to be allocated to growth investment.

143    ATCO provided a confidential table in which it provided a comparison of the project costs to be allocated between growth and sustaining capex based on ATCO’s method adopted in the AA Revision Proposal and the alternative method outlined above.

Experts’ reports

144    Prior to considering the ERA’s decision and ATCO’s responses, it is worth noting that the ERA relied heavily on its expert consultant, Energy Market Consulting Associates (‘EMCa’). Similarly, ATCO relied heavily on its expert Zincara Pty Ltd (‘Zincara’) in responding to the ERA and to EMCa. In many respects, the position of each party is intimately tied to the opinions and conclusions of their respective experts. For that reason it is necessary to consider each report in some detail later.

145    In June 2014, EMCa prepared a report for the ERA titled “ATCO Gas Australia Proposed Access Arrangement for the Mid-West and South-West Gas Distribution Systems: Review of Technical Aspects of the Proposed Access Arrangement” (‘EMCa report’). EMCa also prepared two separate addendums; the first in April 2015 (‘April addendum’) and the second in June 2015 (‘June addendum’), each at the request of the ERA and in response to submissions made by ATCO. The April addendum assessed the Amended AA Revision Proposal. It canvassed whether the information provided by ATCO or third parties engaged by ATCO, changed the conclusions reached in the EMCa report. For the most part, EMCa’s June addendum traversed matters and conclusions which are broadly similar to those reached in the EMCa report and the April addendum.

146    On 25 November 2014, Zincara prepared a report for ATCO titled “Review of ATCO Gas Australia Capital and Operating Expenditure” (‘Zincara report’).

147    A minor preliminary issue in relation to these expert reports concerns the qualifications (and by implication, the expertise) of the authors of the EMCa report and the Zincara report.

148    The EMCa report was prepared by a team comprising senior management with expertise in economics and engineering across both gas and electricity. The April addendum included an additional member of the EMCa team – an engineer and business manager with 31 years’ experience in strategic planning, maintenance, operation and expansion of gas distribution businesses.

149    The Zincara report was prepared by a director and an associate of Zincara. The director is an engineer with more than 35 years’ experience in the energy sector, specialising in, among other things, business planning, implementation of utilities reforms, establishing organizations for privatisation, operating and capital cost reviews. The associate is also an engineer with more than 28 years’ experience in the gas industry.

150    The principal difference in expertise is that the Zincara authors have engineering qualifications alone, while the EMCa authors have qualifications in both engineering and economics. On the basis of this, the ERA therefore invited the Tribunal to conclude that the qualifications of the EMCa team ‘trump’ that of Zincara.

151    The Tribunal has not taken up this invitation. Rather, it has considered each report based on the strength of the arguments and evidence presented in each and given them weight accordingly.

The ERA’s Draft Decision

152    The ERA published its Draft Decision on 14 October 2014.

153    The Draft Decision notes that the ERA retained EMCa to assess ATCO’s proposed capex, opex and governance processes. In relation to capex, the ERA (relying on advice from EMCa) assessed ATCO’s proposed capex forecast under the NGR, by applying a three-stage process:

    first, evaluate whether the expenditure is justifiable on the grounds set out in r 79(2) of the NGR;

    second, consider whether the expenditure satisfies the prudent service provider test set out in r  79(1)(a) of the NGR; and

    third, assess whether forecasts or estimates comply with r 74(2) of the NGR.

154    As will be seen, this process is the same as that applied by EMCa. Under this approach, the ERA first considered whether any of the proposed expenditure satisfied one of the heads of expenditure in r 79(2), before turning to consider the test in r 79(1)(a) and then r 74(2). That is, the ERA considered that the expenditure must satisfy all three of these processes before that expenditure would be permitted to be included in the building blocks - it was not sufficient if it satisfied r 79(2) but failed r 79(1)(a).

155    The ERA noted EMCa’s assessment that the Projects had not undergone a cost-benefit analysis and the risk thresholds for “Catastrophic” events applied by ATCO are lower than other gas distribution networks:

EMCa has assessed the Safety Case, FSAs and the risk thresholds that ATCO has adopted when applying the ALARP test to security of supply projects, and has the following concerns:

•    ATCO has not conducted a cost benefit analysis.

•    ATCO has adopted a risk threshold for catastrophic events that appears to be lower than the threshold employed by other gas distribution networks. EMCa considers that the risk threshold that ATCO has adopted of 25,000 customers for loss of supply to be catastrophic is not prescribed in AS/NZS4645 and AS2885, nor mandated by EnergySafety, and is low by industry standards.

156    In concluding that ATCO had adopted a risk threshold which was “Low” when compared with other gas distributors and not prescribed by AS 4645 or mandated by EnergySafety, EMCa (although not expressly stating) must have considered that the consequence should be lower than “Catastrophic”.

157    Relying on EMCa’s advice, the ERA was therefore not satisfied that the Projects were justified under the test in r 79(1)(a) or under any head under r 79(2):

Based on EMCa’s advice, the Authority is not satisfied that the security of supply related portion in asset performance and safety ($86.34 million) is consistent with good industry practice as required by rule 79(1)(a) of the NGR. Therefore, the Authority is not satisfied that the following projects are justified under any ground in rule 79(2) of the NGR:

-    Two Rocks Spur line ($18.13 million);

-    Peel Spur Line ($20.93 million); and

-    interdependency projects ($47.29 million).

ATCO’s response to the Draft Decision

158    ATCO’s Amended AA Revision Proposal can broadly be summarised as follows:

    ATCO maintained that the portion of the capex proposed for the Two Rocks project and the Peel project that it attributed to growth was justified under r 79(2)(b).

    ATCO maintained that the portion of the expenditure proposed for the Two Rocks project and Peel project that it attributed to sustaining capex was justified under r 79(2)(c)(i), (ii), and (iii).

    ATCO reassessed the proposed Interdependency Projects and decided that six of them could be deferred, reducing the forecast capex from $47.3 million to $34 million, and maintained that the remaining four Interdependency Projects were justified under r 79(2)(c).

    ATCO provided the conclusions reached by Zincara in its report of 25 November 2014.

    ATCO provided confidential Appendix 8.1 which included e-mails from an officer of EnergySafety in November 2014.

    ATCO provided a confidential Appendix 8.2, setting out its detailed justification for the three Projects.

The ERA’s Final Decision and Amended Final decision

159    The ERA published its Final Decision on 30 June 2015 and Amended Final Decision on 10 September 2015.

160    In relation to sustaining capex, it is sufficient to refer to the Amended Final Decision as it embodies conclusions very similar to those reached in the Final Decision. Like the Draft Decision, the ERA relied heavily on EMCa in reaching its conclusions in the Amended Final Decision. Indeed, a great deal of the Amended Final Decision is devoted to referring to various aspects of the findings and conclusions reached by EMCa and EMCa’s criticisms of ATCO, Zincara and the approach taken by EnergySafety.

161     In relation to the Two Rocks project, the ERA agreed with EMCa’s risk ranking of “Intermediate” and the actions consequently required under AS 4645:

The Authority accepts EMCa’s conclusion that the risk ranking for the ‘Northern Networks’ is ‘intermediate’ and not ‘high’. The Authority shares EMCa’s view that for intermediate risks AS 4645 and the prudent service provider test in rule 79(1)(a) requires ATCO to diligently consider all options for reducing the risk ranking to Intermediate or lower, applying a cost-benefit analysis test to determine if an Intermediate ranking is ALARP.

