Envestra proposed two programs under mains replacement. The AER's final decision for each is summarised below.
The AER's final decision is to not accept Envestra's low pressure pipe replacement expenditure on the basis that:
the AER considers the estimate of the volumes is not prudent and efficient.85 The volumes proposed by Envestra exceed those which Envestra has demonstrated are necessary to meet its safety and regulatory obligations over the current period. The AER considers that these obligations will not materially change in the 2013–17 access arrangement period. In addition, mains risk is unlikely to change in the 2013–17 access arrangement period.
the AER considers the estimate of the unit rates do not represent the best estimate possible in the circumstances.86 The AER considers there are flaws in Envestra's proposed methodology for calculating unit rates from unawarded tenders such that the proposed capex does not reflect the efficient and prudent costs of undertaking the proposed mains replacement program.87
For the final decision the AER considers that a total expenditure of $100.4 million ($2011, unescalated direct costs, excluding overheads) for low pressure pipe replacement and $3.4 million ($2011, unescalated direct costs, excluding overheads) for medium pressure supply mains which are necessary for carrying out the low pressure pipe replacement program is conforming capex. This consists of 359 kilometres of low pressure to high pressure block rollout mains replacement and 6 kilometres of integral medium pressure supply mains replacement (see ).
For ad hoc mains replacement and service renewals capex, the AER received no further information and for the reasons given in the draft decision, approves Envestra's proposed $3.0 million ($2011, unescalated direct costs, excluding overheads) for ad hoc service renewals capex and $1.1 million ($2011, unescalated direct costs, excluding overheads) for reactive mains replacement for the 2013–17 access arrangement period as conforming capex.88
Table 4.10 Final decision Victoria network - Mains replacement(a) ($million, 2011)
The AER's final decision is to not approve Envestra's low pressure pipe replacement expenditure on the basis that:
the forecast volume is not prudent and efficient.89 The volumes proposed by Envestra exceed those which Envestra has demonstrated are necessary to meet its safety and regulatory obligations90 over the current period. The AER considers that these obligations will not materially change in the 2013-17 access arrangement period. In addition, mains risk is unlikely to materially change in the 2013-17 access arrangement period. The AER considers $100.4 million ($2011, unescalated direct costs, excluding overheads) for low pressure pipe replacement and $3.4 million ($2011, unescalated direct costs, excluding overheads) for medium pressure supply mains which are necessary for carrying out the low pressure pipe replacement program is conforming capex. This consists of 359 kilometres of low pressure to high pressure block rollout mains replacement and 6kilometres of integral medium pressure supply mains replacement.91
the estimate of the unit rates do not represent the best estimate possible in the circumstances.92 The AER considers there are flaws in Envestra's proposed methodology for calculating unit rates from unawarded tenders such that the proposed capex does not reflect the efficient and prudent costs of undertaking the proposed mains replacement program.93
Envestra initially proposed a low pressure pipe replacement program worth $282.7 million ($2011, unescalated direct costs, excluding overheads) for a total of 636 km of mains replacement, at an average unit rate of $444/metre ($2011, unescalated direct costs, excluding overheads).94
In the draft decision, the AER considered that Envestra could continue to manage its safety and regulatory obligations for the 2013–17 access arrangement period by delivering 265 kilometres (the 2008-11 annual average volume actually completed by Envestra, applied to the five years of the access arrangement period) in combination with other proactive and reactive mains programs.95 These volumes were below the volumes that the ESC had approved for that regulatory period and which had been factored into the tariffs paid by consumers for that period.96 While the ESC approved volume was not completed, Envestra met its safety and regulatory obligations for the 2008–12 access arrangement period.97
The AER also made provision for a pass through, recognising that circumstances may change. For example, new information or conditions may arise which could lead to a change in the optimal mix of programs employed to address the safety risks associated with mains. The pass through allowed for Envestra, after it had delivered the total historical volume, to apply for additional expenditure for mains replacement.98
Further, the AER did not accept Envestra's initial proposed unit rates in its draft decision.99 This was due to flaws in Envestra's model which was used to estimate the unit rates. These flaws included that the congestion factor100 captured costs which were already included in the model. In addition, there appeared to be scale anomalies between suburbs and unexplained differences between suburbs. Also, there was a significant disparity between the model output and tender rates provided to verify the integrity of the model.
