Application Martin No: gr9902 Jones Contents

Coverage of New Facilities

Epic’s latest proposed extensions/expansions policy is that new facilities will not be covered unless, by notice to the Commission, Epic elects otherwise. In considering whether this is reasonable, it is necessary to consider the environment in which any expansion or extension would take place.

South Australia requires additional gas supplies to accommodate market growth and the gas dependent investments that have been proposed. In the presence of excess demand, prospective users have little choice but to finance an expansion of the MAPS if they want to continue with proposed developments. Prospective users could utilise alternative fuel sources, but in the context of South Australia such alternatives are in the main prohibitively expensive.

Owing to the excess demand that is present in the market, Epic may be able to exercise a degree of market power in setting the terms and conditions, including tariffs, for an expansion. This is because it is not constrained by competition or regulation (if Epic were to elect that new facilities would not be covered). Potentially, Epic could be in a position to extract monopoly rents by pricing expansions at just below the point where it would no longer be commercially viable for a prospective user to continue with its proposal.

Such behaviour may discourage investment and entry into downstream markets, and is likely to affect the competitiveness of entrants in downstream markets. As a result, where entry does occur, new entrants may be unable to act as a competitive constraint on incumbents because their costs are higher as they are paying more for gas transportation. Effective competition in downstream markets, and the resulting efficiency gains, would not be achieved. The service provider would capture monopoly rents that would otherwise be passed onto business and households in the form of lower prices. This may impact on South Australia’s economic growth potential.

Accordingly, the Commission considers that the economically efficient operation of the covered pipeline; the public interest, including the public interest in having competition in markets; and the interests of users and prospective users each require that expansions to the pipeline should be covered unless the regulator consents otherwise.

Coverage of new facilities would entitle prospective users to make use of the dispute resolution processes provided in section 6 of the Code.

In terms of extensions, it is not clear that Epic would have as much market power compared with expansions, as it appears that other pipeline companies would be able to construct geographical extensions to the pipeline. This is because Epic’s economies of scale and scope in terms of expanding the existing pipeline are substantially greater than for extending the pipeline.

In these circumstances the Commission considers that Epic’s approach to extensions in its revised access arrangement of 29 June 2001 is appropriate.

The Commission requires the following amendments to made in respect of the extensions/expansions policy in Epic’s revised access arrangement of 29 June 2001.

Proposed amendment FDA3.

For the access arrangement to be approved, the Commission requires that Epic amend clause 10.4(b) to the following:

At the time it comes into operation, any New Facility, except for an extension to the Pipeline, is to be considered part of the Covered Pipeline, unless at that time the Regulator agrees that the New Facility should not be covered. Extensions will be part of the Covered Pipeline, unless the Service Provider, by notice to the Regulator (given before those facilities come into service) elects otherwise.

Recent expansion of the pipeline system for National Power (now Pelican Point Power)

The MAPS has recently been expanded to provide additional capacity for Pelican Point Power. Epic has argued that the Pelican Point expansion should not be included as part of the covered pipeline because the proposed access arrangement will provide that any expansion of the pipeline will not be covered unless Epic elects otherwise.⁴⁵³ In a meeting on 6 September 2001, Epic has further submitted that section 1.40 of the Code talks about the period after the access arrangement has come into effect and therefore, can not have a retrospective action in respect of expansions.

The Commission does not accept these submissions. The Commission is of the view that it is appropriate for the Pelican Point Power expansion to be include under the access arrangement in view of the application of the expansions policy as amended above. The Commission is concerned that in the absence of the inclusion of the expansion that Epic will be in a position to exercise market power in respect of that capacity in the future.

It is the Commission’s view that section 1.40 of the Code is not being applied retrospectively, rather the Pelican Point Power expansion will become part of the covered pipeline at the time that the access arrangement comes into effect in accordance with the expansions policy.

Approaches to Financing Expansions

Clause 3.16(b) of the Code requires that an access arrangement specify how any covered extension or expansion would affect the reference tariff. The two alternatives are a rolled-in tariff or an incremental costs approach. Under an incremental costs approach, prospective users would pay a tariff that reflected the cost of incremental capacity. For example, one method is for the incremental user to pay the reference tariff plus a surcharge for the costs of the expansion which are not met by the addition to the service providers revenue. Rolled-in tariffs are discussed above in section 3.2.3.

Epic’s proposal provides for incremental capacity to be financed by incremental users. The Commission has a number of concerns with such an approach, which are outlined below.

