Draft
Decision

Access Arrangement by Transmission Pipelines
Australia Pty Ltd and Transmission Pipelines Australia
(Assets) Pty Ltd for the Principal Transmission System

Access Arrangement by Transmission Pipelines
Australia Pty Ltd and Transmission Pipelines Australia
(Assets) Pty Ltd for the Western Transmission System

Access Arrangement by Victorian Energy Networks
Corporation for the Principal Transmission System

Date: 28 May 1998

File No:	Commissioners:
CR97/159	Fels
	Asher
	Bhojani
	Lieberman
	Parry

Contents
Abbreviations	
Glossary	
1. Introduction	
1.1 Structure of the Victorian gas industry	
1.2 The Access Arrangements	
1.3 The Commission’s assessment of the Access Arrangements	
2. Market carriage and interstate trade	
2.1 Introduction	
2.2 Definition of market carriage and contract carriage	
2.2.1 Services and policies under each model	
2.3 Interstate trade	
2.3.1 Compatibility of trading arrangements between States	
2.3.2 Pricing and the Interconnect	
2.4 Overall assessment	
3. Reference tariffs	
3.1 Overall reference tariff methodology	
3.1.1 Victorian Access Code requirements	
3.1.2 TPA’s Access Arrangements for the PTS and WTS	
3.2 The initial capital base	
3.2.1 Victorian Access Code requirements	
3.2.2 TPA’s Access Arrangements for the PTS and WTS	
3.3 New facilities investment and capital redundancy	
3.3.1 Victorian Access Code requirements	
3.3.2 TPA’s Access Arrangements for the PTS and WTS	
3.4 Depreciation and inflation indexation of the asset base	
3.4.1 Victorian Access Code requirements	
3.4.2 TPA’s Access Arrangements for the PTS and WTS	
3.5 Rate of return	
3.5.1 Victorian Access Code requirements	
3.5.2 TPA’s Access Arrangements for the PTS and WTS	
3.6 Operations costs and working capital	
3.6.1 Victorian Access Code requirements	
3.6.2 TPA’s Access Arrangements for the PTS and WTS	
3.7 Forecast revenue	
3.7.1 Victorian Access Code requirements	
3.7.2 TPA’s Access Arrangements for the PTS and WTS	
3.7.3 VENCorp’s Access Arrangement for the PTS	
3.8 Cost allocation and tariff setting	
3.8.1 Victorian Access Code requirements	
3.8.2 TPA’s Access Arrangements for the PTS and WTS	
3.8.3 VENCorp’s Access Arrangement for the PTS	
3.9 Tariff path and incentive structure	
3.9.1 Victorian Access Code requirements	
3.9.2 TPA’s Access Arrangements for the PTS and WTS	
3.9.3 VENCorp’s Access Arrangement for the PTS	
3.10 Assessment of reference tariffs and reference tariffs policy	
3.10.1 Victorian Access Code requirements	
3.10.2 TPA’s Access Arrangements for the PTS and WTS	
3.10.3 VENCorp’s Access Arrangement for the PTS	
4. Other Mandatory Elements	
4.1 Access Arrangement	
4.1.1 Victorian Access Code requirements	
4.1.2 TPA’s Access Arrangements for the PTS and WTS	
4.1.3 VENCorp’s Access Arrangement for the PTS	
4.2 Services Policy	
4.2.1 Victorian Access Code requirements	
4.2.2 TPA’s Access Arrangements for the PTS and WTS	
4.2.3 VENCorp’s Access Arrangement for the PTS	
4.3 Terms and conditions	
4.3.1 Victorian Gas Code requirements	
4.3.2 TPA’s Access Arrangements for the PTS and WTS	
4.3.3 VENCorp’s Access Arrangement for the PTS	
4.4 Capacity Management Policy	
4.4.1 Victorian Access Code requirements	
4.4.2 TPA’s Access Arrangements for the PTS and WTS	
4.4.3 VENCorp’s Access Arrangement for the PTS	
4.5 Trading Policy	
4.5.1 Victorian Access Code requirements	
4.5.2 TPA’s Access Arrangements for the PTS and WTS	
4.5.3 VENCorp’s Access Arrangement for the PTS	
4.6 Queuing Policy	
4.6.1 Victorian Access Code requirements	
4.6.2 TPA’s Access Arrangements for the PTS and WTS	
4.6.3 VENCorp’s Access Arrangement for the PTS	
4.7 Extensions and expansions policy	
4.7.1 Victorian Access Code requirements	
4.7.2 TPA’s Access Arrangements for the PTS and WTS	
4.7.3 VENCorp	
4.8 Review and expiry of the Access Arrangement	
4.8.1 Victorian Access Code requirements	
4.8.2 TPA’s Access Arrangements for the PTS and WTS	
4.8.3 VENCorp’s Access Arrangement for the PTS	
4.9 Information provision	
4.9.1 Victorian Access Code requirements	
4.9.2 TPA’s Access Arrangements for the PTS and WTS	
4.9.3 VENCorp’s Access Arrangement for the PTS	
4.10 Ring fencing	
4.10.1 Victorian Access Code requirements	
4.11 Key performance indicators	
5. Draft decision	
5.1 PTS Access Arrangement	
5.2 WTS Access Arrangement	
5.3 VENCorp Access Arrangement	
Appendix A: Interested parties consulted by the Commission	
Appendix B: Submissions	
Appendix C: Attachment A of the Victorian Access Code	
Appendix D: Explanation of EPD model	

Abbreviations
AA	Access Arrangement	
AAI	Access Arrangement Information	
ACA	Australian Cogeneration Association	
ACCC	Australian Competition and Consumer Commission 	
ACI	ACI (Packaging Group) Operations Pty Ltd	
ACM	Australian Chamber of Manufactures	
AGL	The Australian Gas Light Company	
AGUG	Australian Gas Users’ Group	
Allgas	Allgas Energy Ltd	
Amcor	Amcor Ltd	
BCA	Business Council of Australia	
BHPP	BHP Petroleum Pty Ltd	
Boral	Boral Energy Holdings Limited	
CAPM	Capital Asset Pricing Model	
CCA	Current Cost Accounting	
Coastal	Coastal Gas Australia Pty Ltd	
CitiPower	CitiPower Pty	
CLCV	Consumer Law Centre of Victoria Limited	
Commission	Australian Competition and Consumer Commission	
CPI	Consumer Price Index	
CSFB	CS First Boston	
CTM	Custody Transfer Meter	
CUB	Carlton and United Breweries Limited	
DAC	Depreciated Actual Cost	
DORC	Depreciated Optimised Replacement Cost	
EAG	Energy Action Group	
EAPL	East Australian Pipeline Limited	
Ecogen	Ecogen Energy	
Energy 21	Energy 21 Pty Ltd	
Envestra	Envestra Pty Limited	
EoD Linepack	End of Day Linepack	
EPD	Energy Projects Division, Department of Treasury & Finance (Victoria)	
Esso	Esso Australia Resources Ltd	
FATT	Forecast Average Transmission Tariff	
GFCV	The Gas and Fuel Corporation of Victoria	
GJ	Gigajoule (equal to one thousand million Joules)	
GTC	Gas Transmission Corporation (the predecessor of TPA)	
GTSO	Gas Transmission System Operator	
Ikon	Ikon Energy Pty Ltd	
IPART	Independent Pricing and Regulatory Tribunal of NSW	
IRR	Internal Rate of Return	
Kinetik	Kinetik Energy Pty Ltd	
KPIs	Key Performance Indicators	
LNG	Liquefied Natural Gas	
MATT	Maximum Average Transmission Tariff	
MDQ	Maximum Daily Quantity of gas (in GJ)	
MEE	Modern Engineering Equivalent	
MRP	Market Risk Premium	
MSOR	The Victorian Gas Industry Market and System Operation Rules	
Multinet	Multinet Gas Pty Ltd	
Mwh	Megawatt hour	
National Access Code	National Third Party Access Code for Natural Gas Pipeline Systems	
Nova Gas	Nova Gas Australia Pty Limited	
NPV	Net Present Value	
ODRC	Optimised Depreciated Replacement Cost	
Optima	SA Generation Corporation trading as Optima Energy	
ORC	Optimised Replacement Cost	
ORG	Office of the Regulator-General (Victoria)	
O&M	Operations & Maintenance Costs	
PJ	Petajoule (equal to 1 000 000 GJ)	
PTS	Principal Transmission System	
Santos	Santos Ltd	
SOU	Sellers Own Use	
Stratus	Stratus Networks	
Tariff Order	Victorian Gas Industry Tariff Order	
Texas Utilities	Texas Utilities Australia Pty Ltd	
TJ	Terajoule (equal to 1 000 GJ)	
TPA	Transmission Pipelines Australia Pty Ltd (provider of transmission services) 	
TPAA	Transmission Pipelines Australia (Assets) Pty Ltd (transmission assets owner) 	
TUoS	Transmission Use of System (charges)	
UGS	Underground Storage	
Uncle Tobys	Uncle Tobys Company Limited	
VENCorp	Victorian Energy Networks Corporation (operator of Victoria’s gas transmission system)	
Victorian Access Code	Victorian Third Party Access Code for Natural Gas Pipeline Systems	
VPX	Victorian Power Exchange	
WACC 	Weighted Average Cost of Capital	
WTS	Western Transmission System	

Glossary
Ancillary payments	Additional payments made to market participants to compensate when transmission constraints or surprises result in them being disadvantaged by a uniform, daily market price	
Augmentation	The process of upgrading the capacity or service potential of a transmission (or a distribution) pipeline (also referred to as expansion)	
Authorised MDQ	In respect of a customer, the maximum daily quantity of gas, expressed in GJ/day, which is authorised by VENCorp to be withdrawn by or on behalf of that customer. MDQ is also used to describe a notional allocation by VENCorp to market participants for the purpose of calculating uplift payments when congestion of the system occurs 	
Backhaul	A transport service which notionally transports gas between two points in the opposite direction to actual gas flow	
Bypass	The construction of a pipeline to avoid the existing transmission or distribution system or part thereof	
Capacity charge	In a market carriage system: a charge levied on gas throughput on days of peak usage.  In a contract carriage system: a charge levied on transport capacity actually reserved regardless of actual gas throughput	
City gate	Transition point from high pressure transmission pipelines to distribution network	
Commodity charge	A charge levied on the quantity of actual gas transported through the system	
Contract Carriage	The service provider normally manages the system by requiring users to enter into contracts that specify a quantity of service, which a user may trade with another user.  Charges are normally based, at least in part, on the quantity specified in the contract	
Covered Pipeline	Pipeline to which the provisions of the Victorian Access Code apply	
CPI-X	In TPA’s Access Arrangements, CPI-X is part of the formula used to achieve a constant change, over the years of a regulatory period, in the average revenue cap.  See price control formula 	
Distribution	The transport of gas over a combination of high pressure and low pressure pipelines from a city gate to various customers’ usage points 	
Excluded transmission services	Regulated services that are not considered to be amenable to formula-based price controls	
Extension	Extending a pipeline to provide supply of gas to areas not supplied with gas prior to extending the pipeline	
Firm transport	In a contract carriage system: a transport service which guarantees to provide transportation of gas up to the contracted or reserved level every day of the year	
Hub	A ‘balancing point’ which separates injection and withdrawal services, chosen to be located at the Pakenham offtake	
Initial regulatory period	From 1 December 1997 to 31 December 2002	
Injection	The physical injection of gas into the gas transmission system	
Interconnect	The pipeline connecting the existing TPA system at Barnawatha (Victoria) to the EAPL transmission system at Culcairn (NSW).	
Interruptible transport	A transport service which does not guarantee to provide gas at the requested levels every day of the year	
K factor	An adjustment in the price control formula for product mix variations between forecast volumes and actual volumes achieved	
Load factor	The ratio between average and peak daily load	
Market Carriage	To manage the system, the service provider does not normally require users to commit to a certain amount of quantity under contract.  Instead, charges are normally based on a user’s actual usage of the system 	
Matched Injection	Where equal quantities of gas are injected upstream of the hub and withdrawn by a customer also upstream of the hub (so that the hub is not on the physical link between the injection and withdrawal points)	
Matched Withdrawal	Where equal quantities of gas are injected downstream from the hub and withdrawn by a customer also downstream from the hub (so that the hub is not on the physical link between the injection and withdrawal points)	
Nomination	A nomination by a market participant in respect of a quantity of gas to be injected into or withdrawn from the transmission system on a gas day	
Peak period	The period of 1 June to 30 September each year	
Price capping	A form of price regulation that ensures that weighted average price increase in a given year does not exceed the percentage increase in the CPI, less some predetermined factor (CPI-X)	
Price control formula	The formula (described in schedule 5 of the Tariff Order) which controls the yearly increase in the maximum average tariff which TPA is allowed to recover.  It is equal to the initial average tariff, reweighted for forecast volumes, and then increased by a CPI-X factor.  The result is then adjusted by a K factor for differences in the product mix between actual volumes and those previously forecast 	
Reference service	According to the Victorian Access Code, ‘reference service’ means a service which is specified in an access arrangement and in respect of which a reference tariff has been specified in that access arrangement.  The three reference services in TPA’s Access Arrangements are: transmission injection service, transmission delivery service and LNG system security 	
Revenue capping	A form of price regulation where revenue is constrained.  In TPA’s Access Arrangements, average revenue is capped 	
Ring fencing	A form of accounting separation of different functions of the same organisation where a free interchange of information between two functional areas is not desirable	
Service Envelope Agreement	An agreement between VENCorp and TPA whereby TPA agrees to provide gas transportation services and pipeline capacity	
Service provider	A person who owns or operates the whole or any part of a pipeline	
Shipper	Also called trader, merchant or broker.  Agents which purchase gas or pipeline capacity for on-sale to others	
Spot market	A market administered by VENCorp to facilitate the physical balancing through trading of gas where gas is bought and sold at a variable price	
Take-or-pay	A contractual obligation on the part of the purchaser to pay for a certain quantity irrespective of whether the quantity is used	
Tariff D customer	A customer who consumes more than 10 TJ/year or more than 10 GJ in any hour.  This customer is metered daily	
Tariff V customer	Any customer who is not a tariff D customer.  This customer is not metered daily 	
Transmission	Long haul transportation of gas via high pressure pipelines	
Transmission delivery 
tariff D	A tariff which applies to a transmission withdrawal service to a transmission delivery zone, and comprises a transmission volume tariff component, in $/GJ for GJs of gas withdrawn in the anytime period, and a transmission demand tariff component, in $/GJ for 5 day withdrawal MDQ	
Transmission delivery 
tariff V	A tariff which applies to a transmission withdrawal service and comprises transmission volume tariff components	
Transmission injection tariff	A tariff which applies to a transmission injection service and comprising a transmission demand tariff component in $/GJ for 5 day injection MDQ	
Withdrawal	The physical withdrawal of gas from the gas transmission system 	

1.	Introduction
On 3 November 1997 the Energy Projects Division of the Victorian Department of Treasury and Finance (EPD) submitted proposed Access Arrangements and Access Arrangement Information for the Victorian natural gas transmission system to the Australian Competition and Consumer Commission (the Commission) for approval under the Victorian Third Party Access Code for Natural Gas Pipelines Systems (the Victorian Access Code).  
The reforms in Victoria are far wider in scope than the introduction of these Access Arrangements for gas transmission pipelines.  The wider reforms which have occurred or are proposed in Victoria include the introduction of new market arrangements for gas (including a market carriage capacity management system), the restructuring of a vertically integrated State owned business into three gas retailers, three gas distributors, one transmission business and an independent system operator, and the progressive introduction of contestability into the gas market.
The Access Arrangements describe the policies and basic terms and conditions on which the service providers will make access to the transmission pipelines available to third parties.
Three separate gas transmission access arrangements were submitted by EPD to the Commission for approval on behalf of: 
•	Transmission Pipelines Australia Pty Ltd (TPA) and Transmission Pipelines Australia (Assets) Pty Ltd (TPAA) for the Principal Transmission System (PTS);
•	TPA and TPAA for the Western Transmission System (WTS); and 
•	Victorian Energy Networks Corporation (VENCorp) for the PTS.
	In addition, as part of the overall restructuring of the Victorian natural gas industry, VENCorp and Gas Services Business lodged applications for authorisation under Part VII of the Trade Practices Act 1974 with the Commission.  These applications are for authorisation of the proposed Market and System Operations Rules (MSOR) and a generic gas service performance contract respectively.  The Commission’s decisions in relation to these applications are the subject of separate draft determinations.
	EPD has also lodged access arrangements and access arrangements information relating to the three gas distribution businesses (Westar, Stratus and Multinet) with the Victorian Office of the Regulator-General (the ORG).  
	The ORG is assessing the distribution arrangements according to the principles set out in the Victorian Access Code.  Where practical, the Commission and the ORG have coordinated their assessment and approval processes for these arrangements.
	The Commission’s assessment of the access arrangements lodged with it has been conducted in accordance with the requirements set out in the Victorian Access Code and has been based on information provided by EPD, consultants and interested parties.  This document sets out the Commission’s draft decisions and related amendments under section 2.13 of the Victorian Access Code for TPA's Access Arrangements and VENCorp's Access Arrangement.  Although the three Access Arrangements constitute separate applications for approval, the Commission’s draft decision on each Access Arrangement has been reported within a single document.  In view of the degree of commonality between the assessment of TPA’s Access Arrangements for the PTS and WTS, the discussion of the Commission’s draft decisions on these Access Arrangements has been reported collectively, with the exception of those areas in which divergence has necessitated separate considerations.
	This introduction: 
•	sets out the ownership and operator structure for the Victorian gas transmission Access Arrangements; 
•	describes the proposed structure of the Victorian gas industry; 
•	outlines the Commission’s role in assessing and approving access arrangements under the Victorian Access Code; 
•	sets out the Commission’s assessment of the Access Arrangements; and 
•	outlines the process the Commission intends to follow in reaching its final decisions.
	The remainder of this Draft Decision discusses: the issues of market carriage and contract carriage and interstate trade (chapter 2); the Commission’s analysis of the determination of reference tariffs (chapter 3); the assessment of the Access Arrangements in terms of the other mandatory elements in the Victorian Access Code (chapter 4); and chapter 5 sets out the Commission’s draft decisions.  The Commission has identified amendments to the proposed Access Arrangements that must be made or substantially complied with or the Commission must be satisfied that the issues identified in the Draft Decision have been met, in order for the Access Arrangements to be approved.  These proposed amendments are set out in the relevant sections in the Draft Decisions and in Appendix A of the Overview document.
1.1	Structure of the Victorian gas industry
The proposed structure of Victoria’s gas industry is described in the EPD paper, The Gas Market For The Future (November 1997).  Under the proposal, the market will comprise: 
•	the PTS, supplied by a monopoly producer of gas (Esso/BHPP) which accounts for over 98 per cent of the total market;
•	the physically separate WTS, which is supplied by Cultus;
•	a gas transmission business comprising TPA (the service provider) and TPAA (the asset owner) which together own and maintain the transmission assets and provide gas transmission services;
•	a gas transmission system operator, VENCorp, which is responsible for system and market operating functions; 
•	three gas distribution companies (Westar, Stratus and Multinet) with associated asset owning companies; and
•	three gas retailers (Kinetik, Energy 21, and Ikon). 
	Under the proposed structure, the natural monopoly components (the transmission and distribution system pipelines) are separated from the contestable component (retail supply).  VENCorp will link several components together by, amongst other things, managing the wholesale market to ensure there is balance between demand and supply of gas.  Esso/BHPP’s position as the monopoly supplier to the PTS is expected to continue until supply competition is made possible through the development of the Interconnect linking the NSW and Victorian transmission systems, the linking of the WTS and PTS and/or from gas supplied from the underground storage facility.
	The relevant legislation and documents regulating the Victorian gas transmission industry are: 
•	the Gas Industry Act 1994 (as amended by the Gas Industry (Further Amendment) Act 1997);
•	the Victorian Access Code;
•	Orders in Council made pursuant to those Acts, including the Victorian Gas Industry Tariff Order, made under the Gas Industry Act 1994;
•	licences issued by the ORG pursuant to the Gas Industry Act 1994; and 
•	various rules which the legislation and licences require the licensees to observe.
The Victorian Access Code
	The Victorian Government introduced the Victorian Access Code in advance of the introduction of the National Third Party Access Code for Natural Gas Pipeline Systems (the National Access Code) to expedite the reform process and the associated restructuring of the Victorian natural gas systems at the transmission, distribution and retail levels.  The Victorian Access Code largely mirrors the National Access Code and is expected to ultimately be superseded by it. 
	The objective of the Victorian Access Code is to establish a framework for third party access to natural gas transmission pipelines that: 
•	facilitates the development and operation of Victorian and national markets for natural gas;
•	prevents abuse of monopoly power;
•	promotes competitive markets for natural gas in which customers may choose suppliers, including producers, retailers and traders;
•	provides rights of access to natural gas pipelines on conditions that are fair and reasonable for both service providers and users; and
•	provides for resolution of disputes.
	The owner or operator of a pipeline that is covered under the Victorian Access Code is required to lodge an access arrangement with the relevant regulator.  The access arrangement is similar in many respects to an undertaking under Part IIIA of the Trade Practices Act and is designed to allow the owner or operator of the covered pipeline to develop its own tariffs and other terms and conditions under which access will be made available, subject to the requirements of the Victorian Access Code.
	The Victorian Access Code requires that the relevant regulator seeks comments on the access arrangement prior to deciding whether to propose to approve or not approve the access arrangement.  Where necessary, the relevant regulator may specify amendments which it will require to be made to the access arrangement before it will be approved.  If the access arrangement is not approved, it must be modified and resubmitted.  Under certain circumstances, the relevant regulator may draft and approve its own access arrangement.
	The Gas Industry Act 1994 which implements the Victorian Access Code provides for administrative review of certain regulatory decisions made under the Victorian Access Code in Division 4 of this Act.
	Important features of the Victorian Access Code are: 
•	coverage - the mechanism by which pipelines (including distribution systems) become subject to the Victorian Access Code; 
•	reliance on an up-front access arrangement outlining services and reference tariffs applicable to a covered pipeline; 
•	pricing principles; 
•	ring fencing requirements; 
•	information disclosure requirements; 
•	binding arbitration where there is a dispute; and
•	specific timelines for all processes. 
	The aim of the Victorian Access Code is to provide sufficient prescription so as to reduce substantially the number of likely arbitrations, while providing sufficient flexibility for the parties to negotiate contracts within an appropriate framework. 
Victorian Gas Industry Tariff Order
The Victorian Gas Industry Tariff Order is a Victorian Order in Council under the Gas Industry Act 1994 that will regulate the tariffs for certain regulated services provided by TPA, VENCorp, the distributors and the franchise retailers.  Chapter 3 of this Draft Decision assesses the proposed transmission reference tariffs for conformance with the requirements of the Victorian Access Code.
The regulated services are referred to as ‘tariffed services’ and are defined in the Tariff Order in chapter 10.  Chapter 6 sets out procedures for changing tariffs and prices, including the requirement for approval by the Commission. 
Chapter 2 regulates the prices of transmission services provided by TPA.  The Tariff Order specifies initial tariffs for these services and the basis for variation of the tariffs over the initial regulatory period to 31 December 2002.
Chapter 5 of the Tariff Order regulates the prices of services provided by VENCorp.  The Tariff Order sets out the tariffs for the first year of the regulatory period while in subsequent years VENCorp’s tariffs must be approved by the Commission.
The Tariff Order also regulates the prices which TPA and VENCorp can charge for some of their regulated services referred to as ‘excluded services’, for which formula based controls are not appropriate.  Initial prices for some excluded services are listed in the Tariff Order.  The Tariff Order otherwise regulates prices for excluded services on the basis that they must be ‘fair and reasonable’ and consistent with the requirements of the Victorian Access Code.  Any services offered which are not tariffed services or excluded services are ‘competitive services’ and these are not regulated by the Tariff Order or the Victorian Access Code.
An important issue for the Commission has been the legal structure of the Access Arrangements which calls up the Tariff Order for price changes and the MSOR for changes to rules.  Both these instruments can be varied by the Victorian Government outside the operations of the Victorian Access Code.  The Commission understands that the Victorian Access Code allows for the inclusion of external documents in an access arrangement.  However, the Commission is concerned that the use of external documents may create confusion and difficulties in understanding the Access Arrangements.  This may arise as the external documents change over time, particularly where the Access Arrangements themselves are not changed through the process established in section 2 of the Victorian Access Code. 
Regulatory period and regulatory review
The Tariff Order regulates transmission tariffs and prices for scheduled excluded services for the regulatory period from 11 December 1997 to 31 December 2002.  This timing is consistent with the common revisions commencement date of 1 January 2003 specified in the three proposed Access Arrangements.  At the end of the regulatory period the Commission must determine the price control arrangements which will apply to the transmission tariffs for the subsequent regulatory period of five years.
The Tariff Order provides guidance for the regulator in terms of the regulatory review.  This includes the use of CPI-X price paths and ensuring a fair share of efficiency gains between TPA and customers.  The procedures for making the decision to regulate transmission tariffs in the subsequent regulatory period of five years are set out in clauses 1.6 and 9.2 of the Tariff Order.
Annual tariffs reviews
Chapter 6 of the Tariff Order provides that, in each year of the initial five year regulatory period, TPA must submit its proposed tariffs to the Commission for approval in terms of consistency with the formulas in the Tariff Order.
The TPA price control formula comprises an average revenue control and a tariff rebalancing control which applies a cap to the price movements for each individual tariff.  The X factor for the CPI-X formula for TPA in the initial regulatory period is 3.4 per cent and the Y factor rebalancing control for TPA is ‑2.4 per cent.  This will result in individual tariff price changes being capped annually at CPI less 2.4 per cent.
As well as the beginning of the regulatory year, alterations to tariffs may be requested any time during the regulatory year.  In both cases, the Commission has 20 business days in which to respond (or it is taken to have approved the proposed tariff variation).  Chapter 6 of the Tariff Order sets out the rules relating to when approval can and can not be given.  Similarly, the Commission has 20 business days in which to approve or otherwise a proposed new tariff or a proposed closure of a tariff.
1.2	The Access Arrangements
	As stated above, three access arrangements have been lodged with the Commission for approval.  Separate access arrangements have been submitted by TPA for the gas transmission services provided by the PTS and WTS as these are currently physically separate systems, and so require individual access arrangements.
	The VENCorp Access Arrangement relates to VENCorp’s role as independent system operator of the PTS in which it has responsibility for the transmission control, market management and LNG system security functions.  In contrast, the WTS will be operated as a contract carriage pipeline and as such VENCorp’s role will be confined to transmission control.  It is proposed that should the WTS become physically connected with the PTS in the future, the WTS will be designated as a market carriage pipeline and the WTS Access Arrangement will be amended accordingly.  
	Section 2 of the Victorian Access 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’.   
	Although TPAA as the pipeline owner and VENCorp as the pipeline operator are both service providers as defined under the Victorian Access Code, neither TPA nor TPAA directly provide services to users or prospective users.  TPAA leases its pipeline assets to TPA and TPA provides services to VENCorp under the service envelope agreement.  From a practical perspective, VENCorp may be considered to be the real service provider.  
Section 9.2 of the Victorian Access Code provides that where there is more than one service provider in relation to a covered pipeline, one being the owner and another the operator, responsibility for complying with the Victorian Access Code is allocated among them by their access arrangements, or their access arrangements information.  Accordingly, each service provider is responsible only for complying with the obligations allocated to it. 
1.3	The Commission’s assessment of the Access Arrangements
	Under section 2.24 of the Victorian Access Code the Commission may approve a proposed access arrangement only if it is satisfied that it contains the required elements and satisfies the principles set out in sections 3.1 to 3.22 of the Victorian Access Code.  An access arrangement cannot be opposed on the basis that it does not address a matter which is not required under section 3 of the Victorian Access Code. 
	The minimum elements required in an access arrangement are set out in section 2 of the Victorian Access Code.  In combination, these elements aim to ensure that users and prospective users are able to gain access to the services offered by the service provider in a way which meets the principles set out in the CoAG agreement.  The Commission’s assessment of the minimum elements of the Access Arrangements is discussed in chapters 3 and 4 of this Draft Decision.
	The reference tariff principles in section 8 of the Victorian Access Code are discussed in chapter 3 of this Draft Decision.  These principles balance the requirement that a service provider can earn a commercial rate of return on its assets while providing access to its services, with the need to provide the right efficiency based incentives so that service providers are encouraged to pursue productivity gains, and that the benefits gained are shared with consumers.
Submissions and consultations
	This document sets out the Commission’s draft decisions on the Access Arrangements and is based on the principles contained in the Victorian Access Code and the objectives of the Gas Industry (Further Amendment) Act 1997.  
	The Commission has sought input from interested parties during the assessment process of the Access Arrangements.  This has included public consultations and the release in December 1997 of an Issues Paper.  The Commission has received written submissions from 28 interested parties regarding the proposed Access Arrangements.  
	The central themes put forward by interested parties in the submissions have been the novelty of the proposed market carriage model (for the PTS) and concern over the complexity of the overall reform package.
	The EPD has responded to these comments in additional submissions and has provided additional Access Arrangement Information in March 1998.  In light of this additional material, the Commission invited further submissions from interested parties and extended the deadline for assessment of the proposed arrangements.
The Commission is concerned that interested parties have not had the opportunity to form an opinion on the reasonableness of a number of policies and terms and conditions either for reasons of limited access to confidential material or because these policies or terms and conditions have not as yet been fully developed.  In other cases information has been made available some time after the Access Arrangements were lodged.  Further, some important elements are not contained in the Access Arrangements themselves, but in specified regulatory instruments.
	Pursuant to the requirements of the Victorian Access Code, the Commission has published a notice and informed interested parties that it has received the Victorian gas transmission Access Arrangements, published an Issues Paper, and invited, received and considered submissions from interested parties.  
Draft decision
	The Commission has now made a draft decision under section 2.13(b) of the Victorian Access Code that proposes not to approve each of the three Access Arrangements in their current form.  In order for the Commission to grant approval under section 2.16(c) to the proposed Access Arrangements, the amendments identified by the Commission must be made or substantially complied with or the Commission must be satisfied that the issues identified in the Draft Decision have been met.  These proposed amendments are set out in the relevant sections in the Draft Decision and in Appendix A of the Overview document.
	The Commission is now seeking submissions from interested parties on the Commission’s draft decision on each of the three Access Arrangements (TPA's Access Arrangement on the PTS and WTS and VENCorp's Access Arrangement on the PTS) contained in this Draft Decision.  All submissions must be delivered to the Commission by 17 June 1998 and should be addressed to: 
	Mr Mark Pearson
	Senior Assistant Commissioner
	Gas Group
	Australian Competition and Consumer Commission
	PO Box 1199
	Dickson    ACT    2602
	
	Fax:  (02) 6243 1260
	
	All submissions must be in writing, and preferably should also be supplied in electronic format compatible with Microsoft Word 6 for Windows. 
Final decision
After considering submissions, the Commission must issue a final decision (pursuant to section 2.16 of the Victorian Access Code) which:
(a)	approves the access arrangement; or
(b)	does not to approve the access arrangement and provides reasons why it does not approve the access arrangement and states the amendments (or nature of the amendments) which would have to be made to the access arrangement in order for the Commission to approve it and the date by which a revised access arrangement must be submitted; or
(c)	approves a revised access arrangement.
The Victorian Access Code (sections 2.17-2.19) allows the service provider, if necessary, to provide a revised access arrangement which the Commission may approve. 
If the service provider does not submit a revised access arrangement by the required date, or does so but the Commission is not satisfied it incorporates amendments specified in the final decision, the Commission must draft and approve its own access arrangement (section 2.20 of the Victorian Access Code).  Such a decision is subject to merits review under the Gas Industry Act 1994.
The Commission proposes to issue its final decision on the three Access Arrangements on 2 July 1998.  Based on this timetable, the proposed date of effect for the Access Arrangements is 1 August 1998 (or a date at least 14 days after the release of the final decision, which ever comes second).