As the Authority accepts EMCa’s recommendations that the risk ranking for the ‘Northern Networks’ and ‘Two Rocks’ is ‘intermediate’ and not ‘high’, the Authority considers that:

•    the expenditure is not required for ATCO to comply with rule 79(2)(c)(iii) of the NGR; and

•    the expenditure that ATCO has proposed to reduce its considered security of supply risk does not satisfy rule 79(2)(c)(i) of the NGR.

162    Similarly, the ERA agreed with EMCa’s risk ranking of “Intermediate” for the Peel project in almost identical terms to its conclusion on the Two Rocks project:

As the Authority accepts EMCa’s recommendations that the risk ranking for the ‘Peel Region’ is ‘intermediate’ and not ‘high’, the Authority considers that:

•    the proposed expenditure is not required for ATCO to comply with rule 79(2)(c)(iii) of the NGR; and

•    the expenditure that ATCO has proposed to reduce its considered security of supply risk does not satisfy rule 79(2)(c)(i) of the NGR.

163    The ERA reached a similar conclusion in relation to the Interdependency projects.

164    As the ERA concluded that the risk ranking for the Projects is “Intermediate”, it determined that ATCO should formally reassess its security of supply risk for each Project under the steps specified in Table C4 of AS 4645 for an “Intermediate” ranked risk. The ERA considered that ATCO should submit how it proposes to treat the “Intermediate” risk in the form of a cost pass through which, if accepted, would allow ATCO to commence recovery of these costs (through tariffs) during AA5.

165    The ERA therefore required that ATCO include a cost pass through mechanism in the following terms:

The Authority requires that ATCO include the following clause 3.1(e):

ATCO Gas Australia incurs Conforming Capital Expenditure or Conforming Operating Expenditure as a result of addressing an “Intermediate” security of supply risk following an assessment in accordance with the required steps prescribed in Table C4 of AS 4645 for an ‘intermediate’ ranked risk. This expenditure can only be passed through for the following areas of the network identified by ATCO in its Response to the Draft Decision: Northern Network, Peel, Hillary’s, Canning Vale, Fremantle and Lathlain.

166    A cost pass through mechanism in this form was included in the ERA Access Arrangement as amended at 29 September 2015. It appears in cl 2.1(e) of Appendix B. It is necessary to return to this cost pass through later in these reasons.

EMCa’s report on capital expenditure

167    Taken collectively, the EMCa report (with its addendums) is an extensive document. Although the Tribunal has read and considered the EMCa report (and its addendums), what follows are those matters that featured most prominently in the ERA’s Draft Decision and Amended Final Decision and on which the substance of the dispute and the parties submissions were based.

168    EMCa adopted a three-step approach in assessing ATCO’s capex and opex proposals. First, it considered whether the expenditure was justified on any of the grounds set out in r 79(2). Secondly, it considered whether the proposed expenditure on Projects, justified under r 79(2), satisfied the prudency test in r 79(1)(a). Finally, it considered whether the forecasts or estimates underlying those Projects that are justifiable under r 79(2) and satisfy the prudency service test, have been arrived at on a reasonable basis and represent the best forecast or estimate possible in the circumstances, as required by r 74(2). It will be noted that this is the approach which the ERA itself adopted, undoubtedly following the approach taken by EMCa.

169    EMCa reviewed the methods employed by ATCO to forecast its capex and opex. Although EMCa found that many aspects of ATCO’s approach to forecasting aligned with good industry practice, it considered that ATCO’s descriptions of its forecasting approaches for specific expenditure components were vague, listing a range of factors that have been “taken into account” but without defining how they were taken into account. EMCa also found significant subjectivity in the way the ATCO managers had made assumptions at detailed levels that then aggregate up to produce the proposed expenditure forecasts. Although not critical of the managers, EMCa considered that such an approach, when applied without strong top-down challenge, is likely to lead to overestimation.

EMCa also considered that ATCO had failed to provide sufficient evidence for its claims of poor or deteriorating performance of aspects of the network or the improvements in performance outcomes that could be expected from the proposed increases in expenditure. EMCa provided the following example:

ATCO was, for example, unable to identify any safety or non-supply incidents relating to “loss of pressure”, and the rate of leaks (as indicated by UAFG) has been declining steadily over the past five years, yet despite significantly increased proposed expenditure ATCO does not forecast it to decline further from its most recent level.

170    EMCa asserted that it sought ATCO’s business plans for the past four years on the basis that these might provide an insight into ATCO’s cost projections. EMCa said that they were not provided. ATCO only provided top–line capex and opex budgets that it advised were extracted from those plans. Those budgets figures are confidential. However, it is sufficient to note that ATCO’s capex budget figures for the AA4 are considerably higher than its 2012 and 2013 business plan forecasts for the same years, and are also higher than the capex and opex forecasts in its 2014 business plan. The ERA submitted that the disparity would make one wonder about the validity of the assessment that has been undertaken.

171    EMCa proceeded on the basis that ATCO’s Two Rocks project and Peel project contained both growth and sustaining capex elements, with the sustaining element sought to be justified under r 79(2)(c) and its Safety Case.

172    EMCa noted that most of ATCO’s increase in expenditure on sustaining capex was being driven by its application of the Safety Case and in particular the FSAs that it has conducted under the Safety Case and the risk threshold it applied to security of supply related projects when carrying out the FSAs. A greater concern for EMCa was ATCO’s failure to undertake a cost-benefit assessment when applying the ALARP test under the FSAs, which EMCa considered was required under AS 4645.

173    EMCa indicated than when conducting an FSA, AS 4645 and AS2885 require that, where risks are assessed and categorised as “Intermediate”, they must be considered further and only accepted if they satisfy the ALARP test. Importantly, EMCa considered that AS 4645 does not envisage risk mitigation at any cost. Rather, the ALARP test it says requires a cost-benefit analysis to be undertaken and measures implemented only if the costs are justified.

174    EMCa’s concern was that ATCO had “not provided any evidence (and confirmed in answer to questions during the on-site meetings) that it has conducted a cost-benefit assessment for any of the projects that have been identified as being required to reduce risks to ALARP as required by AS/NZS 4645 and AS2885”.

175    EMCa’s further concern related to the risk threshold applied by ATCO, which EMCa considered to be too low:

The second concern we have with ATCO’s approach is that the risk threshold it has adopted for catastrophic events appears to be lower than the threshold employed by other gas distribution networks, as highlighted in Table 18. This driving much higher levels of security of supply related expenditure than we would expect to observe, and which are much higher than this business has previously incurred.

176    EMCa concluded that there is no evidence to support the position that reinforcement is justified to ensure customers do not suffer loss of gas supply due to a single point failure in the ATCO gas distribution network at a threshold of 25,000 customers, when the likelihood of such an event attributable to a distribution network failure is in EMCa view, extremely low. It considered that the continued application of this threshold has the potential therefore to result in inefficient over-investment in the network and concluded:

It follows from the preceding discussion that we are not satisfied that the threshold ATCO has employed when assessing the need for security of supply related expenditure is consistent with good industry practice as required by rule 79(1)(a). Nor are we satisfied that ATCO has properly applied the ALARP test given that there is no evidence it has undertaken a cost benefit assessment either when setting its risk threshold or when assessing whether to proceed with the proposed security of supply projects. We have therefore carefully examined those security of supply related projects, which are contingent on this threshold.

