Application Martin No: gr9902 Jones Contents

Back haul tariff

In a June 1998 access arrangement prepared under the access legislation of 1995 applicable in South Australia, Epic offered a wide range of services, including back haul tariffs.¹⁷¹ Epic dropped from a later edition of the brochure a number of its earlier tariffs including the back haul tariff, on the basis that the services could not easily be supplied and there had been no demand in the market for them.

The Commission notes that numerous interested parties have submitted that a back haul tariff should be included. The Commission also notes that Epic has declined to offer a back haul tariff at this stage, and remains opposed to its inclusion in the Access Arrangement. However, the Commission takes the view that it is not clear that the tests of 2.24 and 3.3 of the Code are satisfied at this time, and is unable to compel Epic to include back haul tariffs in the Access Arrangement.

Incentives for the service provider to reduce costs and expand the market – section 8.1(f)

Within the proposed access arrangement Epic has included a provision that it refers to as the ‘incentive mechanism’. This mechanism provides for a rebate to FT and existing haulage customers where revenue is generated from the sale of IT services utilising capacity made available by them.

The incentive mechanism is designed to have two key results. First, trading of unused capacity is encouraged with the objective of a larger number of customers taking gas supply and thereby broadening the market. Second, the incentive for customers to make available capacity that would otherwise be under-utilised has the potential to improve the overall utilisation, and thereby the efficiency, of the pipeline system. Thus, the incentive mechanism is consistent with an expansion of the market and with greater efficiency, which in turn should reduce costs per unit of delivered gas.

It is also necessary to consider the proposed access arrangement more broadly to assess how its other features are likely to impact on incentives for reducing costs and expanding the market.

As stated previously, in the Commission’s view the reference tariff proposed by Epic is too high. If approved, it would weaken the commercial disciplines of a competitive market that the Code endeavours to replicate. Tariffs at the levels proposed by Epic (whether its estimated cost of service or proposed revenue requirement for this period) would sustain a higher cost base than would be the case otherwise. Second, higher than appropriate tariffs are likely to reduce demand for gas as marginal projects subject to gas haulage costs are priced out of the market.

Therefore, in the Commission’s view the reference tariff and reference tariff policy proposed by Epic are not consistent with providing incentives for the service provider to reduce costs and expand the market.

Section 8.2 factors

Section 8.2 of the Code lists five factors about which the Commission is to be satisfied in determining whether to approve the reference tariff. These are assessed below.

Total revenue to be consistent with the principles and one of the methodologies contained in section 8 of the Code – section 8.2(a)

The ‘total revenue’ referred to in the Code is the revenue from sales of services over the covered pipeline.

According to Epic, the FT and IT services described in the access arrangement can only be made available in limited circumstances.¹⁷² Epic is expected to earn its revenues primarily from existing haulage agreements. To a lesser degree, revenues will also flow from the sale of IT services and from other arrangements entered into outside the terms of the access arrangement. Therefore, most of the total revenue that will accrue to Epic over the initial access arrangement period can not be varied by the Commission’s decision on the access arrangement.

In the face of the difficulty of estimating IT revenue and the likelihood of low or non-existent sales of FT service, the Commission has assessed Epic’s total revenue for purposes of section 8.2 as if it were to account for 100 per cent of Epic’s total revenue.

While Epic has utilised the cost of service approach in determining its reference tariff, in the Commission’s view Epic’s proposed capital base, rate of return and depreciation are overstated. As a consequence, the total revenue that Epic would derive from the FT tariff if it accounted for 100 per cent of Epic’s revenue is greater than would be earned if the principles of section 8 of the Code were applied.

On this basis, the Commission is not satisfied that Epic’s total revenue is consistent with the principles and one of the methodologies contained in section 8 of the Code.

The proportion of total revenue that any one reference tariff is designed to recover is calculated consistently with the principles of section 8 of the Code – section 8.2(b)

Sections 8.38 to 8.41 provide guidance favouring cost-reflective pricing, to the maximum extent that is commercially and technically reasonable. These provisions are subject to considerations of providing incentive for market growth and avoiding loss of supply opportunities.

Over the initial access arrangement period Epic expects that FT and IT services can only be made available in limited circumstances. The revenue that is likely to be derived from the IT service is particularly uncertain owing to the contingent nature of the service. The proportion of Epic’s total revenue that will be recovered from the IT service is also expected to be small (or non-existent) over the next access arrangement period.