In deriving an alternative unit rate estimate for the draft decision, the AER used the available data before it, namely a mixture of 2012–13 contract rates and historical rates. The AER assessed that Envestra had prioritised low cost mains replacement areas in the past and applied this approach in its draft decision. In doing so, the AER set an average unit rate of $238/metre ($2011, unescalated direct costs, excluding overheads), prioritising low to high cost mains up to the historical volume.101
Therefore, on the basis of both the volume and the unit rates assessed by the AER, the AER approved a total expenditure of $63.1 million ($2011, unescalated direct costs, excluding overheads).102
In its submission to the AER, the Energy Users Coalition of Victoria (EUCV) noted that all the distribution businesses proposed significant mains replacement programs in the 2008–12 access arrangement period yet underspent their allowances. The EUCV stated that it considers the maindriver of gas main replacement is the leakage of gas from distribution gas mains and that the cost of unaccounted for gas (UAFG) is primarily borne by consumers. The AER considers that, while UAFG is a driver of mains replacement, it is not a primary driver. The primary drivers are mitigating the safety risk associated with gas leaks and securing reliability of supply. The EUCV stated that it considered the AER's approach of using historical data for setting mains replacement in the 2013–17 access arrangement period to be sensible and supported the approach.103
The Honourable Michael O'Brien, in his capacity as Minister for Energy and Resources, stated that he "support[ed] the approach taken by the AER in its draft decision to consider the level of historical expenditure and to include a pass through event for low pressure to high pressure mains replacement".104 He further noted that "the distributors have undertaken less pipeline replacement than was forecast by the Essential Services Commission. This has manifested itself in cost savings for distributors and improved profitability..."105
Origin stated that it "supports the AER's decision to base capital expenditure allowances for low pressure mains replacement on volumes achieved in the current period" and that it "support[s] the cost pass through arrangement". Origin continued that it considers that the "pass through arrangement promotes the interests of the consumer, with an appropriate balance between the need to maintain the network and to limit customers' exposure to inaccurate forecasts".106
As noted by Origin, consumers bear the cost of Envestra's proposed and approved mains replacement program which is funded but not carried out.
The approved capex for mains replacement is rolled into the business' capital base for the purpose of calculating its required revenue. There are two elements to the required revenue calculation for capex:
a depreciation allowance, enabling the business to recover the initial cost of the asset, and
a cost of capital allowance, enabling the business to provide a return to investors for funding the asset.
Regardless of whether the distribution business spends its forecast capex, it retains the full cost of the capital allowance. This includes the cost of capital for the mains replacement that the service provider has not spent. Further, the service provider has the use of the depreciation allowance relating to this forecast mains expenditure during the access arrangement period.107 Overall, the expenditure on the mains replacement program accounts for a considerable proportion of the total capex allowance. This means that when the service provider does not spend its approved maintenance expenditure, customers pay above the efficient costs for the service they receive.
It maintained its initial proposal that it requires 636 km to meet its safety and reliability obligations. To support this position, it submitted a letter from the ESV to Envestra regarding replacement of its LP cast iron and unprotected steel pipes by 2020.
However, Envestra also proposed an alternative option which included an acceptance to reduce its proposed volume of 636 km to 475 km subject to an amended pass through event being available. Envestra agreed in principle with the AER's pass through mechanism for mains replacement included in the AER's draft decision on the basis that “there is some risk, albeit low, that over a five-year period unexpected circumstances might prevent it from completing the required mains replacement program”108. In proposing a volume of 475 kilometres and a pass through, Envestra also stated that this would address the issue of "consumers paying prices that reflect a higher volume of mains replacement than actually delivered over the period". Envestra further stated that "[t]he benefit of [this] option is that it mitigates the risk to consumers that Envestra will be unable to complete the full mains replacement program due to changes in circumstances or due to an unexpected event, as occurred with the GFC over the 2008–2012 Access Arrangement period".109
Envestra stated that it did not adopt the 265 km approved in the AER’s draft decision on the basis that it is proposing to award contracts, for a total of 475 km, by October 2013.110
In further correspondence with the AER, Envestra subsequently reduced its proposed mains volume to 355 km, subject to an amended pass through event being available.111
As to the operation of the pass through, Envestra submitted that the AER's trigger event of the completion of historical volumes would increase contractor uncertainty and was not consistent with Envestra's new contracting regime of awarding contracts three years in advance of contract execution. Instead Envestra proposed that the pass through trigger event should be Envestra’s Board approving the letting of contracts for 475 km.112