2.	Market carriage and interstate trade
2.1	Introduction
This chapter provides an assessment, in terms of the guiding principles and other criteria of the Victorian Access Code, of the market carriage model proposed by EPD.  It also notes issues raised by interested parties regarding the choice by EPD of a market carriage model in preference to a more traditional contract market.  Primarily these issues relate to:
•	the adequacy or otherwise of services and policies that are being offered by the service provider under a market carriage model; and 
•	the impact of the adoption of the proposed arrangements on interstate trade.
2.2	Definition of market carriage and contract carriage
Table 2.1 below highlights the primary differences between the contract carriage and market carriage models as defined in the Victorian Access Code.  
Table 2.1:	Distinction between contract carriage and market carriage
Contract Carriage	Market Carriage	
•	the service provider normally manages its ability to provide services primarily by requiring users to use no more than the quantity of service specified in a contract;	•	the service provider does not normally manage its ability to provide services primarily by requiring users to use no more than the quantity of service specified in a contract;	
•	users normally are required to enter into a contract that specifies a quantity of service;	•	users are normally not required to enter a contract that specifies a quantity of service;	
•	charges for use of a service normally are based at least in part upon the quantity of service specified in a contract; and	•	charges for use of services are normally based on actual usage of services; and	
 •	a user normally has the right to trade its right to obtain a service to another user.	•	a user normally does not have a right to trade its right to obtain a service to another user.	
Source:	Victorian Access Code, section 9.9.
From the above definition it is obvious that market carriage can be practically implemented in a number of ways.  The Victorian market carriage model therefore represents an interpretation of the above definition.  
EPD has summarised the Victorian market carriage approach to transportation capacity as follows:
•	VENCorp and TPA will enter into and maintain a service envelope agreement, which defines the level of transportation capacity to be provided by TPA under its Access Arrangement.  This will need to meet the requirements of the existing authorised large customers, plus anticipated load growth amongst small (Tariff V) customers;
•	small (Tariff V) customers will receive authorised MDQ for whatever they actually use, and prior to commencement of the spot market, there will be an initial allocation of ‘authorised MDQ’ to existing large (Tariff D) customers;
•	where a party subsequently negotiates with and pays TPA to augment the pipeline, it will receive an additional MDQ authorisation commensurate with the agreed increase in the service envelope attributable to that augmentation;
•	where transmission constraints give rise to ancillary payments being made, uplift charges are allocated in such a way as to ‘penalise’ those parties who have contributed to the cause of those constraints (for example, using gas in excess of their authorised MDQ) - this being the mechanism by which the market carriage model provides the holders of authorised MDQ with ‘financially firm’ transportation rights; and
•	if a transmission constraint is sufficiently serious to result in a requirement for the interruption of gas supplies, then wherever practicable, VENCorp will seek to curtail customers using gas without, or above, their authorised MDQ before curtailing authorised customers - providing such authorised gas users with ‘physically firm’ rights.
EPD contends that market carriage facilitates operation of the pool and helps promote retail competition.
2.2.1	Services and policies under each model
Victorian Access Code requirements
Section 3.10 of the Victorian Access Code requires that an access arrangement must include a statement that the covered pipeline is either a contract carriage pipeline or a market carriage pipeline.  This election in turn determines the types of services offered and policies necessary to meet the requirements of the Victorian Access Code.
The regulator may not oppose an access arrangement solely because the service provider proposes to offer a market carriage regime.  Rather, the regulator is bound by section 2.24 to approve or not approve an access arrangement according to whether the regulator is satisfied that the access arrangement contains the elements and satisfies the principles set out in sections 3.1 to 3.22.  Section 2.24 specifies the factors that the regulator must take into account in making its decision.
Submissions by interested parties
Ecogen and Texas Utilities, in particular, have stated a preference for market carriage.  They believe that that the proposed market carriage model in Victoria is generally superior to the contract carriage model.  Ecogen argues that entry and exit by participants is far easier with market carriage.  In contrast, contract carriage tends to support the status quo by locking-in participants through long term contractual arrangements.
Texas Utilities expects that the market carriage system with its proposed allocation of authorised MDQ will provide retailers and customers with a degree of certainty of access to transmission services similar to that which would be expected under a contract carriage system.  Other interested parties are broadly in support of the market carriage model although they have concerns over some elements.
BHPP, Esso, BCA, and EAG, in particular, oppose the proposed market carriage model.  They have expressed concern at what they see as novel, untried and complex market arrangements, in particular the market carriage capacity management system.  For example, EAG states that the proposed market carriage model and the wholesale gas market structures have not been tried in this format in any other gas markets and the concepts have been developed largely on the basis of theoretical economic modelling.
Esso asserts that Victoria’s proposed market and transportation model is overly complex and inappropriate when compared to the traditional contract carriage model used in deregulated gas industries throughout the world and other States in Australia, and which was the original basis for the National Access Code. 
It is not obvious to some parties that specific services they desire, including firmness of service and capacity trading, are available under the market carriage model.  In making this claim they argue that the requirements of the Victorian Access Code are not met because the services policy does not include provision for a service required by a major segment of the market.
While BHPP’s preferred option is contract carriage, it has suggested a form of hybrid system as an alternative.  Under BHPP’s proposal, capacity on the PTS would be segmented into two parts:
•	the capacity reserved for those with contracts; and
•	the remaining capacity reserved by VENCorp for the benefit of those retailers and other customers who choose VENCorp’s services.
Commission’s considerations
The Victorian Access Code (section 3.10) requires the covered pipeline to be either a contract carriage pipeline or a market carriage pipeline.  A hybrid model - the simultaneously operation of a contract carriage system and a market carriage system - is impractical according to EPD.
The choice of market carriage instead of contract carriage has implications for the type of services offered to users and prospective users (see Table 2.1), with some parties arguing that market carriage does not provide the firmness of service they require.  Of particular concern is the charging of uplift payments, and the potential volatility this creates in the total charges paid by users.
EPD has addressed some of the concerns by the proposed initial allocation of authorised MDQ to current Tariff D customers, whose authorised MDQ will be identical to that contained in current supply contracts.  Unauthorised customers will pay the bulk of uplift charges and will be more susceptible to interruption in the event that congestion is serious enough to warrant curtailment.
Furthermore, users who do not wish to manage the risk associated with the spot market and uplift payments may contract with retailers (or brokers) who will bear the risk on their behalf.  The Commission anticipates that only a few end users will negotiate directly with the service provider whereas most will enter into contracts with retailers.
Retailers and potential retailers are likely to seek market carriage services because these services allow access to the network without the rigidity of traditional take-or-pay contracts.  This is particularly important as retailers’ customer bases become less certain through contestability and because of the existing full allocation of PTS capacity.
With respect to the proposed arrangements the Commission understands some of the concerns raised by interested parties.  The Commission cannot oppose an access arrangement solely on the basis that a market carriage model is proposed, but must assess the proposal in terms of section 2.24.
The Commission accepts that the concepts and processes developed may be novel and complex to those newly exposed to them.  However, experience in the electricity market has shown that market participants quickly become familiar with operating in a new environment.
2.3	Interstate trade
	In the context of assessing the proposed arrangements a fundamental issue in relation to interstate trade is the compatibility of trading arrangements between States – the application of market carriage in Victoria and a contract carriage system in NSW.
A number of interested parties submit that where a pipeline system based on market carriage links with one based on contract carriage it is likely to inhibit interstate trade in gas.  It is also claimed by some interested parties that this is inconsistent with the Competition Principles Agreement signed by CoAG for ‘free and fair trade’ in gas and the development of an integrated gas market in south eastern Australia.   
A further concern of interested parties is the pricing of transmission services for the Interconnect which at present is not covered under either the Victorian Access Code or the National Access Code.
2.3.1	Compatibility of trading arrangements between States
Service provider’s proposal
EPD submits that the proposed market carriage model will not be a barrier to interstate trade.  In response to concerns raised by interested parties, in particular BHPP, it states:
The Access Arrangement guarantees that BHPP (or any other party) can inject gas at Longford and withdraw gas from anywhere in the system, including at the interconnect with NSW, even on critical days.  To obtain this physically-firm service, BHPP pays the required transmission charges (which it can contract with TPA for on a long term basis); cashes out its imbalances each month, and pays its share of the uplift that assures that gas will be physically available to those willing to pay for it.  If BHPP ensures that its customers remain within their authorised MDQ then BHPP will not pay a significant share of the uplift (where the total uplift is already expected to be insignificant as these will be met largely by unauthorised users).  If BHPP does not wish to manage these risks it will be able to contract with competing middlemen (retailers or brokers) who will deal with these arrangements and take the risk of spot imbalances and occasional uplift payments on its behalf.
EPD also points out that volatility from uplift charges will rarely occur as the system becomes constrained in the short term only on two or three days per year in some years and the cost is likely to be in the order of only $100 000 per day across the entire market, and that it will be possible to insure against this risk if desired.  EPD has informed the Commission that TPA may establish a subsidiary to provide risk management in the short term until congestion pricing and transmission rights are in place.  
EPD advises that the most likely gas flows from NSW into Victoria would be at peak times to meet gas demand in northern Victoria.  This trade presents the shipper with the problem that the timing of the peaks is uncertain.  EPD points out that this problem would also exist in a contract carriage system where penalties would exist for failure to ship or if parties exceed their MDQ.  EPD also advises that the EAPL system has larger spare capacity and greater linepack flexibility than the PTS which should mean more stable spot prices.
Submissions by interested parties
Both Esso and BHPP have expressed concern that market carriage will inhibit trade with other States that have contract carriage systems.
Esso says:
.... market carriage in the TPA system will be inconsistent with the open access approach used in all other gas transmission pipelines in Australia, including those interconnecting with the TPA system.  This discontinuity will lessen the prospect of effective interstate competition as Victorian consumers will be unable to contract for the firm gas supply service available to other consumers in Australia.  Similarly, Victorian producers wanting to sell gas interstate through the market carriage system will be unable to provide the firm gas service that will be necessary to compete with producers in other states.  For instance, a potential supplier from Victoria to NSW will encounter an impediment to trade created because gas sourced from Victoria will only be available on a Market Carriage basis, whereas gas sourced from SA or Queensland would be available on a traditional firm basis.
In addition BHPP is of the view that the volatility in tariffs via congestion and uplift payments will not be conducive to interstate trade.
The ‘Market Carriage’ transmission system will create volatile prices for consumers. While common sense suggests that the underlying costs of gas  and gas transportation are stable in Victoria, the Market Carriage model, however, contains features likely to introduce volatility into the prices consumers will pay for delivered gas (perhaps like the $4 800 per Mwh volatility seen in the Victorian power industry).
BHPP also argues that:
For selling gas into Victoria, the incompatibility is perhaps less problematic than the other way around. For selling gas from NSW, or any other interstate interconnection, into Victoria, the interconnection could be treated as an injection point into the Victorian system. However, there may be problems on the NSW side, where the transmission company may penalise shippers who cannot identify in advance whether they will be shipping gas - i.e. the AGL system does not operate on inc/dec bids. 
BHPP says that in shipping gas from Victoria to NSW, a supplier will be competing against firms with known costs, putting Victorian shippers at a competitive disadvantage.  It argues that given the uncertainties of the Victorian system, such as day after pricing, a supplier looking to sell gas into NSW would be disadvantaged as it would not know the cost to ship gas to a NSW gas user, whereas shippers not encumbered by a market carriage structure would not face such an obstacle.
On the other hand Texas Utilities considers that interstate trade will not be affected by the adoption of the market carriage system in Victoria:
Experience in the United States indicates that it is possible for market participants operating under different regulatory scenarios to negotiate access to adjoining systems in spite of those regulatory models...
Commission’s considerations
Interconnection of the south east Australian gas market is vital to creating competition upstream and in order to deliver benefits to consumers in terms of lowest possible prices.  In fact the arrangements are designed to cater for multiple injection points, and the development of alternative sources of supply will be important if the Victorian Government’s forecast that demand will exceed supply in the next few years eventuate.  
For selling gas into Victoria from New South Wales the issue of incompatibility is perhaps less problematic than in the other direction.  In the case of selling gas into Victoria, the interconnection could be treated as an injection point into the Victorian system similar to the injection point from Longford.  However, shippers moving gas into NSW may be disadvantaged by the arrangements if they cannot identify in advance whether they will be shipping gas.  Effective administration of the Interconnect between EAPL and VENCorp should resolve many of the gas flow issues to ensure barriers to interstate trade are removed. 
The market carriage system does appear to allow firm contracts to supply gas to consumers outside Victoria provided that exporters insure against uplift charges.  These charges are expected to be small and can be expected to be easily hedged.  In the short term, when the Victorian gas system is only constrained for a few days a year at most, it is likely that the costs of financial hedges will be minimal.  As the system becomes more constrained uplift costs may increase but this will also depend on competition in gas supplies, the extent of augmentation and the development of the underground storage system. 
The Commission considers that interstate trade will not be adversely affected by the different market systems in Victoria and other States.  The Commission considers that the Access Arrangements allow firm contracts to be written between Victorian exporters and interstate suppliers.  
2.3.2	Pricing and the Interconnect
Service provider’s proposal
EPD states that TPA’s share of the Interconnect should not be a covered pipeline as the Interconnect is not considered to have natural monopoly characteristics since it is subject to significant competition.  Competition is expected to come from:
•	the Eastern Gas pipeline to supply Gippsland Basin gas to NSW to be constructed by BHPP and Westcoast;
•	the Moomba to Sydney pipeline for delivery of Cooper Basin gas to NSW;
•	the regulated TPA system for delivery of  Gippsland Basin gas to the Victorian gas market; and 
•	underground storage, LNG and interruptibility in the Victorian gas market.
	EPD’s primary rationale for stating that the Interconnect does not need coverage is that while the Interconnect may pass some of the relevant National Access Code tests for coverage it does not consider that it would be uneconomic for anyone to develop another pipeline to supply the services provided by means of the Interconnect.
Submissions by interested parties
	AGL, Santos and EAPL have expressed concern that the Interconnect is not presently proposed to be covered by either the National Access Code or the Victorian Access Code.  They consider that as Interconnect tariffs are critical for interstate trade growth, it is vital that the issue of pricing be resolved as soon as possible.
Both AGL and EAPL are concerned that the Interconnect will be incrementally priced and such a policy will become a barrier to interstate trade. 
Commission’s considerations
	The Commission is of the view that, given the importance of interstate trade and hence gas flows, TPA should be required to submit its proposal to exclude the Interconnect from its Access Arrangement to the Commission for assessment under its extensions/expansion policy.  Section 4.7 on extensions/expansions policy of this Draft Decision discusses this matter in more detail. 
Regarding the issue of pricing on the Interconnect, it is worth noting that parties have the capacity to negotiate terms and conditions outside the scope of an access arrangement provided reference tariffs are not exceeded.  
2.4	Overall assessment
While there has been considerable debate on the merits of Victoria’s proposed market carriage model in comparison to the standard contract carriage model, the Commission notes that it is not its role to rule in favour of one model over the other, or to demonstrate that one model is superior to an alternative regime.  Rather than adjudicate between models as some interested parties’ have implied, the role of the Commission is to assess the proposed Access Arrangements in terms of the criteria set out in the Victorian Access Code as described in chapter 1 of this Draft Decision.
The Commission’s assessment is that the Victorian market carriage model is consistent with the Victorian Access Code’s guiding principles and criteria.  It also considers that interstate trade will not be adversely affected by the different systems in Victoria and other States.  However, the Commission has concerns regarding coverage and pricing of the Interconnect.  To improve transparency and ensure interstate trade is enhanced, the Commission expects the service provider to submit its proposal as part of its extensions/expansions policy. 

3.	Reference tariffs
Introduction
The Victorian Access Code specifies a set of Mandatory Elements with which an access arrangement must comply.  These are considered in this chapter 3, reference tariffs and in chapter 4 - Other Mandatory Elements.
Sections 3.5 to 3.7 of the Victorian Access Code require an access arrangement to include a reference tariff for at least one service that is likely to be sought by a significant part of the market and other services for which the Commission considers a reference tariff should be included.  An access arrangement must also include a policy describing the principles that are to be used to determine a reference tariff (a reference tariff policy).  The reference tariff and reference tariff policy must comply with the reference tariff principles in section 8 of the Victorian Access Code.
The service providers have proposed access arrangements which specify initial tariffs for the tariffed transmission services and initial prices for scheduled excluded transmission services.  They specify the principles, procedures and formulae for altering these tariffs and prices, closing services and introducing new services.  They also provide guidance for the Commission in its making of price determinations for the subsequent regulatory period.  The TPA arrangements include an incentive mechanism in the form of a CPI-X price path approach.
In addition to the respective Access Arrangements and Access Arrangements Information, EPD has provided the Commission with several spreadsheet files which contain the model for construction of individual tariffs from forecasts of cost data.
Structure
This chapter assesses compliance of the proposed reference tariffs for the three Access Arrangements (where applicable) using the structure below, taking into account specific requirements of the Victorian Access Code, proposals by the service providers, and submissions from interested parties:
3.1	Overall reference tariff methodology
3.2	The initial capital base
3.3	New facilities investment and capital redundancy
3.4	Depreciation and inflation
3.5	Rate of return
3.6	Operations costs and working capital
3.7	Forecast revenue
3.8	Cost allocation and tariff setting
3.9	Tariff path and incentive structure
3.10	Assessment of reference tariffs.
Section 3.1 is introductory and covers both TPA and VENCorp.  Sections 3.2 - 3.6 will discuss the TPA Access Arrangements only.  As VENCorp is a not-for-profit organisation with minimal assets and not requiring a return on assets, these sections are largely irrelevant.  Discussion of all VENCorp's costs will occur in section 3.7.  Thus, sections 3.7 - 3.10 will be divided into an assessment of the TPA Access Arrangements and then the VENCorp Access Arrangement. 
3.1	Overall reference tariff methodology
3.1.1	Victorian Access Code requirements
Section 8 of the Victorian Access Code establishes the principles which must be followed in the establishment of reference tariffs.  The reference tariff policy and all reference tariffs should be designed to achieve a number of objectives (section 8.1 of the Victorian Access Code):
(a)	providing the Service Provider with the opportunity to earn a stream of revenue that recovers the efficient costs of delivering the Reference Service over the expected life of the assets used in delivering that Service;
(b)	replicating the outcome of a competitive market;
(c)	ensuring the safe and reliable operation of the Pipeline;
(d)	not distorting investment decisions in Pipeline transportation systems or in upstream and downstream industries;
(e)	efficiency in the level and structure of the Reference Tariff; and
(f)	providing an incentive to the Service Provider to reduce costs and to develop the market for Reference Services and other Services.
To the extent that there may be conflict between the application of these objectives, the Commission has the responsibility to determine how they may be best reconciled.  In addition, there are a number of matters on which the Commission must be satisfied before it can approve a reference tariff (section 8.2), including:
(a)	the revenue to be generated from the sales (or forecast sales) of all Services over the Access Arrangement Period (the Total Revenue) should be established consistently with the principles and according to one of the methodologies contained in this section 8;
(b)	to the extent that the Covered Pipeline is used to provide a number of Services, that portion of Total Revenue that a Reference Tariff is designed to recover (which may be based upon forecasts) is calculated consistently with the principles contained in this section 8;
(c) 	a Reference Tariff (which may be based upon forecasts) is designed so that the portion of Total Revenue to be recovered from a Reference Service (referred to in paragraph (b)) is recovered from the Users of that Reference Service consistently with the principles contained in this section 8;
(d)	Incentive Mechanisms are incorporated into the Reference Tariff wherever the Relevant Regulator considers appropriate and such Incentive Mechanisms are consistent with the principles contained in this section 8; and
(e)	any forecasts required in setting the Reference Tariff represent best estimates arrived at on a reasonable basis.
These factors are mandatory requirements on the Commission.  In addition, the Victorian Access Code specifies principles and requirements for each of these factors.  These principles and factors are a mixture of mandatory requirements on the Commission and principles which provide the Commission with different levels of discretion.  Furthermore, the Victorian Access Code provides the Commission with a limited ability to approve ‘principles’ (fixed principles) in an access arrangement that will bind its hands at future reviews.  The Victorian Access Code, however, only permits fixed principles to be included if they meet certain principles in section 8.48 in the code.
Nevertheless, within these parameters, the reference tariff principles are designed to provide sufficient flexibility so that the reference tariff policy can be designed to meet the specific needs of each pipeline system.  The overarching requirement is that when reference tariffs are determined and reviewed, they should be based on the efficient cost (or anticipated efficient cost) of providing the reference services. 
The principles also require that, where appropriate, reference tariffs be designed to provide the service provider with the ability to earn greater profits (or less profits) than anticipated between reviews if it outperforms (or underperforms) against the benchmarks that were adopted in setting the reference tariffs.  The intention is that, to the extent possible, service providers be given a market-based incentive to improve efficiency and to promote efficient growth of the gas market (an incentive mechanism).
Section 8 of the Victorian Access Code provides extensive guidance on the methodology to be used in establishing reference tariffs and their adjustment over time.  Reference will be made to the relevant parts of section 8 where appropriate in the following sections where the basis for the reference tariffs proposed in the Access Arrangements are considered.
Reference tariffs are to be set on the basis that sales of all services provided by the covered pipeline deliver (or are forecast to deliver) a certain amount of revenue (total revenue) over the period for which the reference tariffs remain in effect (the reference tariff period).
The reference tariff principles of the Victorian Access Code (section 8.4) permit a choice of three methodologies for determining the total revenue:
•	Cost of service: where the total revenue is set to recover ‘costs’ with those costs to be calculated on the basis of a return (rate of return) on the value of the assets that form the covered pipeline (capital base), depreciation on the capital base (depreciation) and the operating, maintenance and other non-capital costs (non-capital costs) incurred in delivering all services.
•	IRR: where the total revenue is set to provide an acceptable internal rate of return (IRR) for the covered pipeline on the basis of forecast costs and sales.
•	NPV: where the total revenue is set to deliver a net present value (NPV) for the covered pipeline (on the basis of forecast costs and sales) equal to zero, using an acceptable discount rate.
While these methodologies are different ways of assessing the total revenue, their outcomes should be consistent (for example, it is possible to express any NPV calculation in terms of a cost of service calculation by the choice of an appropriate depreciation schedule).  In addition (section 8.5), other methodologies that can be translated into one of these forms are acceptable (such as a method that provides a real rate of return on an inflation-indexed capital base).  The possibility of combining a ‘price-path’ approach with cost of service based on forecast costs is also noted.
3.1.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
TPA has provided access arrangements which specify initial tariffs for the tariffed transmission services, initial prices for scheduled excluded transmission services.  It specifies the principles, procedures and formulas for altering these tariffs and prices, closing services and introducing new services.  It also provides guidance for the Commission in its making of price determinations for the subsequent regulatory period. 
TPA has adopted the cost of service model (allowed for in section 8.3(b) of the Victorian Access Code) with a three stage approach (Access Arrangement Information section 1.6) to establish reference tariffs for the initial regulatory period covering the period from 1 December 1997 to 30 December 2002. 
Step 1: Set target revenue
A target revenue figure is calculated for each year of the initial regulatory period.  These are based on forecasts of costs comprising a nominated return on capital invested, depreciation of the capital base, operation and maintenance expenses.  Proposed capital investments are also integrated into these forecasts.
Further analysis of the methodologies involved in developing target revenues are considered below.  The depreciated optimised replacement cost (DORC) methodology applied to existing assets is used to establish the initial capital base.  These estimates and the approach used are discussed in section 3.2 of this Draft Decision.  Changes to the regulatory capital base over time are considered in sections 3.3 (New facilities investment and capital redundancy) and 3.4 (Depreciation and inflation) below.  The proposed rate of return or weighted average cost of capital (WACC) to be applied to estimate the cost of capital (or return on investment) is reviewed in section 3.5.  Other Costs are discussed in section 3.6.  In section 3.7 of this Draft Decision, these elements are brought together and actual forecasts of target revenues are considered.  This section also considers the adjustments which are made to revenue forecasts as a result of seeking a smooth transition in average tariffs over time. 
Step 2: Set year 1 tariffs
The target revenue for the first year is disaggregated between services, then within services between capacity and commodity.  These figures are then allocated to each take-off and injection point.  The tariff methodology provides the basis for setting each tariffed transmission service at each location on the transmission system such that:
(a)	at forecast demand, TPA will recover target revenue for year 1; and
(b)	users contribute an appropriate share of the cost of the assets and services which are used in providing the relevant tariffed transmission service (cost reflectivity).
The total price charged to customers for transmission of gas is broken into three components.  Each customer is charged:  
•	an injection tariff, on the volume of gas injected on its behalf on the five peak injection days;
•	a capacity delivery tariff.  Tariff D customers (who have meters which read daily volumes) are charged on the gas delivered on the five days of highest system demand.  Tariff V customers (who do not have daily meters) are charged on their consumption in June to September;  and 
•	a commodity delivery tariff charged on all gas delivered throughout the year.
The tariff methodology for establishing individual tariff components by type and location of service are considered in detail in section 3.8 below.
Step 3: Set formulae for tariff and revenue adjustment from year to year
Formulae are set out in the Tariff Order which govern the average tariff revenue from tariffed transmission services that can be recovered in the next year, given the average revenue achieved in the previous year and also the maximum amount that individual tariffs can be adjusted from one year to the next.  The stated objectives of these formulae are to:
(a)	achieve a clear overall price path that recovers target revenue over the five year period and ensure real gains to customers; 
(b)	create incentives to grow usage where an increase or decrease in total volumes of gas delivered leads to an increase or decrease in total revenue; 
(c)	encourage efficiency gains, particularly capital efficiency; and 
(d)	be consistent with light handed regulation. 
These aspects of reference tariffs are considered in section 3.9 below.
Within this framework the service provider has proposed that target revenue be calculated so as to provide a real rate of return (that is, a real WACC) on an asset base that is indexed for inflation.  Depreciation forming part of the cost base is also indexed for inflation.  Consistent with this approach, the capital base and any new facilities investment is indexed for actual inflation for the purposes of setting the Capital base at the commencement of the next regulatory period.  TPA refers to this inflation adjustment of asset values as a Current Cost Accounting (CCA) approach.  
Submissions by interested parties
Submissions were generally supportive of a cost based approach to the establishment of tariffs.  However, many submissions suggested that the proposed reference tariff methodology had shortcomings which meant that cost reflectivity was not achieved.  Generally, such criticisms focussed on specific aspects of the approach and are summarised where appropriate in the sections below.  
Commission’s considerations
The cost of service approach, as a general approach, seems to be non controversial and is consistent with the Victorian Access Code.  In fact TPA has combined the cost of service approach with a tariff path price approach.  Reference tariffs are determined in advance for the access arrangement period to follow a path that is forecast to deliver a revenue stream consistent with forecast costs of service, but provides for adjustments to account for some subsequent events on an annual basis and others at the commencement of the next regulatory period.  Such a combined approach is given by way of example in section 8.3 of the Victorian Access Code.
However, TPA’s use of a CCA framework in its proposal does not, on the face of it, comply with any of the methodologies provided for in section 8.4 of the Victorian Access Code.  It may, nevertheless, be acceptable under section 8.5 which permits other methodologies to be used provided they can be expressed in terms of the permitted methodologies.  The Commission considers this to be case with the current proposal.  The equivalence is recognised by noting:
•	that the application of a real rate of return to an asset base (and depreciation) which is inflated over time is theoretically equivalent to a historic cost accounting (HCA) approach where the nominal rate of return applied to an asset base with values and associated depreciation based on historic costs;
•	the practical difference is that the time profile of tariff revenues under the CCA approach is flattened relative to the historical cost approach; and
•	it can be demonstrated that the CCA revenue profile is identical to using the historical accounting valuation for assets and a nominal rate of return but with a non-linear depreciation schedule.  This non-linear depreciation schedule is obtained as the residual obtained after deducting the stream of nominal of return on the historical asset base from the combined return and depreciation under the CCA approach.  
The Commission also notes that the methodology adopted by TPA results in the capital base at the commencement of each access arrangement period being equal to the present value of future returns to those assets (calculated at the rate of return).
In terms of future regulatory period, however, the Commission notes that the Victorian Access Code requires that the capital base be determined mechanically, adjusted only for depreciation, new facilities investment and redundant capital (section 8.9).  Therefore, in order for the methodology proposed by TPA to be consistent with the requirements of the Victorian Access Code, the appropriate formula for determining the capital base at the commencement of the next access arrangement period is:
Capital base = initial capital base (indexed) - depreciation (indexed) + new facilities investment (indexed) - redundant capital
The Commission notes that the Victorian Access Code does not provide scope to revalue the existing assets outside of what is permitted by this formula.
There remains an issue as to what should be the basis for the inflation index proposed used in the CCA framework.  TPA has proposed the Consumer Price Index (CPI) compiled by the Australian Bureau of Statistics (ABS) for the city of Melbourne.  The Commission acknowledges that a general price index needs to be chosen, but it should be one which reflects the difference between real rates of return and nominal rates of return as perceived by financial markets.  In this context the CPI may not be the ideal index.  First of all, its consumer costs orientation means that it is over sensitive to some consumer oriented costs such as specific goods taxes and prices of products and services which may have only marginal relevance to general financial conditions.  At the same time factors relevant to business oriented costs may be somewhat muted.  Second, the selection of a Melbourne based index is unnecessarily narrow given the financial markets oriented requirement of the index.  Indeed an Australia-wide based CPI is less likely to be as susceptible to fluctuations of a spurious nature in this context.  Despite, these issues the Commission acknowledges the advantage of using a well recognised index like the CPI.  The Commission understands that the ABS is developing an experimental variation of the CPI to reflect the Ôunderlying rate of inflationÕ in a way which may be better suited for this application.  Unfortunately, an official index of this type will not be available in the near term and the Commission considers that the CPI (All Groups - average of eight state capitals) is the best available compromise.  Further support for the use of this index is the fact that it is also used as the basis for adjusting the value of treasury capital indexed bonds.
The Commission considers that the overall cost of service approach proposed by the service provider meets the requirements of sections 8.3 and 8.4 of the Victorian Access Code.
However, this does not imply that the Commission agrees with the values assigned to the different components of total revenue or the allocation of costs for the purpose of deriving specific reference tariffs.  Such issues are dealt with individually within subsequent sections of this chapter.  
Proposed Amendment - A3.1
	In order for TPA’s Access Arrangements for PTS and WTS to be approved the inflation index referred to throughout the Access Arrangements should be based on the CPI (All Groups - average of eight state capitals). 

