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Issues
Paper

Access Arrangement by
AGL Pipelines (NSW) Pty Limited
for the Central West Pipeline

February 1999

	File No:  CR99/3

Preface
On 31 December 1998 AGL Pipelines (NSW) Pty Limited (AGLP) submitted to the Australian Competition and Consumer Commission (the Commission), for approval under the National Third Party Access Code for Natural Gas Pipelines Systems (the Code), a proposed access arrangement and access arrangement information for the Central West Pipeline (CWP) which extends from Marsden to Dubbo in NSW.  The CWP is a recently built natural gas transmission pipeline that links part of AGL Gas Networks Limited’s (AGLGN) NSW gas distribution network to the Moomba to Sydney pipeline (MSP).
The access arrangement and access arrangement information describe the terms and conditions on which the company will make access to its pipeline available to third parties.  The Commission will assess the access arrangement and access arrangement information against the principles in the Code.
AGLGN has lodged access arrangements relating to its NSW and ACT gas distribution operations respectively with the Independent Pricing and Regulatory Tribunal (IPART) and the Independent Pricing and Regulatory Commission.  The regulators will, where appropriate and possible, coordinate the assessment and approval process for these arrangements. 
Following a preliminary assessment of the information provided by AGLP on 31 December 1998, the Commission issued a notice to AGLP on 29 January 1999, pursuant to section 2.9 of the Code, to furnish additional access arrangement information.  This Issues Paper incorporates, where appropriate, the additional information which was provided in response to the notice on 8 February 1999.
Interested parties are invited to make submissions to the Commission on any issues raised by, or relevant to, this access arrangement by Friday 19 March 1999.  The issues identified in this Issues Paper are only indicative and are not meant to be exhaustive.  Parties making submissions are free to identify other relevant issues for consideration by the Commission.  All submissions should be in writing.  They will be publicly available and placed on a public register for that purpose.  If you wish to include information in a submission which is of a confidential nature, it should be clearly marked as such.  The reason(s) for seeking confidentiality should also be provided.  Under the terms of the Code, the Commission must not disclose such information except if it is of the opinion that disclosure would not be unduly harmful to the legitimate business interests of the service provider, a user or a prospective user.
It would assist the Commission if four hard copies of each submission could be provided and also supplied in electronic format compatible with Microsoft Word 97 for Windows.  Submissions should be addressed to: 
Mr Mark Pearson
Senior Assistant Commissioner
Gas Group
Australian Competition and Consumer Commission
PO Box 1199
Dickson    ACT    2602
Copies of the access arrangement and associated documents are available from the Commission’s website at http://www.accc.gov.au (under ‘Gas’).  Copies in printed form or on computer disk may be obtained from the Commission by contacting Ms Josie Paragalli (phone 02 6243 1274, fax 02 6243 1202). 
Any inquiries should be directed to Michael Walsh on (02) 9230 9156. 

Contents

1.	Introduction	1
1.1	Purpose	1
1.2	The current assessment process	1
1.3	Key issues	2
2.	The NSW gas industry structure and regulatory framework	3
2.1	Structure of the gas industry in NSW	3
2.2	Regulatory framework	3
2.3	Central West Pipeline access arrangement submitted for approval	4
3.	Criteria for assessing access arrangements	6
4.	Issues for consideration	7
4.1	Compliance with the Code	7
4.1.1	The content of the access arrangement	7
4.1.2	Information disclosure	7
4.1.3	Services policy	8
4.1.4	Extensions/expansions policy	8
4.1.5	Terms and conditions	9
4.1.6	Timing of review	9
4.1.7	Ring fencing	10
4.2	Pricing principles and related issues	10
4.2.1	Asset valuation	11
4.2.2	Cost of capital	12
4.2.3	Forecast revenue	14
4.2.4	Total operating costs	15
4.2.5	Cost allocation	16
4.2.6	Capital expenditure	16
4.2.7	Volume of gas delivered	17
4.2.8	Reference tariffs	17
4.2.9	Other revenue	18
4.2.10	Regulatory mechanisms	19
4.2.11	Benchmarking/performance indicators	19
Attachment A	20

Abbreviations and glossary of terms

Access Arrangement	Arrangement for access to a pipeline provided by a pipeline owner/operator that has been approved by the regulator	
AGLGN	AGL Gas Networks Limited 	
AGLP	AGL Pipelines (NSW) Pty Limited 	
the Code	National Third Party Access Code for Natural Gas Pipeline Systems	
Commission	Australian Competition and Consumer Commission 	
Covered Pipeline	Pipeline to which the provisions of the Code apply	
CPI	Consumer Price Index	
CWP	Central West Pipeline	
EAPL	East Australian Pipeline Ltd 	
EAPO	EAP Operations Pty Ltd 	
GJ	gigajoule	
IPART	Independent Pricing and Regulatory Tribunal	
MSP	Moomba to Sydney pipeline	
ORDO	Orana Regional Economic Development Organisation	
PJ	Petajoule (equal to 1,000,000 GJ)	
TJ	Terajoule (equal to 1,000 GJ)	
WACC	Weighted average cost of capital	

1.	Introduction
1.1	Purpose
The purpose of this paper is to: 
•	list a number of issues that the Australian Competition and Consumer Commission (the Commission) has identified as relevant to its role in assessing the access arrangement and access arrangement information for the Central West Pipeline (CWP) submitted by AGL Pipelines (NSW) Pty Limited (AGLP).  This list is not meant to be exclusive; and
•	invite interested parties to make submissions on these and other relevant issues that parties consider the Commission should consider in its assessment of the access arrangement. 