177    As this passage indicates, as ATCO failed to undertake a cost-benefit analysis, EMCa carefully scrutinised the Projects. EMCa was not satisfied with the capex attributable to the Interdependency project:

According to the information provided by ATCO these projects are only being proposed to satisfy its 25,000 customer at risk threshold, which as noted above is lower than industry standards. In some cases the costs of carrying out individual projects also appear to be disproportionate to the reduced risk that would result…

178    EMCa was similarly dissatisfied with the capex attributable to the Two Rocks project:

In this case ATCO has assumed a 60,000 customer threshold. While the threshold applied in this case is higher, the costs associated with reducing the risk of a supply interruption to 60,000 customers still appear disproportionate to the reduced risk that would result from building the spur line, with the costs of carrying out the project forecast to be in excess of $300 per customer.

179    Additionally, EMCa considered that ATCO had not satisfactorily justified the growth component of the Two Rocks project. Therefore, disallowing some of the costs of this Project on that basis placed a further burden on the need to justify it on security of supply grounds as claimed.

180    EMCa was also not satisfied with the capex in relation to the Peel project:

In this case ATCO has assumed a 29,000 customer threshold. In a similar manner to the other projects, the costs associated with reducing the risk of a supply interruption to 29,000 customers appears disproportionate to that would result from building the spur line, with the costs of carrying out the project forecast to be in excess of $720 per customer.

181    However, EMCa was not suggesting that these Projects could never be justified. It indicated what would be required to justify the costs attributable to them:

Although we cannot accept that these projects (or the security of supply related portion of these projects), which total $86.3m, are justified under rule 79(2) based on the information that ATCO has provided in its AA, this should not be taken as a finding that these projects could never be justified. We would expect though that any assessment that ATCO may choose to respond in response to the ERA’s Draft Decision would be conducted in accordance with good industry practice. This should include:

•    distinguishing between events that have a direct safety consequence for employees, customers and/or the wider public and events that primarily have a potential loss of supply impact;

•    evidence-based assessment of risk likelihood;

•    evidence of consideration of risk mitigation measures; and

•    the assessment of proposed projects by reference to consideration of costs and benefits as is required by the aforementioned standards.

182    As this passage makes clear, EMCa maintained its view that for these Projects to be justified, they must undergo a cost-benefit analysis.

183    Overall, therefore, EMCa’s main findings can conveniently be summarized as follows:

•    ATCO has not provided sufficient evidence of existing performance issues or justified the significant increases in capex and opex that it proposes, nor has it been able to show how performance outcomes would improve as a result of such higher levels of expenditure. The proposed expenditure in these instances fails to satisfy several components of NGR rule 79 and of rule 91(1);

•    In several categories of expenditure, ATCO’s proposed increased expenditure requirements are inconsistent with its chosen current actual expenditure levels and its most recent business plans prior to its AA4 budgeting. In these cases, the proposed expenditure fails to satisfy rule 79(1)(a);

•    ATCO’s devolved approach to budgeting has not been subject to sufficiently rigorous top-down challenge. In our experience, bottom-up budgets that are not subject to a rigorous top-down challenge process are more likely to be over-estimated. In these cases, the proposed expenditure fails to satisfy rule 79(1)(a) and rule 9(1);

•    Significant drivers such as the criteria used in claiming justification for expenditure based on ATCO’s Safety Case, have not been adequately justified by reference either to fundamental impact analysis or to peer benchmarks. The use of these criteria has led ATCO to propose significant increases in expenditure. The relevant proposed expenditure fails to satisfy rule 79(1)(a); and

•    ATCO’s project costings and volume activity costings appear reasonable. In the relevant instances, the expenditure satisfies rule 79(1)(a) and 91(1).

Areas of dispute

184    It is useful at this stage to set out the areas of dispute.

185    ATCO indicated in its Amended AA Revision Proposal that the Two Rocks, Peel and Interdependency projects are designed to reduce risk from “High” for a loss of supply incident on high pressure infrastructure affecting greater than 25,000 customers. It maintained that not addressing the “High” loss of supply risks would result in a breach of AS 4645, the Safety Case and likely action from EnergySafety.

186    ATCO therefore contended that the capex in question is justified under the following heads in r 79(2):

(1)    to maintain and improve the safety of services: r 79(2)(c)(i);

(2)    to maintain the integrity of services: r 79(2)(c)(ii); or

(3)    to comply with a regulatory obligation or requirement: r 79(2)(c)(iii).

187    The ERA was not satisfied that r 79(2)(c)(iii) has been met for any of the Projects. Similarly, it was not satisfied that ATCO has complied with r 79(2)(c)(ii) in respect of the Peel project and the Interdependency project. ATCO submitted that the ERA did not address the application of r 79(2)(c)(ii) in relation to the Two Rocks project. The ERA also considered that r 79(2)(c)(i) had no application to the Projects.

188    It should be noted that the ERA rejected the growth components of the Projects. ATCO no longer seeks a review of that outcome.

189    ATCO argued that the claimed capex satisfies the prudency test in r 79(1)(a). The ERA disputed this.

190    In reaching these conclusions, ATCO therefore contended that the ERA made a series of factual errors, incorrectly exercised its discretion or made decisions which were unreasonable having regard to all the circumstances. In order to demonstrate each area of failure, ATCO identified several specific matters running to many paragraphs in its Review Application and supporting submissions – a ‘list’ of failures.

191    Were the Tribunal to simply reproduce that extensive list it would not be conducive to a meaningful understanding of the core issues in dispute. The Tribunal has noted the grounds of review raised by ATCO in its application and supporting submissions. However, to enable those issues to be more efficiently addressed, the Tribunal has grouped them into specific topics - which in any case, closely follow the submissions of ATCO and the ERA.

192    The Tribunal has adopted this approach also because (with some small differences) the ERA agreed with ATCO that its reasons for rejecting ATCO’s sustaining capex across each of the Projects were essentially similar. This also means that the Tribunal need only consider the areas in dispute by reference to a single Project – and the others, only to the extent that there are differences that require specific mention.

193    Adopting this approach, the areas that ATCO claimed the ERA was in error can be grouped as follows:

(1)    The ERA’s failure to accept that the Projects satisfied one or more limbs of r 79(2)(c);

(2)    The ERA’s failure to consider the application of r 79(2)(c)(ii) to the Two Rocks project;

(3)    The ERA’s failure to accept that the Projects satisfied the prudency test in r 79(1)(a);

(4)    The ERA’s requirement for a cost-benefit analysis to demonstrate compliance with the prudency test in r 79(1)(a) and its rejection of ATCO’s view that a quantitative assessment was not necessary;

(5)    The ERA’s downgrading of ATCO’s risk ranking from “High” to “Intermediate” and the consequences which would follow;

(6)    Assuming the ERA was correct to assess the risk as “Intermediate”, the ERA was wrong to suggest that a cost-benefit analysis of options was required to satisfy the ALARP test;

(7)    The ERA’s failure to determine that a proper application of AS 4645 (as varied by ATCO’s Risk matrix) results in ATCO being obliged under its Safety case to undertake the projects;

(8)    The ERA’s requirement that ATCO assess its projects under the cost-pass through mechanism for an “Intermediate” risk imposed under the Final Decision.

194    The Tribunal considers that the issues raised by the errors identified by ATCO can be conveniently dealt with under a discussion of the following topics:

    Rule 79(2)(c)(iii) – Compliance with a regulatory obligation or requirement;

    The nature of the analysis required under AS 4645;

    The operation of r 79(2)(c) and r 79(1)(a);

    The risk thresholds applied by ATCO; and

    The ERA’s failure to consider the application of r 79(2)(c)(ii) to the Two Rocks Project and the Peel Project.

The Tribunal will then separately consider the ERA’s determination to require ATCO to assess its Projects under a cost-pass through mechanism.