3.2	The initial capital base
3.2.1	Victorian Access Code requirements
The Victorian Access Code requires the regulator to approve a value for an existing pipeline (an initial capital base) as part of the first access arrangement for that pipeline.  The value that is assigned to the existing assets is then treated under the Victorian Access Code as a historical cost that is carried forward mechanically to future regulatory periods (and adjusted only for depreciation, new capital expenditure and, where appropriate redundant assets).  The initial capital base, therefore, is the present value of expected future returns to the existing assets (evaluated using the regulated WACC).
The initial capital base has a significant effect on the value of the businesses.  Indeed, providing all bidders are rational, any difference between the sale price for a business and the capital base could be explained by the market employing a different WACC, some buyers being able to achieve cost saving synergies with their existing businesses or through buyers having different beliefs about future market growth and opportunities.
In addition, the initial capital base will have a significant effect on the level of tariffs over a considerable period given the long life of assets.
The Victorian Access Code (sections 8.11 and 8.10 (a) and (b)) requires that normally the value of the initial capital base should not fall outside the range of depreciated actual cost (DAC) and DORC.  In establishing the initial capital base, the Victorian Access Code (section 8.10) also requires the Commission to consider: 
•	other well recognised asset valuation methodologies (section 8.10(c)) and the advantages and disadvantages of these methodologies (section 8.10(d));
•	international best practice and the impact on the international competitiveness of energy consuming industries (section 8.10(e));
•	the basis on which tariffs have been (or appear to have been) set in the past, the economic depreciation of the covered pipeline, and the historical returns to the service provider from the covered pipeline (section 8.10(f));
•	the reasonable expectations of persons under the regulatory regime that applied to the pipeline prior to the commencement of the Victorian Access Code (section 8.10(g));
•	the impact on the economically efficient utilisation of gas resources (section 8.10(h));
•	the comparability with the cost structure of new pipelines that may compete with the pipeline in question (for example, a pipeline that may by-pass some or all of the pipeline in question) (section 8.10(i));
•	the price paid for any asset recently purchased by the service provider and the circumstances of that purchase (section 8.10(j)); and
•	any other matters considered relevant (section 8.10(k)).
In addition, the Commission is guided by the objectives in section 8.1, of which the following are particularly relevant:
•	replicating the outcome of a competitive market;
•	ensuring the safe and reliable operation of the pipeline;
•	not distorting investment decisions in pipeline transportation systems or in upstream and downstream industries; and
•	efficiency in the level and structure of the reference tariff.
As noted above, the regulator’s decision over the valuation of existing assets is clearly quarantined from the valuation of new investment.  Sections 8.12 and 8.15 of the Victorian Access Code provide that new pipelines and additions to an existing pipeline are valued at their actual cost.
3.2.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
TPA has chosen to use an asset valuation based on DORC, the methodology associated with the upper limit acceptable under the Victorian Access Code (section 8.11).  It argued that such an approach is likely to provide better economic signals and is more likely to replicate the outcome of a competitive market.  The optimisation process ensures that redundant or oversized assets are not included in the capital base and are not paid for by users.  By comparison, it notes that historical based costs would undervalue the asset and distort user’s choices in using the pipeline.  In addition, it notes that recorded historical estimates are sensitive to varying accounting policies over time and would incorporate inconsistencies including dubious assumptions about past recovery of asset costs.
TPA employed consultants Gutteridge, Haskins and Davey Pty Limited (GDH) to determine the valuation of transmission system assets on the basis of DORC.  This valuation involved three stages:
•	Optimisation - determine the optimal configuration and sizing of pipeline assets;
•	Replacement costs - a modern engineering equivalent (MEE) is established for each asset in the optimised system and a standard replacement cost (SRC) established; and
•	Depreciate those assets (straight line) using the standard economic life (SEL) of each asset together with an estimate of the remaining life (RL) of each asset.  For example if the standard economic life of an asset is 40 years and its remaining life is ten years, the asset would be depreciated to 25 per cent of the replacement cost of the MEE.
SRCs are calculated on the basis that ‘brownfields conditions’ exist, that is, all existing infrastructure (e.g. roads, footpaths and other services) is in place and the replacement of Transmission System assets would therefore need to allow for such features.
Minimum remaining lives are assumed for each asset type so that if an asset is still working at the end of its economic life it is attributed a minimum remaining life of five years.
On this basis, TPA claims the effect of optimisation was to reduce replacement cost valuations of system assets as at 1 July 1997 by nine per cent, from $642 million to $585 million.  Depreciation reduced the optimised asset valuation further to $357 million.  EPD made a policy decision to reduce this valuation further, mainly in respect of assets on the WTS to limit what it considered undesirable network price differentials.  In essence EPD considered tariffs would be unacceptably high using the proposed tariff setting procedure in  conjunction with the initial DORC for WTS assets.  Reducing the DORC valuations was the mechanism used to achieve the desired tariff level without compromising the overall approach to the establishment of tariffs.  Further aspects of this adjustment are discussed in section 3.7 below.
Non-system assets (mainly land and buildings) are not included in the above figures.  Land and buildings are valued at the lower of market and depreciated replacement value ($14.3 million) and other assets at book value ($2.4 million).
Table 3.1 summarises the valuation figures and shows adjustments made to arrive at the proposed DORC valuation and includes several historical valuations for comparison purposes.
Table 3.1:	Valuations of TPA’s transmission pipeline systems ($ million) and other assets
Valuation Methodology	PTS	WTS	Total	
Replacement Costs (RC)	615.7	26.8		642.5	
Depreciated Replacement Cost (DRC)	390.7	24.3		415.0	
Optimised Replacement Cost (ORC)	557.8	26.8		584.6	
Depreciated Optimised Replacement Cost (DORC)	332.9	24.3		357.2	
Adjusted DORC (Policy Reasons)	331.7	15.3		347.0	
Land and buildings (lesser of market value and DRC) 				14.3	
Other assets (book value)				2.4	
Total Capital Base				363.7	
Estimated Historical Actual Cost (AC)a				287.8	
Estimated Depreciated Actual Cost (DAC)b				185.9	
Estimated CCA Valuationc				381.9	
Notes:	(a)	TPA, Access Arrangement Information, Supplementary Information, 6 March 1998. 
(b)	While no DAC valuation for TPA pipeline assets is available from historical accounts this estimate which assumes the same proportional depreciation in moving from AC to DAC as for RC to DRC is likely to be a reasonable approximation.
(c)	EPD, letter to the ACCC and the ORG, 15 April 1998.
New assets are based on forecast capital expenditure required to meet forecast growth.  TPA has no obligation to incur this capital expenditure: thus there is an incentive to find cheaper options.
These figures have been updated to 1 January 1998 taking account of depreciation, forecast inflation and capital expenditure for the period 1 July 1997 to 31 December 1998.  It is these updated figures which have been used as the initial capital base for the Access Arrangements and for determining target revenues.  
Submissions by interested parties
The main concerns raised by the submissions were as follows:
•	that DORC valuation generally results in excessive asset values, and that the Victorian Access Code treats DORC as one extreme, with DAC setting the other extreme, and with values in between to be considered;
•	that international best practice as demonstrated in North America uses historical cost values;
•	that the outcomes of a competitive market generally reflect historical cost values;
•	IPART in NSW has set the initial capital base for AGL at around 80 per cent of DORC, or roughly the mid‑point between DORC and DAC, Boral Energy Holdings Limited (Boral) has prepared revenue forecasts for Envestra based on asset values between 49 per cent and 77 per cent of DORC, and there have been significant concerns raised by the use of DORC for determining transmission and distribution prices in electricity;
•	that long term users have already paid for the depreciation of the existing system and therefore the use of a DORC methodology means that the assets will be valued upwards and recovering the depreciation from users again; and
•	that DORC does not provide the correct economic signals, as the correct economic signals would not recover any sunk costs on a forward looking basis.
In addition, there were a number of statements to the effect that the objective is to determine a fair and reasonable valuation of the existing assets.
The arguments that the service provider made in support of the adjusted DORC valuations included the following:
•	it was not possible to estimate DAC from the available data, and therefore that methodology did not provide a certain asset value and DORC provided a practical starting point;
•	the use of modern engineering equivalent asset values and the optimisation of the systems resulted in the benefits of technological change to be passed on, and for users to be insulated from the costs of excess assets;
•	contributes to fair and economically efficient tariffs; and
•	recognises the valuable investment made in building the asset base over many years.
In addition, EPD quoted a number of other precedents for the use of DORC (or deprival value), which include the Commission for determining telecommunications access charges, the guidelines for asset valuation published by the Steering Committee on National Performance Monitoring of Government Trading Enterprises, and the Standing Committee of the Agriculture and Resource Management Council of Australia and New Zealand Water Industry Asset Valuation Draft Guidelines.
Commission’s considerations
There are a number of issues which may arise in considering the validity of a DORC valuation to be used in determining the initial capital base for the establishment of tariffs.  One is whether the DORC valuation is the appropriate one given the historical perspective, the nature of the pipeline and the proposed basis for establishment of tariffs.  In considering this, the Commission has also had regard to other possible approaches to asset valuation.  This reflects the scope provided under the Victorian Access Code and the consequent obligation on the regulator to exercise judgement in determining an appropriate asset value which can be best reconciled with other criteria in the Victorian Access Code.  The Commission has also sought to obtain a DAC valuation alternative by auditing actual cost figures and deriving an estimate for the DAC. 
In determining the appropriate asset valuation, the Commission notes that economic theory does not provide an unambiguous answer and that regard to notions of fair treatment and the effects on the different interest groups affected by the pricing approach to the recovery of sunk assets need to be taken into account.  The factors in section 8.10 of the Victorian Access Code direct the regulator towards this analysis.
The valuation methodology and economic theory
For a new access arrangement being applied to an existing pipeline system the Victorian Access Code (section 8.10) provides for methodological flexibility for asset valuation with DAC normally offering valuations at the lower end and DORC the upper of the acceptable range.  This may reflect a recognition in the Victorian Access Code that for an existing pipeline being brought into an access regime there is no economically ÔrightÕ valuation for the purpose of tariff determination and market determined approaches will involve a circular analysis.  
Economic theory notes that in the short run efficiency is achieved with pricing based on marginal costs.  Since the initial capital base is a sunk cost, the regulator could choose to value it just above scrap value to achieve these short run efficiencies, recognising that subsequent capital expenditures would need to be valued at actual cost to promote any expansion necessary for continued viability of the industry.  However, some economic efficiency considerations are also relevant with higher asset valuations using multi-part tariffs.  The constraint at the upper end is the value that can be maintained before the end-users either bypass the system or seek an alternative fuel source.  In relation to the former, bypass will become possible whenever prices reflect the cost of an efficient new entrant.  Thus, for sunk assets, economics only provides a range for the revenue constraint, and therefore for the value of the assets.
This discussion assumes, however, that the treatment of existing assets can be separated from the treatment of new assets.  One consideration for dynamic efficiency is that the price set for existing assets may influence the expectations of investors as to the regulator’s treatment of future investment.  While the Victorian Access Code clearly separates the treatment of existing assets from new assets, industry participants are likely to see the regulator’s treatment of existing assets as setting a precedent for how it will exercise its (generally wide) discretion when making other decisions under the Victorian Access Code in the future.  Therefore, opportunistic behaviour by the regulator with respect to existing assets may dampen the incentives for investment in the industry.
The merits of alternative valuation methodologies (s8.10 (a),(b),(c) and (d))
In addition to the DAC and DORC methodologies mentioned in the Victorian Access Code, a valuation based on CCA principles, as being proposed in the Access Arrangements for adjusting the capital base over time, is a readily available alternative in this instance.  Such a valuation ($382m) is included in the Table 3.1 above.  However, since it exceeds the DORC valuation, even if that value was thought to be appropriate the Victorian Access Code would require it at least be reduced to the DORC valuation.
IPART has promoted an alternative approach that avoids endorsing a particular valuation methodology independent of proposed tariffs.  It analyses cash flows arising from a proposed tariff path in terms of benchmark financial indicators to confirm the reasonableness of the tariffs.  While it would then be possible, in principle, to base a valuation on projected cash flows the approach is of limited value in this case since the tariff revenues proposed are already based on a specific valuation.  However, the Commission has recognised the value of the financial indicator analysis as a means of providing a ‘reality check’ on the tariff revenues resulting from the proposed tariffs in terms of the likely financial performance of the service provider.  These aspects are considered elsewhere in this document.
In addition, the indicators have helped to confirm the Commission’s assessment and to provide reassurance as to the reasonableness of EPD’s assess base calculation.
As noted above, economic theory does not provide an unambiguous answer as to the most appropriate asset valuation methodology.  That said, however, the two methodologies that are listed in the Victorian Access Code, DORC and DAC, have a number of advantages and disadvantages that will be discussed in turn.
The DORC methodology has theoretical economic attraction for a number of reasons.  First, regulators often look to the efficiency drivers and performance of competitive or contestable markets for guidance on efficient decision rules for regulating natural monopoly markets.  Such comparisons can provide a number of guiding principles for a range of complex regulatory problems.  In addition, the establishment of broadly symmetrical pricing and incentive structures across regulated and competitive markets has intuitive appeal on general resource allocation grounds.  It is noted in this regard that one of the objectives for reference tariffs is to replicate the outcomes of a competitive market (section 8.1(b)).
Second, the maintenance of reference tariffs over time at a level that is consistent with a DORC asset valuation may act to reduce shocks to reference tariffs as the replacement of assets becomes necessary (noting that the Victorian Access Code requires that the full replacement cost of assets be included into the capital base).  However, as actual systems comprise of assets of varying vintages with different service lives, the variations in prices may be muted in practice whatever valuation methodology is adopted. 
Lastly, any value that is in excess of DORC may produce reference tariffs that will expose the service provider to being bypassed.  While the significant entry and exit costs that characterise gas transmission make large scale duplication of the existing system unlikely, bypass will become more likely at the edges of the system.  Moreover, to the extent that parts of the system are bypassed, some of this cost inevitably gets absorbed by the remaining customers who do not have bypass options.
The Commission considers that both valuation methodologies demonstrate positive features.  However, the Commission also considers that while DAC has some positive features, it notes that much of the attraction of DAC is based upon a view as to how tariffs have been determined in the past — particularly as to whether customer charges and rates of return have been commensurate with rational economic behaviour.  Again, this issue is independent of how the assets will be treated at future reviews.  
A major difficulty with the use of a DAC valuation for the purpose of these access arrangements is a practical one.  Because the business originally integrated transmission, distribution and gas retailing together as part of the Gas and Fuel Corporation’s (GFCV) operations, there are no separate records of depreciation just for TPA assets.  In addition, the business has in recent years used a CCA approach for accounting purposes.  This means that a verifiable DAC valuation is not available.  While a reasonable estimate of a DAC can be made and included in Table 3.1, it does not facilitate the assignment of associated capital costs to different users to provide for cost reflectivity as required by the Victorian Access Code.  The DORC approach assigns values to specific assets and it is at this micro level that many of the economic advantages of the DORC methodology emerge in the structuring of tariffs for different users.  As discussed elsewhere, the Victorian Access Code effectively requires a DAC valuation for future reviews but the starting point for this will be based on the valuation set by this determination.
Consistent with this, the Commission considers that no single asset valuation methodology will provide the answer that is appropriate in all cases.  In particular, even though DORC has the advantages discussed above, the Commission does not consider that this could be justified where this resulted in TPA earning windfall profits and/or existing users facing higher transportation charges.  As will be apparent in the discussion to follow, the Commission also notes that the claimed ‘fairness’ of DAC assumes a certain methodology for setting tariffs in the past, which may or may not be the case.
The Commission therefore considers that it is essential to look at a number of indicators to test the implications for the viability of the businesses, the tariffs charged to end-users, and the impact on competition and efficiency in related markets of any asset valuation methodology that might be feasible within the framework of the Victorian Access Code.  In particular, the Commission notes that its decision must have regard to both ‘the legitimate business interests of the service provider’ (section 2.24(b)(i)) and ‘the interests of users and prospective users’ (section 2.24(b)(vi)).  Section 8.10 lists a number of factors directed towards testing the implications of the asset valuation on all relevant parties. These are considered further below.
Best practice and the impact on energy consuming industries (s8.10(e))
The Commission considers that this factor may require the regulator to determine benchmarks for transportation tariffs, both for overseas companies and for other domestic pipelines.  It suggests that one objective for determining the initial capital base is that it produce tariffs that are consistent with best practice transportation tariffs.  That said, however, the use of the word ‘comparable’ suggests that it is legitimate for tariffs to reflect costs differences that may arise from factors such as the terrain, customer type and density, and the distance of transportation.  In this context, strict benchmark comparisons are difficult to obtain.  For the purpose of this determination the Commission considers that the optimisation and the current (efficient) prices being assigned to assets as part of the DORC procedure and subsequently endorsed by independent consulting engineers has essentially covered this criteria.
The basis on which tariffs appear to have been set in the past and historical returns (s8.10(f))
As noted above, a number of submitters have argued that the tariffs they paid in the past resulted in much of the existing infrastructure having been paid for, so that a low valuation, such as that likely to be provided by DAC, is now justified for its remaining economic life.  The Commission considers that this factor requires it to try to make an effort to ‘unravel the past’ and form a view as to whether these claims are justified.
In determining a fair value for existing assets, it is necessary to estimate the extent to which there has been a return of capital - through depreciation - on past investment.  As the depreciation that has been recorded in financial accounts has not necessarily matched the depreciation that has been factored into tariffs, it is necessary to estimate an economic depreciation from past revenue streams.  Given the pattern of capital expenditure over the life of the entity, this depreciation can then be used to estimate a fair written down value for the existing sunk assets.  The way alternative valuations may be supported from this kind of analysis is illustrated in the box below.
Box 3.1:	Past pricing and the initial asset valuation relevant to 8.10(f)&(g) of the Victorian Access Code 

Consider the example of two identical pipelines, A and B (both built 20 years ago with 20 years life remaining) and now being brought into the regulatory framework of the Victorian Access Code.  Each had an initial cost of $1 000m, at a time when the Post-Tax Nominal Cost of Capital was nine per cent. Over the 20 years, there has been no new capital expenditure and inflation has remained steady at four per cent.  All costs associated with the efficient running the system are identical for each pipeline.  The only difference in the operation of the two pipeline systems has been pricing policy, which in the case of pipeline A has permitted annual net cash flows after tax of $100m per year, and in the case of B has permitted annual net cash flows of $88m per year. 
The question is, how should the Initial Capital Value of each pipeline be established with the introduction of the Victorian Access Code?  Is DORC or DAC the more appropriate methodology and is the same methodology appropriate to each?  If past returns are to be taken into account then it is fairly clear that a different methodology could apply in each case.  If the regulator is seeking to set a (residual) valuation which is fair to the pipeline owner and consistent with reasonable commercial expectations, then the valuation to be put on the pipeline is that which allows the pipeline owner to have achieved the nine per cent return anticipated when the pipeline was built.  On this basis, the residual value of pipeline A would be $500m (in this case its DAC valuation, assuming straight line depreciation), and the residual value of pipeline B would be $1 096m.  In case B the residual value is double the DAC valuation and close to the original undepreciated cost of the pipeline.  With four per cent inflation it also corresponds to the depreciated value of the pipeline in a current cost accounting (CCA) framework.  In the absence of technological change and other factors that may lead to optimising pipeline changes if it were built today, this would also correspond the present DORC valuation.
This illustration shows that a DAC valuation may be appropriate in one instance in terms of the Victorian Access Code and the DORC valuation in another. In a broad range of situations an intermediate value may be more appropriate.  Of course actual returns may be outside these ranges which could suggest residual value estimates either below DAC or above DORC, however, the Victorian Access Code would call for the DAC or DORC limits, as appropriate, to be applied in such cases.
For existing pipelines, where transmission prices were not previously regulated, there could be a general presumption that the pipeline owner would be a profit maximiser (with relatively high tariffs) suggesting a DAC valuation as being appropriate.  Exceptions to this may include a pipeline initially sized with the expectation of market growth but with low volumes initially so that a commercial return will not be achieved if the residual value is set at DAC at this point in time.  Another important group of possible exceptions are government owned pipelines.  Prior to the 1990’s Australian Governments have not always sought a commercial return on infrastructure.  Where that has been the case, application of the above analysis may suggest a valuation well above DAC for many such assets.  
When related to actual cases, these comments suggest that IPART’s concerns with the DORC valuation in relation to AGL’s NSW pipeline assets may be well founded while a DORC valuation in other circumstances (e.g. the Moomba to Sydney pipeline previously owned by the Commonwealth Pipeline Authority or the Victorian transmission pipeline assets now owned by the TPA) may be acceptable.  However, in all cases the more appropriate valuation methodology needs to be confirmed by examining the historical financial records relating to the pipeline assets in question.	

For the purpose of the present determination there are a number of informational shortcomings which make a thorough assessment of these issues difficult.  These mainly arise because the pipeline services in question, for the greater part of their existence, were part of GFCV’s integrated operation covering gas retailing and distribution as well as transmission.  The transmission services were only separated in December 1994 with the formation of Gas Transmission Corporation (GTC) (subsequently TPA).  
With the integrated operation, customers paid for a bundled service which did not provide for separation of charges for transmission, distribution and charges for the price of gas.  At this stage, any notional separation designed to judge whether the transmission charges in the past were fair and reasonable must be viewed as totally arbitrary.  
As suggested in the boxed illustration above, the twofold difference in Table 3.1 between the estimated valuations based on DAC and DORC does not, by itself, mean that a DORC valuation is inappropriate as the initial valuation of the capital base.  When much of the infrastructure was built the cost of capital was, at times, much higher than now.  If a CCA approach had been employed throughout the period it is quite conceivable that the present valuation of assets on this basis could be as high as the present DORC based valuation.  The crucial factor is whether effective return on the pipeline in the past has been in line with the cost of capital prevailing at the time new investments were being committed.  
Recognising the informational difficulties, the ORG undertook this analysis for the assets of the former GFCV, looking at the period between 1957/58 and 1996/96.  In summary, the ORG used financial information available from the previously integrated GFCV to estimate the economic depreciation that had been factored into GFCV’s tariffs in the past.  In the assessment
•	economic depreciation was defined as the entity’s residual income after recovering all costs and a reasonable return on the asset base; and
•	the fair ‘economic written down value’ for the former GFCV’s assets was then determined by summing the value of the existing assets of the former GFCV from the time that it was created (in 1958) and all capital expenditure undertaken since then, and deducting the accumulated economic depreciation. 
The purpose of this exercise was to calculate a written down value for the assets of the former GFCV that reflected how tariffs were set in the past (and thus the historical returns to the asset owner), rather than according to how assets were depreciated for financial accounting purposes.  The results that were obtained from the differing assumptions about the rate of return  and the treatment of the cost of natural gas are provided in Table 3.2 below.
Table 3.2	Estimated written down value of GFCV’s sunk assets ($000’s) under alternative scenarios
	Rate of Return Assumption	
Gas Pricing 	LTBR	LTBR + 1%	LTBR + 2%	LTBR + 3%	
Assumptions	$000’s	$000’s	$000’s	$000’s	
Contract Gas Cost 	(1,363,726)	42,297	2,034,681	4,824,038	
Commercial Gas Cost	3,509,024	5,411,395	7,944,901	11,319,816	
Source:	Reproduced from the ORG’s Draft Determination for the Victorian Distribution Businesses.
The ORG’s preferred scenario is LTBR + 2% assuming a commercial gas cost, which estimates the value of the assets of the former GFCV at almost $8 billion.  This value is well in excess of the proposed initial capital base for the equivalent assets - the three distribution businesses and TPA which is ($2.2 billion), and is also well in excess of the historical current cost written down value for the same assets which is ($2.1 billion).  Both of these exceed the corresponding DAC based valuations by a factor of about two.
While this analysis has been done for all of the assets of the former GFCV which is now disaggregated into the three distribution businesses as well as TPA, the Commission considers that it is reasonable to draw implications for the separate components from the whole of the former GFCV.
The analysis provides support for the Applicant’s argument that its proposed valuation methodology will not lead to a revaluation of the existing assets and to ‘double dipping’.  In essence, the analysis indicates that past tariffs have implied an economic rate of depreciation which has under-recovered the capital invested in the existing assets, compared to a DAC.  As the estimated written down economic value is well in excess of the combined DAC value for the same assets, the analysis does not provide support for the argument that tariffs have been set on an actual cost of service basis for the market as a whole in the past.  This suggests, in turn, that the conditions under which a DAC valuation would provide a fair valuation to be applied in future do not appear to have been met.
More significantly, since the estimated written economic values of the assets is also well in excess of the proposed valuations for the initial capital base, there also appears no justification for a further discounting of the proposed valuation as suggested in some submissions simply because it is based on the DORC methodology.
The reasonable expectations of persons under the regulatory regime that applied to the pipeline prior to the commencement of the Victorian Access Code (section 8.10(g))
This factor would appear to imply that it is appropriate for the regulator to not create significant ‘shocks’ for either the service provider or the users through the determination of the initial capital base, having regard to the features and implications of the previous regulatory arrangements.  The implication appears to be that with the introduction of a new regime, both sides have a right to be treated fairly, and not to have previous expectations unreasonably altered.  That said, however, the Commission considers that where the service provider had been earning excessive returns in the past then it is reasonable to expect that these would be wound back at least to the level that would be consistent with a DORC valuation as the maximum allowable under the Victorian Access Code.
In order to assess the reasonable expectations of the various parties, the ORG extended their analysis for the former GFCV mentioned above and imputed the revenue stream to transportation (transmission and distribution) and projected this forward on reasonable assumptions, and has compared this to the revenue streams implied by the DORC valuation and the DAC valuation (using the likely revisions to WACC emanating from the ORG and Commission Determinations). 
The ORG concluded that the proposed asset valuation methodology would lead to a reduction in the amount of revenue derived from transportation against that which could have been expected without the introduction of the Victorian Access Code, in turn implying a fall in average transportation charges.  It is noted, however, that the effect on final end‑user transportation charges depends upon how it is decided to allocate costs in the future which is discussed further in section 3.8 below.  
The Commission has noted the conclusion of the ORG based on this analysis that overall, DORC valuations as proposed would be consistent with the reasonable expectations of all parties prior to the commencement of the Victorian Access Code.
The impact on the economically efficient utilisation of gas resources (s 8.10(h))
This factor directs the regulator to look at whether the valuation methodology that is selected is consistent with providing the price signals which result in incentives for the efficient development and use of gas resources available to the Victorian market. 
As noted earlier, economic principles do not provide clear guidance on the valuation of sunk assets from the perspective of economic efficiency.  They do however suggest that irrespective of their evaluation sunk costs should be recovered in a manner that distorts the behaviour of system users and operators as little as possible.
The Commission considers that this objective can be met if reference tariffs are determined efficiently so that end users pay a price reflecting the true cost of using transportation.  On this issue, an appropriate allocation of costs (associated with the overall valuation, whatever that may be) to specific users or services is perhaps more important than the overall valuation.  In this context, as noted earlier, the establishment of the DORC valuation, which is derived by examining individual assets, facilitates the allocation of costs for specific users.  To the extent that the DORC valuation achieves overall price levels reflective of long run costs, the potential for efficient allocation of gas resources will be further enhanced.  
The comparability with the cost structure of new pipelines that may compete with the pipeline in question (e.g. a pipeline that may bypass some or all of the pipeline in question) (s 8.10(i))
This factor suggests that the asset valuation methodology chosen should not leave TPA open to uneconomic by‑pass (i.e. not justified on the basis of stand alone cost of entry).  As noted above, this suggests that the valuation should not be in excess of the DORC valuation.
The price paid for any asset recently purchased by the service provider and the circumstances of that purchase (s 8.10(j))
This factor allows a regulator to have regard to the price that may have been paid for a pipeline in a recent sale.  This factor would appear to be a variant on section 8.10(g), and suggests in effect that fairness dictates that the service provider’s legitimate expectations at the time of the sale be respected.  The regulator is also required, however, to have regard to the circumstances of the sale, and is under no compulsion to accept the sale price of an asset as the regulatory asset base.
In Victoria, the transfer of the transmission assets from GFCV to TPA could be interpreted as a ‘sale’.  However, the Commission considers that even if this was interpreted as a sale, then it would not be considered to be an arms length transaction, and so does not yield any information that should be taken into account for the purposes of this criterion.
Any other factors the relevant regulator considers relevant (s 8.10(k))
The Government ownership of TPA and planned privatisation introduces another factor for the Commission to consider.  There is no distinction between government and privately owned pipeline systems in the Victorian Access Code and therefore any revenue raising objectives associated with mooted privatisation of TPA assets cannot be taken into account in assessing the asset valuation or other aspects of the determination.  However, to the extent that the Victorian population are not only the beneficiaries of revenues raised from any asset sales, but also benefit from less costly pipeline system services (both past and in the future), there is a limited degree of comfort in the valuation placed on TPA assets in that the overall fairness or public interest are unlikely to be seriously compromised. 
The DORC valuation procedure
Given that the Victorian Access Code nominates DORC as one of the valuation bounds, there is still a need to check that technical aspects of the valuation and any necessary assumptions are appropriate.  To assist the Commission in this, a consultant was engaged to desk check the basis for the DORC valuation.
The Commission considers that the philosophical arguments for DORC and its associated efficiency properties require a focus on forward looking replacement costs associated with continued operation of the pipeline.  Only then do the DORC valuations provide a valid indicator for estimating long run marginal costs which are important in deriving economically efficient tariff structures.  Here there is some tension between a valuation based on recreating an asset ‘from scratch’ and a valuation linked to actual replacement or refurbishment which may be somewhat less costly.  The former being relevant to the likely cost of a new entrant and by-pass considerations, the latter to long run costs  associated with the operation of the pipeline. 
For these reasons issues of particular interest were the optimisation and valuation assumptions.  It is questionable whether the ‘brown fields’ assumption is universally appropriate for estimating replacement cost.  For example, rather than estimate the cost of locating an asset where existing extensive infrastructure needs to be disrupted an alternative route may be less costly.  Similarly, if rather than replacing a pipeline at the end of its useful life, it can be refurbished at a fraction of replacement cost then the refurbishment cost may be more appropriate than the replacement cost, since the asset is unlikely to actually be replaced.  The best example of this is the ‘goldlining’ of old ‘fully depreciated’ reticulation systems where it is a major issue in respect of distribution networks.  However, it is not clear that factors having such a significant impact on valuation are also relevant for transmission.  In addition, the ‘optimisation’ assumptions may compensate for a lower refurbishment based cost approved.  
Sinclair Knight Merz Pty Ltd (SKM), commissioned to ‘desk check’ the DORC valuation being proposed as the basis for the initial Capital Asset base, came up with a valuation about nine to 12 per cent higher than that indicated by TPA.  Neither GHD nor SKM considered replacement costs in terms of measures to extend the useful life of existing assets rather than a ‘from scratch’ installation.  However, to the extent that the Access Arrangement will be based on the lower of the two valuations the Commission has no justification for altering the DORC valuation proposed.
It is also noted that TPA made some reductions to the DORC valuation mainly in relation to the WTS system to achieve tariffs which were more in line with Government policy.  The Commission accepts that such a change is within the prerogative of the service provider and will not require any adjustment.
Updating the DORC valuation for introduction to the regulatory framework 
The CCA adjustment update of the DORC valuation from 30 June 1997 to 1 January 1998, the start of the regulatory period, assumed an inflation rate of 3.0 per cent per annum.  In fact, the CPI declined marginally over this period.  The Commission considers an adjustment for inflation over this period, consistent with actual inflation, would be more appropriate.  The Access Arrangements are unlikely to commence until late 1998 but the Commission recognises that target revenues will need to be based on annual projections and a requirement to update the valuation to say August 1998 may be largely immaterial.
Overall conclusion
After considering the criteria in the Victorian Access Code for assessing the valuation for the initial capital base, the Commission considers that the proposed capital base provides an appropriate balance of the interests of the various stakeholders under the Victorian Access Code criteria.  The Commission accepts the modified DORC valuation.  Future decisions will be made on a case-by-case basis recognising the economic arguments for and against the various valuation methodologies.
Proposed Amendment - A3.2
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, the adjustment of the initial capital base valuation for the period 1 July 1997 to 1 January 1998 (or if appropriate, the commencement of Access Arrangements) should be based on actual changes in the CPI over the period, rather than the 3 per cent per annum rate in the proposed Access Arrangements. 