1.2	The current assessment process
The proposed access arrangement and access arrangement information describe the terms and conditions on which AGLP will make access to the CWP available to third parties during the initial access arrangement period which AGLP proposes will last approximately five years.  AGLP will, however, have the discretion to submit revisions earlier than the scheduled review, and has indicated that it will do so in the event that it extends the CWP to Tamworth.
The Commission’s current assessment process relates to the initial access arrangement period.  However, it will also impact on subsequent access arrangement periods.  In particular, AGLP has proposed a Fixed Principle (refer Forecast Revenue below) that would not be subject to change, without AGLP agreement, when AGLP submits reviews to the access arrangement.  Accordingly, submissions may address aspects of the proposed access arrangement as they relate to the initial and also to subsequent access arrangement periods. 
Under the National Third Party Access Code for Natural Gas Pipeline Systems (the Code), the Commission is required to:
•	inform interested parties that it has received the access arrangement from AGLP; 
•	publish a notice in a national daily paper which at least describes the covered pipeline to which the access arrangement relates; states how copies of the documents may be obtained; and request submissions by a date specified in the notice;
•	after considering submissions received, issue a draft decision which either proposes to approve the access arrangement or not to approve the access arrangement and states the amendments (or nature of the amendments) which have to be made to the access arrangement in order for the Commission to approve it.  Submissions will be sought again following release of the Commission’s draft decision;
•	after considering any additional submissions, issue a final decision that it either approves or does not approve the access arrangement (or revised access arrangement) and states the amendments (or nature of the amendments) which have to be made to the access arrangement (or revised access arrangement) in order for the Commission to approve it; and
•	if the amendments are satisfactorily incorporated in a revised access arrangement, issue a final approval.  If not, the Commission must draft and approve its own access arrangement.
1.3	Key issues
The Commission has identified a range of issues (refer Chapter 4 in particular) which are likely to be relevant to its assessment of the proposed access arrangement and for which it invites comments.  Of these, likely key issues that the Commission will focus on during its assessment include:
•	the proposed rate of return (a real pre-tax weighted average cost of capital (WACC) of 10 per cent);
•	the proposed asset valuation methodology incorporating Depreciated Optimised Replacement Cost (DORC) adjusted for ‘economic depreciation’;
•	single zone pricing; 
•	the reasonableness of volume forecasts; and 
•	the proposed Fixed Principle.
2.	The NSW gas industry structure and regulatory framework
2.1	Structure of the gas industry in NSW
Briefly, the industry comprises: 
•	the Cooper Basin Producers in South Australia which have supplied natural gas to NSW since 1976.  The Interconnect pipeline which links the NSW and Victorian natural gas systems was commissioned in 1998 and provides a further potential source of gas supply into NSW from the Gippsland Basin.  However, as a result of the Longford processing plant explosion, gas flows are likely to be mainly southwards in the short term.  In addition, Duke Energy has announced its plans to construct the Eastern Gas Pipeline to ship gas from the Bass Strait to Sydney and Port Kembla with operation expected by September 2000;
•	the Moomba to Sydney pipeline system (MSP), owned by East Australian Pipeline Ltd (EAPL) which provides and markets gas transmission services.  The MSP transmits gas from the Cooper Basin to the city gate at Wilton, with spur lines to several country centres (including Lithgow, Canberra, Yass and Wagga Wagga); 
•	the CWP which is a small (255 km) spur line from Marsden to Dubbo (owned by AGLP), the subject of this access arrangement; 
•	AGL Gas Networks Limited (AGLGN) which distributes natural gas to most major centres in NSW, including Sydney, Newcastle and Wollongong; 
•	the Albury Gas Company Ltd which distributes natural gas in Albury, and Great Southern Energy Gas Networks Pty Ltd which distributes natural gas in Wagga Wagga; and
•	22 authorised suppliers (including retailers).
The Australian Gas Light Company (AGL), a publicly listed corporation, owns the ‘AGL’ companies, and is also the majority (51 per cent) shareholder of EAPL.  The AGL Group will provide general, administration and marketing services to AGLP.  EAP Operations Pty Ltd (EAPO), a subsidiary of EAPL which carries out operations and maintenance activities on the MSP, is contracted by AGLP to undertake these activities on the CWP.  
2.2	Regulatory framework
The main legislation and relevant documents regulating access to the NSW gas transmission industry are: 
•	the Code, under which transmission service providers are required to submit access arrangements to the Commission for approval;
•	the Gas Pipelines Access (South Australia) Act 1997; and
•	the Gas Pipelines Access (New South Wales) Act 1998.
Code Bodies and Appeals Bodies in NSW with respect to transmission pipelines are:
•	the Commission - Regulator and Arbitrator; 
•	the National Competition Council - Code Advisory Body;
•	the Commonwealth Minister - Coverage Decision Maker;
•	the Federal Court – judicial review; and
•	the Australian Competition Tribunal – administrative appeal.