Consideration

Rule 79(2)(c)(iii) – compliance with a regulatory obligation or requirement

195    ATCO submitted it was under a “regulatory obligation or requirement” under r 79(2)(c)(iii) to undertake the Projects and that the expenditure on them was conforming expenditure. While the expression “regulatory obligation or requirement” is not defined in the NGR, it is the expression defined in the NGL.

196    ATCO reached the conclusion that it was under a regulatory obligation or requirement by the following process of reasoning:

(1)    Section 28(1)(a) of the NGL requires the ERA, in making an Access Arrangement Decision, to do so “in a manner that will or is likely to contribute to the achievement of the national gas objective”. The NGO is defined in s 23 of the NGL as follows:

The objective of this Law is to promote efficient investment in, and efficient operation and use of, natural gas services for the long term interests of consumers of natural gas with respect to price, quality, safety, reliability and security of supply of natural gas.

(2)    Under s 28(2)(a)(i) of the NGL, in exercising a discretion in approving or making those parts of an access arrangement relating to a reference tariff, the ERA must take into account the RPP in s 24 of the NGL, which it is convenient to set out again:

(1)    The revenue and pricing principles are the principles set out in subsections (2) to (7).

(2)    A service provider should be provided with a reasonable opportunity to recover at least the efficient costs the service provider incurs in—

(a)    providing reference services; and

(b)    complying with a regulatory obligation or requirement or making a regulatory payment.

(3)    A service provider should be provided with effective incentives in order to promote economic efficiency with respect to reference services the service provider provides. The economic efficiency that should be promoted includes—

(a)    efficient investment in, or in connection with, a pipeline with which the service provider provides reference services; and

(b)    the efficient provision of pipeline services; and

(c)    the efficient use of the pipeline.

(4)    Regard should be had to the capital base with respect to a pipeline adopted—

(a)    in any previous—

(i)    full access arrangement decision; or

(ii)    decision of a relevant Regulator under section 2 of the Gas Code;

(b)    in the Rules.

(5)    A reference tariff should allow for a return commensurate with the regulatory and commercial risks involved in providing the reference service to which that tariff relates.

(6)    Regard should be had to the economic costs and risks of the potential for under and over investment by a service provider in a pipeline with which the service provider provides pipeline services.

(7)    Regard should be had to the economic costs and risks of the potential for under and over utilisation of a pipeline with which a service provider provides pipeline services.

(3)    Thus, s 24(2)(b) of the NGL requires that a service provider be provided with a reasonable opportunity to recover at least the efficient costs it incurs in complying with a regulatory obligation or requirement or making a regulatory payment.

(4)    Under s 6(1) of the NGL, a “regulatory obligation or requirement” includes the following:

(a)    in relation to the provision of a pipeline service by a service provider—

(i)    a pipeline safety duty; or

(ii)    a pipeline reliability standard; or

(iii)    a pipeline service standard; or

(b)    an obligation or requirement under—

(i)    this Law or the Rules; or

(ii)    an Act of a participating jurisdiction, or any instrument made or issued under or for the purposes of that Act, that levies or imposes a tax or other levy that is payable by a service provider; or

(iii)    an Act of a participating jurisdiction, or any instrument made or issued under or for the purposes of that Act, that regulates the use of land in a participating jurisdiction by a service provider; or

(iv)    an Act of a participating jurisdiction or any instrument made or issued under or for the purposes of that Act that relates to the protection of the environment; or

(v)    an Act of a participating jurisdiction, or any instrument made or issued under or for the purposes of that Act (other than national gas legislation or an Act of a participating jurisdiction or an Act or instrument referred to in subparagraphs (ii) to (iv)), that materially affects the provision, by a service provider, of pipeline services to which an applicable access arrangement applies.

(5)    Section 2 of the NGL defines “pipeline reliability standard” and “pipeline safety duty” in the following terms:

pipeline reliability standard means a standard imposed by or under an Act of a participating jurisdiction, or any instrument made or issued under or for the purposes of that Act, relating to the reliable haulage of natural gas in that jurisdiction;

pipeline safety duty means a duty or requirement under an Act of a participating jurisdiction, or any instrument made or issued under or for the purposes of that Act, relating to—

(a)    the safe haulage of natural gas in that jurisdiction; or

(b)    the safe operation of a pipeline in that jurisdiction

(6)    The expression “regulatory obligation or requirement” also extends to an obligation or requirement under an Act (or instrument under an Act) which materially affects the provision of pipeline services via the relevant pipeline: s 6(1)(b)(v).

(7)    The interpretation of the NGL, the regulations under it, and the NGR is governed by the interpretation principles in Sch 2 to the NGL: s 20 of the NGL. Clause 13 in Sch 2 provides that, subject to a contrary intention, expressions defined in the NGL (such as “regulatory obligation or requirement”) are to be taken to mean the same as such terms in statutory instruments (such as the NGR).

197    ATCO submitted that no contrary intention appears in the NGL, the regulations, or the NGR indicating that the term “regulatory obligation or requirement” should have a meaning in the NGR which is different from the meaning of that term in the NGL. By this process of reasoning, ATCO maintains that the term “regulatory obligation or requirement” in r 79(2)(c)(iii) has the same meaning as that term in the NGL. Therefore, the expression “regulatory obligation or requirement” under the r 79(2)(c)(iii) is said to include a “pipeline safety duty” as defined in the NGL.

198    ATCO therefore considered that it was under a regulatory obligation or requirement if it was under a pipeline safety duty or requirement. ATCO said that this duty or requirement arises under its Safety Case (as approved by EnergySafety) and under Western Australian laws; relevantly the Regulations.

199    For now, the Tribunal is prepared to assume (without deciding) that ATCO is under a regulatory obligation or requirement. However, for the reasons discussed below, that does not of itself mean that the claimed sustaining capex is permitted.

EnergySafety

200    ATCO placed considerable reliance on input it received from an officer of EnergySafety in support of its capex relating to the three Projects.

201    The identity of the EnergySafety officer is not material. It is sufficient to note that the officer has an engineering background. ATCO did not suggest the officer had expertise in any other area. Neither party questioned the officer’s authority to respond on behalf of EnergySafety. For that reason, the officer’s response will be considered that of EnergySafety and will be referred to in that way.

202    There were a number of e-mail exchanges between ATCO and EnergySafety in November 2014. On 14 November 2014, EnergySafety sent an e-mail to the ERA, in response to the Draft Decision “to ensure that ATCO is given an opportunity to continue to comply with the technical regulatory requirements and its associated safety case.”

203    In that e-mail, EnergySafety reached several conclusions and made several recommendations. First, EnergySafety appeared to conclude from the Draft Decision that the Projects would not proceed:

4)    In the draft decision the report would indicate that these projects are not going to proceed and in that justification, it would further appear that the draft decision has used the risk model of AS/NZS2885.1: Pipelines-Gas Liquid and Petroleum and a Quantitative Risk Assessment.

204    The conclusion demonstrates a misunderstanding of the scheme of regulation under the NGR. The Draft Decision, of course, does not prevent ATCO from proceeding with the Projects. What the ERA was suggesting in the Draft Decision is that it would not allow the capex associated with those projects to be included in the building blocks used to set reference tariffs, as it was not satisfied it complied with the NGR.