3.3	New facilities investment and capital redundancy
3.3.1	Victorian Access Code requirements
Once the value of the initial capital base is established, the capital base for each subsequent period is determined as the value of the capital base at the start of the preceding period, plus new facilities investment (or recoverable portion), less depreciation for the preceding period, less redundant capital (section 8.14 of the Victorian Access Code).  
New facilities investment
The Victorian Access Code (sections 8.15-8.16) allows for the capital base to be increased to recognise additional costs incurred in constructing new facilities for the purpose of providing services.  The amount of the increase is the actual capital cost provided that the investment is prudent in terms of efficiency, in accordance with accepted good industry practice and is designed to achieve the lowest possible cost of delivering services.  
Furthermore, if the incremental revenue is not expected to exceed the cost of the investment, the service provider (and/or users) must satisfy the relevant regulator that the new facility has system wide benefits (justifying a higher tariff for all users), or that the new facility is necessary to maintain the safety, integrity or contracted capacity of services.
To the extent that the investment does not meet such criteria or is speculative in character the augmentation of the capital base needs to be correspondingly reduced.  
Reference tariffs may be determined on the basis of forecast investment (section 8.20 of the Victorian Access Code) during the access arrangement period provided that such investment is reasonably expected to pass the requirements noted above when the investment is forecast to occur.  However, the inclusion of forecasts does not imply that the criteria contained in section 8.16 of the Victorian Access Code have been satisfied.  The relevant regulator may reserve its judgment until the time that the investment is undertaken or at the next review.  The Victorian Access Code (section 8.22) also notes that the reference tariff policy should specify how discrepancies between forecast and actual investment are to be reflected in the capital base at the commencement of the next regulatory period (so as to meet the objectives of section 8.1 of the Victorian Access Code). 
Capital redundancy
Section 8.27 of the Victorian Access Code stipulates that a reference tariff policy may include a mechanism that will remove from the capital base at the commencement of the next period an amount which:
•	ensures that assets which cease to contribute to the delivery of services are not reflected in the capital base; and 
•	share costs associated with a decline in sales volume between the service provider and users. 
Before approving such a mechanism, the regulator must consider the potential uncertainty and its effect on the service provider, users and prospective users.
Where redundant assets subsequently contribute to or enhance the provision of services, the Victorian Access Code (section 8.28) allows them to be added back to the capital base as if they were new facilities investment and subject to the associated criteria for inclusion of such expenditure in the capital base.
3.3.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
New facilities investment
Within a regulatory period forecast capital expenditures needed to meet forecast growth in demand in reference services are rolled into the capital base for the purpose of establishing reference tariffs.  Investments over the initial five year period is estimated to be $60.7m.  While the TPA is not obliged to undertake these forecast investments, there is an obligation to deliver the services associated with the augmentation, possibly in a less costly manner. 
New facilities investment (extensions and augmentations) may be added to the capital base when they occur subject to certain provisions which closely parallel the requirements of the Victorian Access Code.  Where a prudent investment does not satisfy the roll-in test (that is meet the necessary roll-in conditions) the short-fall instead of being added to the capital base may be held as speculative investment fund (section 8.19 of the Victorian Access Code) or recovered through a surcharge/capital contribution levied on incremental users (section 8.25 of the Victorian Access Code). 
Redundant assets
The Tariff Order states (clause 9.2(d)) that the asset base for the subsequent regulatory period is the asset base at the start of the initial period adjusted for inflation, depreciation additions and disposals.  No mention is made in the formula for the removal of redundant assets.
Commission’s considerations
New facilities investment
As the provisions in the Access Arrangements for adding new investments into the capital base follow the Victorian Access Code closely there is no need for additional comment on this aspect of capital base augmentation from the perspective of acceptability of the approach.
Capital redundancy
Of concern to the Commission is the omission of redundant assets from the formula which calculates the asset base at the start of the subsequent regulatory period and the potential this has for users to pay for assets that have ceased, or substantially ceased, to contribute to the delivery of services.  
Proposed Amendment - A3.3
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, clause 9.2(d) of the Tariff Order should be amended to allow the Commission, at the commencement of the subsequent regulatory period, to review, and if necessary to adjust, the asset base for wholly or partially redundant assets.  

3.4	Depreciation and inflation indexation of the asset base
3.4.1	Victorian Access Code requirements
Under the cost of service approach proposed by TPA, depreciation of the capital base represents one element of costs used in the establishment of reference tariffs.  Each asset or group of assets must be assigned its depreciation schedule designed so that (following section 8.33 of the Victorian Access Code) :
•	the impact on reference tariffs is consistent with the efficient growth of the market for the related services;
•	depreciation occurs over the life of the asset(s) with progressive adjustments where appropriate to reflect changes in expected economic lives; while
•	ensuring that the asset is depreciated only once and that total accumulated depreciation will not exceed the valuation of the asset when initially incorporated in the capital base.
Although there is no specific provision in the Victorian Access Code to allow for adjustments to the asset base for inflation, some flexibility is allowed in the method used to calculate revenue.  Section 8.5 permits any methodology to be used provided it can be expressed in terms of one of the methodologies described in section 8.4 of the Victorian Access Code.
3.4.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
Since the Access Arrangement proposes a CCA framework for establishing target revenues the capital base is notionally re-valued in line with price inflation on an annual basis as previously noted.  Using the re-valued figures in conjunction with a real rate of return to establish capital costs effectively provides the same overall investment return as using unadjusted capital values with an equivalent nominal rate of return, but results in a more level tariff profile over time than alternative approaches. 
Depreciation of system assets uses the straight-line method based on standard asset lives.  However, in line with the CCA approach, depreciation costs are also adjusted to reflect revaluations in line with an inflation index.
While these adjustments to the capital base are described in the TPA Access Arrangement Information document for the purpose of deriving target revenues over the initial five year regulatory period, the same CCA approach is specified for the establishment of the initial capital base for the start of second regulatory period.  That is the 1 January 1998 capital base is the starting point with adjustments made for depreciation, new investment and actual inflation that has occurred between that date and 1 January 2003. 
Commission’s considerations
While the depreciation costs are consistent with the CCA framework they are not, at face value, consistent with section 8.33(d) of the Victorian Access Code which requires that an asset is depreciated only once.  This provision is clearly satisfied from a CCA perspective but the section of the Victorian Access Code goes on to note: 
the sum of the Depreciation that is attributable to any asset or group of assets over the life of those assets is equivalent to the value of that asset or group of assets at the time at which the value of that asset or group of assets was first included in the capital base  
Since depreciation costs are linked to an inflation index in the CCA approach, the sum of depreciation costs will not equate to the initial value of the assets when they were first introduced to the capital base.  The Commission would argue that the key word in the qualification is ‘equivalent’ since it is necessary to inflate the depreciation to achieve the same overall return as would be achieved using an equivalent non-indexed accounting framework (e.g. a nominal rate of return in combination with valuations and depreciation based on historical costs). 
The CCA approach can also be viewed as a mechanism to achieve the equivalent of a non-linear depreciation schedule over time with depreciation costs unindexed for inflation, but again giving an equivalent rate of return.  In this instance, the inflation part of the depreciation cost simply gets relabelled as part of the cost of capital associated with an asset value, which, as a consequence of the relabelling, is not being depreciated as fast.  Such an interpretation is fully compliant with the letter of the Victorian Access Code and generates identical tariffs.  As a consequence, the Commission considers that the CCA depreciation approach proposed is fully consistent with the Victorian Access Code requirements.
The TPA tariff methodology uses a real rate of return in conjunction with asset valuations linked to a CCA approach where simple inflation index adjustments are made annually to the capital base.  For target revenue estimates, forecasts of inflation are used but in establishing the capital base for the start of the second regulatory period, actual inflation estimates will be applied.  The apparent inconsistency is resolved through the CPI-X price-cap which leads to tariff levels changes appropriate to actual inflation rather than forecast inflation.
The only stage the DORC methodology is used within the proposed access arrangement is to establish the initial capital base.  All subsequent adjustments to the capital base are no different to what would occur with a valuation based on actual costs using the CCA approach.  
The Commission is favourably inclined towards the CCA approach which yields fairly level tariffs over time because of the economic efficiency advantages identified by EPD.  
3.5	Rate of return
3.5.1	Victorian Access Code requirements
The Victorian Access Code (sections 8.30-8.31) states that the rate of return used should provide a return which is commensurate with prevailing conditions in the market for funds and the commercial risk associated with the provision of reference services.  As an example, it suggests using a weighted average of the returns applicable to each type of capital (equity, debt and any other source of funds) with such returns determined on the basis of a well accepted financial model such as the capital asset pricing model (CAPM).  The financing structure assumed should also reflect standard industry structures.
3.5.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
TPA has proposed a rate of return based on WACC using CAPM benchmark comparisons to establish the cost of equity and historical interest rates to establish the cost of debt.  The WACC calculations also take account of dividend imputation which is relevant under the Australian tax system.  In the context of the TPA proposal, where a current cost accounting approach to asset valuation is used, the real rate of return becomes the critical parameter.  This in turn requires any inflation rate assumption (implicit in WACC proposals) to be specified.  The WACC figures proposed are based on a report prepared by CS First Boston (CSFB).
The underlying parameters, equations and other assumptions used within the CAPM framework to develop the proposed post-tax nominal WACC and other WACC derivatives are summarised below. 
Table 3.3:	Parameter settings used in TPA WACC calculations
Parameter	Value 	Rationale Given by TPA/Formula	
Gearing (D/V) - where 
V = debt(D)+equity (E)	60%	Based on comparable entities, noting high gearing of Victorian electricity distributors	
Risk Free Rate of Return (rf )	8.00%	Based on twelve month range of 6.1% - 8.2% for Sep 2009 bonds plus a premium for the 30-60 year economic life of the assets.	
Market risk premium1 
(rm - rf )	6.5 %	Range of 6-7% represents the generally accepted range in the corporate finance industry.	
Corporate Tax Rate (T)	36.0%	Current Statutory Rate	
Cost of Debt ( rd )	8.75%	0.75% above rf  to provide for risk premium and lender margin (claim of 60-90 basis points for similar debt).	
Gamma (  )- the assumed utilisation of franking credits by shareholders	25%	Estimate based on future possible ownership structure (given government intentions to privatise) with adjustment to capture effect of low dividend pay-out ratio.	
Asset Beta ( a )
	0.45	Based on CSFB’s report where estimated e’s of other gas companies (mainly overseas) used to provide benchmark comparisons are adjusted for different gearing ratios plus a term to reflect debt risk.  
[ a = e E/V +   d D/V   ]	
Debt Beta2 ( d )	0.12	Calculated from assumed rf, rd and market risk premium.   d = (re -  rf ) / ( rm -  rf)	
Equity Beta  ( e )	0.95	Derived from Asset Beta, Debt Beta, debt/equity and corporate tax rate assumptions3
[ e = a (1 + (1-T) D/E) + d D/V ]	
Expected Return on Equity (re )	14.19%	CAPM formula re = rf  +  e( rm -  rf)	
Inflation ( f )	3%	Considered reasonable assumption for initial tariff setting period.	
Post-Tax Nominal WACC r0	8.34%	re [(1-T)/(1-T(1-))].E/V+rd (1-T).D/V	
Post-Tax Real WACC rr0	5.18%	(1+r0 ) / (1+f) -1	
Pre-Tax Nominal WACC r1	13.02%	r0  / (1-T)	
Pre-Tax Real WACC rr1	9.73%	 (1+ r0 / (1-T))/(1+f) -1	
Source:	TPA Access Arrangement Information, pp. 16-18. 
Notes:	1.	In the context of the model used, it is implicit that rm is a partially grossed up figure which takes account of the value of imputation credits to the overall market.
	2.	Not reported in publicly available Access Arrangement documentation.
	3.	This is inconsistent with the formula for a given above for de-levering.
As indicated in the table the post-tax nominal WACC is defined by the formula proposed by Officer:  

As noted in Table 3.3 above the pre-tax nominal WACC is assumed to be obtained by grossing up the post-tax estimate on the basis of the corporate tax rate.  The real WACC estimates make a further adjustment for the assumed rate of inflation. 
Submissions by interested parties
CUB and ACI noted the similarity between the proposed pre-tax nominal WACC (13.02 per cent) and the corresponding figure (13 per cent) nominated by IPART in its AGL distribution network determination but considered that the assumption concerning the utilisation of imputation credits ( = 25 per cent) should be reviewed given that IPART had suggested a range from 20 to 60 per cent as being appropriate. 
The BHPP submission commented that the regulatory regime may add to, or decrease the risk pertinent to TPA’s operations and that this should be taken into account when assessing the WACC.
The Australian Cogeneration Association (ACA) provided the most detailed comments on TPA’s WACC analysis.  They considered the inherent risk for the operator was low in view of the K factor - price adjustment mechanism to take account of errors in forecast volumes and the provision for smooth transition of pricing from one regulatory period to the next.  As a consequence of the lower risk a higher debt equity ratio can be supported.  They also noted that the risk free rate assumed in the development of the proposed WACC exceeded current bond rates by more than one per cent.  They suggested recent takeover offers and floats of similar gas companies provide a useful guide as to the appropriate WACC.  ACA conclude that the WACC should be two to three per cent lower than that proposed by the TPA.
A number of WACC specific submissions were received from BHPP, Westpac and the Commonwealth Bank which focussed on the parameters used in the WACC analysis.  These submissions made similar points to the ACA but were more specific in identifying the appropriate values for the WACC parameters.  The parameter values suggested are referred to within the discussion below but it is noteworthy they all acknowledged:
•	the need to apply current interest rates and inflation expectations;
•	that the effective tax rate pertinent to the WACC formulation was likely to be considerably less than the statutory rate assumed by CSFB; and
•	the likely utilisation of imputation credits is likely to be above that assumed by CSFB. 
Commission’s considerations
The WACC is a critical element of pricing principles since it is what determines the prospective profitability of the service provider.  Its value should be determined on the basis of financial market benchmarks taking into account the level of commercial risk involved in establishing the service infrastructure.  If it is too low, the service provider would not expect to be able to recover the efficient (and fair) costs of service provision and perhaps, more importantly, may not have adequate incentive to augment facilities when appropriate.  If it is too high, the service provider would have a strong incentive for over-capitalisation and the opportunity to derive monopoly rents.  Such issues are directly relevant to the reference tariff objectives enunciated in section 8.1 of the Victorian Access Code. 
The consultant’s report which forms the basis of TPA analysis deriving WACC estimates is not in the public domain.  The Commission had a number of reservations over assumptions used to establish the proposed WACC and for this reason sought additional specialist advice from Professor Davis to assist in its assessment of the WACC proposal.  Generally, the comments in submissions received from the two banks and from BHPP re-iterated many of Professor DavisÕs points.  
In the main, concerns surrounded the financial parameters relevant to the CAPM approach and used to derive the WACC.  The key parameters relevant to this analysis are:
•	the risk free interest rate (rf ), the real risk free rate (rrf )and by implication the anticipated rate of inflation (f) and the interest rate applicable to debt (rd );
•	the market risk premium (MRP);
•	the likely utilisation of imputation credits ();
•	the effective tax rate (Te);
•	the likely level of debt funding (D/V); and
•	the equity beta (e) relevant to the stand-alone operation within the proposed regulatory framework.
In addition, some minor formula errors were identified by Professor Davis in the service provider’s application of the WACC framework and these were rectified in the Commission’s application of the model.  Also, some re-formulation was required to accommodate effective tax rates within the framework.
Despite agreement on some issues it is clear that the values assigned to the financial parameters remain contentious and warrant discussion in some detail since they form the basis for determining the rate of return that will be permitted on the regulated assets.
Interest rates and inflation
The Victorian Access Code (section 8.30) clearly states that the rate of return should be ‘commensurate with prevailing conditions in the market for funds’.  The Commission interprets this as implying that all information for deriving the rate of return should be as up to date as possible at the point the access arrangements come into effect.  In the case of interest rates and inflation expectations which are parameters set by the financial markets on a daily basis and are readily determined there seems little justification for using historic data.  This point was echoed by Davis and the submissions and represented a common criticism of the figures used by CSFB.  
This approach reflects the fact that the relevant WACC for regulatory purposes should be a forward looking concept which gives an indication of the minimum expected commercial return necessary to underwrite new investment in the facilities required to provide the reference services taking account of the commercial (and regulatory) risks involved.
Selected interest rates and inflation estimates relevant to the setting of the WACC are shown below in Table 3.4.
Table 3.4:	Current financial market interest rates and inflation expectations1
 
Financial Indicator	Average Value (per cent pa)
Dec 97-May 984	Volatility in period 
(Std. Dev.)	Current Value
8/5/98	
5 Year Gov Bond Rate	5.52	0.17	5.40	
10 Year Gov Bond Rate	5.85	0.18	5.69	
Indexed Bonds (August 2005 series) 	3.96	0.21	3.65	
Indexed Bonds (August 2010 series) 	3.93	0.20	3.63	
Indexed Bonds (August 2015 series) 	3.88	0.18	3.61	
Indexed Bonds (August 2020 series) 	3.84	0.17	3.59	
Estimated 5 year real rate2	3.98	0.21	3.66	
Estimated 10 year real rate2	3.94	0.20	3.64	
Implied 5 year inflation expectation3	1.48	0.11	1.68	
Implied 10 year inflation expectation3	1.83	0.10	1.98	
Notes:	1.	Based on the average weekly closing quotes over the months of December 1997 through to 8 May 1998 as published in The Australian Financial Review.
	2.	Interpolations based on indexed bond figures.
	3.	Inferred by comparing nominal and real interest rates over the corresponding period. 
	4.	5 December 1997 to 15 May 1998.  
The risk free rate
TPA states that ‘the ideal proxy for the risk free rate would be the yield on a default risk-free bond with the same maturity as TPA’s assets’.  To reflect this approach the risk free rate assumed by CSFB in the estimation of the WACC is eight per cent.  This is based on a 12 month (August 1996 to August 1997) historical average ten year bond rate augmented by a 45 basis points (the observed premium of 30 year US Treasury Bonds over their ten year maturity counterparts) to proxy the interest rate on a 30 year maturity Australian government bond rate. 
While the Commission acknowledges that the yield on Government Bonds provides an estimate of the risk free rate it does not agree with CSFBÕs proposal for a number of reasons.  First, the CAPM model on which the WACC is based is a one period model and the interest rate benchmarks implicit in the model are correspondingly short-term.  Second, rarely does initial debt funding for such investments extend beyond ten to 15 years and in any event, as noted by the Commonwealth Bank would be likely to re-set interest swaps on a five yearly basis.  Third, the temporal structure of cash flows means that the bulk of a project’s costs are recovered well in advance of the technical life of the assets.  Fourth, even where a long term cost of capital is appropriate to the valuation of long-lived assets, it does not follow that it is appropriate for pricing decisions in the short run when the asset values are annually adjusted for inflation (thus removing a need for an inflation risk premium) and the allowable cost of capital can be revised at each review (to adjust for long term changes in market perceptions). 
The Commission accepts arguments in submissions and those of Professor Davis that neither very long term interest rates nor historic interest rates are appropriate to the estimation of the WACC relevant to TPA assets.
This will require a significant revision of the Access Arrangement since the proposed 8.0 per cent for the risk free rate compares with current five and ten year bond rates of around 5.4 and 5.7 per cent.  The Commission considers that the term associated with the risk free rate should coincide with the five year period until the next review.  The rate on five year Government bonds which may be used for this purpose is currently 5.4 per cent per annum.
It is probably worth noting that for practical purposes, within the CCA framework proposed, the choice of long (for example, 30 years) or short term (five or ten years) interest rates is largely immaterial since it is the real interest rates which matter.  As the difference between long and short term real interest rates (indexed bond rates) is less than 20 basis points (see Table 3.4 above), there will be only minor differences in the real WACC estimates regardless of the maturity, provided, of course, that the inflation assumption is also matched to the duration of the bond used.  The main problem with the CSFB figure therefore is that it does not reflect current market conditions and it is inconsistent with the inflation assumption subsequently applied.  
Inflation assumptions and the real risk free rate
While the inflation rate is not an explicit parameter in the basic WACC estimation it is an inherent aspect of the risk free rate and cost of debt parameters.  Also it is fundamental to deriving real rates of return which are used in the target revenue calculations and making current cost accounting adjustments to the asset values on an annual basis.  CSFB have assumed an annual rate of inflation of three per cent over the initial five year price setting period.  In considering this figure, the Commission was concerned that it was not consistent with the historically based estimates of the risk free rate and cost of debt used.  The effect of choosing a rate of inflation lower than that prevailing in the corresponding historical period meant that the real rate of return proposed for establishment of tariff levels is excessive.
Similarly, when current interest rates are used as the basis for the risk free rate and cost of debt it is still important that the three per cent forecast be reviewed for consistency.  An indication of the inflation anticipated by financial markets and corresponding to the interest figures is provided by the difference in the normal bond rates and inflation indexed bonds for the same term.  The indexed bond series have maturity dates which do not correspond to current five or ten year bond rates but the corresponding figures are readily derived by interpolation and are shown in the interest table above.  These figures represent the real risk free rate corresponding to the current nominal risk free rate (based on the five year bond yield) and indicate that the current expectations of inflation over the initial regulatory period are 1.7 per cent.  The Commission considers this inflation figure should be used in establishing the real rate of return and forecasting target revenues pertinent to TPA. 
Cost of debt
CSFB suggested that the appropriate margin for the cost of debt is around 60-90 basis points above the relevant risk free rate with a nominated value of 75 basis points.  Although the Commission has no reservations over a margin of this magnitude, when combined with the risk free rate proposed by CSFB, the cost of debt of 8.75 per cent is well above market rates.  This provides strong support for the alternative risk free rate proposals discussed above. 
The lending margin is basically an empirical matter and may not only vary with the credit rating of the company and its chosen level of gearing, it may also depend on the aggressiveness of lenders for financing the project at the time funds are being raised.  Westpac suggest that, for a service provider with an A- credit rating and gearing of around 60 per cent, the likely margin would be 85 to 100 basis points above the five year Commonwealth bond rate.  The Commonwealth Bank suggest that for gearing of 70 per cent a 100 basis points margin is indicative of the likely range.  The BHPP submission assumed a margin of 79 basis points.  On the basis of these comments the range for debt margin may be slightly higher than that assumed by CSFB.  The Commission will therefore consider values in the range of 60 to 100 basis points.   
A margin in the middle of this range in combination with the current yield on five year Government bonds suggests a cost of debt figure of 6.20 per cent for use in the WACC estimation.
The market risk premium
The market risk premium is a parameter in the CAPM model which together with the risk free rate and firm specific beta determine the expected return of the business.  CSFB proposed 6.5 per cent for the market risk premium given that the conventionally accepted value has been six to seven per cent under the classical tax system.  Davis suggests that this may not be in keeping with a forward looking CAPM framework favoured by the Commission.  For example, the more stable inflation environment now prevailing may mean that the relevant market risk premium is less than has been observed over recent years.  Also following the introduction of imputation, the premium as measured in the conventional way would have fallen - to reflect the additional value of franking credits.  However, a ‘partially grossed up’ premium is appropriate within the WACC model and with such adjustment the six to seven per cent range may still be acceptable.  
Davis also notes that this range is too high to be consistent with reasonable estimates of risk aversion and derives alternative figures based on a dividend growth model.  With this approach he estimates a range of between 4.5-7.0 per cent for the market risk premium but favours figures at the lower end of the range.  Support for a lower value is also provided by an analysis by Officer who reports that MRP (as measured by comparing equity return and 10 year bond rates) while highly variable on a year to year basis has exhibited values averaging under three per cent values in recent decades.  Despite the falling trend six to seven per cent is still the Ôconventional market wisdomÕ favoured by many financial analysts in view of the year to year volatility.  For this reason selecting a value in the low range may generate WACC estimates considered anomalous by a substantial portion of the financial market.  
On balance the Commission believes the lower end of the probable range should be reduced giving a range from 4.5 to 7.5 per cent and, along with Davis, has chosen to use a mid-value six per cent as the market risk premium for the purpose of estimating WACC. 
Level of debt funding
CSFB have assumed that the proportion of debt funding pertinent to TPA will be 60 per cent based on what has happened with the purchase of utilities in the electricity sector.  While actual debt is at the discretion of the private sector purchaser of TPA, the Commission considers that the nature of regulation proposed for TPA means there is relatively low commercial risk and the optimal level of gearing for the company will be correspondingly high as suggested in the ACA submission.  Even if, as expected, gearing following privatisation exceeds 60 per cent, cashflows will be sufficient to facilitate a substantial reduction within the initial regulatory period.  While the Commission acknowledges that higher figures have been proposed by other parties on the basis of what has happened with the sale of electricity assets to foreign buyers, using that as a guide would not be consistent with the approach espoused below in Box 3.2 on ownership considerations.  Davis commented that he saw no reason why gearing ratios (around 30 per cent) for US energy companies should not apply here, nevertheless, the submissions from the banks and BHPP express a strong expectation of gearing between 60 and 70 per cent.  The Commission will accept the 60 per cent assumption of CSFB but will also consider values from 40-80 per cent in re-assessing the WACC. 
Role of imputation credits and gamma estimation
The availability of tax imputation requires a modification to the standard WACC/CAPM model to reflect the value to shareholders of tax credits associated with share dividends.  In this revised model the rate of utilisation of tax credits, , becomes a significant parameter.  The analysis of imputation credits and its impact on assessed costs of capital in Australia is a developing field and some issues remain contentious.  While the formula used to derive the post-tax nominal WACC as indicated in the Access Arrangement Information seems appropriate, the value used for  appears questionably low.  Davis has suggested a figure of 50 per cent or above is more appropriate than the 25 per cent assumed by TPA.  This change reflects his views that downward revisions proposed by CSFB to the 50 to 90 per cent estimates for Australian firms (based on dividend drop-off studies) were overdone.  He noted:
•	a 20 to 30 per cent reduction to reflect foreign ownership was unnecessary since the figures obtained in the studies were already influenced by foreign ownership;
•	the assumption that pay-out ratios would be comparable to overseas companies is inconsistent with the incentive for high pay-out ratios under the Australian imputation tax system;
•	this has been compounded by an excessive adjustment to  to reflect the impact of less than 100 per cent pay-out ratios; and
•	reducing the  is also likely to require compensating adjustments to the return on equity (re ) calculation and these have not been made.
Accordingly, the Commission sees little merit in the  of 25 per cent proposed by CSFB and believes that values in the range 50 to 90 per cent suggested by dividend drop-off studies (which examine the change in share price after going ex-dividend) provides a reasonable guide.  Values in this range would also be consistent with the CommissionÕs preferred approach for foreign ownership adjustments covered in the boxed discussion below and should accommodate the concerns raised on this issue in the CUB and ACI submissions.
However, as discussed below, the deferral of tax (through accelerated depreciation) also defers imputation credits giving them diminished value in the hands of shareholders.  Using the adjustments to  recommended by Davis for less than a 100 per cent pay-out ratio and a stylised model of cash flows the discounted value of credits relative to their nominal value suggests a modified range for  of between 40 and 70 per cent based on the drop-off studies and a middle value of 55 per cent.  In view of the fact that there are likely to be other tax concessions not considered in their analysis a somewhat reduced range of between 40 and 60 per cent may be more appropriate.  The mid-value of this range not only coincides with Davis’ nominated value but also with what has been proposed in the Westpac and BHPP submissions on WACC.
Tax status of the owner
The tax position of the potential owner may raise questions as to the validity of the approach being adopted for the development of the WACC.  For example, an overseas owner may not being able to take advantage of imputation credits although this could be offset to a greater or lesser degree by the more generous taxation treatment available to some overseas (e.g. US) investors for the goodwill component of any purchase price.  There is also the more general question of the taxation status of the business and whether it will pay dividends at all and the effective tax rate of the corporate entity during the regulatory period under consideration.  The Commission’s approach to such issues is considered further in Box 3.2 below.
Box 3.2:	The impact on WACC parameters of ownership 
There has been considerable debate over whether weight should be given to the possibility of foreign ownership of the business and the implications this would have for the  to be used in the WACC estimation.  The Commission considers this debate to be somewhat misguided.  For example, if the possibility of foreign ownership is used to moderate the value of , it would seem also appropriate to modify other parameters such as the gearing, the perceived beta values and the effective tax rate on the same basis.  Clearly, the different perceptions, tax treatment and opportunities are major factors which could lead a foreign purchaser to value the business more (or less) highly than an Australian operator. So although a foreign firm may not be able to take advantage of imputation credits, the business could be counter cyclical to its domestic operations and therefore provide shareholder benefits in other ways (effectively the foreign firm perceives a lower beta).  This in turn, may mean that optimal leverage is also higher for the foreign firm.  Such effects may be amplified if the foreign firm is able to derive more generous tax depreciation concessions than an Australian owner. 
The approach the Commission would prefer is to assume the operator is Australian owned with the WACC parameters determined accordingly.  The alternative of assuming foreign ownership (say a US investor) may also be methodologically sound, but is less feasible given the difficulty of assessing the relevant WACC parameters.  A ‘mix and match’ approach is unnecessarily arbitrary and lends itself to regulatory ‘cherry picking’.  If there is a concern that a foreign owner is able to justify a higher purchase price for the assets, that is not a regulatory issue.  Similarly, the prospect that a foreign owner may, after exhausting its own tax concessions, sell to an Australian owner which then takes advantage of the imputation credits that typically accumulate after the other tax concessions have been exhausted, is not an issue relevant to regulation. 
With an Australian owner assumption used to derive the benchmark WACC, the Commission will seek to ensure parameter values are chosen to reflect this situation.  Such an approach suggests an estimate of  towards the high end of ranges discussed by commentators and more moderate gearing levels than suggested by recent overseas purchasers of electricity utilities. 
Just as the Commission considers it appropriate to abstract from foreign ownership, it is also appropriate to abstract from complexities introduced by special circumstances (e.g. accumulated tax losses, accumulated imputation credits etc) of an Australian purchaser. Accordingly, the effective tax rate assumed to apply to the regulated facility should reflect the tax treatment available to a stand-alone Australian firm. 
Similarly, the Commission will abstract from government ownership and develop WACC estimates based on private ownership.	