The Independent Pricing and Regulatory Tribunal (IPART) is currently Regulator and Arbitrator in NSW with respect to distribution pipelines.  IPART is at present reviewing AGLGN’s 1997 access undertaking.  The access undertaking, which was approved under the NSW Third Party Access Code for Natural Gas Distribution Networks (NSW Access Code), is deemed to be an access arrangement in force under the Code.  The review is being conducted under the Code, but subject to a number of provisions of the NSW Access Code.  This review also includes the following transmission pipelines that are deemed to be distribution pipelines until 1 July 2002: Wilton to Horsley Park; Horsley Park to Plumpton; Plumpton to Killingworth; Killingworth to Walsh Point; and Wilton to Wollongong.
2.3	Central West Pipeline access arrangement submitted for approval
Chapter 3 of the Code specifies that the service provider is required to establish an access arrangement and submit it to the regulator for approval.  The service provider is defined as “a person who owns (whether legally or equitably) or operates the whole or any part of a Pipeline”.  AGLP owns the CWP. 
Development of the Central West Project, which includes the transmission and distribution of gas to the Forbes, Parkes, Narromine and Dubbo environs, was facilitated through the Federal Government’s Regional Development Program, which made funding of up to $2 million available to the Orana Regional Economic Development Organisation (ORDO). 
Construction of the CWP, which transports gas from the Marsden off-take (on the MSP) to Dubbo, was completed by June 1998.  AGLGN undertakes the distribution of gas to the region.
The CWP has a maximum operating pressure of 10.2MPa.  It is currently uncompressed, with a maximum delivery capability of 10.1 TJ/day (3.7 PJ/year).  Its outside diameter is 219.1mm (8”) for the southern leg of 130km from Marsden to Alectown, and 168.3mm (6”) for the remaining 125km.
3.	Criteria for assessing access arrangements
The Commission may approve a proposed access arrangement only if it is satisfied that it contains the elements and satisfies the principles set out in sections 3.1 to 3.20 of the Code, which are summarised below.  An access arrangement cannot be opposed on the basis that it does not address a matter that section 3 of the Code does not require it to address.  Subject to this, the Commission has a broad discretion in accepting or opposing an access arrangement.  
An access arrangement must include a policy regarding the services to be offered which includes a description of the services to be offered and allows (where possible) prospective users to obtain the portions of the service that they require.  The policy must also allow for such separate elements to be tariffed separately.  
An access arrangement must also contain one or more reference tariffs.  A reference tariff operates as a benchmark tariff for a particular service and provides users with a right of access to the specific service at the specific tariff while enabling the service provider to levy the reference tariff for that service.  Tariffs must be determined according to the Reference Tariff Principles in section 8 of the Code. 
An access arrangement must also include the following elements:
•	terms and conditions on which the service provider will supply each reference service;
•	a statement of whether a contract carriage or market carriage capacity management policy is applicable;
•	a trading policy that enables a user to trade its right to obtain a service (on a contract carriage pipeline) to another person; 
•	a queuing policy to determine users' priorities in obtaining access to spare and developable capacity on a pipeline; 
•	an extensions/expansions policy to determine the treatment of an extension or expansion of a pipeline under the Code; 
•	a date by which revisions to the arrangement must be submitted; and 
•	a date by which the revisions are intended to commence.  
In considering whether an access arrangement complies with the Code, the Commission must (pursuant to section 2 of the Code) take into account:  
•	the legitimate business interests of the service provider;
•	firm and binding contractual obligations of the service provider or other persons (or both) already using the covered pipeline;
•	the operational and technical requirements necessary for the safe and reliable operation of the covered pipeline;
•	the economically efficient operation of the covered pipeline;
•	the public interest, including the public interest in having competition in markets (whether or not in Australia);
•	the interests of users and prospective users; and
•	any other matters that the Commission considers are relevant.  
4.	Issues for consideration
4.1	Compliance with the Code
4.1.1	The content of the access arrangement
The required contents of an access arrangement were listed in broad terms earlier in Chapter 3.  The Commission must be satisfied that AGLP’s access arrangement meets the content requirements of the Code before it can approve the access arrangement.  It must also be satisfied of the reasonableness of the terms and conditions on which services will be offered.
This is not merely a checklist exercise.  It will be important to ensure that the access arrangement is complete in the sense that no significant segment of market participants or potentially significant types of service have been overlooked.  Comments from market participants will be very helpful in identifying any such significant omissions - if there are any.  In addition, market participants and other interested parties may be able to provide useful guidance on the reasonableness of the terms and conditions on which services will be offered and the assumptions and other factors that underpin the proposed reference tariffs.
4.1.2	Information disclosure
The Code requires that a proposed access arrangement must be supported by access arrangement information.  Section 2.6 specifies that access arrangement information must contain such information as in the opinion of the regulator would enable users and prospective users to understand the derivation of the elements in the proposed access arrangement and to form an opinion as to the compliance of the access arrangement with the provisions of the Code.  Section 2.7 states that the access arrangement information may include any relevant information but must include at least the categories of information described in Attachment A to the Code (refer Attachment A to this Issues Paper).