205    The Tribunal also does not accept EnergySafety’s conclusion that the ERA only considered and used AS/NZ 2885.1, suggesting it was the only standard it considered. In its Draft Decision, the ERA refers to both standards in reaching its conclusion. This is consistent with EMCa’s advice where it also considered both standards in reaching its conclusion. In its April addendum, EMCa explained its reasons for referring to AS 2885:

We reject EnergySafety’s conclusion that we relied upon AS 2885 in our assessment of ATCO’s proposed AA4 sustaining capex projects. We referred only to that standard to assist in interpreting the guidelines in Appendix C of AS 4645, given that they do not appear to contemplate risk mitigation options of the scope, scale and cost proposed by ATCO. AS 2885 applies to high pressure gas transmission pipelines and risk treatments can often incur significant costs. Ultimately and primarily, ATCO must comply with AS 4645, not AS 2885.

206    EnergySafety then commented on the application of the standards and concluded that the wrong standard has been applied:

5)    If operating under AS/NZS 2885, which ATCO is not, an operator may conduct a quantitative risk assessment (cost/benefit analysis) that would allow, in some circumstances, acceptance of a higher risk threshold. i.e. if it is proved that the current mitigation strategies were indeed ALARP or using the terminology - “Tolerable”. In other words, any capital spent on lowering the risk of a loss of supply event would be disproportionate to the added gain. In contrast AS 4645 does not cater for this level of quantitative scrutiny. This information can be obtained by putting the 2 risk models side by side.

6)    AS/NZS2885 applies to high pressure gas transmission pipelines. AS/NZS4645 applies to Gas Distribution Networks. It is not feasible to adopt the risk model of AS/NZS2885 to regulate networks that require compliance to AS/NZS4645.1 as the conditions under which these apply are vastly different.

7)    In other words the wrong risk model has been used to arrive at this draft decision disallowing the ATCO proposed network reinforcement projects.

207    For the reasons stated above the Tribunal rejects the conclusion reached by EnergySafety at paragraphs 6 and 7 of its e-mail above.

208    Later, EnergySafety commented on the nature of the assessment required under AS 4645:

Re 6) AS/NZS4645.1:2008 relates to gas distribution networks that are by their very nature in densely populated areas, that are also under continued high levels of risks from third party interference and operate at pressure and flow scenarios that can be managed safely in a practical and cost effective manner. Therefore only a qualitative risk model has been adopted in AS/NZS4645.

Re 7) A quantitative risk assessment (QnRA) does not form part of AS/NZS4645 and a QnRA was used to justify the preclusion of these projects.

209    ATCO relied on this statement in support of its view that AS 4645 does not require a cost-benefit analysis, and accordingly, it was not in error in not commissioning one in relation to the Projects. However, EnergySafety’s conclusion that AS 4645 does not cater for quantitative scrutiny is not supported by any compelling analysis undertaken by EnergySafety, other than it seems, the view of EnergySafety. EnergySafety’s conclusion is also unconvincing because it has not considered the question of whether a quantitative analysis is required by any provision of the NGR, quite separately to AS 4645.

210    EnergySafety appeared to conclude that were the Draft Decision applied, it may place ATCO in breach of the Regulations:

8)    If ATCO would conform to the draft decision then they will be breaching the Gas Standards Act 1972 immediately when such access arrangement becomes effective. Because the risk of a loss of supply event is high to extreme, ATCO is then unquestionably obliged to mitigate to a lower, acceptable risk level. The Draft Decision in effect directs ATCO into non-compliance with AS/NZS 4645 and is considered untenable from a technical and safety regulatory point of view.

211    EnergySafety’s comments above further demonstrate a misunderstanding of the Draft Decision and the role of the ERA. The Draft Decision does not excuse ATCO from compliance with the Regulations nor does it, of its own operation, place ATCO in breach of the Regulations. The ERA merely concluded that it was not satisfied that the costs of the Projects claimed by the ERA met the requirements of the NGR. The statement also failed to indicate the process by which EnergySafety reached the conclusion that the risk of loss of supply is “High” to “Extreme” or the evidence available or relied on in support of that conclusion.

212    EnergySafety also explored the risk ranking reached by ATCO:

A notifiable incident is defined in the Gas Standards (Gas Supply and System Safety) Regulations 2000 (GSR) as “an incident, event or other thing of which the Director requires notification under regulation 34.” Looking through the lens of the Draft Decision in particular, para 451, EMCa states that, in its view, ATCO’s adopted risk threshold of a catastrophic event of a loss of 25,000 to be “low by industry standards.” Under the severity classes in AS/NZS 4645 Table C1, a supply catastrophic event is defined as a “long term interruption of supply.” According to GSR reg 43(1)(c), EnergySafety considers a loss of a major customer exceeding 50 TJ/year or 100 other customers to be considered a notifiable incident. This is 250+ times less than the risk threshold mentioned by EMCa. Considering the urban sprawl in the WA metropolitan areas with critical customers dispersed within it, such as hospitals, NG bus depots and schools, it is this office’s view that ATCO’s threshold of 25,000 is, if anything, too high contrary to the belief of EMCa.

Therefore, ATCO’s assessment of a “catastrophic” loss of such supply event (sic) t around 25,000 customers is accepted by EnergySafety.

213    Regulation 43(1)(c) to which EnergySafety refers, requires a network operator to notify the Director of any unplanned interruption of the supply of gas to any consumer whose annual gas consumption usually exceeds, or can reasonably be expected to exceed 50TJ, or to at least 100 customers. Therefore, when the passage refers to this being “250+ times less than the risk threshold mentioned by EMCa”, it is a reference to ATCO’s supply risk threshold of 25,000 customers which is ‘250’ multiplied by the 100 customers mentioned in reg 43(1)(c). It is on that basis that EnergySafety concluded that ATCO’s threshold was if anything, too high. It is also for that reason that EnergySafety accepted ATCO’s classification of “Catastrophic” as a loss of supply to around 25,000 customers.

214    The e-mail noted that plastics gas mains are inadvertently dug-up and damaged on a regular basis and refered to a recent example impacting in excess of 700 customers. It also explained that steel mains can be damaged, though it suggested that the potential for this to occur is lower due to the strength of the material and the frequency of vehicle patrols inspecting the pipelines for nearby construction activity.

215    The e-mail therefore concluded that a loss of supply event cannot be classified as “Hypothetical” because it has been proven that a loss of supply event is indeed possible on steel mains. Table C2 of AS 4645 defines “Hypothetical” as “Theoretically possible but has never occurred on a similar gas distribution pipeline”.

216    However, it is unclear when the email refers to a “proven” event of damage whether there have been actual examples of damage to comparable steel gas networks that would take it outside the descriptor of a “Hypothetical” event.

217    EnergySafety’s email concludes with the following recommendation to the ERA:

EnergySafety respectfully requests that the Economic Regulatory Authority reviews its decision making processes and consider reversing the current Draft Decision that prevents ATCO remedying the major predictable supply interruptions it has successfully identified and in doing so reinforce the gas distribution network.

218    EnergySafety sent a second e-mail to the ERA on the 14th November 2014 in which it outlined significant safety concerns “that may arise from the restriction imposed on ATCO disallowing it to expand its network on economic grounds.”

219    On 22 November 2014, EnergySafety sent an e-mail to ATCO in which it stated:

1.    ATCO has to comply with the Safety Case which links to AS4645.1

2.    Any scenario that involves 20-25,000 customers or more is considering the duration of the interruption, is classified as catastrophic to severe.

....

4.    No cost benefit analysis is accepted to justify not taking action as AS/NZS4645 is qualitative only.

220    The Tribunal has already commented on the conclusions reached by EnergySafety in paragraphs 1 and 4 of the e-mail of 22 November 2014 above. The findings and statements of EnergySafety are not compelling for the reasons discussed and the ERA and EMCa were entitled to give them little weight.

221    However, the Tribunal is in no way critical of EnergySafety. EnergySafety is a safety body and the officer, an engineer. It would not be expected that EnergySafety have an understanding of the process of economic regulation prescribed by the NGL and NGR.