Effective tax rates
Even assuming a stand-alone Australian owned operation, the difference between the tax depreciation rates and economic depreciation rates means there is a more rapid payback of capital and a considerable deferral of any tax liabilities associated with the project.  These serve to improve early cashflows to the investment and improve the internal rate of return of the project above that indicated by the assumed WACC parameters.  This effect may be interpreted as an effective tax rate for the return on equity (Te) less than the statutory rate assumed by CSFB for the CAPM/WACC framework.  In the derivation of the CAPM/WACC equations the tax rate used is not usually identified but it is clear from the context that the effective tax rate (Te) is appropriate and the corporate tax rate (T) is irrelevant as far as determining the post (and pre) rates of return on equity. 
However, use of this rate in the CAPM framework is problematic as the cash flows effect is not easily integrated into the single period CAPM framework.  While Davis, BHPP and the banks all acknowledge that an effective tax rate is appropriate, and is likely to be well below the statutory rate, they all avoid the issue of how it may be integrated into the CAPM framework.  Instead they suggest that the tax rate effects are best handled in the valuation of post tax cash flows.  This is easy when the task is to place a value on a business based on its likely cash flows, the more conventional application of CAPM with which the commentators are familiar.  When the CAPM framework is to be used to derive pricing which in turn will determine the cash flows, the problem becomes less tractable.  To abstract from the multiperiod framework and identify an effective tax rate appropriate to the CAPM framework the Commission estimated the NPV of tax payments relative to the NPV of the income stream available to equity. 
Simulation by Commission staff of financial flows in stylised models of a pipeline systems suggest the effective tax rate could be as low as 20 per cent.  Cash flow projections for TPA conducted for the Commission by the Macquarie Bank confirmed an effective tax rate of this magnitude.  In view of the theoretical difficulties in reconciling the single period CAPM model with a multiperiod cash flow framework, the Commission has decided to consider a range of values for the effective tax rate from 20 to 30 per cent.
In conducting its analysis, the Commission has assumed that the initial capital base available for tax depreciation purposes coincides with the initial capital base used for regulatory purposes.  This will not always be the case.  On 4 August 1997 the Federal Treasurer announced the new basis for depreciation of assets of tax exempt entities when they enter the tax net.  Essentially, the new provision states that the tax depreciable base for tax exempt bodies is the last audited value prior to 1 July 1997, notionally written down.  To qualify for the audited value at 1 July 1997 the accounts must have been finalised prior to the 4 August 1997 announcement.  As TPA’s (previously GTC) accounts were not finalised until 26 August of that year the relevant book values will be those at 30 June 1996.  As it happened, GTC in that financial year had revalued its assets on a DORC basis similar to that described in the previous section and these values were used for reporting purposes.  This means that the valuation for tax purposes will be close to that proposed in the access arrangements and justifies the approach used.
As well as an effective tax rate for the return on equity, it is also possible to have an effective tax rate for the return on the debt (Td) component of capital in the WACC framework.  A value less than the statutory rate would generally imply that the enterprise did not derive the full tax benefit of the tax deduction (at the statutory rate) for interest payments on debt.  This can happen if the business is in a tax loss situation and the full benefits of unused deductions are not achieved until the enterprise begins to pay tax.  Again this is a cashflow timing issue as with the effective tax rate but the benefits are typically only deferred for a short period.  This is because, in most cases, tax would be payable from the outset if the tax deduction on interest were not available and hence some partial benefit is available immediately and the benefits are not normally deferred more than a year or two.  In the case of TPA tax is expected to be payable in the first year or so and Td is therefore assumed to be the same as the statutory rate. 
The recognition of different effective tax rates for debt and equity requires some additional detail in OfficerÕs formulae to obtain the post tax nominal WACC and in the grossing-up adjustments required to obtain the pre-tax nominal WACC.  These modified formulae are shown in Table 3.5 below.
Table 3.5:	Weighted average cost of capital formulae with effective tax rates
WACC	Cost of Equity Contribution	Cost of Debt Contribution	
Post Tax Nominal (Officer)	re [(1-T)/(1-T(1-))].E/V	rd (1-T).D/V	
Post Tax Nominal	re [(1-Te)/(1-Te(1-))].E/V	rd (1-Td).D/V	
Pre-Tax Nominal	[re /(1-Te(1-))].E/V	rd.D/V	

Beta estimation
The equity beta (e ) is estimated from benchmark comparisons with other comparable companies, using a de-levering process to derive an asset beta, then re-levering based on the financial parameters pertinent TPA to estimate the likely e for the company.  Davis has identified flaws in the formulae used by CSFB and has questioned the derivation of some of the parameters used:
•	the de-levering formula used to estimate comparable asset betas (a s) from a sample of estimated equity betas omitted the impact of corporate tax;
•	Davis also queries the relevance of a debt related beta (d ) to the CAPM framework given that it is reflects a premium for default risk which is diversifiable.  Even if a d  is incorporated Davis believes there is no case for calculating it in the way CSFB has done.  CSFB use a figure of 0.12 while Davis suggests a contribution of zero is appropriate in the present context.  The Commission is inclined to accept Davis’ arguments but as a compromise considered values for d  in the range from zero to 0.12, and used the mid-value of 0.06 to develop a benchmark value for WACC.
•	while TPA acknowledges a role for imputation credits in the estimation of WACC it is ignored in the estimation the equity beta used in the WACC.  The relevant formula is indicated in Davis’s report and has been used in the Commission’s re-assessment of the WACC.  The revised formula which incorporates both  and Te is as follows: 
e  =  a [1 + (1-Te(1-)) D / E] + d D/V 
Despite the seriousness of these problems, there seem to be compensating errors and the Betas proposed are not very different from figures re-calculated by the Commission.  Nevertheless, the link between benchmark data used and the a used do not appear to have been firmly established and beta estimates obtained retain a degree of arbitrariness.  While the average a of the sample of US gas transmission companies used for benchmark comparisons was 0.53, it was recognised that many of the these companies were also involved in other activities such as gas exploration and supply which made their overall operation more risky.  By comparison, the sample of US distribution companies had an average a of 0.40.  However, closer to home AGL had an estimated a of 0.36 and Allgas energy actually had a negative estimate a.  These lower values are more consistent with the high takeover/float multiples mentioned by in the ACA submission and suggest that a lower a assumption could have been used.  
Further, support for a a in the lower range is provided by a survey of utilities by OFGAS in the UK.  That survey included 40 US gas companies (most subject to rate-of-return regulation) with an average a of 0.28.  The subset of six ‘transmission only’ enterprises had an average a of 0.26.  In a larger sample (of 58) which included gas companies from other countries the average a was 0.40 and the modal range was between 0.3 and 0.4, with over 60 per cent of the companies having a s in the range of 0.1 to 0.4.
There are inherent uncertainties in establishing the a relevant to the Australian framework.  However, the evidence seems to support values in the range from 0.25 to 0.45 and this is the range considered by the Commission with values in the middle of that range thought more likely to be appropriate.  
For the purpose of calculating the WACC it is necessary to translate the a to the corresponding value of e.  Using the formula above to calculate the e and assuming gearing of 60 per cent, a  of 0.5, a d of 0.06 and an effective tax rate of 25 per cent this translates to a range for e from 0.61 to 1.08 with the a of 0.35 giving a e of 0.85.
It should be noted that a number of commentators, including Davis and Westpac had reservations over deriving the e estimates from what might be considered a fairly arbitrary value for a.  Instead they preferred to directly nominate a value of e which matched what their perceptions of the value should be.  Intuitively they consider the value for e this type of business should be less than 1.  Westpac suggested a value of 0.7 (in conjunction with gearing of 60-70 per cent) and Davis suggested a value of 0.6 (in conjunction with gearing of 30 per cent).  Given that the values derived above for e are consistent with this range, the Commission sees little point in arbitrarily setting a independently of the model parameters.  By retaining the formula approach, the Commission notes that the WACC estimates will better reflect the CAPM framework by retaining their sensitivity to more basic WACC parameters. 
Recalculation of rates of return 
The Commission considers the above concerns over CSFB’s assumptions used to derive WACC warrant a re-calculation of proposed WACC and the resultant target revenues used to set tariff levels.  To assist in the development of an alternative WACC, Table 3.6 summarises the parameter values suggested by TPA, Davis, and the Westpac, CBA and BHPP submissions.  Table 3.6 also includes parameter values published by IPART which are included for comparison only.  The Commission’s assessment of an appropriate range for WACC arises from consideration of each of the parameters based on the earlier discussion.  In the context of the interest rate and inflation parameters, the latest available market value is used.  The range established is based on the estimated standard deviation of movements since last December to reflect a possible movement in financial markets prior to the Access Arrangement coming into effect.  In all cases the mid-range value represents the choice the Commission would make if it needed to set a value for each parameter.  
Table 3.7 shows the resultant WACC estimates where these have been calculated by the parties concerned using their adaptation of the WACC framework and the parameters shown in Table 3.6.  Because the WACC is to be applied in a CCA framework it is the real pre-tax WACC which is used in target revenue calculations.  While these have not always been calculated the post-tax nominal WACC generally have been and these can be used for comparison purposes on the assumption that the appropriate grossing up to a pre-tax figure and adjustment for inflation to generate the real pre-tax WACC should produce a similar proportional increase/decrease for each. 
While the CAPM/WACC framework provides a well recognised theoretical framework to establish the cost of capital, there is less than full agreement on the precise magnitude of the various financial parameters which need to be applied (as evidenced by the range of parameter values suggested by different commentators).  While parameter values could be ‘cherry picked’ to identify extreme values of WACC, market commentators would generally recognise those estimates as inappropriate although they might be reluctant to identify which parameter values need to be adjusted.  For these reasons the identification of a single value for the WACC or even a specific range of values is relatively arbitrary.  The mid-value for the WACC estimates based on mid-values for parameter ranges identified by the Commission is shown in Table 3.6.  However, the Commission acknowledges that the identification of a single number is somewhat presumptuous.  

Table 3.6:	Comparison of WACC parameters used by TPA, Davis, Westpac, CBA, IPART and ACCC values
CAPM Parameter	TPA Proposal 	Davis	Westpac	CBA	BHPP	IPART (a) medium	IPART (a) low-high	IPART (b) range	ACCC Mid-range value	ACCC low-high range	
Real Risk Free Rate (rrf ) %	4.85	3.92	3.9	3.5	4.3	na	na	na	3.66	3.5-3.9	
Nominal Risk Free Rate (rf ) %	8.00	6.00	5.6	5.6	6.37	7.8	7.7-8.3	5.8-7.4	5.40	(e)	
Cost of debt margin (over rf ) %	0.75	0.75	0.85-1.0	1.0	0.79	1.2	0.7-1.3	0.88	0.80	0.6-1.0	
Cost of debt(rd ) %	8.75	6.75	6.5	6.6	7.16	9.0	9.0-9.0	6.8-8.3	6.20	(e)	
Expected Inflation Rate (f) %	3.0	2.0	3.9	2.0	2.0	na	na	1.5-2.5 (c)	1.68	1.57-1.79	
 Market Risk Premium (rm-rf ) %	6.5	6.0	6.5	6.5	6.5	7.0	7.0-7.0	5-7	6.00	4.5-7.5	
Corporate Tax Rate (T) %	36	36	36	36	36	36	36-36	36	36	(e)	
Effective Tax Rate (Te) %	36	36	<36	na	36	36	36-36	36	25	20-30	
Usage of Imput. Credits () %	25	50	50	0	50	34	21-50	20-50	50	40-60	
Debt Funding (D/V) %	60	30	60-70	70	60	50	40-50	60	60	50-70	
Debt Beta (d ) 	0.12	0.00	na	0.1	na	na	na	na	0.06	0.00-0.12	
Asset Beta (a )	0.45	0.444	na	0.4	0.45	na	na	na	0.35	0.25-0.45	
Equity Beta e  = d D / V +
a [1 + (1-(1-)Te) D / E]	0.95	0.60	0.7	1.1	1.0	0.74	0.64-0.88	0.66-0.88	0.85	(e)	
Notes:	(a)	IPART figures from AGL Determination July 1997.  Real WACC’s were not assessed and real risk free rates and inflation were not defined.  Because these parameters were assessed in 1997 when interest rates were considerably higher, not all the parameters are directly comparable to others in the table.
	(b)	IPART figures from Albury-Moama Gas Distribution Consultation Paper March 1998.
	(c)	Inferred/calculated.
	(d)	Shaded areas with ‘na’ indicate parameter values not specified or not used in the specific formulation.  Where a number is given it reflects the value at the time the comment was made (for example, interest rates) or a value of convenience (but in most cases not consistent with the accompanying comments - for example, in cases an effective tax rate below the corporate tax rate was acknowledged but not used).
	(e)	Range not shown since in all cases they are calculated from other parameter values (for example, rf determined by rrf and f). 

Table 3.7:	WACC estimates corresponding to parameter given in Table 3.6
CAPM Parameter	TPA Proposal 	Davis	Westpac	CBA	BHPP	IPART (a) medium	IPART (a) low-high	IPART (b) range	ACCC Mid-range value	ACCC low-high range	
Cost of Equity re = rf+e (rm-rf) %	14.19	9.60				10.9	9.5-13.0		10.5		
Post-Tax Nominal WACC (r0) %
re [(1-Te)/(1-Te(1-))].E/V +
rd (1-T).D/V	8.34	6.54	5.8	6.8	6.8	8.3	8.0-8.6		6.0		
Post-Tax  Real WACC  (rr0) %
(1+r0 ) / (1+f) -1	5.18	4.45							4.2		
Pre-Tax Nominal WACC (pr0) %
=re /(1-Te(1-)).E/V +rd .D/V	13.02	10.22				13.0	12.5-13.5	9.0-12.0	8.5		
Pre-Tax Real WACC  (prr0) %
= (1+ pr0)/(1+f) -1	9.73	8.06	6.9		8.4			7.5-9.5	6.7	6.3-7.1	
Notes:	(a)	IPART figures from AGL Determination July 1997.  Real WACC’s were not assessed and real risk free rates and inflation were not defined.  Because these parameters were assessed in 1997 when interest rates were considerably higher, not all the parameters are directly comparable to others in the table.
	(b)	IPART figures from Albury-Moama Gas Distribution Consultation Paper March 1998.
	(c)	Shaded areas indicate values were not actually calculated by the party concerned.

To help identify a reasonable range for the WACC based on the nominated range of WACC parameters, the Commission used a Monte Carlo statistical technique to identify the distribution of WACC estimates taking values uniformly from across the full spectrum of the nominated ranges.  A second distribution was obtained where a greater weighting was given to values in the centre of the range.  The spread of values obtained for the pre-tax real WACC is shown in Diagram 3.1.
Despite the arbitrariness of this procedure, the range for WACC where most of the estimates fall provides a useful guide as to a reasonable range for consideration by the Commission.  The Monte Carlo simulations suggest that sixty per cent of the pre-tax real WACC estimates fall in the range from 6.3 to 7.1 per cent based on the proposed parameter ranges.
Diagram 3.1:	Relative occurrence of pre-tax real WACC estimates with parameters drawn from the nominated ranges 

Source:	ACCC calculations
Further support for figures in this range is provided by Monopoly and Mergers Commission decisions in the UK which has a similar regulatory framework for utilities to Australia.  There the ‘magic number’ for the pre-tax real WACC is seven per cent.  Support for this figure is provided by the reaction of financial markets to the various rate decisions which indicate that the figure is consistent with market perceptions of the appropriate rate of return.  Translation of this figure to the Australian context would require an assumption of similar financial market conditions and regulatory risk.  In this context, dividend imputation in Australia would imply the 7.0 per cent could be somewhat discounted in Australia by an amount which reflects the effective tax rate.  (With a gamma of 0.5 and an effective tax rate of 20 per cent the discount would be about 0.3 per cent.)
Given the inherent uncertainty in the appropriate level of WACC for regulation of gas transmission, the Commission has some discretion in the actual figure chosen.  Consistency with the CAPM/WACC framework can be maintained provided it is within the range indicated by supportable WACC parameters.  In this context the Commission is conscious of perceptions of regulatory risk (mentioned by BHPP in their submission) which may have some bearing on the WACC determined.  This is independent of whether such risk actually exists since it is financial market perceptions which are important in this instance.  Given that regulation of the gas transmission is new to Australia and the Commission is a new regulator these risk perceptions may be somewhat higher now than would be expected over the longer term. 
Of course it is difficult to quantitatively assess the significance of this uncertainty for the WACC.  Nevertheless, the Commission is inclined to choose a WACC towards the top end of the range identified above, and has chosen a pre-tax real WACC of 7.0 per cent as being reasonable in the circumstances.  Other WACC estimates relevant for determining tariffs will also be based on this using the mid-values in the suggested ranges for inflation and the effective tax rate to make the calculations. 
This seemingly generous value chosen towards the high end of the range is also justified by an assessment of the consequences of deterring a value for the WACC which is perceived to be wrong.  The key adverse consequence of too low a value is considered to be the possibility that the service provider will not have the incentive to invest in new capital when it is required with ensuing consequences for the integrity of the system and the plight of users seeking to expand their usage of gas.  Such circumstances are unlikely to be compensated for by slightly lower tariffs for all users.  By contrast, the consequences of a slightly high WACC are considered relatively minor.  These include a relatively small incentive for over investment considering redundancy provisions in the Victorian Access Code.  There is also an allocation distortion for users caused by tariffs which are slightly high or low, however, these are assessed as insignificant as the transmission costs for most users form only a small part of their overall gas expenses. 
The Commission has nominated a forecast inflation figure of 1.7 per cent per annum to be used in conjunction with the suggested WACC in establishing the regulatory framework for the initial regulatory period.  It may be noted that this inflation forecast differs from some other ‘headline’ short term inflation forecasts (for example, by Treasury in the 1998-99 Budget and by the banks in recent publications).  This does not invalidate the average five year forecast rate proposed by the Commission or undermine the  regulatory framework.  Even if the forecast is incorrect, it must be emphasised that this would not materially impact on tariffs emanating from these Access Arrangements.  This is because the regulation relies on a real rate of return and uses actual inflation to adjust tariffs from one year to the next.  What is important is that in order for the framework to work as intended, it is necessary for the assumed forecast rate of inflation to be used consistently in establishing parameters which drive the establishment of reference tariffs (for example, WACC, inflation, X factor, operations and maintenance costs etc).  The Commission’s inflation choice is based on the current link in financial markets between real and nominal interest rates and will require this rate to be used along with the suggested real pre-tax WACC in establishing other regulatory parameters.  The key WACC estimates consistent with the suggested values for other parameters discussed in this section, and with the Commission's inflation forecast, are summarised in Table 3.8 below.  The Commission will require the use of these figures in establishing the reference tariffs for the initial regulatory period.  
Table 3.8:	Proposed parameter setting for use in the derivation of tariffs
CAPM Parameter	TPA Proposal 	Commission Proposal	
Expected Inflation Rate (f) %	3.0	1.70	
Post-Tax Nominal WACC (r0) %	8.34	6.20	
Post-Tax  Real WACC  (rr0) %	5.18	4.43	
Pre-Tax Nominal WACC (pr0) %	13.02	8.82	
Pre-Tax Real WACC  (prr0) %	9.73	7.00	

To provide further assurance that the WACC figures chosen are appropriate the Commission engaged Macquarie Bank to assess projected cash flows to check on the on going viability of the business and how its operations are likely to be viewed by financial markets.  In addition the financial indicators used by IPART were also used to confirm that the likely credit rating of the business and funding assumptions were likely to be consistent with other assumptions made in the WACC analysis.  These analyses are dealt with in section 3.7 of the Draft Decision, however, generally they provide support for the range of values for WACC being suggested by the Commission.
Proposed Amendment - A3.4
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved: 
(i)	the WACC estimates and associated parameters forming part of the Access Arrangements should be amended to more accurately reflect the current financial market settings.  In particular, the pre-tax real WACC should be set at 7.0 per cent and the forecast rate of inflation set at 1.7 per cent; and 
(ii)	the target revenues and forecast revenues should be based on these new parameters, including the X factor, and applied in the derivation of individual tariffs. 

3.6	Operations costs and working capital
3.6.1	Victorian Access Code requirements
The Victorian Access Code (sections 8.36 and 8.37) allows for recovery of the operating, maintenance and other non-capital costs that would be incurred by a prudent service provider acting efficiently.  
Attachment A to the Victorian Access Code (see Appendix C to this paper) requires the disclosure in the Access Arrangement Information, unless it would be unduly harmful to the legitimate business interests of the service provider, user or prospective user, of costs (including wages & salaries, rental equipment, gas used in operations, materials & supply and corporate ) with some disaggregation by zones, services or categories of assets.
3.6.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
Total forecast Operational costs, for both the PTS and WTS, for the years 1998 - 2002 are $19.5 million, $19.6 million, $19.4 million, $19.1 million, $19.2 million respectively.  While TPA has sought to reflect efficiency savings in its forecast of Operational costs, EPD has assumed additional efficiency savings. 
In supplementary information to the Access Arrangement Information, EPD provided forecast costs for the five years of the initial regulatory period disaggregated into 12 cost categories and with data for Murray Valley also stated separately.  These data indicate that ‘labour’ and ‘outside services’ each account for about one third of total Operations and Maintenance (O&M) costs.  Separate figures are also given for the ‘administration’ and ‘marketing’ contained in the totals.  The data (net of Murray Valley) is also disaggregated into nine pricing zones.
Submissions by interested parties
Various submissions noted that O&M expenses had not been disaggregated as required under Attachment A of the Victorian Access Code.  Those interested parties considered that, therefore, they were unable to comment other than to call for more information.  Upon the release of the supplementary information, the Commission requested further industry comment by 27 March 1998.  
BHPP believes the absolute level of forecast costs to be too high.  It says that GTC’s 1996 costs were $20.6 million.  Of this, LNG system security ($1.38 million) and transmission system control ($4.5 million) will now be performed by VENCorp.  Also TPA will operate 1 600 km of pipeline whereas GTC operated and maintained 2 200 km.  BHPP expects this reduction in pipeline length to result in a proportional reduction in O&M costs (to the extent that O&M costs are not fixed) of approximately $5 million.  Consequently, it believes O&M costs of $9.8 million are more appropriate.  The BCA supports this analysis.
In response to BHPP’s comments EPD said that costs are largely fixed and that the reduction in staff associated with the reduction of pipeline length resulted in a saving of $1.2 million rather than the $5 million suggested by BHPP.  Further, there are additional costs that will be incurred by TPA in 1998 which were not incurred by GTC in 1996.  A reconciliation of GTC’s 1996 costs to the forecast 1998 TPA costs was submitted.  
Commission’s considerations
TPA’s starting point for forecast O&M is the GTC 1997 Corporate Plan (in which GTC includes the productivity savings it expects).  Costs relating to VENCorp activities are removed and the remaining costs allocated to TPA activities.  Total TPA O&M (not including compressor fuel costs) is forecast to be $24.3 million in 1998, rising to $25.4 million in 2002.  
Costs not associated with reference services were then removed.  The Commission has no reason to believe that the methodology for the allocation of costs between reference services and other TPA services is unreasonable. 
Finally, the total remaining costs were reduced by EPD by an expected ‘productivity factor’.  This factor is in addition to GTC’s expected productivity savings built into its forecasts.  The EPD productivity improvement factor by which EPD reduced TPA’s forecast revenue for each of the five years 1998 - 2002 is 0.77, 2.56, 4.31, 6.10 and 7.73 per cent respectively.  This is equivalent to a cumulative reduction of 1.5 per cent per year.  This results in the total forecast operational costs tabled in the Access Arrangement Information and noted above (in service provider’s proposal).  A more detailed explanation of this process can be found in Appendix D.  
Two industry accepted benchmarks for O&M costs are cost per pipeline length and cost per volume transmitted.  O&M per 1 000 km in 1998 is forecast to be $16 million.  This compares unfavourably with other Australian transmission pipelines which have costs in the range of $9.0-12.8 million/1 000 km.  However TPA’s forecast O&M of $0.13/GJ compares favourably with these same pipelines which have a range of $0.15-0.20/GJ.  Both measures compare unfavourably with GTC’s figures for 1995/96 of $9.4 million/1 000 km and $0.09/GJ respectively.  However, these figures must be viewed in the light of the structure and size of the Victorian transmission system.
The Commission has reviewed the cost forecasts and has no reason to believe that the current forecast levels are excessive.  It has noted BHPP’s analysis but has identified no basis for concluding that EPD’s response to BHPP’s comments is unreasonable.
However, the Commission is concerned that the level of productivity savings implied in the level of total costs forecast of just over $19 million for each of the next five years does not appear to incorporate productivity savings of the level that could be expected from a government enterprise that is about to be privatised.  It notes that EPD has required TPA to achieve efficiencies of one and a half per cent per year on top of those incorporated in GTC’s forecasts.  However, it believes that much greater efficiency savings will be available and that a further reduction in these forecast costs of one per cent per year will still leave scope for TPA (as well as customers) to benefit from efficiencies achieved.  
The TPA forecasts are based on an inflation forecast of three per cent.  However, as argued in section 3.5 above, the Commission considers an inflation rate of 1.7 per cent to be a more appropriate forecast.  To be consistent, the forecast O&M costs should reflect this change.  That is, they should increase by 1.3 per cent less than proposed in the Access Arrangement Information.  This reduction, combined with the increased productivity requirement, will result in a combined reduction of 2.3 per cent.  
Proposed Amendment A3.5
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, the Operational costs component of the target revenues contained in the Access Arrangements should be reduced by an amount equal to 2.3 per cent per year (cumulative) throughout the initial regulatory period.  

The combined effect of the productivity increases required by EPD and the changes required by the Commission will be to reduce the O&M costs forecast by GTC by 18 per cent in the fifth year of the initial regulatory period.  
Consequently, the Commission indicates now that if this charge does not arise, it will, at the tariff review, ‘claw back’ from the subsequent regulatory period’s target revenues an amount equal to that recovered by TPA for the Commission’s regulatory costs forecast for the initial regulatory period.
A return on net working capital is also included in the tariff calculations which is separate from the O&M cost.  Calculated using pre-tax nominal WACC, the amount for 1998 is $520 000.  This required return implies the level of working capital of $4 million (though this is not stated anywhere in the Access Arrangement Information).  The Commission notes that there is no forecast working capital for the distribution companies.  However, the level of working capital implied in the return forecast does not appear unreasonable to the Commission.  The forecast return will need to be reduced in line with the reduction in WACC required above.  
Proposed Amendment A3.6
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, the forecast return on working capital, for each year of the initial regulatory period, should be recalculated using the WACC consistent with amendment 3.4. 

In conclusion, the Commission is satisfied that the allocation of operating, maintenance and other non-capital costs between tariffed services and non-tariffed services has been made appropriately.  With the amendments proposed above taken into account, the Commission is of the view that the forecast revenue will allow for the recovery of the operating, maintenance and other non-capital costs that would be incurred by a prudent service provider acting efficiently.  
3.7	Forecast revenue 
3.7.1	Victorian Access Code requirements
Three methodologies are set out in the Victorian Access Code (section 8.4) for determining total revenue: cost of service; internal rate of return; and NPV.  The service provider has proposed the cost of service model.  This provides that the total revenue recovers costs, which are calculated on the basis of a rate of return on asset values, depreciation of the asset base, plus the operating, maintenance and other non-capital costs incurred in delivering all services.
3.7.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
The ‘target revenue’ for each of the five years of the initial regulatory period is the sum of all the forecast costs (as described above) for that year.  The target revenue for each year of the initial regulatory period is shown in the table below.  
To create a smooth pricing path, EPD has proposed that the average unit revenue ($/GJ) in each year after the first year should increase by the formula CPI-X.  For each year after the first year, the average unit revenue multiplied by the forecast total anytime volume of gas consumed will give a ‘forecast revenue’.  X is initially set so that the NPV of this forecast revenue stream is equal to the NPV of the target revenue stream.  X is then adjusted to a level that EPD judges to represent best practice for a similar company.  This process gives an X of 3.4 per cent.  The NPV of the forecast revenue stream is materially the same as the NPV of the target revenue.  The target revenues and forecast revenues for the five year regulatory period are set out in Table 3.9 below.  
Table 3.9:	Target and forecast revenue for TPA
Year ending 31 December ($m)	1998	1999	2000	2001	2002	
Target revenue	70.2	72.2	74.8	77.1	77.3	
Forecast revenue	70.2	73.1	74.2	76.4	77.4	
Source:	TPA Access Arrangement Information, p. 21
Submissions by interested parties
CitiPower states that the forecast $70.2 million for TPA’s costs and revenue requirements appears reasonable.  As noted in the above sections, BHPP argues that it should be a lot less.
Commission’s considerations
The Commission considers the desire for a smooth pricing path within the initial regulatory period to be reasonable and does not oppose the substitution of the target revenue stream with a forecast revenue stream of the same (or less) NPV.
As indicated in Table 3.10 below, the recommendations in this Draft Decision, will reduce target revenues by around 17 per cent (equivalent to revenues of $12 million in 1998).  It should be noted that comparisons of changes beyond 1998 are exaggerated by the different inflation assumptions.  Since revenues are adjusted annually based on actual inflation, the 17 per cent difference observed for 1998 is also indicative of the difference in future years.  These changes in target revenues will also require a re-calculation of the X factor used in the adjustment of tariffs over time.  Initial estimates suggest the X will increase from 3.4 to 3.7 per cent.  
The cumulative impact on target revenues of the recommended changes in the access arrangement proposals relating to the establishment of the costs of providing the reference services are summarised in Table 3.10 below. 
Table 3.10:	Target revenue estimates resulting from recommended changes to cost of service calculations ($m)
Year Ending December 	1998	1999	2000	2001	2002	
TPA proposal	70.2	72.2	74.8	77.1	77.3	
Actual inflation adjustment of DORC to 1 January 1998	69.5	71.5	74.1	76.4	76.5	
Reduce inflation assumption from 3 per cent to 1.7 per cent	68.7	70.1	72.0	73.5	73.0	
Reduce pre-tax real WACC to 7.0 per cent	58.3	59.4	60.9	62.2	61.9	
Recommended changes to O&M forecasts	58.3	59.0	60.1	61.0	60.2	
Source:	Commission calculations
Financial Indicator Analysis
To assess the implications of the total revenue for the credit worthiness of the transmission business, the Commission has produced the range of financial indicators that credit rating agencies normally use to undertake such assessments.  However, considerable care is required in making inter-company comparisons since the risk factors, optimal leverage and taxation position are important commercial considerations.  As such the financial ratios which are appropriate for one company may not be appropriate for another.  In constructing and interpreting these indicators, the Commission has sought advice from the Independent Pricing and Regulatory Tribunal in NSW (IPART) which uses these and other financial indicators extensively to set regulated price paths.
The financial indicators that were considered by the Commission and the ranges applicable to utilities are those which were provided by Standards & Poor’s Ratings Group to the NSW Treasury.  In interpreting these ratios, the Commission considers that a credit rating above ‘A’ would be considered to be an indicator of sufficient credit worthiness to ensure the financial viability of this type of business, noting that the NSW Treasury has adopted a minimum target of an A rating for its government trading enterprises.  Table 3.11 below shows, for different categories of business risk, the range of each indicator that is consistent with an ‘A’ credit rating, as well as the indicators for the categories above and below ‘A’. 
Table 3.11:	Standard and Poors’ credit rating indicators
Utility Business Risk Profile	Funds Flow Interest Cover	Funds Flow Net Debt Pay Back	Internal Financing Ratio	
	AA	A	BBB	AA	A	BBB	AA	A	BBB	
Excellent	3.25	2.75	1.50	6.0	9.0	12.0	70	60	40	
Above Average	3.50	3.00	2.00	5.0	7.0	9.0	80	70	50	
Average	4.00	3.25	2.50	4.0	5.5	7.0	100	90	55	
Below Average	4.25	3.50	3.00	4.0	5.5	7.0	100	100	75	
Vulnerable	X	4.00	3.50	X	4.0	6.0	X	100+	90	
As TPA has just been formed and does not as yet have a commercial financing structure, the Commission has adopted assumptions about the balance sheet of the businesses to construct a meaningful test of the revenue stream that its view on total revenue would imply.  In general, the Commission has used assumptions used within a model of accounts supplied by EPD.  This includes assumptions on the rate of debt/equity ratios, the rate of debt pay-back and dividend policies which may not be appropriate under all scenarios or those adopted by the company.  Nevertheless, it forms a reasonable basis for estimating the financial indicators. The particular assumptions adopted are:
•	the market value of the transmission business is the capital base;
•	the business commences the access arrangements period with 70 per cent debt which reduces by a constant amount (provided funds are available); and
•	the cost of debt is the same as assumed by the rate of return calculation relevant to each scenario.
Table 3.12 below shows the relevant financial indicators for TPA over the access arrangement period that is implied by the projected total revenue that was proposed by TPA, as well as those implied by the projected target revenue following the changes to the access arrangements recommended by the Commission.  
In interpreting these ratios, the Commission considers that TPA has risk profile which is between above-average to excellent given the likely stability of earnings and lack of competitors for the services being provided.  
In comparing, the financial indicators pertinent to Standard and Poors’ credit rating criteria, it is noted that the impact on the indicators of the Commission’s recommended changes are relatively minor.  This is partly due to the fact that the interest rate on debt assumption partly offsets the more generous pre-tax real WACC assumption.  It should be noted that the assumed inflation rate will have only a minor impact on the financial indicators.  Indeed, because tariffs are linked to actual inflation in the regulatory framework rather than forecast inflation, the financial ratios will tend to be preserved in a broad range of economic settings.
Table 3.12:	IPART financial indicators calculated for TPA under EPD proposal and ACCC recommended changes (AGL figures are included for comparison)
Company	AGL	TPA 
EPD proposal	TPA 
ACCC changes	
Financial indicator	Av  '96 & '97	5 yrs avge	5 yrs avge	
Funds flow adequacy %	103.1	82.5	77.6	
Funds flow interest cover(times)	9.8	2.6	2.7	
Funds flow net debt pay back (yrs)	1.5	8.6	11.0	
Internal financing ratio %	108.5	123.2	118.3	
Pre-tax interest cover (times)	6.8	2.0	1.9	
Total debt percentage (gearing %)	28.4	66.6	66.8	
PATBI to funds employed %	13.4 (a)	9.6	6.6	
PBIT to revenue %	21.1	57.0	47.5	
PBITD to revenue %	27.7	74.4	69.2	
PBIT to funds employed %	17.6(a)	11.8	7.9	
EBIT on operating assets %	12.4(a)	11.0	7.4	
Notes:
(a)  These figures are not strictly comparable to TPA figures since the funds employed relate to a balance sheet value rather than stock market capitalisation and the operating assets are book values rather than the value of the assets for regulatory purposes.
(b)  Financial indicators formulae		
Funds flow adequacy	(profit after tax + depreciation)/(dividends + capex)	
Funds flow interest cover	(profit after tax + depreciation + interest + tax)/interest	
Funds flow net debt pay back	(total debt - cash)/(profit after tax + depreciation)	
Internal financing ratio	(profit after tax + depreciation - dividends)/capex	
Pre-tax interest cover 	(profit before interest and taxes)/interest	
Total debt ratio	(total debt)/(total debt + total equity)	
PATBI to funds employed	(profit after tax + interest)/(total debt + total equity)	
PBIT to revenue	(profit before interest and taxes)/target revenue	
PBITD to revenue	(PBIT + depreciation)/target revenue	
PBIT to funds employed	PBIT/(total debt + total equity)	
EBIT on operating assets	EBIT/average total assets	
The rating is not uniform across the Standard and Poors related indicators.  The funds flow interest cover is very close to the A rating number in each case and the funds flow net debt pay back is between A and BBB.  On the other hand, the internal financing ratio clearly has an AA rating in each case.  Nevertheless, on balance, the analysis suggests that TPA would have an A or A- credit rating under both the EPD scenario and under ACCC’s revised scenario.  This is reinforced, given the high gearing of 70 per cent assumed in the EPD model.  At the mid-range gearing ratio of 60 per cent assumed in the WACC formulation the first two indicators which are heavily influenced by the level of debt would move closer to the A ratings.  The ratings suggest that the recommendations of the Commission will not adversely compromise the financial viability of TPA nor its ability to raise finance for ongoing investment. 
This conclusion provides a degree of comfort with the rate of return requirement being imposed by the Commission in this determination.  It should be noted that the financial indicators are irrelevant as a check on the value assigned to the initial capital base.  This is because the financial indicators depend on the rate of return, but being ratios are relative insensitive to the value of the asset base.  In a sense, alternative valuations in the short to medium term represents only a re-scaling of the size of the business.
Macquarie Bank financial analysis
The Commission has engaged the Macquarie Bank to independently assess the cash flows associated with TPA under the Commission’s regulatory framework.  They have developed a model which is not constrained in the way of that provided by EPD and thus allows a more realistic appraisal of the business over the longer term.  Their model captures the need for ongoing replacement investment and extends the cash flow modelling over the full life-cycle of the pipeline system (50 years).  However, in other respects the Macquarie Bank analysis of the credit worthiness of TPA under the regulatory arrangements proposed, closely parallels that given above.  In particular, they also use Standard and PoorÕs two dimensional indicative credit rating framework for global power companies which they summarise in the following matrix.  
	Weak	A	BBB	BB	
Financial Profile	Average	AA	A	BBB	
	Strong	AAA	AA	A	
		Strong	Average	Weak	
		Business Profile	