Following a preliminary assessment of the access arrangement information, the Commission directed AGLP on 29 January 1999, pursuant to section 2.9 of the Code, to furnish amended access arrangement information.  When AGLP provided the information on 8 February 1999 it requested that the Commission not publicly disclose certain aspects which AGLP considers to be of a commercially sensitive nature.
The Commission has not yet formed an opinion on whether disclosure of some or all of the information for which confidentiality has been claimed would be unduly harmful to the legitimate business interests of AGLP, or a user or a prospective user.  In order to expedite the public consultation process the Commission has currently only released information for which confidentiality has not been claimed.  The Commission has not yet assessed whether the revised access arrangement satisfies the information requirements of the Code.
Issues for consideration
a)	Does the access arrangement information as amended enable users and prospective users to understand the derivation of the elements in the proposed access arrangement and to form an opinion as to the compliance of the access arrangement with the provisions of the Code?
b)	Are the items listed in Attachment A adequately addressed?  If not, what additional information (including any relevant information in addition to Attachment A) should be provided?
4.1.3	Services policy
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 contain one or more services which are likely to be sought by a significant part of the market, and any service or services that in the regulator’s opinion should be included in the services policy. 
To the extent that is practicable and reasonable, a service provider should make available only those elements of a service required by users and prospective users and apply a separate tariff for each element if this is requested. 
During the initial phase of its operation, AGLP proposes to offer a single reference service which it describes as a Transportation Service with: 
•	the reference tariff based solely on throughput (without the adjustment for load factor which is customarily adopted in pipelines to encourage load management);
•	payment based on actual throughput (without the usual obligation to pay for a minimum quantity in each contract year whether or not that quantity is taken); and
•	no charges for authorised overruns until contracted capacity reaches 85 per cent of the pipeline capacity.
AGLP is also proposing to offer Negotiated Services, which are services beyond the Transportation Service.
AGLP has advised that it intends to offer a reference service with capacity and throughput charges in the second access arrangement period as it expects that the pattern of usage of the pipeline will be sufficiently established by then.
Issues for consideration
a)	Is the proposed Transportation Service likely to be sought by a significant part of the market?
b)	Is there any demand for other reference services in the initial access arrangement period?  If so, would the provision of these additional services be compatible with the proposed Transportation Service?  
4.1.4	Extensions/expansions policy
Section 3.16 of the Code requires an access arrangement to include an extensions/expansions policy which sets out the method to determine which extensions and expansions will be treated as part of the covered pipeline and, if covered, how they will affect reference tariffs.  
AGLP intends that any expansion will form part of the covered pipeline and that it will not affect the reference tariff on the CWP.  It also states that an extension of the CWP to Tamworth as part of its Central Ranges Pipeline project (if and when it occurs) will form part of the covered pipeline.  This extension will not affect the reference tariff for existing delivery points, and for delivery points on the extension, AGLP has discretion to submit proposed revisions.
Issue for consideration
a)	If the pipeline is extended to Tamworth, the volume of gas flowing through the Marsden to Dubbo pipeline could increase considerably.  Is it appropriate that, in such an event, users along the extension will not be asked to contribute to the costs associated with the Marsden to Dubbo section of the pipeline?
4.1.5	Terms and conditions
AGLP sets out the terms and conditions on which it proposes to supply the reference service in section 2 of, and Schedule 2 to, the access arrangement.  AGLP states that it will supply the reference service on the terms and conditions set out in its standard Service Agreement for the reference service from time to time.  The Service Agreement has not been included as part of the access arrangement.
Issue for consideration
a)	Are the proposed terms and conditions reasonable?  Should the Service Agreement be included as part of the access arrangement?
4.1.6	Timing of review
AGLP proposes to submit revisions to the access arrangement four years and six months after the commencement of this access arrangement, which implies that the length of the initial access arrangement period will be approximately five years.  
AGLP anticipates that the CWP’s pattern of use will be established at that stage and it will introduce a reference service with capacity and throughput charges.
In the case of a new pipeline such as the CWP, the first review is particularly important as it provides an opportunity to assess the reasonableness of the gas throughput projections that underpin the reference tariffs.  Under AGLP’s proposals, no adjustments would be made to reference tariffs in the initial period to compensate for over or under achievement of the projected volumes and no retrospective adjustment would be made in the next access arrangement.
Issue for consideration
a)	The Commission recognises the need to balance the rapidly changing nature of the natural gas industry and the uncertainty which naturally arises in such an environment (which suggests a short time period) against the need for business certainty (which typically coincides with longer periods).  The Commission is interested in views as to the appropriate timing of the first review of the access arrangement.  
4.1.7	Ring fencing
Ring fencing is a term used to describe the segregation of one activity from another within a business.  For regulatory purposes, this results in the regulated activities being separated from any non-regulated activities within the one business. 
Regulators require adequate ring fencing to ensure that service providers do not indulge in anti-competitive cross subsidisation between different regulated activities or between regulated and non-regulated activities.  Ring fencing is also an attempt to ensure that unwarranted disclosure of commercially sensitive information obtained from users and prospective users by the service provider does not occur. 
The Code imposes minimum ring fencing obligations on service providers.  It also provides for the Commission to impose additional requirements or waive minimum requirements through a public consultation process. 