The nature of the analysis required under AS 4645

222    As indicated, the Regulations require that the Safety Case comply with a number of specified standards, including AS 4645. ATCO’s Safety Case is expressed to comply with AS 4645. Much of the battle of the parties and their consultants was therefore directed at what AS 4645 required. A recurring and polarising issue is whether AS 4645 relevantly requires a qualitative analysis (as ATCO argued) or a cost-benefit analysis as the ERA argued.

223    There is a considerable lack of precision in the way both EMCa and Zincara described the source of the analysis required. It is unclear whether EMCa was asserting that a cost-benefit analysis is required:

    by AS 4645 (as part of the overall framework of that standard);

    as part only of the ALARP test for an “Intermediate” ranked risk;

    as a requirement of r 79(2)(c) itself;

    by the operation of the prudency test in 79(1)(a); or

    through a combination of all.

224    A few examples from the EMCa report serve to highlight this problem. In chapter 4 of the EMCa report, EMCa points to the following issues with ATCO’s analysis that suggest it does not meet r 79(1)(a) and 79(2)(c):

ATCO has expressed a belief that projects that relate to safety do not require economic justification. This stance is reflected in the lack of cost-benefit analyses in the FSAs with respect to the ALARP criterion and may be based on the assumption that satisfying rule 79(2)(c) does not require an economic test. However, as discussed in Sections 5 and 6 and in Appendix A, we believe such a test is required.

225    Although the passage is intended to demonstrate a lack of compliance with both r 79(1)(a) and r 79(2)(c), there is in fact no mention of r 79(1)(a) itself.

226    In chapter 5 of its report, EMCa commented that “of even greater concern though is that ATCO has not conducted a cost-benefit assessment when applying the ALARP test under the FSAs, as required by AS/NZS4645 and AS2885”.

227    In Table 16 of its report, EMCa provided a summary of the reasons why ATCO’s proposed capex does not satisfy r 79. In relation to the Two Rocks project and the Peel project, that summary is in the following terms:

Not justified under either:

•    Rule 79(2)(c) because:

-    ATCO has not conducted the cost benefit assessment required by AS/NZS4645 and AS2885 when applying the ‘as low as reasonably practicable’ test; and

-    the 25,000 customer threshold applied by ATCO in defining a catastrophic loss of supply is not consistent with good industry practice.

•    Rule 79(2)(b) because compelling information has not been provided by ATCO to demonstrate that the expected incremental revenues of these spur lines exceed the proposed capex.

228    This passage does not mention r 79(1)(a).

229    In Appendix A of its report, EMCa referred to the requirements of the ALARP test in AS 4645 and, immediately following, concluded that “ATCO has not provided any evidence (which was confirmed in answer to questions during the on-site meetings) that it has carried out the cost benefit assessment required by AS/NZS4645 and AS2885.” Given the proximity of the passages, what appears to be suggested is that the cost-benefit analysis to which it is referring is in fact the test required by paragraph C5.2 of AS 4645 to demonstrate ALARP. Under AS 4645, that test is required only where a risk is ranked as “Intermediate” and steps are to be taken to demonstrate ALARP.

230    In its April addendum, EMCa considered that AS 4645 and the prudency test in r 79(1)(a) required ATCO to diligently consider all options for reducing the risk ranking to “Intermediate” or lower, applying a cost-benefit analysis test to determine if an “Intermediate” risk is ALARP.

231    Finally, in relation to the Two Rocks project, EMCa concluded in its April addendum:

While noting the very high cost per customer of the mitigation that ATCO has proposed, it is not within our scope to undertake, on ATCO’s behalf, the depth of analysis that correct interpretation of AS 4645 requires. In the absence of this analysis, we conclude that:

(a)    ATCO does not have a regulatory obligation to satisfy under the NGR (per r. 79(2)(c)(iii)); and

(b)    The expenditure that ATCO has proposed to reduce its considered security of supply risk does not satisfy r. 79(2)(c)(i) of the NGR.

232    It is unclear how EMCa concluded that ATCO “does not have a regulatory obligation”. As indicated, EMCa did not undertake a process of reasoning like ATCO to indicate whether a regulatory obligation exists, as ATCO said, under its Safety Case. Nor did EMCa justify the level of analysis it says is required by AS 4645.

233    It is unnecessary to refer to further examples to highlight the lack of precision in EMCa’s approach. That same lack of precision appeared in the Zincara report. For example, in the case of all three Projects, Zincara reached the same conclusion:

In summary, Zincara considers that ATCO does not have to demonstrate ALARP as the project is considered high risk and as such, Zincara therefore considers the project to be consistent with rule 79(2)(c).

234    However, Zincara’s conclusion says little about the interaction between r 79(2)(c) and r  79(1)(a).

235    The lack of precision is perhaps hardly surprising as both EMCa and Zincara were ultimately focussed on advising their respective clients on the amount of capex to be included in the building blocks. They were not focussed in any great detail on the interplay between the standards and the NGR. For example, EMCa did not spend any detail on assessing ATCO’s claim that it is under a regulatory obligation in the way ATCO had developed that argument. Again, it is hardly surprising that it did not do so, not least because the background of EMCa’s authors is in economics and engineering.

236    Notwithstanding this, that level of precision is important because a great deal of the dispute now attaches to the proper application of AS 4645 and the NGR.

237    Both parties pointed to various provisions of AS 4645 (many of which the Tribunal has already alluded) in support of their view that AS 4645 requires, or conversely does not require a cost-benefit analysis, however described. To the extent that the parties, or more relevantly their experts, may have been suggesting that such a view is apparent from the text of AS 4645 as a whole – and it is not clear that they were suggesting that – the Tribunal is not in a position to make such a determination. The Tribunal was not taken to the history of this standard or other evidence that would enable it to draw such a conclusion. Rather, the Tribunal’s approach is to consider whether a particular provision in AS 4645 requires, within its terms, a quantitative cost-benefit analysis, or something else.

238    One of EMCa’s concerns was ATCO’s failure to undertake a cost-benefit assessment when applying the ALARP test under the FSAs, which EMCa considered was required under AS 4645. The difficulty with this conclusion is that the ALARP test is only required where an “Intermediate” classification has been adopted. It is not required where a “High” classification is adopted, as ATCO had done. For a “High” classification, AS 4645 requires modifying the threat, the frequency or the consequence to ensure that the risk is reduced to “Intermediate” or lower. For a gas distribution network in operation, the risk must be reduced “as soon as possible, typically within a timescale of not more than a few weeks”.

239    As ATCO consistently proceeded on the basis of a “High” risk, it had no reason to apply an ALARP test as required by EMCa - at least not the ALARP test prescribed by AS 4645. The Tribunal sees no basis for concluding that AS 4645 requires that the same ALARP test be applied to a “High” risk. AS 4645 specifically deals with the requirement for an ALARP test at paragraph C5.2, immediately following Table C4, where the ALARP requirement appears only under the “Intermediate” risk category, not in relation to other risks. For the reasons indicated earlier, the Tribunal is also not prepared to conclude that the ALARP approach in paragraph C5.2 emerges as an inherent feature of all risks classified under AS 4645.