MacquarieÕs business risk assessment of TPA uses a qualitative approach taking account of such factors as likely volatility of earnings, gearing, regulatory environment, market stability and the susceptibility of TPA markets to competition.  The financial risk assessment is, on the other hand, quantitatively based using the same Standard and PoorÕs ratios considered earlier but calculated using MacquarieÕs own cash flow model.
In both assessments Macquarie drew comparisons with utilities in the electricity sector as benchmarks relevant to Australian financial markets. 
Macquarie summarised their conclusion as follows:
We believe that TPA's business profile is likely to be predominantly the same as GPU Powernet and slightly stronger than the currently rated Victorian electricity distribution companies.
The financial profile based on the benchmark capital structure of 60% debt to net assets suggests that TPA will be significantly stronger than the 74% geared GPU Powernet and on par with the similarly geared electricity companies.
External factors aside, there is no reason to believe that the benchmark structure would be unable to attract at least a "BBB" long-term rating with an "A" being realistically achievable.
These conclusions by Macquarie provide independent confirmation of the CommissionÕs own analysis. 
3.7.3	VENCorp’s Access Arrangement for the PTS
Service provider’s proposal
VENCorp incurs costs in four areas of activity and these are listed below with the forecast cost for 1998/99.  Primarily they relate to the PTS operations.  WTS related costs consist solely of transmission control ($0.1 million of the figure below), though this will change when the WTS is connected to the PTS.
Table 3.13:	Forecast VENCorp costs for 1998/99
Activity	$ million	
Transmission Control	4.5	
Third Party Access	4.8	
Operation of the Spot Market	2.8	
LNG System Security	1.4	
TOTAL	13.5	
Source:	VENCorp Access Arrangement Information, Supplementary Information, 6 March 1998, p. 2. 
More detailed cost disaggregation forecast for the next four years is contained in Attachment 1 to the supplementary Access Arrangement Information.
Submissions by interested parties
ACI states that additional costs will necessarily be incurred in moving to a market-based system and expresses no significant concerns related to VENCorp’s operating costs, so long as these are benchmarked and carefully controlled.  
The ACA considers that the $12.1 million is an excessive cost burden which does not reflect the ‘real’ value of VENCorp services.
Commission’s considerations
A large part of the costs (44 per cent) are due to management of gas flow and system security which is normally provided by the pipeline owner operator and was previously carried out by GTC.  Third Party Access costs are the nominations, scheduling, metering and settlement costs associated with dealing with multiple retailers.  Spot market costs relate to market clearing logic including the determination of the spot price, management of constraints, monitoring of prudential requirements and determining and settling spot market imbalances.  
Assessment of these costs is difficult for the Commission, especially those which are part of the new gas market system in Victoria.  The Commission currently has no evidence to suggest that the level is unreasonable.  However, it intendeds to monitor these costs closely, and in that regard the Commission notes that VENCorp is required to submit its yearly budgets to the Commission for consideration.
3.8	Cost allocation and tariff setting
3.8.1	Victorian Access Code requirements
The Victorian Access Code (section 8.38) requires that reference tariffs should recover costs directly attributable to the reference service and a fair and reasonable share of joint costs.  It also requires (section 8.42) that a particular user’s share of revenue to be recovered also follows these principles.
3.8.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
EPD considers that the proposed tariffs are consistent with the Victorian Access Code, are cost reflective, give efficient pricing signals, recover allowed revenue and give price stability.  
The calculation of tariffs proceeds in three main stages which are summarised below.  These stages are described in more detail in the remaining clauses of this section. 
(a)	The target revenue is allocated between the different services provided in earning this revenue.  These services are: transmission injection service, transmission delivery service and matched flows.  These services are described in the Tariff Order.
(b)	The target revenue for each service is then further allocated between revenue that should be recovered at peak only (‘capacity-driven’ costs) and those to be recovered throughout the year (‘commodity-driven’ costs).  These costs are allocated to each offtake point and injection point (as appropriate) across the Transmission System.
(c)	Using the forecast levels of utilisation of each service, the total revenue to be recovered at each location is converted to a $/GJ tariff such that, if the outturn is in line with the forecast, the planned costs will be recovered at each location, and the overall target revenue will be recovered.
Costs will be allocated between:
•	injection and delivery.  
Rather than paying for transportation as such, a user will pay for injection and delivery.  Injection costs are those associated with transportation to the ‘hub’ (at the Pakenham offtake) and delivery costs are those associated with transportation from the hub.  Purchases from the pool would involve no injection charge.  This allows flexibility to purchase from different sources.  Shippers who do not require gas to go through the hub are given a discount for ‘matched injection’;
•	locational specific and common.  
Common costs include corporate overhead and systems operation and are spread across all users through a ‘postage stamp’ charge.  Locational costs include operational costs for pipeline and compressors, and capital.  There are 24 geographically defined asset groups (categorised as either injection or delivery) which are classified by physical characteristics.  A user’s charge depends on the number of asset groups involved in transporting that user’s gas; and
•	capacity (charged on volumes transported at peak times) and commodity (charged on volumes transported at all times).
This methodology reflects the users’ physical use of the system which is intended to be a proxy for long-run incremental costs.  The PTS has 106 take-off points grouped into 52 delivery locations.  Reference tariffs are set for eight pricing (or delivery) zones, based on the volume and demand-weighted average of the delivery point allocated costs within each defined zone. 
A flow diagram of the transmission tariff pricing methodology is shown in Diagram 3.2 below.  
Diagram 3.2:	Transmission tariff pricing methodology 
	
Source:	Access Arrangement Information p. 25.
Note:	The peak demand tariff is paid by Tariff D (demand-metered) customers and the peak volume tariff is paid by Tariff V (volume-metered) customers.  Tariff D and Tariff V customers are as defined for distribution charging.
Non-system assets include land and buildings.  System assets include pipelines, regulators, compressors and odourizing plants.  Non-system O&M are costs applying to non-system assets as well as administration & management and the cost of odourant.  
Locational costs are allocated to 24 asset groups, which are defined physically (e.g. changes in pipeline diameter).  Peak locational cost pools (for capital related costs) are allocated on the basis of optimised replacement cost (ORC - this reflects the ‘service potential’ of the asset, with users of newer parts of the system not ‘unfairly’ penalised).  Pipeline O&M is allocated by pipeline length.  Compressor O&M is allocated on fuel gas usage by the stations.
Transportation assets used from Longford to Pakenham determine the target revenue for injection.  Within an asset group, costs are based on demand/volume and distance to each delivery point (including gas flowing right through that asset group).  Through costs from up stream are allocated to delivery points on demand/volume basis only.
For pricing, the 52 delivery points are aggregated into 8 zones.  These have been chosen to provide a reduced set of tariffs but maintain material cost of supply differences.  
Other pipelines connected to the system will pay tariffs specific to their connection point.  This recognises the loads at these points could distort the zonal average to be passed through to end users.  
Due to the variable nature of planned expenditure and gas flows, tariffs can fluctuate materially.  Therefore they have been ‘levelised’.  As explained previously, a NPV of the five years of costs is calculated.  A 1998 tariff is then calculated so that when it is increased by CPI-X it will give a revenue stream with the same NPV.  
Locational anytime and common anytime costs are combined into one anytime tariff as they are charged on the same basis (anytime volume).  Thus, the basis for Transmission Use of System (TUoS) is shown in Table 3.14 below.  
Table 3.14:	Transmission use of system charges
	Delivery Service 
Tariff D Customers	Delivery Service 
Tariff V Customers	Injection Service	
Peak Charge	Actual gas delivered on the five days of highest system demand over the peak period (June to September): ‘Peak Demand’	Actual gas delivered over the peak period (June to September): ‘Peak Volume’	Actual gas injected on the five Peak Longford Injection days over the peak period (June to September): ‘Peak Injection’ 	
Anytime Delivery Charge	Actual gas delivered over the calendar year	Actual gas delivered over the calendar year	Not charged for Injection	
Source:	TPA Access Arrangement Information, p. 32. 
Consistent with the above, PTS customers’ charges are computed on the five peak days at each supply point; and WTS customers’ charges are computed on the five peak days of the WTS.  
The 5 peak day criteria is based on historical demand characteristics.  The analysis carried out indicated that for most years there was a noticeable change in load for between 4 and 6 days and the remaining winter days.  Also the LNG facility under ‘normal’ forecast winter conditions can supply effectively over 5 days.  Therefore, a 5 day criteria was selected.  
While charges are based on the customers’ characteristics, it is retailers who will be charged TUoS (according to the types of customers they supply).
Customers upstream from the hub receive a reduction in injection charge for any matched injection.  Similarly, where gas is injected downstream from the hub (for example, a shipper buys from the Interconnect) a lower delivery price is paid for matched delivery.  This customer pays no injection charge and, if in North Hume (the zone adjacent to the Interconnect), pays half the withdrawal charge.  
The WTS is one of the 24 asset groups, and one of the nine pricing zones, in the PTS tariff model.  As such, the tariffs calculated for the WTS are allocated a share of TPA’s total depreciation and return for both direct and indirect assets in the same way as for the PTS.  Both locational and common O&M are identified separately for PTS and WTS and charged to the appropriate system.  
WTS does not have an injection charge.  As it is not part of the spot market arrangements a simplified tariff structure is possible.
EPD provided the Commission with the electronic model (consisting of over a dozen spreadsheets) used to calculate the tariffs.  This model contains some confidential data.  However, related data has been released by EPD subsequent to the initial Access Arrangement Information.  The Commission has described EPD’s tariff model in some detail in Appendix D.  In some areas, this summary provides a more precise description than the paraphrase above.
Submissions by interested parties
Many interested parties stated that EPD had not provided sufficient information for them to assess whether the target revenue and/or tariffs were reasonable and that there was insufficient data for them to replicate the calculation of the tariffs.  However, as outlined in chapter 4 of the Draft Decision the Commission does not believe that data to this level of dis-aggregation is required by the Victorian Access Code which requires interested parties to be able to ‘understand the derivation of the elements in the proposed Access Arrangement’ - not necessarily to be able to duplicate the tariff calculations.  
Capacity:commodity split
The main focus of submissions was the proportion of costs which will be recovered by capacity tariffs and the proportion to be recovered by commodity tariffs.  Various submissions considered the proposed 70:30 apportionment to under-price peak winter delivery and over price off-peak delivery.  These interested parties stated that they would prefer instead an allocation of around 95:5.  
CUB favourably quoted a 1995 GTC submission to the Gas Council of NSW in which GTC stated that ‘most North American regulators (are) now adopting a capacity to commodity ratio of 95/5 or higher.  ... the commodity charge relates to ... compressor fuel and compressor operation time dependent overhaul costs.  The remainder of the operating and capital costs are independent of throughput’.  The ACA and ACI also claim that compressor fuel is the only cost that should be recovered by the volume charge.  ACA consider that this would result in a 95/5 ratio.  BHPP claims that the short run marginal cost for off-peak periods is effectively zero and that pricing above this marginal coat leads to a loss of consumer surplus.  
Santos took a contrary view, claiming ‘it would be more appropriate if off-peak supply bore the cost of facilities optimised for that off-peak rate.  It would then be appropriate for peak users to bear the incremental cost between peak and off-peak rates’.  Santos also stated that the linking of capacity charges to the system use on only five days is not cost reflective.  It suggested that use of 20-30 days for peak would reduce potential manipulation of the system.  
Furthermore, Santos argues that a shipper’s ability to avoid peak charges by not shipping in winter means that this shipper will be subsidised by winter shippers.  In this its concerns are similar to the ACA which claims the current allocation favours poor load factor customers at the expense of high load factor customers like cogenerators.  
EPD acknowledges that a capacity:commodity split based on fixed/variable costs may result in a split range between 80:20 and 100:0.  It notes, however, that splits outside this range are not unknown and cites the example of ‘the United Kingdom National Transmission System (which) currently has a split of 55:45 for charges calculated from 1 October 1996’.
Capital expenditure
The other major issue raised is whether capital expenditure associated with the expansion of the system’s capacity should be rolled into the tariff.  BHPP and the ACA note that the rolling-in to tariffs of new capacity costs will result in new capacity users being subsidised by old capacity users and argue that this should not happen.  As well, BHPP claims that the lower than marginal cost being charged to new users (because some marginal cost of the new capacity is being recovered from existing users) will result in overbuilding.  Ecogen states ‘The regulator should ensure that only those investments which satisfy a genuine market need should be added to the asset base for tariff determination’.  
Other issues
Concern was raised that the use of ORC for cost allocation, rather than DORC, would make users of older parts of the system (which have been depreciated) subsidise those using newer parts of the system (with resulting higher depreciation).  
There was some concern that the final price to the user is not completely fixed.  BHPP states that users are unable to know their transmission costs because they will not know which days are peak days until after the event.  
Santos submitted that the discount available to NSW (backhaul) gas (no injection charge, and 50 per cent discount on withdrawal for North Hume) is inadequate and does not reflect the use of pipelines.
Uncle Tobys states that a consumer’s distance along the Murray Valley pipeline should be taken into account in the setting of tariffs, that is, there should not be one average tariff for the whole of the Murray Valley pipeline.  
Western Transmission System
CitiPower offers the only comments specifically on WTS cost allocation or tariffs.  It said:
The write down of the Western System results in lower tariffs than would otherwise apply. The lower tariffs may result in higher consumption and demand for further transmission capacity, the cost of which will effectively be subsidised by the write down. It appears that the write down brings the ratio of ODRC to ORC of the Western System into line with that of the Principal System and is consistent with the non-age-related allocation of costs in the Principal System. If the two systems were treated as one, Western System would be allocated costs close to the written down value, however in this case the other costs would be carried by the Principal System. The TPA Information document does not fully explain the reasoning behind the write down.   
Commission’s considerations
The reference services proposed by TPA are defined in clause 3.1 of the Access Arrangement (quoted above in service provider’s proposal).  This section states that the services relevant to the target revenue are: transmission injection service, transmission delivery service and matched flows.  However, the glossary in the Tariff Order (where items are defined) indicates that matched flows is not properly seen as a reference service.  The Commission understands that TPA is offering three reference services in relation to the proposed Access Arrangements: transmission injection service and transmission delivery service (both of which are tariffed transmission services) and LNG system security (which is a scheduled excluded transmission service).  Discussions with EPD confirm this view.
Major issues arising from EPD’s chosen tariff methodology include the basis of cost allocation, the treatment of new capital expenditure, the cost reflectivity of the pricing zones and the forecast volumes.  These issues are discussed below.  
Cost allocation
In assessing this issue, the Commission must take account of the following:  whether the proposed tariffs reflect costs directly attributable to the reference services and an appropriate share of TPA’s joint costs; and secondly, does each user’s share of revenue reflects costs directly attributable to that user plus an appropriate share of joint costs.  
Very few costs can be attributed to any individual user.  Almost all pipelines are used by more than one customer, as are all compressors and odourant facilities.  O&M costs are mostly related to the running of the system and are thus also joint costs.  This then raises questions as to whether these costs have been shared appropriately.
Depreciation and return on direct assets are allocated to each asset group on the basis of each asset group’s ORC.  EPD states: 
The apportionment has been based on ORC so that users are charged in relation to the service potential of the assets.  By using the ORC, the age of the individual system assets become irrelevant and users of newer parts of the system are not ‘unfairly’ penalised.  This becomes a key issue as the assets are depreciated and refurbished/replaced.
Use of the ORC will smooth out variations in the allocation of costs over time (eventually flowing through to tariffs); this will produce greater future price stability and will remove any charge-related interest that users might otherwise have in TPA’s replacement decisions.
The Commission agrees with this approach.  Over the long term, ‘expired’ assets will be replaced.  Allocation of costs on the basis of ORC will give tariffs which better reflect long run incremental costs for all users.  Many submissions by interested parties (when discussing market vs. contract carriage) emphasised the need for certainty.  Stable pricing is a major contributor to certainty.  Allocation of costs by ORC will avoid major price shocks which would flow from the renewing of assets.  
Locational O&M is allocated to asset groups on the basis of the length of the pipeline in the asset group (ignoring whether small or large diameter).  Pipeline O&M typically consists of a number of activities.  The O&M costs applicable to any part of the transmission system’s pipeline depend on length (size of undertaking), age (more maintenance and corrosion problems with increasing age) and location if access is a major problem (either due to population pressures or remoteness).  O&M would also vary with diameter but to a lesser extent.  The Commission considers that, for the sake of simplicity, the allocation of O&M on the basis of pipeline length alone is a reasonable approach to cost allocation.  
Common O&M, and return and depreciation on indirect assets, are not distance based.  They are allocated solely on volume.  All of the return and depreciation on indirect assets has been allocated to reference services.  However, all the indirect assets of TPA are relevant to all TPA’s activities (both reference and excluded services).  The Victorian Access Code requires that these costs therefore be apportioned to both categories of service.  
Proposed Amendment A3.7
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, the return on, and of, TPA’s indirect assets should be apportioned between reference and excluded services on the basis of the forecast revenue for those services or on some other basis agreed with the Commission.  

Tariffs are based on users making a contribution to the costs associated with each asset group through which the user’s gas is transported.  Consequently contribution to revenue increases as users are further away from the source of gas at Longford.  
All tariffs are based on the volume of gas transported for a user with one being allocated on all gas transported during the year and two being allocated on gas transported on peak days.  As such, all tariffs are variable and therefore have no fixed component.  While the peak charge closely parallels the capacity charge under a contract carriage system it provides for greater flexibility for users who can reduce their costs by reducing peak usage.  
The allocation of forecast costs to the tariffs as described above results in $46.3 million being recovered in capacity (peak) charges and $22.5 million in commodity (anytime) charges in 1998.  The ratio of this recovery is 67/33 per cent.  This will increase to 70/30 in 2002.  
Some submissions by interested parties called for more costs to be allocated to the capacity charge.  If compressor gas is the only cost feeding into the commodity charge, as advocated by some submissions, the split would be 98.4/1.6 as the gas costs are only $1.1m out of $68.8m for 1998.  
Other submissions claim that it is unreasonable that users who are able to avoid purchases in peak times will pay substantially less than those who can/will not.  The call in these same submissions to increase the capacity charge will exacerbate this ‘unreasonableness’.  The only way these two positions could be harmonised is if the capacity charge was based on MDQ and not peak gas actually transported.  
BHPP noted that there will be a loss of consumer surplus if non-peak volumes are priced above marginal cost.  However, as pointed out by EPD, there will be a loss of consumer surplus if either component (peak or non-peak) of TPA’s services are priced above marginal cost.  Also, pricing of both components at marginal cost will raise insufficient revenue to cover total costs.  This is the standard problem of natural monopoly pricing.  Thus the question is how much fixed costs (not directly associated with capacity) to allocate to non-peak pricing.  The answer is largely an arbitrary one as there is no right or wrong answer on the basis of the nature of the costs.  The decision could be based on the appropriateness of the pricing signals that will be sent by the resulting tariff.  
The Commission is inclined to accept the proportion of revenue recovered by capacity and commodity charges as proposed.  It does, however, take note of the untried nature of the market carriage system, and considers it appropriate to reconsider this issue in the review at the end of the first regulatory period. 
Various submissions pointed out that the tariff structure would advantage those customers who were interrupted on peak days and those who were counter-cyclical, shifting costs onto those who use gas mainly in the winter or fairly constantly through out the year.  This feature is considered one of the advantages of the tariff structure.  It requires customers to pay in proportion to their contribution to the maximum capacity demanded from the system and gives an incentive for users to minimise their usage on days of peak demand.  Indeed the pricing structure is the feature which provides incentives for best utilisation of pipeline infrastructure.  To the extent that users avoid peak times, the pressure on system capacity (and enhancements) is diminished.  Efficient use of the assets is encouraged.  
Some submissions expressed concern that Tariff V customers and Tariff D customers will be charged on completely different basis which they believe is non-cost reflective, that is, tariff V customers according to their June-September volume and Tariff D customers on peak 5 day volumes.  However, in total, costs are allocated to both groups on the same basis: MDQ.  Thus, the two classes of customer are each required to contribute their appropriate portion of the target revenue.  The different tariff structure reflects the fact that metering is not available to determine usage on the five peak days for individual Tariff V customers and that therefore an alternative is necessary.
Western Transmission System’s tariffs
As noted above (section 3.2), EPD made a policy decision to reduce the DORC of the WTS assets to limit what it considered to be undesirable network price differentials.  The model was adjusted so that all tariffs other than for the WTS were unchanged by this revision. 
However, it remains that users on the PTS pay for some of the costs associated with the WTS.  This is due to the methodology of the EPD tariff model (discussed above) which calculates depreciation and return on DORC but, for direct assets, allocates them to asset groups on the basis of ORC.  Accordingly, as has been pointed out in some submissions, consumers who use older (more depreciated) pipelines will contribute to the recovery of costs associated with newer pipelines.  Thus it is that users in some price zones will contribute to revenue associated with assets used by consumers in other price zones.  The WTS happens to be a zone favoured by this approach (at the moment).  As also noted above, the Commission agrees with cost allocation based on ORC.  
New capital expenditure
The only significant new capital expenditure included in the tariffs is the Brooklyn-Corio loop.  This loop will increase the capacity of this line thus allowing supply from the underground gas storage (UGS) up to 250 TJ/day capacity.  TPA argues that this is necessary as forecast peak demand cannot be supplied from Longford after 2000 given the contract limitations at that time.  TPA considers the Brooklyn-Corio loop the cheapest and most likely alternative (compared to looping the Longford-Dandenong line and looping the Barnawatha-Wollert line for supply from Moomba).  
The anticipated incremental revenue of at least $5 million is greater than the expected annual cost of $4 million according to EPD.  The Commission requested supporting evidence for this claim, but nothing had been received at the time of writing this Draft Decision.  If satisfactory evidence is received, the proposed looping would satisfy the test under section 8.16(b)(i) of the Victorian Access Code which allows the cost to be incorporated into TPA’s capital base.
If the UGS project does not go ahead and the loop therefore does not go ahead, it is argued that TPA will probably need to undertake another more expensive alternative.  The Access Arrangement Information (section 5.3) makes it clear that ‘TPA and VENCorp will agree as to the amount of pipeline capacity that TPA will provide to VENCorp under certain variable conditions.  This agreement, the Service Envelope Agreement [SEA], will establish TPA’s obligations’.  Currently an interim SEA is in place and a more substantial SEA is being negotiated by the parties.  Neither the interim nor the draft agreement state an amount of pipeline capacity and neither place an obligation on TPA to provide any expansion of the TPA system.  
Thus, TPA can fulfil its obligations as currently expressed without undertaking the Corio loop expenditure (or any of the more expensive alternatives).  If the Corio loop did not go ahead, it is possible that TPA would reap a windfall gain of up to $4 million for each of the last two years of the initial regulatory period.  The mechanism which would allow this is meant to provide TPA with an incentive to find a better (cheaper) way to provide the necessary capacity and not meant to facilitate a windfall gain for non provision.
A similar concern exists in regard to the capital expenditure forecast for the Brooklyn Compressor Station Upgrade which is also based on increased deliverability past 2000.  
Proposed Amendment - A3.8
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, either: 
(i)	the service envelope agreement should incorporate an obligation on TPA to provide the Corio loop and the Brooklyn compressor upgrade (or equivalent); or 
(ii)	the Corio loop and Brooklyn compressor capital expenditure should be removed from the capital base and the tariff calculations.  

EPD has indicated to the Commission that it accepts the need to incorporate TPA’s future expansion obligations into the SEA.  
It should be noted that EPD does propose to incrementally price new pipelines to serve new loads (as BHPP advocates). 
Gas source
The Victorian Government is keen to develop under-ground storage as a competitive source of peak gas for Victorian users.  ‘The Government intends to sell the UGS assets together with an obligation to provide retailers with peak day deliverability (at a level less than UGS capacity) for a period of some five to seven years commencing in 2001.’  On this basis TPA forecasts that 250 TJ/day of peak gas will be supplied from the UGS from 2001.  
Recipients of gas from UGS are assumed (in the tariff model) to be users in the Calder price zone and the western section of the Metro zone.  Other possible sources of peak gas will be the spot market, the Interconnect with NSW, direct from BHPP at Longford, and LNG.  On the basis of discussions held with EPD, and further confidential information supplied, the Commission considers the peak sourcing assumptions in the tariff model to be reasonable.  
The UGS is unlikely to be the physical source of most of the off-peak (anytime) gas consumed by users in Calder and western Metro pricing zones.  The majority of each user’s gas will still be purchased from Gascor and come from Longford.  However the model assumes (for the sake of simplification) that all gas used by the Calder and western Metro zones will be sourced from UGS.  The proposed anytime tariffs for the Calder zone will therefore be lower than a tariff which assumes sourcing from Longford while the anytime tariffs for most other zones will be higher.  It is unclear whether the Metro tariff is higher or lower.  However the difference between the proposed tariffs and alternative tariffs is likely to be very small.
A major argument for not including greater sophistication in the tariff model is that there is no solid basis on which to forecast non-peak volumes to be sourced from the UGS.  Thus the increased complexity in the model would not be matched by increased accuracy in revenue allocation.  The review in 2002 may be a more appropriate time in which to take this source into account for the anytime tariff calculation.  At that stage there should exist historical data for a year which will greatly aid forecasting.  
EPD has informed the Commission that the maximum delivery capability of the PTS is now considered to be 990 TJ/day: an increase from the 970 TJ/day noted in section 5.2 of the Access Arrangement Information.  The Commission considers that this increase should be reflected in the calculation of the reference tariffs.  This should result in a slightly lower injection tariff.
Proposed Amendment - A3.9
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, TPA should amend the forecast injection at Longford in the tariff model from 970 TJ/day to 990 TJ/day.  

A different pricing issue arises with respect to gas sourced from NSW.  Under the proposed tariffs, almost all users pay the same delivery charge irrespective of the source of their gas.  The exception is North Hume users who source gas from the Interconnect.  They pay half the peak delivery rate (the standard tariff is discounted by a ‘matched withdrawal factor’ of 50 per cent).  EPD says that ‘the matched withdrawal factor is designed to convert relevant transmission tariffs into cost-reflective tariffs which reflect the direction of supply’.  
So, for example, any Metro users (most customers) who buy NSW gas will pay a withdrawal tariff designed to reflect the cost of using the pipelines from Pakenham while (conceptually) using pipelines from Barnawatha (a much greater distance).  To some extent this lower tariff could be seen as a concessional backhaul rate.  
However, the tariffs as proposed produce an anomaly:  users closer to the Interconnect will pay more than many of those further from the NSW border.  This situation is illustrated in Table 3.15 below.
Table 3.15:	Average per GJ transmission prices for Tariff D customers1
	Gas from Longford
$/GJ	Gas from Interconnect2
$/GJ	
Metro	0.213	0.167	
South Hume	0.298	0.253	
North Hume	0.697	0.426	
Source:	ACCC calculation based on proposed tariffs in Access Arrangement. 
Notes:	1.   Based on tariffs in the Tariff Order.  Assumes users’ 5 day peak volume is 1.7 per cent of total volume (average for system).
	2.   Assumes no injection charge paid and the 50 per cent reduction (which applies to the peak charge only) for North Hume.
As already noted, tariffs are calculated assuming that all North Hume users will require transportation from Longford.  Any resourcing to the Interconnect by North Hume users will therefore initially result in a loss of revenue to TPA.  However, this would also free capacity on the northern pipeline (Pakenham to Barnawatha) for gas to be sold into NSW.  To the extent that gas sales into NSW are thus generated (that is, that the northern line continues to be utilised at the levels applicable before the resourcing), TPA will experience a net increase in revenue approximately equivalent to that obtained from the matched injection tariff.  
As it is likely that the northern line will be used to capacity, there is little need for TPA to recover any more revenue from North Hume users sourcing gas from NSW than is needed to cover the incremental costs of these users, which are negligible.  This is true also for South Hume, Echuca and Calder users who also use the northern line.  These users could be offered a matched withdrawal tariff equal to the standard withdrawal tariff for the Metro zone.  This would correct the pricing anomaly which currently exists, would still give TPA a return in excess of that reflected in the WACC if these users do source from NSW, and has the advantage of being simple.
The availability of a return in excess of WACC will give TPA an incentive to encourage greater efficiency in the system and promote interstate trade.  
Proposed Amendment - A3.10
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, TPA should offer users in the Metro, Calder, South Hume, Echuca and North Hume pricing zones a withdrawal tariff for gas sourced from NSW equal to the proposed Metro withdrawal tariff (as adjusted in compliance with all other relevant amendments required by the Commission in this Draft Decision).