Issues for consideration
a)	While ring fencing arrangements are not an essential aspect of the access arrangement itself, the Commission welcomes any comments on the adequacy of AGLP’s ring fencing arrangements.  Is there any tension between the requirements of the Code and the provision of marketing and corporate services by AGL Group on AGLP’s behalf?  Are the minimum ring fencing requirements sufficient in this instance to meet the objectives of the Code?  
b)	The Commission understands that AGLP’s proposed reference tariffs are intended to cover all costs, as AGLP considers that any other revenue that may accrue is not material.  Do AGLP’s proposals suitably address issues of accounting separation?
4.2	Pricing principles and related issues
The pricing of transport services is the core element of an access arrangement.  Accordingly section 8 of the Code establishes pricing principles for setting the prices of transport services.  These provide for considerable flexibility but are nevertheless designed to achieve key objectives listed in section 8.1 of the Code. 
In broad terms, these objectives require the tariffs to generate sufficient revenue to enable the service provider to make a commercial return on its investment in pipeline assets over the life of those assets, and to provide it with an appropriate incentive to expand the system in a timely manner.  At the same time the return needs to be moderated so that revenues do not reflect the exercise of market power often available to an unregulated natural monopoly operation.  In addition the tariff structure needs to be cost reflective to promote economic efficiency in the use of the system.  Finally, the Code recognises the dulling effect revenue constraints can place on efficient pipeline operations and suggests the inclusion of pricing mechanisms to provide incentives for the service provider to strive for efficiency improvements. 
It remains for the Commission to determine whether the proposed pricing methodology is consistent with the outcomes sought by the Code. 
The methodology proposed for the setting of reference tariffs is contained in the access arrangement and access arrangement information.  The proposed tariff consists solely of a commodity charge based on throughput achieved.  Most other pipelines collect the majority of revenue on the basis of contracted amounts (through capacity reservation charges).  AGLP considers this has the advantage, particularly for inexperienced gas users, that users will not have to be concerned with load management issues.  AGLP expects to use capacity and throughput charges from the next access arrangement period.  Consequently, load management will be an issue from that time.  
The tariffs have been set low at the beginning of the access arrangement period (in order to encourage growth) and then rise steeply throughout the period (so that the rate at the end of the period is 56 per cent higher than at the beginning of the period).  The proposed tariff is to apply to actual throughput only with no penalty for overruns (until the pipeline achieves a contracted capacity of 85 per cent).  AGLP considers that the tariff in the next access arrangement period will be linked to the CPI.
AGLP has proposed a single price zone which it says reflects a regional infrastructure development objective of ensuring that no local community will be at a price disadvantage to any other.  Further, it argues that a distance based tariff would have resulted in the pipeline not being built.  It says that prospective users of the CWP support zonal pricing. 
The proposed tariffs are set for each year, providing AGPL with an incentive for efficiency gains as it will reap the total of any benefit.  No comment has been made on how these gains may be shared with customers. 
A capital asset pricing model (CAPM) approach has been used to develop a real (rather than nominal) rate of return which is applied to an initial asset base valued using the depreciated optimised replacement cost (DORC) approach.  There are significant issues to be considered with respect to both the establishment of the rate base and the rate of return proposed.
The Commission has explored these issues as they relate to the Code as part of the extensive process of public consultation it undertook when reviewing the Victorian transmission access arrangements.  These issues are considered in more detail in the following sections. 
4.2.1	Asset valuation
In establishing the initial capital base, the Code requires the regulator to consider the depreciated historical cost (DHC), the DORC and any other well recognised asset valuation methodology.  In practice, DHC may be considered to set the lower boundary of valuations and DORC the higher.  The CWP Access Arrangement uses the DORC methodology.  This is derived from the cost of construction, optimised, adjusted for the $2 million funding grant from the government and depreciated. 
Recent regulatory decisions with regard to gas pipelines illustrate that the appropriate asset valuation must be determined on a case by case basis.  The 1998 approvals of the Victorian gas transmission and distribution access arrangements, by the Commission and the Office of the Regulator-General respectively, entailed methodology based on DORC.  The regulators noted that these approvals related specifically to the Victorian assets, and did not amount to a more general endorsement of the DORC approach.  IPART’s 1997 approval of AGLGN’s access undertaking for its NSW network set tariffs consistent with an initial asset base valued at less than the full DORC valuation.  IPART’s September 1998 Draft Decision on Great Southern Energy Networks Pty Ltd’s access arrangement for the Wagga Wagga natural gas system was also consistent with a valuation lower than DORC.
Determination of the initial capital base underpins the revenue flow accruing to the regulated utility.  The estimate, therefore, is crucial to ensuring an adequate return to the pipeline owners while providing users with prices which replicate those likely to have arisen in a competitive environment marked by past rational investment decisions. 
Table 1:	Total asset values ($M):  Central West Pipeline 
Replacement Cost (Construction Cost)	30.71	
Optimised Replacement Cost	27.93	
Adjusted Optimised Replacement Cost	25.93	
Depreciated Optimised Replacement Cost (DORC)	29.49	
Source:  Revised Access Arrangement Information, p. 8.  