As noted in section 2.7.3, there is a difference between the stated pipeline primary capacity (348 TJ per day), which is firm (that is, reliable) capacity, and its stated maximum capacity (418 TJ per day). The difference between the two provides an indication of the margin of capacity available to the service provider to ultimately make available for interruptible use. The Commission has not formed a view on whether Epic may have been overly conservative in establishing that margin and whether therefore the capacity for Epic to earn additional revenues from IT service has been understated. Also relevant to calculation of spare capacity is the level of contracted but unused capacity. The Commission intends to review this situation at the commencement of the next regulatory period on the basis of IT capacity sales between now and then.

Nevertheless, assuming that Epic were to earn 100 per cent of its revenue from the only reference service, the Commission is of the view that the FT reference tariff proposed by Epic is excessive and not calculated in accordance with the principles of section 8 of the Code.

The proportion of total revenue recovered from users of a service is calculated consistently with the principles of section 8 of the Code – section 8.2(c)

Section 8.42 of the Code gives guidance that pricing should be cost-reflective, to the maximum extent commercially and technically reasonable.

As outlined in the discussion of section 8.1 factors, the Commission has reached the view that the relationship at this stage between FT and IT tariffs is appropriate. Therefore the Commission is also satisfied that the proportion of total revenue that will be derived from each category of user (FT and IT) is consistent with the principles of section 8 of the Code, subject to the qualifications expressed above in respect of compliance with section 8.2(b).

Incentive mechanisms are incorporated consistently with the principles of section 8 of the Code – section 8.2(d)

The proposed access arrangement incorporates an incentive mechanism that is to apply to the rebateable IT service. The Commission is satisfied that the mechanism is consistent with the principles of section 8 of the Code.

Epic has not included incentive mechanisms of the type described in sections 8.45(a) and (b) of the Code. These sections provide for the service provider to retain revenues achieved beyond forecast levels. Epic has adopted this approach because the capacity of the existing pipeline is fully contracted for the period of the proposed access arrangement and it is not expected to be possible for additional gas to be hauled on a firm basis without expansion of the system.

It is the Commission’s intention to review the relevant circumstances at the time of the next access arrangement. At that time the Commission will again consider whether it is appropriate to broaden the scope of the incentive mechanism.

Forecasts are best estimates – section 8.2(e)

Epic’s proposed initial tariff in Schedule 4 of the access arrangement is based on existing levels (for the year ending December 1998) of contract revenue and pipeline capacity, rather than demand forecasts. Because the pipeline system is fully contracted, the Commission has calculated the initial tariff based on the total system primary capacity stated in this Final Decision.

Access policies, terms and conditions and review of the access arrangement

In this chapter the mandatory non-tariff elements of the proposed access arrangement for the MAPS are assessed for compliance with the Code. The Code requirements are outlined for each mandatory element followed by a summary of the service provider’s proposal, the issues raised in submissions, Epic’s response to submissions and the Commission’s considerations. Where relevant these are followed by amendments that the Commission proposes be made for the access arrangement to be approved. All amendments are replicated in the executive summary.

Section 3 of the Code establishes the minimum content of an access arrangement, which includes the following non-tariff mandatory elements:

• 
  a services policy that must contain at least one service that is likely to be sought by a significant part of the market;
  
• 
  terms and conditions on which the service provider will supply each reference service;
  
• 
  a capacity management policy to state whether the covered pipeline is a contract carriage or market carriage pipeline;
  
• 
  in the case of a contract carriage pipeline, a trading policy which refers to the trading of capacity;
  
• 
  a queuing policy which defines the priority that users and prospective users have to negotiate capacity where there is insufficient capacity on the pipeline;
  
• 
  an extensions/expansions policy which determines whether an extension or expansion of a covered pipeline is or is not to be treated as part of the covered pipeline for the purposes of the Code; and
  
• 
  a review date by which revisions to the access arrangement must be submitted and a date on which the revisions are intended to commence.
  

An access arrangement must also contain a reference tariff policy and at least one reference tariff. These provisions were assessed for compliance with the Code in chapter 2.

In this chapter the 29 June 2001 version of the access arrangement proposed by Epic is considered.

Services policy

11. 
    Code requirements
    

Sections 3.1 and 3.2 of the Code require an access arrangement to include a services policy, which must include a description of one or more services that the service provider will make available to users and prospective users. The policy must describe any services likely to be sought by a significant part of the market, and any that in the relevant regulator’s opinion should be included.

When practicable and reasonable, a service provider should make available those elements of a service required by users and prospective users and, if requested, apply a separate tariff to each.

Epic’s proposal

Epic proposes to offer one reference service, FT service, which is a firm service. In addition, Epic is prepared to offer non-reference services. Epic has specified an interruptible service, and has also included provisions for other services: Non-specified services.

FT service

FT service consists of the delivery by the service provider of a quantity of a user’s gas equal to the sum of the final nominated delivery quantities for that day to one or more delivery points.

FT service is not to be interrupted, subject to the terms of the access arrangement.