Volume
The Commission believes that overall, the volumes are forecast at an acceptable level.  This view is supported by the report of a consultancy commissioned by the ORG on forecast demand.  This report called into question the methodology of TPA’s forecasts.  Its conclusions were, however, that the general level of forecast demand is reasonable in the first couple of years of the initial regulatory period but tended to be conservative for the rest of the period.  
For the Interconnect, TPA’s forecast volume is for 5 PJ per year flowing from south to north.  While the capacity of the Interconnect itself will be much greater, TPA considers 5 PJ to be the maximum physical increase the PTS can accommodate before augmentation is needed.  
The general expectation of industry is that gas will flow from south to north.  However, AGL has contracted to sell 5 PJ/year of gas into Victoria, requiring that gas to be transported south.  It is reasonable to expect, then, that up to 10 PJ a year may be contracted for transportation north through the Interconnect.  If the gross 10 PJ figure was used in the tariff calculations, overall tariffs may decrease marginally and in North Hume they could reduce by at least a third.  This reduction would be a benefit for North Hume, Murray Valley and Interconnect users and could be expected to have a positive influence on market growth and interstate trade.
The Tariff Order (clause 6.1(h)) does allow the Commission (with respect to volumes forecast to flow interstate) to approve TPA’s current forecast now but to substitute a revised forecast (when approving tariffs for the next regulatory year) to determine the maximum average transmission tariff (MATT) to be used in calculating the K factor.  With this in mind, the Commission believes the use of 10 PJ in the tariff model to be appropriate now.  If this forecast proves in the future to be in error, the Commission may use the Tariff Order mechanism mentioned above to retrospectively adjust MATT to an appropriate level.  
Proposed Amendment - A3.11
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, reference tariffs should be based on a forecast volume for the Interconnect of 10 PJ per year.  

Each year will see a recalculation of tariffs, increasing by CPI-X but also adjusting for actual volumes achieved through the K factor.  At that time the Commission will be able to reject revised forecasts if it considers them unreasonable.  The Commission’s expertise in this area will grow over time as actual data on performance years becomes available.
Model audit
At various points in the calculation of tariffs, the methodology described by TPA in its Access Arrangement, and detailed in Attachment D, has not been followed exactly.  Rather it has been simplified to reduce the overall complexity.  For example, where a small proportion of an asset zone is used for delivery downstream, none of its costs have been fed into the tariffs for those downstream users.
The Commission considers that this simplifying of the model is not likely to produce significantly different tariffs to those which would be produced under a more complex and accurate model.  Indeed any differences would be lost in the final averaging of the tariffs for the 24 asset zones into tariffs for the eight pricing zones.
Murray Valley
The Murray Valley incremental tariff has been calculated separately on cost data for Murray Valley only.  This is in keeping with TPA’s stated approach of calculating incremental tariffs for new infrastructure.  The model assumes that gas flows in 1998 will be approximately one fifth of those in subsequent years.  However it also includes return on and of capital for half of 1998 and O&M for a full year.  The Commission considers this to be inconsistent.  It results in the proposed tariffs being higher than appropriate.  
Proposed Amendment - A3.12
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, the Murray Valley tariff should be calculated using a proportion of yearly costs similar to the proportion of yearly volumes forecast for 1998. 

Conclusion
The Commission is of the view that the chosen methodology is appropriate for the allocation of costs.  The tariff model, with the amendments proposed above, allocates costs to users on the chosen bases quite accurately.  At the final stage in the process, tariffs are averaged into eight pricing zones in order to present a relatively simple set of tariffs and to group users together to the extent that potential changes in usage by some customers will be unlikely to significantly affect tariffs.  This aggregating will necessarily mean that some users will pay more, and some less, than they would have if there had been a greater number of pricing zones.  However, overall the Commission is of the view that, after implementation of the proposed amendments, the tariffs will recover from each user a fair and reasonable share of costs.  
3.8.3	VENCorp’s Access Arrangement for the PTS
Service provider’s proposal
Some of VENCorp’s tariffs are the result of certain costs directly allocated to the relevant users and others are allocated to customers according to their capacity to bear the costs.  
There will be approximately 110 custody transfer meters (CTMs) in the PTS and approximately 700 Tariff D meters.  One million dollars of VENCorp costs are assessed to relate to data handling functions.  VENCorp believes reading and processing data from CTMs is more complex than from Tariff D meters and has consequently constructed two different tariffs.  The tariff of $7/day for CTMs is the same as the Victorian Power Exchange’s (VPX) wholesale meter fee (VENCorp considers the function of these two types of meters to be similar).  VPX has 3 000 meters similar to VENCorp’s 700 Tariff D meters.  VENCorp has escalated VPX’s charge of $1.60/meter by 50 per cent to reflect the lower efficiencies of reading a smaller number of meters.  This produces a tariff for Tariff D customers of $2.40/day.  This charge is expected to minimise the possible distortion arising from fully recovering costs in this tariff.  These tariffs produce an under-recovery of $109 000 which is recovered in other charges.
The registration fee (for each market participant) was set at $30/day based on previous work done in the electricity industry.  Fees on the three retailers will recover $32 850.  
The LNG system security costs (of $1.4 million) are allocated on total forecast injected volumes.  
System control costs associated with the WTS are $88 000.  These will be recovered by a commodity charge of 2.82 cents/GJ common to both Tariff V and Tariff D customers in that system.  
The balance of costs ($11.1 million of ‘common costs’) are to be recovered by a commodity charge on PTS users.  VENCorp notes that the proportion of injection volumes between Tariff V and Tariff D customers is 50.9:49.1.  However it has chosen to allocate 78 per cent of common costs to Tariff V customers resulting in a tariff for Tariff V customers of 7.64 cents/GJ and for Tariff D a tariff of 3.08 cents/GJ.  The reason for this allocation is that it produces charges which match customers’ ability to pay, minimises distortions in usage and results in VENCorp charges being about one per cent of total delivered costs to users.
Also note that where possible VENCorp costs have been allocated on a cost reflective basis. VENCorp common costs (being costs not readily allocated on a cost reflective basis) have in general been allocated in such a way as to ensure that total VENCorp charges do not exceed 1% of total delivered energy costs for any customer except in the cases of customers with low price elasticity, in which case the 1% may be exceeded as there will be no significant consequential distortion in usage.  Where specific beneficiaries of VENCorp services are identifiable, the costs are allocated directly to those beneficiaries.  An example of the latter is data reading.
Submissions by interested parties
Various submissions say insufficient detail has been given to understand the derivation of tariffs.  These concerns have been reduced by the release of supplementary information by EPD.  
BHPP and Esso note that all users will bear the cost of all VENCorp’s services, whether or not they use all the services.  BHPP believes that the basis of cost allocation is ad hoc and may change each year, adding to uncertainty.  It calls for VENCorp’s services to be optional so that customers only pay for those services they use.  BHPP also says
VENCorp’s total annual costs for the year ending 30 June 1999 are projected at $12 100 000 (Tariff Order, p. 7).  The loose regulation of VENCorp’s costs may have been designed to protect VENCorp from cost overruns.  This annual cost is based on merely the administrative, metering and (partial) LNG costs of operating VENCorp and not the actual costs of VENCorp’s market activities, which are to be recovered via Uplift.
It also appears that VENCorp’s tariffs are subject to increase when ‘reasonable’ costs are incurred.  This is inconsistent with the incentive mechanism required in the Victorian Access Code.  The EPD should provide cost control measures to protect the industry from potential huge VENCorp cost overruns.
CUB argues that gas transmission system operator (GTSO) (that is, VENCorp) tariffs are not cost reflective.  It says transmission functions should be paid according to capacity and spot market operations according to commodity.  It also says it is unacceptable that users have to pay GTSO’s total costs no matter what they are, that is, that there is an open-ended liability.  CUB prefers that a total cost (of say $11 million) be set with GTSO keeping any over recovery and bearing any under-recovery.  
The ACA says that a high proportion of costs are allocated on a volume basis such that high load factor customers will subsidise poor load factor customers.  It states that costs should be allocated on ‘anytime maximum demand’ to reflect customers’ use of VENCorp services.
Commission’s considerations
VENCorp has identified $1 million as directly attributable to the cost of reading customers’ meters.  It therefore seeks to recover these costs appropriately through a fixed daily charge as the costs are independent of volumes.  It notes that the reading of CTMs is more complicated than the reading of Tariff D customer meters and that therefore the appropriate tariff will be higher.  As it does not have cost data disaggregated between the two types of meters, any decision on the tariff levels will be somewhat arbitrary.  Given this, the Commission does not consider it inappropriate for VENCorp to model the tariffs on the structure existing in the electricity industry, adjusted with regard to what different user groups ability to pay.  As in other areas, the Commission expects that tariffs will be adjusted to reflect the costs incurred as soon as reliable data becomes available.
To recover the $11.1 million of ‘common costs’, VENCorp bundles the costs of system operation, spot market operation and end of day linepack (EoD linepack) operation into the one set of tariffs based on customer volumes.  This structure is not strictly cost reflective as not all users of the transmission system will be users of the other two markets and those who are users of the other two market services may use those services in different proportions to their total system usage.  
However, all users benefit from the operation of the spot market as it is likely to result in increased utilisation of the system.  This reduces the need for system expansion which may otherwise result in increased tariffs.
Further, it would be extremely difficult and somewhat arbitrary at this stage to establish a unit price for VENCorp services related to the spot market and EoD linepack as there is little indication of the volumes that will flow in these markets.  Thus, the Commission considers recovering the costs of the spot market operation and EoD linepack operation from all market participants to be appropriate at this time with a move to recovery from spot market participants when volumes are somewhat more certain.  
The proposed tariffs are not uniform with Tariff V customers paying more than twice as much per gigajoule as Tariff D customers.  To find an economic justification for this it may be noted that Ramsay pricing provides a way of covering costs by charging a premium above marginal cost in proportion to a customer’s willingness to pay.  
The marginal cost of any of VENCorp’s customers will be zero since VENCorp will undertake essentially the same ‘common’ expenditure irrespective of the load factor in the pipeline.  The appropriate collection of the $11.1 million of common costs will need to be covered by the Ramsay ‘premia’.  A reasonable proxy for willingness to pay is the actual cost of delivered gas to the user and it is on this basis that Tariff V customers pay more than Tariff D customers.  
VENCorp has constructed the tariffs so that for most users the total charge payable to VENCorp will be about one per cent of that user’s total cost of delivered gas.  VENCorp believes that this pricing will not distort consumption decisions.  While not a fixed charge, the charge approximates what might be imposed under a Ramsay pricing rule and therefore meets economic efficiency criteria.
Thus, in summary, the Commission accepts the proposed tariffs, mindful that they will be reviewed in May 1999.  The Commission expects that for subsequent regulatory years, the proposed tariffs will be more cost reflective to the extent that the available data facilitates.
3.9	Tariff path and incentive structure
3.9.1	Victorian Access Code requirements
The Victorian Access Code (section 8.3) allows discretion in choosing the way in which the reference tariff may be varied.  For example, it may be designed on the basis of a ‘price path’ approach (where a determined path is not adjusted yearly), a ‘cost of service’ approach (adjusted for actual outcomes) or variations or combinations of these approaches.
The Victorian Access Code (section 8.44) also states that the reference tariff should, where the Commission considers appropriate, contain a mechanism to enable TPA to retain some, or all, of returns which exceed the expected level, particularly where these increased returns are due to TPA’s efforts.  This incentive mechanism should give the service provider an incentive to increase sales volumes, minimise costs, develop new services, and undertake only prudent investment (section 8.46).  It should also ensure that users gain from increased efficiency, innovation and volume of sales.  
The Victorian Access Code (sections 8.47 - 8.48) provides that certain principles (any Structural Elements but not Market Variables) may be fixed at the time of a review.  Regard must be had to the interests of the service provider and users.  
3.9.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
Price formula for this regulatory period
EPD has chosen an average revenue yield control rather than a revenue cap or price cap.  In year 1 the tariffs are set as described in section 3.8.2 above.  In subsequent years, average tariffs will increase according to a CPI-X formula.  For the initial regulatory period X is 3.4 per cent.  
The average revenue allowable in any year is called the maximum average transmission tariff (MATT).  For each year after the first year, the MATT is the sum of the average transmission tariffs (by customer class and transmission pricing zone) in the first regulatory year, escalated by CPI-X and re-weighed for forecast volumes.  It is then adjusted by a correction factor (K).  To prevent distortion from inaccurate volume forecasts for gas to interconnected pipelines the Commission has a limited right to retrospectively adjust MATT.    
K is intended to correct for the differences in weighting between actual charging parameters and pricing zones, and the weightings forecast when the tariffs were approved.  The correction factor has two components, dealing with the difference between forecast and estimate volumes (Ka) and the difference between estimates and actual volumes (Kb).  Each individual tariff component is also capped by CPI+Y to protect customers from substantial movements in tariff components or major tariff rebalancing.  Y has been set at ‑2.4 per cent.  
The Commission can reject the revised forecasts, presented each year by TPA as part of TPA’s statement of proposed tariffs for the next regulatory year, if the Commission considers them not satisfactory.  This facility is meant to be a protection against gaming.
With average revenue capped, TPA has an incentive to reduce operational and maintenance expenditure, reduce capital expenditure and increase the total volume of gas transported.  
Price formula for future regulatory periods
The Access Arrangement proposes five year regulatory periods with a review at the end of each period.  It proposes a revision of the Access Arrangement be submitted by 30 June 2002 with the new arrangement to commence on 1 January 2003.  Clause 9.1(b) of the Tariff Order determines this subsequent regulatory period to be five years.  
Chapter 1 of the Tariff Order applies to all future tariff reviews by the Commission.  Clause 1.6(b) allows the Commission to regulate prices in any manner it considers appropriate.  Clause 1.6(c) states the Commission must have regard to:
1)	the cost of supplying services;
2)	the return on assets in the gas industry;
3)	relevant benchmarks for prices, costs and return;
4)	the financial implications of the determination; and 
5)	any other factors it considers relevant.
Clause 9.2 of the Tariff Order places limits on the Commission in its determination of the tariffs to apply in the subsequent regulatory period.  In summary, clause 9.2 of the Tariff Order (with the relevant sub-clauses noted) states that the Commission is to:
(a)(b)	use a CPI-X approach (not rate of return regulation) where only one X factor applies without revision for the entire subsequent regulatory period;
(c)(d)	in setting the X factor, apply a weighted average return which is commensurate with prevailing conditions in the market for investments having a similar nature and degree of business risks as those faced by TPA, and use the fixed asset base for TPA at the start of the initial regulatory period, being the value specified in its access arrangements, adjusted to take account of inflation since 1 July 1997, depreciation, additions and disposals;
(e)	have regard to the public policy adjustments to TPA’s fixed asset base which are identified in its access arrangements and which are designed to protect the interests of Consumers;
(f)(m)(l)	ensure a fair sharing between TPA and its customers of the benefits achieved through efficiency gains, if, in the initial regulatory period TPA has achieved efficiencies greater than the value implied by the value X in the CPI-X formula in the initial regulatory period;  with respect to this the Commission may issue a statement of regulatory intent;  this fair sharing may take place over more than one regulatory period; 
(g)	have regard to the need to take into account in the first year of the subsequent regulatory period the correction factor for the difference between forecast and actual quantities in the last year of the initial regulatory period; 
(h)	have regard to costs; benchmarks for prices, costs and returns on assets; and the level of executive remuneration by reference to benchmarks; and 
(i)	if a tariff is not cost reflective at the end of the initial regulatory period, facilitate a smooth transition to cost reflectivity of tariffs over time. 
Subsections (j) and (k) apply only to distribution tariffs and are irrelevant for the Commission.
Submissions by interested parties
No submissions directly addressed the issues in this section.  
Commission’s considerations
As noted in the Access Arrangement, TPA has an incentive to increase profits by reducing operational and maintenance expenditure, reducing capital expenditure and increasing the total volume of gas transported.  
The target revenue is not affected at all by changes in costs.  Consequently, any reduction in costs will result in an increase in TPA’s profit.  Consumers are expected to benefit in the subsequent regulatory period through lower forecast costs for that period.
Any changes in total volumes (either revised forecasts or those actually achieved) compared to the forecasts in the tariff model will not alter the average revenue TPA is allowed to collect.  Consequently, TPA has a strong incentive to grow the total market as the extra revenue generated throughout the regulatory period will result in an increase in profit.  Consumers will benefit indirectly as the higher volumes used in the subsequent regulatory period will result in lower tariffs from that time on.  
Any reduction in capital expenditure incurred compared to forecast will also result in increased returns for TPA.  This offers an incentive to TPA to choose the most cost efficient method of achieving the system enhancements sought from the forecast capital expenditure.  As discussed in the previous section, the Commission considers this incentive reasonable as long as TPA is required (by the SEA or some other means) to provide the capacity increase which is currently forecast to flow from the projects included in the tariff model.  
Price control formula.
There are, however, other incentives to certain behaviour introduced by the Tariff Order.  These are created by the mechanisms which determine the relationships between three sets of parameters:
•	tariff: injection, withdrawal and anytime;
•	customer:  Tariff V and Tariff D;
•	location:  the location of each price zone.
Pricing is uneven between the parameters in each set.  Consequently any change in the proportions of parameters in any set could lead to a change in revenue for TPA.  The price control formula (schedule 5 of the Tariff Order) holds the parameter mix in the first set constant while allowing some changes to the second and third.  These are discussed below.
As already noted, forecast volumes for the five years of the regulatory period have been presented in the Access Arrangement and feed into the tariff calculations.  In November each year revised forecasts for the next year, estimate forecasts for the current year and actual volumes for the previous year will be provided to the Commission.  At this time tariffs for the next year will be calculated using the price control formula.  
The use of average withdrawal revenues in the price control formula, which are held constant for the whole regulatory period, locks in the forecast capacity:commodity (peak/off peak) ratio used in the tariff model.  Thus TPA will benefit from any improvements in load factors, that is, a more efficient use of the system.  As total demand grows, customers will benefit in subsequent regulatory periods.
The more efficient use of the system will allow greater volumes to be transported before capacity enhancement is needed, with lower tariffs resulting as costs are spread over larger volumes.  However it is unclear to the Commission how TPA may promote improved load factors and therefore why it should benefit from them.  The major influence on load factors will be the financial incentive of the tariff structure, rather than any TPA initiative.  
Proposed Amendment - A3.13
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, the price control formula should be amended so that the K factor adjusts for any difference between the forecast load factor and that actually achieved. 

When the customer and location parameter mixes in actual sales differ from that forecast, the average revenue collected may also differ due to the different tariffs which apply to each parameter.  For example, if a greater proportion of actual sales are to Tariff V customers (as they would be in a relatively cold winter) then the average revenue collected will be greater than the forecast average revenue as the average tariff for V customers is greater than for D customers.  However, the revenue requirements of TPA will not have altered.  The K factor is calculated so that any extra (less) revenue collected in the previous year due to the actual parameter mix being different to that in the revised forecast is removed from (added to) the revenue requirements for the next year.  Thus there is no lasting affect on revenue from actual parameter mix changes.  
By contrast, any changes in parameter mix between the initial forecast volumes in the Access Arrangement and the revised forecast volumes is NOT corrected for.  This is the result of the MATT for each regulatory year being based on the average transmission tariff of the first year re-weighed for the volumes forecast for the regulatory year.  As a result, for example, a once-off forecast increase in the proportion of Tariff V customers will lead to a once-off increase in revenue, irrespective of whether that forecast is achieved.  A permanent actual increase in proportion of Tariff V customers will lead to a permanent increase in revenue (through the increase in the forecast mix) from the time of the change in forecast mix irrespective of whether this anticipates or responds to the actual change.  
Thus, TPA has a strong incentive to increase the forecast volumes for high tariff customers and decrease forecasts for low tariff customers.  High tariff customers are Tariff V customers as opposed to Tariff D customers; and customers in high tariff pricing zones (those furthest from Longford) as opposed to low tariff pricing zones (those closer to Longford, including Metro).  
It would appear that the only incentive TPA has to actually change the parameter mix (as opposed to forecasting a change) is that a change would give a better basis for justifying the forecast of an even bigger change in subsequent years.  Again, it is unclear to the Commission how TPA would be able to affect the parameter mix.
There are two safeguards provided to the Commission within the Access Arrangement which will help counteract this potential gaming.  First, no individual tariff can be increased more than one percentage point higher than the allowed increase in average tariffs.  If there is substantial gaming so that a significantly large K factor is calculated, TPA may not be able to consume the complete K factor in tariff increases.
Second, the Commission is able to reject forecasts it finds unsatisfactory.  Each year VENCorp will receive forecast volumes from both retailers and TPA independent of each other.  It is then to produce its own forecast for the following year by November.  VENCorp’s forecasts would greatly assist the Commission in its assessment of TPA’s forecasts.  
Proposed Amendment - A3.14
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, clauses 5.2.2(a)(2) and 5.2.3(a)(2) of the MSOR should be amended by inserting the words ‘and the Commission’ after ‘Participant’.  

The TPA is required to give the Commission its proposed tariffs (including tariff components which include forecast volumes) for a regulatory year at least 30 business days before the start of that regulatory year.  In light of the potential value of VENCorp’s forecasts, the Commission will not approve TPA’s proposed tariffs until it has had time to compare TPA’s submission with the VENCorp forecasts.  
Proposed Amendment - A3.15
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, clause 6.1(g) of the Tariff Order should be deleted and the following clause inserted: 
	If the regulator does not notify a regulated entity of the regulator's decision regarding a statement given by the regulated entity under clause 6.1(a) or (c) by the later of the following dates: 
(a)	20 business days after the day on which the regulator received the statement; or
(b)	10 business days after the day on which the regulator received VENCorp’s forecasts;
	the regulator is deemed to have approved the statement with effect from the 21st business day after the regulator receives the statement.  

It is hard to see any net benefit from this re-weighing mechanism in the price control formula.  It gives TPA an incentive to promote actual changes in the parameter mix to high tariff parameters.  However TPA’s incentive to increase overall volumes is a greater incentive for it to promote growth, irrespective of where, or for which type of customer, that increase in volumes may arise.  The incentive to game the Commission in its forecasts, resulting in higher tariffs to customers, is great.
The Access Arrangement Information does not offer any reason for the re-weighing that enables this gaming opportunity.  The incentive to favour some customers over others would appear to be contrary to the intention of section 8.46(a) of the Victorian Access Code which says incentive mechanisms should avoid artificially favouring the sale of one service (used here in a broader sense than ‘reference service’) over another.  The Commission therefore does not accept the proposed K factor calculations.  
Proposed Amendment - A3.16
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, the price control formula should be amended so that the K factor adjusts for the parameter mix differences between volumes actually achieved and those forecast in the Access Arrangements (rather than those revised forecasts given to the Commission with an application for altered tariffs prior to the start of each new regulatory year).

Productivity savings 
As noted above, the X in the CPI-X formula is not a productivity component.  Rather it is the solution to the question of what yearly adjustment to make to tariffs so that there is a smooth progression from the tariffs constructed for the first year of the initial regulatory period (while preserving the NPV of the target revenue stream for the initial regulatory period).
With regards to the sharing of productivity benefits in the first regulatory period, consumers benefit immediately from the savings imposed by EPD and those forecast by TPA, whether they occur or not, and TPA benefits from any further savings.  The proposed tariffs are based on these savings and the Tariff Order locks the tariffs into a set price path that will not be affected by costs or sales volumes in the initial regulatory period.
The proportion in which productivity benefits (and other factors which lead to returns in the initial regulatory period which are in excess of those implied by the WACC) are shared between users and TPA in the subsequent regulatory period will be determined by the Commission at the tariff review.  The limits on the Commission in this regard are discussed below.  
Regulatory lock-in
For future regulatory periods clause 1.6 of the Tariff Order regulates the Commission’s price determinations.  On top of this, clause 9.2 of the Tariff Order further defines and limits the scope of the Commission’s price determination for the subsequent regulatory period.  The intent of clause 9.2 is to guide the Commission on how productivity savings from the initial regulatory period are to be shared in the subsequent period and the structure of the tariff path in that period.
The Commission accepts the requirements of clause 1.6 of the Tariff Order.  They are very general and propose nothing more than what a prudent regulator would undertake in assessing TPA’s tariffs.
The Tariff Order (clause 9.2(f)) requires the Commission to ensure a fair sharing between TPA and its customers of the benefits achieved through efficiency gains which are greater than the value implied by X in the CPI-X formula.  Clause 9.2(a) and (b) require the tariffs in the subsequent regulatory period to be expressed in a CPI-X formula with only one X factor for the entire subsequent regulatory period.  This means that the average tariff path over the five years of the regulatory period is to be a straight line (as it is proposed for the first regulatory period).  However, clause 9.2 leaves it up to the Commission to determine the starting point and the end point for the subsequent regulatory period’s tariffs.  This flexibility enables the Commission to ensure that users gain from increased efficiency, innovation and volumes (section 8.46(e) of the Victorian Access Code).  
It is possible that TPA will, in the first regulatory period, achieve returns greater than those implied by the WACC used in calculating the target revenue.  These ‘excess’ returns may occur for a number of possible reasons including: volumes achieved are greater than forecast; costs are less than forecast; capital expenditure is less than forecast; etc.  In some cases the reason for the excess return will be due to the efforts of TPA and in other cases it will be no more than a ‘windfall’ gain by TPA.  The Commission understands the Tariff Order (as discussed in the above paragraph) will allow the Commission full discretion as to which parts of these excess returns are to be shared between TPA and customers, and which parts are to be wholly transferred to customers at the beginning of the subsequent regulatory period.  
In the context of this freedom afforded the Commission, clause 9.2(i) of the Tariff Order is somewhat confusing.  It could be understood by some to require that the smooth price path of the subsequent regulatory period begins with the tariffs applicable in the last year of the initial regulatory period (thus negating some of the Commission’s freedom described in the above paragraph).  The Commission understands (from discussions with EPD staff) that the intention of clause 9.2(i) is to isolate consumers from ‘rate shock’ which they might otherwise experience in the rebalancing of various distribution tariffs to cost reflectivity.  It is not intended to have any consequences for transmission tariffs.  
Proposed Amendment - A3.17
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, the word ‘distribution’ should be inserted before both occurrences of the word ‘tariff’ in clause 9.2(i) of the Tariff Order.  

In its consideration of which elements of the excess returns to allow TPA to benefit from in the subsequent regulatory period, the Commission will expect TPA, as part of its submission to the Commission’s review of tariffs, to identify the source of any excess returns and to present supporting arguments for the portion of the excess return from which it claims it should continue to benefit.  
The principles nominated by EPD in clause 9.2 (d) of the Tariff Order also effectively require that the tariffs be based on the asset base determined for the start of the initial regulatory period adjusted for inflation, depreciation, additions and disposals.  Any ‘mistake’ in the construction of the tariff base which may subsequently become apparent would thus be locked in.  The Commission considers that it is appropriate that redundant assets be removed from the capital base.  An appropriate amendment has been proposed in section 3.3 above. 
The Commission notes that clause 9.2(h)(3) of the Tariff Order requires the Commission, in its review of tariffs, to consider the level of executive remuneration in TPA compared to the private sector.  This should go towards meeting industry concern that there are no controls over operational costs, with special reference to executive salary abuses in the UK. 
The Commission consider the other requirements of clause 9.2 of the Tariff Order not discussed, to be reasonable and acceptable and in line with the Victorian Access Code.
Conclusion
The proposed tariff structure and price control formula do give TPA incentives to decrease costs, increase market demand and reduce capital expenditure.  The price control formula also seeks to introduce other ‘incentives’ with which the Commission does not agree.  They largely consist of mechanisms which expose TPA to potential revenue increases (and decreases) on the basis of changes in market attributes for which it is unlikely to be responsible.  Consequently the Commission has proposed that these be removed from the formula.  Similarly, it has proposed the removal of attributes which give TPA incentives to game the Commission.  
One factor in constructing the appropriate incentives for TPA is the extent to which TPA will be allowed to keep returns in excess of those implied by the WACC, both in the initial regulatory period and any continuing benefit in the subsequent regulatory period.  The Commission proposes to avoid any restrictions on its ability to act as it considers most appropriate at the time.  In that regard, the Commission is pleased that the Tariff Order seeks to place few limits on it.  As noted above, the Commission has accepted those few limits with modification.
3.9.3	VENCorp’s Access Arrangement for the PTS
Service provider’s proposal
EPD has stated:
The organisational form selected by EPD for VENCorp is intended to be a not-for-profit entity.  This has the advantage that the system operator is not required to earn a profit which in itself might create difficulties for a body, at least initially, that is meant to be a neutral and impartial system operator and is a monopoly.  
The board of VENCorp, which includes industry representatives, has the ability to establish incentive arrangements with management in order to limit costs and achieve other desired objectives related to, e.g. safety, reliability, the efficiency of metering and settlement activities etc.  EPD consider that the VENCorp board is in a better position than EPD, or a regulator, would be to define the appropriate balance between costs, risk management and the quality of other services that VENCorp is expected to deliver (such as safety, reliability and metering and settlement services). 
EPD considers it desirable to rely initially on a high level of disclosure of VENCorp’s activities and costs and a light handed regulatory approach so as to provide VENCorp, under the oversight of its board, flexibility to carry out its functions.  Over time and as experience develops, there is no reason why such incentives as suggested by BHP could not be incorporated in the Access Arrangements should it be considered necessary although the issues of appropriately capitalising VENCorp to bear the risk created by the incentive arrangements would need to be considered. 
Submissions by interested parties
Submissions have noted that there is no incentive for VENCorp to be efficient.  BHPP  stated:
It appears that VENCorp’s revenue requirement will not be subject to any effective regulatory oversight.  (The reliance on a Board to provide cost control is completely inadequate.  No Board could be constituted and administered in a way that would effectively represent the diverse interests of gas industry players.)  This is particularly worrisome given that VENCorp’s costs may well be much higher than projected given the experience of ISOs generally.
There appear to be no ‘incentive’ features to VENCorp’s tariffs.  Each year VENCorp will give the regulator its projected cost service and its projected tariffs.  The regulator appears to have broad scope to review these tariffs, though it is worrisome that the regulator has no explicit mandate to hold VENCorp to any prudence standards or cost control standards (Tariff Order, p. 8).
Nova Gas also states that the total pass-through of costs does not make VENCorp accountable and gives it no incentives to control costs.  
Commission’s considerations
The proposed VENCorp tariffs are calculated to recover all relevant forecast costs for 1998/99.  In the month prior to each subsequent year the tariffs are to be recalculated to recover forecast costs for that year after adjustment for the difference between actual costs and revenue in the preceding year.  
For example, if in 1998/99 revenue collected is less than costs (either because there was a cost blow out or because volumes were smaller than forecast and therefore receipts were lower) then the 1999/00 tariffs calculated in June 1999 would be designed to recover this shortfall as well as all forecast 1999/00 costs (which themselves may be significantly higher than forecast or actual 1998/99 costs).  Thus it is clear that VENCorp has no financial incentive to reduce costs.
EPD considers that industry participation on the board of VENCorp will impose an adequate restraint on costs.  Some industry participants are sceptical of this.  Some stakeholders have suggested that the Commission should exercise some form of control over VENCorp.  However, given that VENCorp is a non profit organisation with no outside funding it is difficult to see how the Commission can impose cost control.  In addition, the underlying policy supporting both the Victorian and National Access Codes is premised on the relevant regulator(s) maintaining as light-handed an approach as possible in the performance of its duties.
The Commission understands industry’s concerns expressed in submissions that there is limited incentive for VENCorp to operate efficiently.  There are few avenues available for the introduction of incentives to a non-profit organisation, though the Commission believes industry participation on the board of VENCorp will produce some discipline.  To this end, it is noted that the directors will be subject to Corporation’s Law and the responsibilities which arise from that law.
The Commission has attempted to counter this concern by opening VENCorp operations to greater public scrutiny.  The Authorisation of the MSOR, which is also before the Commission, has been approved on the condition (among others) that VENCorp consult with industry over its proposed fees each year and report on this to the Commission, and that after the end of each year VENCorp report to industry on its actual performance against budget.  The Commission proposes the same amendments to the MSOR for the purposes of this Draft Decision.
Proposed Amendment - A3.18
	In order for VENCorp’s Access Arrangement for the PTS to be approved, clause 2.5 of the MSOR should be amended to the following effect:
(i)	VENCorp, before submitting its annual statement to the regulator for approval in accordance with clause 6.1 of the Tariff Order, must publish a report setting out:
(a)	the budgeted expenditures and revenues, and the structure and value of proposed market fees for the next regulatory year;
(b)	the method used in determining the proposed structure and values; and
(c)	an assessment of the extent to which the proposed structure and values comply with the principles set out in section 8.1 of the Victorian Access Code.
(ii)	In preparing its proposed structure and value of market fees, VENCorp must consider other fee structures and values in existence which are appropriate for comparison purposes.
(iii)	The above report must be made available to market participants and interested parties upon request, and a copy supplied to the Commission.
(iv)	Interested parties have 20 business days after the release of the report to make submissions to VENCorp.
(v)	VENCorp must consult interested parties and reconsider its fee structure and values in light of any submissions or comments that it receives.
(vi)	VENCorp must compile a report of any submissions and consultations.  This report must be submitted to the Commission when fees are submitted to it for the annual regulatory review.  
(vii)	One month after the end of each financial year, VENCorp must publish a report setting out its budgeted and actual expenditures and revenues for the previous financial year, and analysis of any significant variation.  The report must take into account and separately identify, for the previous financial year, current and projected expenditures and revenues in respect of each of VENCorp’s activities/functions, including:
•	system security; 
•	collection, storage and processing of metering data and billing and settlement of market transactions; 
•	costs of operating the dispute resolution function; and 
•	the funding requirements of the participant compensation fund.  
The report must be made available to market participants and interested parties upon request, and a copy supplied to the Commission.