Issues for consideration
a)	Are the initial asset values for the CWP fair and reasonable?  Is DORC the most appropriate asset valuation methodology for the CWP?  Are the proposed values based on a rational, optimal configuration? 
b)	What, in your opinion, would be a fair and reasonable value for the CWP?  What is the basis of your estimate?
c)	Is the valuation likely to result in inefficient consumption or investment decisions?
d)	Is the use of ‘economic depreciation’ reasonable?  Has it been applied appropriately?
e)	Are the economic lives of the various assets appropriate?
4.2.2	Cost of capital
The proposed rate of return is calculated using a WACC approach, based on the CAPM adjusted for the effects of dividend imputation.  AGLP states that the weighting used is the debt to equity ratio applicable to the CWP, and notes that recent regulatory decisions relevant to the gas industry have adopted a debt to equity ratio of 60:40.  AGLP further modifies the CAPM approach to determine the cost of equity (to account for asymmetric risk and self-insurance).
AGLP considers the Commission’s 1998 decision on the Victorian transmission access arrangement (7.75 per cent for a real pre-tax WACC) to be an appropriate benchmark.  It then considers the risk associated with the CWP compared to the Victorian systems and concludes that the appropriate pre-tax real WACC is 10.0 per cent.  
The Commission notes that IPART’s September 1998 Draft Decision with respect to the Wagga Wagga natural gas system, which was consistent with a real return of 7.5 per cent, may also be considered a relevant benchmark.  While the Wagga Wagga system is more mature than the CWP, there are some similarities in their respective risk profiles.  Both are comparatively small regional systems, and are likely to rely on a small number of customers to account for much of their load.  
AGLP used the following formulae to determine the nominal post-tax WACC, and then converted to real pre-tax WACC on the basis of first adjusting for tax, then adjusting for inflation:
Pre Tax Nominal	= {Re  / (1–T(1–y)) x (E/V)}+(Rf +Dm) x (D/V)
Post Tax Nominal	= {Re  x [(1–T)/(1–T(1–y))]x(E/V)}+(Rf +Dm) (1–T) x (D/V)
Where		
Re = Cost of Equity	y = Imputation Credit Take Up Rate	
T = Corporate Tax Rate	E = Equity	
D = Debt	V = Debt plus equity	
Rf + Dm = Cost of Debt		
The parameters listed in Table 2 form the basis for AGLP’s proposed WACC.  Note that the categorisation of each value in the table is according to whether it contributes to a high or low range estimate of WACC.
Table 2:	Components of CAPM and WACC inputs
Parameter		Ranges	
		High	Low	
General 
Economic Parameters	Inflation	2%	3%	
	Corporate Tax Rate	36%	36%	
	Imputation Take Up Rate ()	25%	50%	
Gearing	Debt	50	60	
	Equity	50	40	
Cost of Debt	10 Year Bond  Rate	5.2%	4.8%	
	2010 CPI Linked Bond Rate	3.5%	3.2%	
	Debt Margin	1.45%	1.0%	
	Bank Costs	0.5%	0.5%	
Nominal Cost of Debt	Based on 10 Year Bond  Rate	6.65%	5.8%	
	Based on CPI Linked Bonds	7.45%	6.7%	
Cost of Equity	Market Risk Premium	7.0%	6.0%	
	Asset Beta	0.9	0.55	
	Equity Beta	1.66	1.23	
	Margin for Asymmetric Risk	1.0%	0	
	Margin for Self Insured Risk	0.5%	0	
Nominal Cost of Equity	Based on 10 Year Bond Rate	18.2%	12.2%	
	Based on CPI Linked Bonds	19.0%	13.1%	
WACC Results	Nominal Post Tax WACC	10.7%	6.0%	
	Nominal Pre Tax WACC	16.9%	9.4%	
	Real Pre Tax WACC	13.9%	6.8%	
Source:  Revised Access Arrangement Information, p. 13.
Issues for consideration
a)	Are the formulae (and conversion process) employed to calculate the WACC consistent with current thinking for application to a regulated asset base?  Is the resulting rate of return appropriate?  If not, what alternative would more likely represent the risk profile of the CWP assets? 
b)	Do the various components of WACC accurately reflect prevailing market rates?  Is the use of 10 year bonds as a long run estimate of the risk free rate appropriate for this application?  How should the risk free rate be estimated?
c)	Are the equity and asset betas and their ratios appropriate?
4.2.3	Forecast revenue
Forecast revenue is set at a level, over the life of the asset, which allows AGLP to earn a reasonable rate of return on assets employed in providing tariffed transmission services.  The key parameters in establishing forecast revenue are: 
•	regulatory asset values;
•	cost of capital;
•	operational costs; and 
•	net working capital.  
The method used to calculate the return on assets is based on economic depreciation and a real pre-tax WACC.  In this initial access arrangement, the tariffs proposed will produce a revenue from the forecast volumes which will under-recover costs (see 4.2.8 below).  Consequently, the economic depreciation will be negative which will lead to an increase in the regulatory asset value.  It is proposed in the access arrangement that, as a Fixed Principle, the residual value at 30 June 2004 be $45.2 million (in dollars of that day).  Tariffs in future access arrangement periods, which will be based on this value, will thus recover costs which are not recovered by tariffs in the current access arrangement period.
Table 3:	Forecast revenue:  1999 - 2004 
Year ending 30 June	1999	2000	2001	2002	2003	2004	
Total Revenue  ($M)	0.49	0.99	1.56	2.23	3.00	3.49	
Source:  Calculated by the Commission from proposed tariffs and forecast volumes (Revised Access Arrangement Information, p. 4 and p. 23 respectively).