• 
  There is likely to be multiple tariffs for the same service and a level playing field would not exist in down stream markets. If prospective entrants into either the gas retail or electricity generation markets had to pay significantly higher tariffs for gas transportation, this might effect their ability to compete in those markets and therefore the likelihood and effectiveness of their entry. The result could be either that new entry is limited, or that such entry is unable to act as a competitive constraint on incumbents.
  
• 
  However, market participants submitted that multiple tariffs are not uncommon and not inappropriate. Irrespective of whether future expansions would be rolled-in, different tariffs will be paid for expansions that were contracted in recent years. Further, it is possible that users and the service provider will negotiate tariffs commercially rather than adopt the reference tariff so it is possible that multiple tariffs will exist even if the costs of expansions are rolled-into the capital base.
  
  

Nevertheless, the Commission does not consider that multiple tariffs for the same service is an optimal outcome.

• 
  If an incremental costs approach to expansions is adopted, existing capacity will be cheaper than developable capacity and there is likely to be excess demand for existing capacity as it becomes available. Some form of mechanism to allocate this capacity is required. In the absence of a roll-in at some point, the difficulty in allocating the capacity will remain and reoccur each time contracts expire.
  
• 
  The incremental costs of expansion are not constant. For example, the next few stages of expansion on the MAPS are relatively expensive and would produce relatively little additional capacity. Therefore, prospective users may be reluctant to finance an expansion of the pipeline.
  

On the other hand, a roll-in is also problematic in the context of the MAPS. For example:

• 
  As Origin and TGT submitted, a rolled-in tariff on the MAPS may deter investment in an alternative pipeline. Under a roll-in, the cost of expansion is averaged over all users. Therefore prospective users would not pay the marginal cost of incremental expansion but the average cost of all capacity. As a result, expansion of the MAPS is likely to be preferable on the basis of cost than the development of a new pipeline for prospective users.
  
• 
  A rolled-in tariff, particularly one which estimates tariffs depending on the amount of expansion which takes place, results in a degree of uncertainty for users.
  
• 
  It does not appear likely that a rolled-in tariff would meet the requirements of the Code at this stage. As outlined above, an expansion can be rolled-into the capital base if the criteria in section 8.16 are satisfied. Section 8.16(b) requires that one of the following conditions are satisfied:
  

1. 
   the Anticipated Incremental Revenue generated by the New Facility exceeds the New Facilities Investment; or
   
2. 
   the Service Provider and/or Users satisfy the Relevant Regulator that the New Facility has system wide benefits that, in the Relevant Regulator's opinion, justify the approval of a higher Reference Tariff for all Users; or
   
3. 
   the New Facility is necessary to maintain the safety, integrity or Contracted Capacity of Services.
   

Epic has indicated that because the MAPS is fully compressed and the pipeline must be looped to expand capacity, further expansions in the near future would be unlikely to satisfy 8.16(b)(i).

Section 8.16(b)(ii) provides for a roll-in where the service provider and/or users satisfy the regulator that a new facility would result in system wide benefits which would justify higher tariffs for all users. According to Origin, system wide benefit involves enhancing the security of supply, which is unlikely to occur for an expansion of capacity. Users and the service provider have not argued that system wide benefits would be likely to occur. While the Commission has not assessed whether an expansion would result in system wide benefits, on the basis of submissions there is some doubt that it would.

There is no evidence before the Commission that an expansion is required to maintain safety, integrity or the contracted capacity of services (section 8.16(b)(iii) of the Code).

Accordingly, it does not appear that an expansion of the MAPS would be likely to satisfy section 8.16(b) of the Code at this stage.

Determining which approach is preferable involves balancing the advantages of each approach. In brief, the key issues are as follows:

• 
  whether a rolled-in tariff would be permitted under the Code in the current circumstances;
  
• 
  the effect on incentives to expand existing infrastructure or build new infrastructure;
  
• 
  the effect multiple tariffs may have on competition in downstream markets; and
  
• 
  the allocation problem arising from the excess demand for existing ‘cheap’ capacity.
  

On balance the Commission considers that an incremental approach to expansions is preferable because:

• 
  it does not distort economic incentives for expansion and new investment;
  
• 
  a roll-in may not satisfy section 8.16(b) of the Code at present;
  
• 
  the allocation problem can be solved by other means as discussed below.
  

However, the Commission notes that it may be appropriate in future regulatory periods for expansions to be rolled into the capital base. Such proposals will be considered at that time and the issue of whether new facilities investment should be rolled-in to the capital base will be revisited in the next access period if appropriate.