Application Martin No: gr9902 Jones Contents

Commission’s considerations

Based on the confidential worked example provided by Epic, the Commission is satisfied with the approach proposed for calculating the reference tariff from the Commission’s revenue determination, and accepts Epic’s tariff escalator proposal of 95 per cent of CPI for the duration of this access arrangement.

The Commission has revised the revenue requirement in the first year downwards by $1.7 million, such that the NPV of the revenue stream over the regulatory period (assuming Epic’s tariff escalator) is equal to the NPV of the Commission’s cost of service revenue stream over the regulatory period.

The tariff escalator applied should lead to tariffs that cover the costs including appropriate return for an efficient pipeline operator. In the longer term, the impact of depreciation should be to reduce the level of efficient tariffs. While the Commission has accepted Epic’s proposed escalator for this access arrangement, the Commission considers that tariffs on the pipeline should be trending downward over time. Therefore, in the absence of capital expenditure it is likely that an escalator of 95 per cent of CPI will be too high in the next access arrangement period.

Incentive Mechanism

The Code (section 8.44) provides for the regulator to require or approve an incentive mechanism. Such a mechanism enables a service provider to retain all or a share of any returns from the sale of a reference service that exceeds the level expected at the beginning of the access arrangement period. This mechanism is particularly to operate where the increased returns are attributable, at least in part, to the service provider’s efforts. The incentive mechanism should encourage the service provider to increase sales volumes, minimise costs, develop new services, and undertake only prudent investment (section 8.46). The mechanism should be designed to ensure that users gain from any increased efficiency, innovation and improved sales volumes. The mechanism may include:

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  specifying that tariffs are based on forecast, not realised, values of variables;
  
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  setting a target revenue and specifying how revenue in excess of this is to be shared between the service provider and users; and
  
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  establishing a rebate mechanism for rebateable services that does not provide a full rebate to users.
  

In its Draft Decision, the Commission proposed an amendment to give effect to the incentive mechanism as proposed by Epic in its 2 March 2000 lodgement. However, the Commission stated that it would wish to encourage any realistic refinement of or revision to the incentive mechanism that would bring about greater flexibility in the services offered.

In response to the Draft Decision and submissions from interested parties, Epic’s incentive mechanism was revised in its 17 May 2001 lodgement, such that a different rebate would apply in respect of existing users who enter an existing facilities agreement (pre-2006), and those who do not (post-2006). This mechanism is set out in section 5.3 of the revised access arrangement with a worked example included as an appendix to the 29 June 2001 lodgement, page 87.

The Commission received several submissions relating to the incentive mechanism outlined in Epic’s 17 May 2001 lodgement. While there seemed to be broad acceptance of Epic’s proposal, the main concern expressed was the inclusion of a capital component in the IT tariff.

NRG Flinders primary concern with this clause 5.3 is that Epic should not be allowed to recover the full capital cost of the pipeline in the FT Capacity Charging Rate and also including a capital charge in the IT Commodity Charge Rate. Otherwise NRG Flinders would have no disagreement with a tariff structure that includes different rates.¹⁶¹

TGT submitted that:

The incentive mechanism is acceptable. However, TGT is concerned that the FT Capacity Charge Rate and the IT Commodity Charge Rate are set fairly and logically...

… if it is assumed that use of IT Services will be minor and therefore the FT Services will provide Epic's allowable Total Revenue it is not appropriate for the IT Commodity Charge Rate to include a capital component.¹⁶²

Commission’s considerations

At a broad level, the regulatory framework provides the service provider with incentive to minimise costs. Should Epic be able to reduce operations and maintenance expenditure from approved forecasts, it is able to retain the difference.

The Commission is broadly satisfied with the revised incentive mechanism set out in Epic’s 29 June 2001 lodgement of its revised access arrangement. The Commission notes the concern expressed by NRG Flinders and TGT that the IT tariff contains a capital element. However, the Commission understands this to be necessary to ensure that the appropriate price signals are sent to Epic’s customers with respect to FT and IT services.

If it is the case that anomalies arise owing to the structure of Existing Haulage Agreements, the Commission believes that these could be corrected through an Existing Facilities Access Agreement as described in 4.3(c)(ii). However, the Commission refers the existing users and potential IT users to its discussion of EFAA in section 3.1.5. In that section the Commission has indicated that it would be concerned if an existing user attempted to utilise an EFAA so as to hinder a potential IT user’s access to existing facilities. It is the Commission’s intention to review the incentive mechanism for the next access arrangement to ensure it is effective and appropriate.

Fixed Principle

Sections 8.47 and 8.48 of the Code allow a reference tariff policy to include certain principles that remain fixed for a set period (referred to as the ‘fixed period’). These fixed principles can not be changed without the agreement of the service provider and may only include structural elements and not ‘market variable’ elements.

While a fixed period may apply for all or part of the duration of an access arrangement, the regulator is required to consider the interests of users and prospective users in determining the period.

Section 10.8 of the Code defines a ‘market variable element’ as:

… a factor that has a value assumed in the calculation of a Reference Tariff, where the value of that factor will vary with changing market conditions during the Access Arrangement Period or in future Access Arrangement Periods, and includes the sales or forecast sales of Services, any index used to estimate the general price level, real interest rates, Non Capital Cost and any costs in the nature of capital costs.

Clause 5.2(a)(vi) of the original access arrangement stated that the capital base was to be adjusted annually by the capital cost revaluation, which would have been equal to the CPI and would be a fixed principle.

The Commission did not object to Epic’s proposal to adjust the capital base annually by a CPI index. However, the Commission did object to making this adjustment a fixed principle on the basis that it includes a market variable element (CPI).

There were no submissions on Epic’s proposed fixed principle.