Issues for consideration
a)	AGLP does not expect to fully recover costs during the initial access arrangement period, and proposes to ‘catch up’ in later periods.  Is the implied longer term revenue path fair and reasonable? 
b)	Is the methodology used to calculate the return on assets based on economic depreciation and a real pre tax WACC appropriate?  What are the alternatives and their relative merits?
c)	To what extent does the target revenue for AGLP reflect a fair assessment of the efficient costs of operation?
d)	Do the target revenues provide sufficient incentive to reward high performance and encourage efficient market growth?
e)	Would the proposed Fixed Principle provide an equitable basis for establishing reference tariffs for the second access arrangement period?
4.2.4	Total operating costs
EAPO will undertake operations and maintenance on the CWP on behalf of AGLP.  Corporate services and marketing will be provided by the AGL Group.  Total operating costs are shown in nominal terms in the table below.  They represent the same real figure of $723,500 (in 1999 dollars) for each year, escalated by the assumed inflation rate of 2.5 per cent.
Table 4:	AGLP’s operating costs ($000):  1999 - 2004 
Year ending 30 June	1999	2000	2001	2002	2003	2004	
Total Operating Costs	723.5	741.7	760.1	779.1	798.6	818.6	
Source:  Revised Access Arrangement Information, p. 20.
Issues for consideration
a)	Is the proposed level of operation and maintenance costs for AGLP appropriate?  Do these costs compare with industry best practice in Australia and overseas, taking account of pipeline age, size and industry structure? 
b)	Is it efficient and appropriate for users to be responsible for system use gas and for linepack?
c)	Are the corporate and marketing expenditure forecasts reasonable?
d)	Does the proposed access arrangement provide sufficient incentives for efficiency gains, including reduced operating costs?  Is the method of sharing potential gains (between AGLP, EAPO and users) reasonable?
4.2.5	Cost allocation
As a general principle under the Code, the costs of operating and maintaining the transmission assets should be allocated to users according to their use of those assets, where attributable.  Costs that cannot be directly attributed should be allocated to various users in an efficient and equitable manner. 
Issue for consideration
a)	AGLP states that tariffs which allocate costs to users other than on a zonal basis are not commercially and technically reasonable for the CWP.  Is there a more appropriate tariff structure than the proposed uniform tariff for all users during the initial access arrangement period? 
4.2.6	Capital expenditure
The Code requires that new expenditure be prudent and within the bounds of good industry practice.  AGLP projects the replacement of minor pipeline components to be the only capital expenditure in the initial access arrangement period and forecasts the same amount, in real terms, of $6,750 for each year of the access arrangement period.  In the event that the pipeline is extended to Tamworth, AGLP will submit proposed revisions to the access arrangement for approval which the Commission will assess under section 2 of the Code. 
Issues for consideration
a)	Are the capital expenditure forecasts for the CWP fair and reasonable given the age of the pipeline? 
b)	Will the proposed tariff structure encourage investment decisions congruent with a competitive market outcome?
4.2.7	Volume of gas delivered
Forecast average daily and peak demand for gas are shown in the table below.
Table 5:	Forecast demand:  1999 - 2004
Year ending 30 June	1999	2000	2001	2002	2003	2004	
Ave Demand (GJ/d)	757	1364	1973	2581	3189	3438	
Peak Demand (GJ/d)	1295	2335	3376	4417	5458	5884	
Annual Volume (TJ)	276	498	720	942	1164	1255	
Source:  Revised Access Arrangement Information, p. 23.  
Issues for consideration
a)	Volume assumptions are key elements in the determination of tariff levels.  The Commission must determine whether the volume forecasts of gas are reasonable.  If you consider the forecast volume levels to be inappropriate, please indicate the levels you consider reasonable along with the basis for these levels.
b)	How should the access arrangement take into account the possibility of significantly increased volumes in the event that an extension from Dubbo to Tamworth commences operation during this access arrangement period?
4.2.8	Reference tariffs
The proposed reference tariff consists solely of a throughput charge.  As noted earlier, the proposed tariffs start quite low and rise steeply to a figure which AGLP estimates to be less than that needed to fully recover costs during the initial access arrangement period.  AGLP expects tariffs under future access arrangements will be set to fully recover costs, including costs under-recovered in this access arrangement period.  Tariffs from that time will be linked to the CPI.  
Table 6:	Proposed tariffs in $/GJ of throughput for years ending 30 June
1999	2000	2001	2002	2003	2004	
$1.78	$1.98	$2.17	$2.37	$2.58	$2.78	
Source:  Revised Access Arrangement Information, p. 4.
AGLP states that the proposed single zone reference tariff is intended to encourage sufficient demand in Forbes, Parkes, Narromine and Dubbo to justify its investment.  AGLP contends that other tariff methodologies such as distance based or stand alone would result in a delivered price for gas that would be uncompetitive with alternate fuels and therefore the pipeline would not have extended to some of the towns.  Thus, without the combined volumes, the pipeline would not be viable.
The Commission understands that the sharply rising tariff path is designed to encourage demand growth in the early years. 