240    Zincara appeared to have been aware of this issue. It noted that some confusion arose because ATCO’s Safety Case misused the term ALARP, and that it has used ALARP to mean “acceptable risk” which could be a “Low” or “Intermediate” risk. The following passage from the Zincara report explains where “acceptable risk” ought to have been used in place of ALARP:

In Section 4.2.2.3.5 of the Safety Case, ATCO describes the steps that it takes following the risk ranking:

1.    If the risk is ranked Extreme or High, ATCO determines the steps that are necessary to reduce the risk to ALARP.

2.    If the risk is Intermediate, ATCO determines the appropriate action to reduce the risk to ALARP.

3.    If the risk is Low or Negligible, ATCO determines the management plan to prevent future occurrence and to monitor changes that could affect the rating

To be consistent with ATCO’s risk management approach, Step 1 and Step 2 (described above) should use the term “acceptable risk” which could be intermediate (in which case the ALARP test should be applied) or low.

241    What Zincara appeared to be suggesting is that ATCO would only need to apply the guidelines for ALARP if the risk is at an “Intermediate” level but not if it is “High” (as incorrectly described in step 1 from the above passage). This construction is consistent with two examples of its application cited by Zincara in the case of meter installations and cast iron networks. The approach is also consistent with Table C4 of AS 4645. Despite this misapplication, Zincara did not consider it would affect the methodology adopted by ATCO in preparing its forecast capex. Zincara therefore concluded that ATCO’s approach is compliant:

As such, Zincara considers that ATCO’s risk management practice is consistent with that of a prudent service provider acting efficiently in accordance with accepted good industry practice, to achieve the lowest sustainable cost of delivering pipeline services.

242    It is for this reason that in the case of all three Projects, Zincara reached an identical conclusion that ALARP was not required:

In summary, Zincara considers that ATCO does not have to demonstrate ALARP as the project is considered high risk and as such, Zincara therefore considers the project to be consistent with rule 79(2)(c).

243    However, had ATCO applied an “Intermediate” risk classification then under Table C4, AS 4645 would have required that ALARP be demonstrated. In this respect, there is no need to look further than the clear words of paragraph C5.2 of AS 4645 which expressly require substantiation of the costs and benefits of any risk reduction measure. Indeed that provision provides a further directive – a requirement that several options be considered as part of that assessment. Zincara did not appear to dispute the nature of the cost-benefit analysis required by paragraph C5.2 of AS 4645, had it applied to ATCO:

As discussed in Section 3.1.1, AS/NZS4645.1 requires that if the risk is assessed as extreme or high, ATCO is to take action that reduces the risk to low without any cost benefit analysis. However, if the action only reduces the risk to intermediate, then ATCO is required to investigate further action. If ATCO has to resolve to extreme measures to reduce the risk to low, it is required to carry out a cost benefit analysis and demonstrate that the cost is grossly disproportionate to the benefit.

244    A number of observations can be made regarding this conclusion. What Zincara in fact did at section 3.1.1 was set out the process undertaken by ATCO. Under that process, if the risk is considered “Intermediate” after the risk treatment, ATCO would then conduct a further risk treatment option to reduce the risk to “Low” or “Negligible”. If the treatment option did not reduce the risk to “Low”, ATCO would consider additional treatment options and also carry out a cost-benefit analysis in accordance with AS 4645. The Tribunal agrees with Zincara that ATCO’s “High” risk ranking did not impose on it the ALARP requirement required under paragraph C5.2 of AS 4645. It is axiomatic though that if ATCO had classified a risk as “High” under its risk matrix, then it would take the actions required by its risk matrix to address a “High” risk. However, that conclusion says little about whether the risk ought to have been so classified. Secondly, when Zincara refers in section 3.1.1 to a cost-benefit analysis required for certain risks under AS 4645, it is not clear how it has reached this conclusion because there was inadequate discussion of it in this part of the report.

245    Zincara’s conclusions are therefore not a complete answer to ATCO’s claim to include the capex costs associated with the projects. The ALARP requirement under paragraph C5.2 did not extend to ATCO because it had applied risk measures (and definitions of those risks) that ultimately resulted in a “High” risk ranking. The relevant question is however whether a “High” ranking was appropriately applied. This is discussed further below.

246    Given the lack of precision on the part of both EMCa and Zincara to which the Tribunal has already referred, the best that can be said is that each expert alluded generally to the operation of r 79(2)(c) or r 79(1)(a), or a combination, in support of their positions on allowable capex. That is, AS 4645 is not the only source of the obligation. As the ERA relied on the conclusions of EMCa, that assessment will also effectively determine whether the ERA made the errors alleged by ATCO. At this point, it is therefore important to consider the operation of r 79(2)(c) and r 79(1)(a).

The operation of r 79(2)(c) and r 79(1)(a)

ATCO’s submissions

247    ATCO said it is unclear whether the “prudent and efficient” criterion in r 79(1)(a) will always be met where capex is “necessary” or “required” under r 79(2)(c)(iii), for example because it is required as a result of a pipeline duty or requirement, and the service provider cannot choose to cease to provide gas services by means of the relevant pipeline. A similar issue arises as to whether the criterion applies if something is “necessary” under r 79(2)(c)(i) or (ii).

248    ATCO was prepared to concede that r 79(1)(a) is intended to provide some form of relevant filter on what expenditure will be allowable even in the circumstances where the service provider is required to incur capex in order to meet a regulatory obligation or requirement, or where it is otherwise necessary. However, ATCO’s preferred construction of r 79 generally was that the provision prima facie permits such expenditure, but only if it meets the “prudent and efficient” criterion. ATCO suggested that the “prudent” limb in r 79(1)(a) would be met almost as a matter of course. This is because it is axiomatic that any prudent service provider would comply with “regulatory obligations and requirements” under r 79(2)(c)(iii), or for that matter where expenditure is “necessary” under r 79(2)(c)(i) or (ii). As regards the “efficient” limb, ATCO submitted that attention must be given to the means for achieving sustainable compliance at the lowest cost.

249    Where there is only one way of doing what is “justifiable”, then ATCO suggested that should be taken to be efficient, in accordance with “good industry practice”, and incurred to achieve the lowest sustainable cost for the purposes of r 79(1)(a). Where there is more than one way of meeting a “regulatory obligation or requirement”, or doing something which is “necessary”, ATCO argued that r 79(1)(a) invites inquiry as to whether the proposed course of action meets the “prudent and efficient” criterion.

250    ATCO maintained that it applied the criterion because it considered more than one way to spend the “justifiable” expenditure on the Two Rocks project, and the current proposal was chosen from those options. ATCO suggested that the question is not whether the justifiable expenditure necessarily meets the “prudent and efficient” criterion, but whether the option so chosen satisfies the “prudent and efficient” criterion. Under this approach, ATCO necessarily rejected EMCa’s requirement that it ought to have undertaken a cost-benefit analysis.

251    Additionally, ATCO asked the Tribunal to consider the following process of reasoning for concluding that r 79(1)(a) does not demand a cost-benefit analysis:

MR GRAY: ... But the first step in that is to go back to the submissions I made about the hierarchy of provisions in rule 79 and how it is that we put our case that there has been an impermissible gloss placed on section 79 by imposing a cost - a quantitative costs-benefit analysis requirement in all cases, including in cases where the various roman numeral subparagraphs at paragraph (c), subrule (2) are engaged.

.....

We say 79(2) itself contains a hierarchy of justification, starting with economic justifications or two different kinds in (a) and (b), and then moving on to different justifications, justifications of a different character altogether, justifications that are not economic justifications but are justifications in the nature of obligations or other subject matter consonant with the National Gas Objective.

The National Gas Objective is not only limited to the long-term interests of consumers on matters of price, but also on matters of safety, security, supply and such like. Now, just taking (2) one - subrule (2) one paragraph at a time, the first justification is in the nature of an economic justification. It is informed by subsection (3).

...