Issues for consideration
a)	To what extent are the reference tariffs likely to replicate the outcomes of a competitive market? 
b)	Does the proposed level and structure of tariffs promote efficiency in pricing?  Are the pricing principles economically sound, in terms of providing price signals for maximising the efficient utilisation of the system?  Is the proposed single zone appropriate?
c)	Are the reference tariffs sufficient to allow safe and reliable operation of the facility?
d)	To the extent that pricing has been determined to achieve a delivered price (ie. commodity price plus transmission on the MSP plus transmission on the CWP plus distribution plus retail) below a ceiling related to the cost of alternate fuels, is the sharing of revenues between these components cost-reflective?  In particular, is there any element of ‘cross-subsidy’ between AGLP and AGLGN?  If so, what are the consequences?
4.2.9	Other revenue
Once contracted capacity reaches 85 per cent of the pipeline’s capacity, AGLP proposes overrun charges of 120 per cent and 200 per cent respectively of the reference tariff for authorised and unauthorised overruns.  AGLP has also proposed daily variance charges of 120 per cent of the throughput rate.  These charges are additional to any other charges.
AGLP states that the proposed reference tariff has been designed to recover the revenue attributable to the throughput rate of the throughput service and that no allowance has been made for any other revenue that may accrue as it would not be material.  
Issues for consideration
a)	Do you consider the penalties for overruns and variances appropriate?
b)	Is it likely that the revenue generated from overruns and variances during the initial access arrangement period will be material?  If so, should this revenue be incorporated in the revenue model or in some other way used to reduce reference tariffs?
4.2.10	Regulatory mechanisms
Under the regulatory framework, the fixed tariffs allow AGLP to receive all the benefits of efficiency gains and increases in market volumes in the initial access arrangement period. 
Issues for consideration
a)	How should efficiency gains be distributed between regulated assets and consumers?  Submissions may address the appropriateness of profits and the distribution of efficiency gains. 
b)	Does the mechanism provide sufficient incentive to reduce costs?  Does the contracting out of operations and maintenance work affect AGLP’s incentives to reduce costs in this area?
c)	Are there adequate safeguards on service quality to ensure cost reductions are not achieved at the cost of quality?
4.2.11	Benchmarking/performance indicators
As part of its on-going role as regulator of transmission pipelines, the Commission is working to identify and develop appropriate efficiency and productivity indicators to use as benchmarks for the regulated utilities.  The measures should be both financial and non-financial and look to internal and external comparators.
AGLP has provided two performance indicators for the CWP and related pipelines: unit cost of construction/mm/km and operating costs per 1000 km.
Issue for consideration
a)	Are the supplied performance indicators relevant?  Are more appropriate measures available?  Have the supplied indicators been interpreted correctly? 
Attachment A
INFORMATION DISCLOSURE BY A SERVICE PROVIDER TO INTERESTED PARTIES
Pursuant to section 2.7 the following categories of information must be included in the Access Arrangement Information.
The specific items of information listed under each category are examples of the minimum disclosure requirements applicable to that category but, pursuant to sections 2.8 and 2.9, the Relevant Regulator may:
	allow some of the information disclosed to be categorised or aggregated; and
	not require some of the specific items of information to be disclosed,
if in the Relevant Regulator's opinion it is necessary in order to ensure the disclosure of the information is not unduly harmful to the legitimate business interests of the service provider or a user or Prospective user.
Category 1: Information Regarding Access & Pricing Principles
				Tariff determination methodology
				Cost allocation approach
				Incentive structures
Category 2: Information Regarding Capital Costs
				Asset values for each pricing zone, service or category of asset
				Information as to asset valuation methodologies ‑ historical cost or asset valuation
				Assumptions on economic life of asset for depreciation
				Depreciation
				Accumulated depreciation
				Committed capital works and capital investment
				Description of nature and justification for planned capital investment
				Rates of return ‑ on equity and on debt
				Capital structure ‑ debt/equity split assumed
				Equity returns assumed ‑ variables used in derivation
				Debt costs assumed ‑ variables used in derivation
Category 3: Information Regarding Operations & Maintenance
				Fixed versus variable costs
				Cost allocation between zones, services or categories of asset & between regulated/unregulated
				Wages & Salaries ‑ by pricing zone, service or category of asset
				Cost of services by others including rental equipment
				Gas used in operations ‑ unaccounted for gas to be separated from compressor fuel
				Materials & supply
				Property taxes
Category 4: Information Regarding Overheads & Marketing Costs
				Total service provider costs at corporate level
				Allocation of costs between regulated/unregulated segments
				Allocation of costs between particular zones, services or categories of asset
Category 5: Information Regarding System Capacity & Volume Assumptions
				Description of system capabilities
				Map of piping system ‑ pipe sizes, distances and maximum delivery capability
				Average daily and peak demand at "city gates" defined by volume and pressure
				Total annual volume delivered ‑ existing term and expected future volumes
				Annual volume across each pricing zone, service or category of asset
				System load profile by month in each pricing zone, service or category of asset
				Total number of customers in each pricing zone, service or category of asset
Category 6: Information Regarding Key Performance Indicators
				Industry KPIs used by the service provider to justify "reasonably incurred" costs
				Service provider's KPIs for each pricing zone, service or category of asset