We say subrule (2)(a) certainly imposes an economic justification test, and we say that the limitation, such as it is, imposed by subrule (3) is not such as to deprive that criterion of its character as a costs-benefit-type test. It’s a quantitative costs-benefit test; it’s just that the economic values to be included in that test are economic values that can be said to directly accrue to the four categories of entities mentioned, service providers, etcetera.

...

MR GRAY: - - - we say 79(1)(a) is to be construed in a way that it doesn’t just duplicate the ground already covered by the justifications in 79(1)(b) and that is 79(2). And because in 79(2) there are cost benefit requirements in each of justifications (a) and (b) it’s highly unlikely that there is some formal quantitative cost benefit requirement in (1)(a). It certainly doesn’t read like there is. We disagree, with respect, with our friend’s submissions that any of the four limbs or elements of (1)(a) impose such a requirement. They don’t read like that. I will take them one at a time. Prudent service provider, well, if you had a statutory obligation to do something you have to do it. Granted, you have to adopt the cheapest, appropriate way of doing it but that’s - again, I repeat my submission - not a quantitative cost benefit analysis of the cost of balancing the cost of doing what you’re required to do with the benefit in terms of avoidance of economic impact on users and so forth. It’s simply finding the cheapest way to achieve the required regulatory outcome and efficiently that requirement doesn’t add anything to what I’ve already said. If one has an obligation it has to meet it. Then, granted you have to adopt the cheapest way to meet it but it doesn’t mean you have to conduct some sort of balancing of the broader benefit to be achieved by incurring the cost. You just have to find the cheapest cost…

252    ATCO’s argument was that EMCa’s and the ERA’s insistence on a cost-benefit analysis was in substance, a contention that, in quantitative terms, a service provider must demonstrate that the costs of a project are outweighed by economic benefits. This amounts to mandating compliance with r 79(2)(a) or (b) in every case, an outcome that deprives r 79(2)(c) of a legitimate role.

253    ATCO also suggested that some risks, particularly those that may have to be addressed under a regulatory obligation relating to safety, will not be readily susceptible to a strict monetary cost-benefit analysis. It will not always be possible for societal benefits of elimination of such risks to be quantified. This must be so in light of the prevalence of regulatory obligations directed to the risk to human life or injury. ATCO argued that it is wrong to read into r 79(1)(a) a requirement that efficiency should be assessed by reference to cost-benefit considerations where it may well be that the benefit in question (eg avoidance of death or injury) is qualitative and involves societal norms. In the case of expenditure for a purpose under r 79(2)(c)(i)-(iii), the costs issue which must be addressed under r 79(1)(a) is whether the safety or integrity of service risk, or the regulatory obligation in question, is being addressed cost efficiently. ATCO said its analysis satisfied that test and there is nothing in the text or context of r 79(1)(a) that compelled the conclusion urged by the ERA.

254    ATCO accepted that if there is a cheaper method evidently available to satisfy the relevant regulatory obligation in a manner conducive to the achievement of the NGO, then a more expensive option for doing so will not satisfy r 79(1)(a).

The ERA’s Submissions

255    The ERA argued that r 79(1)(a) requires satisfaction of a wider and more stringent test than is required by AS 4645. In this respect, the purpose and focus of AS 4645 and the Safety Case is the assessment and treatment of risk. The focus of r 79(1)(a) is economic efficiency, for the purpose of determining if ATCO’s proposed capex should be included in the determination of total revenue for the purpose of calculating a regulated tariff. Further, a cost-benefit analysis is widely recommended as a requirement for evaluating publicly funded infrastructure projects.

256    The ERA maintained that for capex to be conforming, it must satisfy both r 79(1)(a) and r 79(2). At a high level, that much is agreed between the parties. However, the ERA argued that (contrary to what it considered ATCO to be suggesting), there is no necessary implication that, merely because certain proposed capex might be justified as necessary for one of the objectives identified in r 79(2)(c)(i), (ii), or (iii), the particular proposed expenditure is prudent, efficient, or otherwise satisfies any of the requirements in r 79(1)(a). Nor must it necessarily follow that the proposed expenditure is the lowest sustainable cost of achieving that objective.

257    The ERA argued that in the absence of some form of quantitative analysis, such as a cost-benefit analysis, ATCO did not demonstrate that the proposed capex was efficient and the lowest sustainable cost of providing the regulated services, even if it was necessary for one or more of the purposes in r 79(2)(c)(i)-(iii). The ERA maintained that it is insufficient for ATCO to point to compliance with a regulatory obligation under its Safety Case as justifying the capex because that conflates a safety obligation with the economic objectives in, among other things, r 79. Were that the case then compliance with r 79(2)(c)(i), (ii), or (iii) alone would be sufficient to render proposed capex conforming, despite the operation of r 79(1)(a).

Consideration

258    It is useful to again set out r 79(1) and r 79(2) in full ahead of the Tribunal’s consideration of these arguments:

79    New capital expenditure criteria

(1)    Conforming capital expenditure is capital expenditure that conforms with the following criteria:

(a)    the capital expenditure must be such as would be incurred by a prudent service provider acting efficiently, in accordance with accepted good industry practice, to achieve the lowest sustainable cost of providing services;

(b)    the capital expenditure must be justifiable on a ground stated in subrule (2).

(2)    Capital expenditure is justifiable if:

(a)    the overall economic value of the expenditure is positive; or

(b)    the present value of the expected incremental revenue to be generated as a result of the expenditure exceeds the present value of the capital expenditure; or

(c)    the capital expenditure is necessary:

(i)     to maintain and improve the safety of services; or

(ii)     to maintain the integrity of services; or

(iii)     to comply with a regulatory obligation or requirement; or

(iv)     to maintain the service provider’s capacity to meet levels of demand for services existing at the time the capital expenditure is incurred (as distinct from projected demand that is dependent on an expansion of pipeline capacity); or

(d)    the capital expenditure is an aggregate amount divisible into 2 parts, one referable to incremental services and the other referable to a purpose referred to in paragraph (c), and the former is justifiable under paragraph (b) and the latter under paragraph (c).

259    As previously stated, the projected capital base for a period is determined by taking the opening capital base and adding to it conforming capex permitted under r 79 (less certain deductions). The opening capital base is not revalued under the NGR at each access arrangement period for the purpose of determining the projected capital base.

260    In this way, the decision to include sustaining capex impacts both the projected capital base for the period and also subsequent periods. Additionally to this consequence, a rate of return is applied to the projected capital base, which together with other items, ultimately determines the total revenue by which reference tariffs are calculated.

261    The purpose of this “trail” is to demonstrate the significance that capex attaches to the regulatory process under the NGR. If capex is allowed when it ought not be, then the projected capital base and ultimately the revenue requirement will be higher (all other things being equal) than ought to be, and customers will be paying higher tariffs than they should. This might occur, for example, if a service provider were allowed to include ‘gold plated’ capex when that is not required. Similarly, allowing less capex than ought to be allowed, may result in insufficient costs to fund the necessary expenditure needed to adequately deliver reference services, with the consequence that service delivery and safety may be compromised.

262    Sustaining capex therefore plays a very significant role in the scheme of regulation, and the NGR provide for a fine balance between allowable and disallowable capex. Rule 79 is designed to ensure that the balance is appropriately struck and should be construed with that in mind.

263    ATCO suggested that there is a hierarchy of justifications in r 79(2) where the character of r 79(2)(a) and (b) stand in contrast to r 79(2)(c). However, there are no express words in r 79 to indicate that the criteria in r 79(2)(a) and (b) on the one hand, have any different status in r 79 than the criteria in r 79(2)(c).