It should also be noted that if VENCorp’s costs increase too much (as some industry participants fear in the light of the experience in the electricity industry) it could change the cost/benefit assessment in the Authorisation and result in a reconsideration of the Authorisation.  It is the Commission’s intention to monitor VENCorp’s costs closely in line with industry concerns.
3.10	Assessment of reference tariffs and reference tariffs policy
3.10.1	Victorian Access Code requirements
Section 3.7 of the Victorian Access Code requires the access arrangement to include a policy describing the principles that are to be used to determine a reference tariff (a reference tariff policy).  This reference tariff policy must, in the Commission’s opinion, comply with the reference tariff principals in section 8 of the Victorian Access Code.
Section 8 of the Victorian Access Code contains the general objectives for a reference tariff and certain factors about which the relevant regulator must be satisfied before approving a reference tariff.
Section 8.1 of the Victorian Access Code requires reference tariffs to be designed with the objectives of: recovery of efficient costs; replication of a competitive market; ensuring the safe and reliable operation of the pipeline; efficient investment decisions; efficiency of the tariff structure; and incentives to reduce costs and develop market.
According to section 8.2 of the Victorian Access Code, before approving a proposed reference tariff, the relevant regulator must be satisfied that the service provider has complied with the methodologies and principles contained throughout section 8 of the Victorian Access Code. 
3.10.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
Clause 5.3.4 of the Access Arrangement says that the principles used to determine the reference tariffs are defined in section 4 of the Access Arrangement Information.  Clause 5.3.4 also refers to mechanisms and formulae in the Tariff Order and to the extensions/expansions policy.  
Section 3.2(a) of the Access Arrangement Information lists the following five ‘pricing principles’.
1)	Consistency with the Victorian Access Code.  Here TPA listed the six objectives contained in section 8.1 of the Victorian Access Code;
2)	Cost reflectivity.  Costs are allocated to users according to their use of assets and benefit received from operation; 
3)	Efficient pricing signals.  Tariffs are priced at a level commensurate with the long run marginal cost of providing that service.  This provides appropriate signals to users and developers of gas sources;  
4)	Recovery of allowed revenue.  The average revenue regulation aims to allow TPA a reasonable return on assets, whilst providing tariff stability for users and incentives on TPA to improve operational efficiency; and 
5)	Price stability.  Tariffed prices at each off-take should be stable.  This is consistent with providing long-run pricing signals.
Submissions by interested parties
Most of the comments from interested parties relevant to the assessment of reference tariffs have already been considered under previous sections in this Draft Decision.  However, there has been general scepticism expressed about the efficiency aspects of the Access Arrangements which warrant further comment.  For example, BHPP states that users will not be able to make efficient decisions as ‘the true cost of peak usage is unknowable’, and the EAG states:  
The major group of customers creating the peak load demand, the franchised Tariff V customers are excluded from pricing signals by both the glide path approach and the uniform tariff in place until the first five year pricing review to be completed by until 2002. The glide path approach again ameliorates rate shock for another 5 years. 
How can the proponents of the market changes expect consumers to adjust their demand to reduce consumption if the event has occurred a month or so ago. This issue is exacerbated by the imposition of a glide path ensures that the major pricing signals are masked from the most significant source of constraint, deemed consumers. 
Commission’s considerations
It is unclear to the Commission what constitutes TPA’s reference tariff policy.  The Victorian Access Code expects the reference tariff policy to contain principles used to determine the reference tariffs.  The principles described by TPA in section 3.2(a) of its Access Arrangement Information appear to satisfy the Victorian Access Code’s requirement in both style and substance.  In contrast, the items listed by TPA in clause 5.3.4 of its Access Arrangement include mechanisms and formulae which the Commission does not consider to be consistent with the concept of ‘principles’ as used in the Victorian Access Code.  Finally, the term ‘reference tariff policy’ is contained in neither TPA’s Access Arrangement or the Access Arrangement Information.  Consequently, the Commission concludes that no reference tariff policy has been included in the Access Arrangement.
Proposed Amendment - A3.19
	In order for TPA’s Access Arrangements for the PTS and WTS to be approved, TPA should develop and include in the Access Arrangements a reference tariff policy as required in section 3.7 of the Victorian Access Code. 

The Commission understands that TPA is in the process of developing a reference tariff policy which will be made available to the Commission.
The Commission’s assessment of the reference tariffs in the TPA’s Access Arrangements for the PTS and WTS pursuant to the Victorian Access Code has been made throughout the discussion in this chapter so far.  The following discussion draws together the Commission’s conclusions within the framework of the introductory sections (8.1 and 8.2) of the Victorian Access Code’s section on reference tariffs.
Section 8.1 objectives
Recovery by the service provider of efficient costs associated with the provision of reference services (8.1(a)) - 
The Commission has taken considerable care (in section 3.5) to ensure that the proposed the rate of return (WACC) (as amended by the Commission’s proposals) will provide the service provider with a commercial return on its investments.  The outcome of the CAPM/WACC framework adopted for this purpose was supported by the likely credit rating analysis of TPA by both the Commission and Macquarie Bank (section 3.7 of the Draft Decision).  The requirement within the Access Arrangements for new investment to be retained in the regulatory asset base only if it conforms to set prudency requirements (section 3.3) will ensure that the relationship between commercial returns and efficient investment will be maintained over time.  Complementary to the determination of this analysis is the way other costs have been scrutinised and amendments required to the Access Arrangements, where necessary, to ensure that forecast costs being incorporated into the tariffs reflect efficient costs likely to be incurred during the regulatory period (section 3.6.2).  Subject to the required amendments being made to the Access Arrangements the Commission considers that reference tariffs will provide the service provider with the opportunity to earn a stream of revenue which recovers efficient costs associated with the reference services.
Replicating the outcome of a competitive market (8.1(b)) - 
Given that the provision of the reference services is a natural monopoly the is a question of how this counter-factual objective is to be interpreted.  In this context, the setting of the rate of return based to a value commensurate with commercial returns achieved by similar operations against their stock market valuations (the CAPM framework) means that scope for monopoly profits is strictly limited, and, that consistent with the previous paragraph, the returns achieved are expected to be similar to those achieved by a firm facing similar commercial risks operating in a competitive environment.  The return will be based on only those assets necessary to deliver the services required.  This is achieved through the optimising process in the valuation of assets.  While the reference tariffs will also allow TPA to achieve a return in excess of a normal return from increased efficiencies and growth in sales, this can also occur in a competitive market.  However, over time, as in a competitive market, this benefit will pass onto customers.  Pricing reflective of efficient costs is also a feature of competitive markets and as already mentioned in the previous paragraph care has been taken to ensure that tariffs are reflective of efficient costs.  However, competitive markets also achieve this property at the level of individual services, thereby ensuring price structures which achieve an efficient allocation of resources by users.  Such an efficient structuring of tariffs in these Access Arrangements is achieved by ensuring that individual reference tariffs are based on an allocation of costs which reflect both current and long run costs of providing the reference service in question (section 3.8).  
Ensuring the safe and reliable operation of the pipeline (8.1(c)) - 
The reference tariffs are based on costs forecast as being necessary for the safe and reliable operation of the pipeline.  Each tariff review is an opportunity for TPA to increase its revenue if the safety and reliability of the pipeline demands it.  Other factors which will tend to preserve the integrity of the system include the contractual arrangements that TPA has with VENCorp to maintain the service envelope and the need by TPA to satisfy commercial markets that its assets are well maintained and operated efficiently.
Not distorting investment decisions in pipeline transmission systems or in upstream or downstream industries (8.1(d)) - 
Efficient investment decisions upstream and downstream will be facilitated by pricing based on an allocation of costs to users which approximates long run costs of service provision (section 3.8.2).  Inter-temporal investment distortions are minimised by the levelising process which present stable prices over the regulatory period and the CCA framework which avoids tariffs which increase or diminish markedly over time.  EPD has argued that for TPA to undertake efficient levels of system expansion it needs to recover all the revenue it receives from charging the tariff applicable to the zone where demand is satisfied by the relevant system expansion.  Under the Commission’s proposed amendments, TPA will only receive revenue equal to the increased sales volumes multiplied by the average tariff for the whole TPA system.  
However, the Victorian Access Code allows for TPA to impose surcharges to make up for any revenue above that collected through tariffs which is necessary to justify any investment decision.  This means that such expansions will only be undertaken when the user can justify the surcharge in terms of the benefits to its own business or when TPA can justify a surcharge on the basis of benefits to the overall system (section 4.7).  While the WACC selected by the Commission is towards the high end of the nominated range (section 3.5) this is considered unlikely to encourage over investment because of the redundancy provisions which have been introduced into the Access Arrangements (section 3.3).  The risk of inefficient investment by another pipeliner seeking to bypass the system is minimised by the upper limit, DORC valuation, placed on assets by the Code which would tend to create pricing which makes such ventures commercially unviable (section 3.2).  To the extent that new markets may emerge, the additional volumes will, as a result of the regulatory framework, lead to lower tariffs for all users sharing the same infrastructure.  This will maintain the price advantage of the incumbent with the access arrangement providing for competition in related markets both upstream and downstream.  The Commission is satisfied that the reference tariffs will not distort pipeline investment decisions or investment decisions in related markets.  
Efficiency in the level and structure of the Reference Tariff(s) (8.1(e)) - 
The efficiency of reference tariff structures has been already noted above.  However, some additional comments that relate to the market carriage arrangements are also warranted.  The structure of the tariffs is efficient in that users who purchase from the spot market pay for transportation only from the hub.  However, the tariffs are inefficient in that they will require the same payment from users irrespective of the source of that user’s gas.  The Commission has sought to correct this in its proposed amendment to the tariff applicable to users sourcing gas from NSW.  There remains a small inefficiency to the extent that the tariffs do not accommodate users sourcing from alternatives other than those assumed in the tariff model.  This problem is considered relatively small, hard to correct without historical volume data, and will only occur for two years of the initial regulatory period.  A more efficient structure may be contemplated in the next tariff review.  EAG’s comments above do not take into account that the price signals transmitted from TPA’s tariffs will be seen by retailers and a few large users.  Tariff V customers will be charged by retailers and retailers may well construct tariffs that transmit appropriate pricing signals.  The major advantage of the market carriage system which does not seem to be appreciated in the comments of BHPP and EAG above, is that it is not the specific price signals on five peak days which is important.  Rather, it is the general incentive for those users with discretion in the volumes they demand to reduce those volumes throughout periods of high demand, not just on the five days which would otherwise lead to peak demand.  Such behaviour, has the potential to enhance the efficient use of the pipeline with benefits emerging for both customers and the pipeline operator. 
Incentives for the service provider to reduce costs and expand the market (8.1(f)) - As noted in section 3.9.2 above, the Commission considers that the proposed tariffs and price control mechanism give TPA incentives to increase sales volumes, minimise costs and develop new services.  While, the service provider reaps most of the benefits of such developments in the initial regulatory period, the benefits of increased efficiency, innovation and volume of sales will flow to users in subsequent regulatory periods.
The Commission is satisfied that, with the suggested changes to the proposed Access Arrangements, the reference tariffs and the proposed tariff adjustment process are generally designed to achieve the objectives stated in section 8.1 of the Victorian Access Code.
Section 8.2 factors
Section 8.2 of the Victorian Access Code lists five factors on which the Commission must be satisfied in determining whether to approve the reference tariffs.  These are assessed below.
Total revenue to be consistent with the principles and one of the methodologies of section 8 of the Victorian Access Victorian Access Code (8.2(a)) - 
The Commission considers that the total target revenue in the proposed Access Arrangements is based on a tariff setting procedure involving assumptions which are inconsistent with certain aspects of the Victorian Access Code.  Accordingly, the Commission has proposed amendments which would reduce the total revenue by approximately 17 per cent and improve the allocation of costs for forming reference tariffs (sections 3.5, 3.6 and 3.7).  The Commission is of the view that the proposed amendments in this Draft Decision will be consistent with the principles contained in section 8 of the Victorian Access Code. 
The proportion of total revenue that any one reference tariff is designed to recover is calculated consistent with the principles of section 8 of the Victorian Access Code (8.2(b)) - 
The Commission is satisfied that, with the amendments proposed, the allocation of operating, maintenance and other non-capital costs between tariffed services and non-tariffed services will be appropriate (section 3.8).  The Commission’s proposed amendment to the allocation of return on, and of, capital will result in reference tariffs covering an appropriate share of joint costs.  The Commission is satisfied that the allocation of costs between reference services is also consistent with the principles of section 8 of the Victorian Access Code.  
The proportion of total revenue recovered from users of a service is calculated consistent with the principles of section 8 of the Victorian Access Code (8.2(c)) - 
The Commission conducted a detailed review of the computer models used to allocate costs to specific tariffs by user group and by zone to ensure that such allocations were in compliance with, and were likely to meet, the objectives of the Victorian Access Code (section 3.8).  The Commission considers that, after implementation of the proposed amendments, the tariffs will recover from each user a fair and reasonable share of costs.  
Incentive mechanisms are incorporated consistent with the principles of section 8 of the Victorian Access Code (8.2(d)) - 
Incentive mechanisms are incorporated into the reference tariffs and the mechanisms for adjusting tariffs over time (section 3.9).  Essentially, the incentives emerge from a combination of Access Arrangement provisions and the opportunity to achieve above normal returns as outlined above in the discussion of incentives.
Forecasts are best estimates (8.2(e)) - 
The Commission considers the forecast O&M costs in the Access Arrangement Information to be reasonable after requiring a reduction of 2.3 per cent per year (see section 3.6.2 above).  The Commission is aware of the ORG’s consultancy on demand forecasts which questions the methodology used though accepts the final figures as reasonable.  While sharing some of the reservations, the Commission considers that the forecasts are adequate for their purposes in the tariff calculations.  It has considered EPD’s forecast capital expenditure of $60 million over the five years of the initial regulatory period contained in the Access Arrangement Information which is based on a consultant’s evaluation of GTC’s forecast of approximately $500 million capital expenditure.  With the proposed amendments previously noted, the Commission is of the view that these forecasts represent best estimates arrived at on a reasonable basis.
Pass through of tariff reductions
The Commission considers that the implementation of the amendments required by this Draft Decision will lead to reference tariffs which meet the requirements of the Victorian Access Code.  However, for the objectives of the Code to be met, it will be important for all users to be exposed to the full impact of these changes.  At present, the prices for natural gas to many customers are set according to legislated retail tariff caps.  Therefore, in this context, the Commission considers it important that the Victorian Government reduce the legislated retail tariff caps to fully reflect any reduction in transmission tariffs resulting from the Access Arrangements.
3.10.3	VENCorp’s Access Arrangement for the PTS
Service provider’s proposal
EPD has, for the majority of VENCorp’s costs, chosen an ‘end-use customer bearable methodology’.  VENCorp’s costs are estimated to be about one per cent of retailer’s costs in the Victorian Gas Industry.  One of VENCorp’s charging principles is that VENCorp’s charges should be around one per cent of delivered energy costs for most customers.  This generally ‘means that higher-use customers must be levied a lower average $/GJ rate than low-use customers’.  If charges materially exceed one per cent, it will be for a customer segment which has a low price elasticity.
In its Access Arrangement Information, VENCorp lists the tariff design objectives of section 8.1 of the Victorian Access Code.  It also gives (in section 3.3(a)) the following set of guiding principles by which cost allocation methodologies and the resulting tariffs are to be tested:
(1)	allocate VENCorp costs to end-use customer groups on a commercially reasonable and economically efficient basis;
(2)	allocate costs so as not to distort potential investment decisions in pipeline and end-user facilities;
(3)	provide incentives to grow the gas market;  
(4)	costs must be simple to understand and implement; and
(5)	as far as possible, allocation should be cost reflective.
In the Supplementary Information of 6 March 1998, VENCorp gives another set of guiding principles used in constructing tariffs:
•	they must be simple to understand and implement;
•	VENCorp charges should be around one per cent of total delivered energy costs for most customers;
•	where charges exceed the one per cent guideline, this should be for customer segments with low price elasticity.
Submissions by interested parties
Submissions noted that VENCorp’s charges result in customers paying for all VENCorp’s services even if they do not use them.
Commission’s considerations
It is unclear to the Commission what constitutes VENCorp’s reference tariff policy.  Section 3.2(a) of VENCorp’s Access Arrangement Information summarised section 8.1 of the Victorian Access Code.  The Access Arrangement Information lists one set of guiding principles and the Supplementary Access Arrangement Information lists another.  The term ‘reference tariff policy’ (which would clearly identify the appropriate principles) is not contained in VENCorp’s Access Arrangement Information even though the Access Arrangement (5.3.4) indicates it will be.  Consequently, the Commission concludes that no reference tariff policy has been included in the Access Arrangement.
Proposed Amendment - A3.20
	In order for VENCorp’s Access Arrangement for the PTS to be approved, VENCorp should develop and include in the Access Arrangement, a reference tariff policy as required in section 3.7 of the Victorian Access Code.

Section 8.1 objectives
While the proposed reference tariffs for VENCorp, on their own (see below), may not appear to achieve all of the objectives of section 8.1 of the Victorian Access Code, the Commission considers that the VENCorp Access Arrangement cannot be assessed in isolation from its context which is the reform of the Victorian gas industry.  Specifically, the VENCorp Access Arrangement should be considered alongside the proposed TPA Access Arrangements.  This holistic approach is contemplated by section 9.2 of the Victorian Access Code.  
Within most gas industry structures, the TPA and VENCorp functions would be undertaken by the one entity.  EPD considers that the proposed market carriage system will function better with the pipeline operator being independent of the pipeline owner.  The Commission accepts this proposition (see section 4.2 below).  The Commission considers it is reasonable to expect the objectives of the Victorian Access Code to be satisfied by the combination of the two Access Arrangements.
Recovery by the service provider of efficient costs associated with the provision of reference services (8.1(a)) - 
Full cost recovery leaves open the likelihood of inefficiencies.  On the other hand, the non-profit nature of VENCorp will mean that any over-recovery of costs will automatically be passed back to customers in the following financial year.  Further, the Commission is of the opinion that industry representation on the board of VENCorp will result in some control of costs.  Finally, the Commission has proposed amendments which will open VENCorp to greater public scrutiny.  These factors should help minimise inefficiencies.  If significant problems do occur, the reassessment of the Access Arrangement in 2002 will afford an opportunity to adopt a structure which, in the light of experience, is more appropriate.
Replicating the outcome of a competitive market (8.1(b)) - 
VENCorp is a not-for-profit operation and therefore many of the features which may otherwise require scrutiny become irrelevant.  The remaining factors pertinent to replication of a competitive market are efficiency and cost-reflective pricing.  These aspects are considered further below.
Ensuring the safe and reliable operation of the pipeline (8.1(c)) - 
The fact that VENCorp’s revenue is based on full cost recovery means that the safe and reliable operation of the pipeline should not be threatened by cost considerations on its part.  To the extent that the safe and reliable operations of the pipeline depend on TPA, VENCorp will, through its SEA with TPA, be able to require pre-determined levels of safety and reliability.
Not distorting investment decisions in pipeline transmission systems or in upstream or downstream industries (8.1(d)) - 
These tariffs are not likely to distort investment decisions in upstream or downstream industries as by their design they will only contribute one per cent to most user’s costs.  Charges greater than one per cent of total costs will only be levied on users with low price elasticity and even then such costs will remain only a small component of their overall cost of gas.
Efficiency in the level and structure of the reference tariff(s) (8.1(e) - 
Some of VENCorp’s charges are cost reflective (as discussed in section 3.8.3 above).  The majority of charges to customers, though, do not reflect the costs incurred by those customers but are charged, as VENCorp states, on ability to pay and the basis of VENCorp charges being one per cent of retailers’ costs.  There are no clear cut economic answers to VENCorp’s pricing.  The Commission considers that using a ‘customer bearable methodology’ in line with Ramsay pricing is likely to be less distorting than some alternatives.  In this context the efficiency criteria is preferred to an allocation of costs on some kind of pro rata basis or the same price for all.
Incentives for the Service Provider to reduce costs and expand the market (8.1(f)) - 
As already noted in section 3.9.3, the structure of VENCorp as a non-profit entity removes the possibility of incorporating incentive mechanisms into the tariff structure.  However, considering TPA and VENCorp together, the market will benefit from a transmission service provider having an incentive to grow the market.  Further, most of the costs associated with transmission will be related to cost reduction incentives (VENCorp costs are only one seventh of all transmission costs).
Thus, the Commission considers that the objectives of the Victorian Access Code have largely been met by the proposed VENCorp tariffs.  In the cases where an objective has not been met, this is the result of the limitations of VENCorp being a separate entity to TPA and the Commission considers the failure to achieve these objectives to be outweighed by the advantages of the pipeline operator being separate from the pipeline owner.  
Section 8.2 factors
The costs of several services are bundled together into one tariff which results in a tariff which does not initially appear to satisfy the Victorian Access Code’s requirement (section 8.38) that users pay for the services they receive.  However, the Commission is of the view that given the structure of VENCorp and given that historical data are not yet available for its operations, tariffs more accurately reflecting users’ costs are not technically feasible at this time.  
Although section 8.2 of the Victorian Access Code notes factors on which the Commission must be satisfied, there is no rational basis for assessing whether the criteria are met or not, given that there is no actual market for VENCorp services.  Therefore, the Commission has chosen to not apply a literal interpretation of section 8.2.  Rather, the Commission has focussed on the need for VENCorp services to facilitate the operation of Access Arrangements proposed by TPA and the efficient operation of the market for gas.  In this broader context, the structure of VENCorp and its tariffs may be considered acceptable as an integral part of an efficient gas market.  To the extent that the segments of the gas market meet the section 8.2 criteria, the Commission has no reason to reject the VENCorp Access Arrangement on the basis that it does not meet the section 8.2 criteria.

4.	Other Mandatory Elements
	The mandatory elements of the Victorian Access Code include the following aspects of pipeline access details:
•	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 market carriage or contract carriage pipeline;
•	a trading policy which refers to the trading of capacity.  This is not consistent with a market carriage pipeline, such as the PTS, although some issues arise in this case of ‘capacity rights’ trading in a multi zone context.  A trading policy is relevant for the WTS as it has been designated a contract carriage pipeline by the service provider;
•	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 Victorian Access Code; and
•	a review date by which revisions to the Access Arrangements must be submitted and a date on which the Access Arrangements are intended to commence.
	Reference tariffs are also a mandatory element of an access arrangement and these are assessed for compliance with the Victorian Access Code in chapter 3 of this Draft Decision.
	In this chapter each aspect of a mandatory element for the PTS and WTS as listed above is assessed for conformance with the Victorian Access Code.  The Victorian Access Code requirements are outlined for each mandatory element followed by an outline of the service provider’s proposal, the issues raised in submissions, and the Commission’s considerations.  This is followed where relevant by amendments which must be made for the Access Arrangements to be approved.   
4.1	Access Arrangement
4.1.1	Victorian Access Code requirements
The Victorian Access Code requires that an access arrangement be in writing, and that it may specify regulatory instruments with which the service provider will comply (section 3.1).  The service provider must have sufficient rights for it to be able to deliver its services in accordance with its access arrangement (section 3.2).
4.1.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
TPA has submitted its proposed Access Arrangements in writing specifying that it will comply with the Victorian Access Code, the MSOR (PTS only) and the Tariff Order.  TPA has submitted that it has sufficient rights in respect of the PTS and the WTS (including under the Pipelines Act 1967, Gas Industry Act 1994 and (in relation to TPA) the lease between it and TPA Assets) to make available its services in accordance with the Access Arrangements.
Submissions by interested parties
No material concerns have been raised about compliance with sections 3.1 and 3.2 of the Victorian Access Code.
Commission’s considerations
The Commission is unaware of any material non-compliance with sections 3.1 and 3.2 of the Victorian Access Code.
4.1.3	VENCorp’s Access Arrangement for the PTS
Service provider’s proposal
VENCorp has submitted its proposed Access Arrangement in writing specifying that it will comply with the Victorian Access Code, the MSOR and the Tariff Order (where applicable).  VENCorp has submitted that, upon establishment it will have sufficient rights in respect of the PTS (including under the Pipelines Act 1967, Gas Industry Act 1994 and the operations agreement between it and TPA) to make available its services in accordance with the Access Arrangement.
Submissions by interested parties
No material concerns have been raised about compliance with sections 3.1 and 3.2 of the Victorian Access Code.
Commission’s considerations
The Commission is unaware of any material non-compliance with sections 3.1 and 3.2 of the Victorian Access Code.
4.2	Services Policy
4.2.1	Victorian Access Code requirements
Sections 3.3 and 3.4 of the Victorian Access 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 relevant 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.
4.2.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
TPA states in its Access Arrangements for the PTS and the WTS that it will offer tariffed transmission services, excluded transmission services and competitive transmission services to users or prospective users of the PTS and WTS.  Tariffed and excluded transmission services will be made available at the reference tariffs and in accordance with the reference tariff policies (clause 5.3).  Reference services will be made on the terms and conditions described in clause 5.4.
TPA advises that these services are defined in chapter 10 of the Tariff Order and are described more fully in the description of TPA’s service envelope in relevant clauses.  The Tariff Order defines the tariffed transmission services, specifies the initial tariffs for these services, and the basis for variation of the tariffs over the regulatory period.  It also regulates the prices of excluded transmission services, which are services that are not considered to be amenable to formula-based price controls.  The Tariff Order lists initial prices for scheduled excluded services, and regulates prices for non-scheduled excluded services on the basis that such prices are required to be ‘fair and reasonable’ consistent with the requirements of the Victorian Access Code.  Any services offered by TPA which are not tariffed transmission services or excluded transmission services are competitive transmission services, whose prices are not regulated by the Tariff Order or the Victorian Access Code.  Chapter 3 of the Draft Decision assesses the proposed reference tariffs.
TPAA as owner of both the PTS and WTS will lease the PTS and WTS to TPA under a short term operating lease, thereby enabling TPA to offer the services described in these Access Arrangements. 
Submissions by interested parties
Some parties, including AGL, Australian Gas Users Group (AGUG), BHPP, Esso and Amcor raised concerns in their submissions about the adequacy of the services policy being offered for the PTS for reasons associated in large part with the choice of the market carriage model.  In particular, parties were concerned that long-term firm contracts for delivered gas appeared not to be available.  As the parties considered that such services were sought by a significant part of the market, it has been contended that TPA’s services policy fails to comply with the principles set out in section 3.4 of the Victorian Access Code. 
In relation to the WTS, no concerns have been raised about compliance with sections 3.3 and 3.4 of the Victorian Access Code.  
Commission’s considerations
The Commission notes that retailers and potential retailers are likely to seek the market carriage services being offered because these services allow access to the system without the rigidities of traditional take-or-pay contracts, which will become increasingly important as retailers’ customer bases become less certain through contestability and the existing full allocation of TPA capacity.
The Commission also notes that the reference services have been unbundled.  Accordingly, the mandatory aspects of a services policy appear to be met.
However, some interested parties have contended that traditional ‘firm’ contract carriage services should be made available because they are likely to be sought by a significant part of the market.
The Commission has the power to require that a services policy include any service or services that the Commission considers should be included (section 3.4(a)(ii) of the Victorian Access Code).  While the Commission is aware of these users’ stated preferences, it is concerned that provision of contract carriage services on a market carriage system may cause undue complexity.  EPD has argued that these types of arrangements might disadvantage certain market participants.
The Commission notes that contract carriage services are not generally available under the market carriage model chosen for the PTS, and may to some extent be incompatible.
4.2.3	VENCorp’s Access Arrangement for the PTS
Service provider’s proposal
VENCorp states in its Access Arrangement that it will offer tariffed VENCorp services and competitive VENCorp transmission services to users or prospective users of the PTS, as set out in the Gas Industry Act 1994 and the MSOR, to operate the transmission system and operate and administer the market.  It will make available the tariffed VENCorp services at the reference tariffs and in accordance with the reference tariff policy (Tariff Order clause 5.3).  It will make the reference services available on the terms and conditions described in clause 5.4 of the Access Arrangement.   
Submissions by interested parties
As with the TPA’s submission, the comments made by interested parties concerning the services policy have been noted above.  However, some interested parties have also contended that they would prefer not to use VENCorp services and so should not have to pay for them.  For example, both BHPP and Esso contend that some users will incur unnecessary costs as the use of VENCorp’s services will be imposed on all market participants whether or not they require them.
Commission’s considerations
In considering the question of whether users would be obliged to purchase VENCorp services for which some parties suggest they have no need, the Commission notes that the PTS would require certain system operations regardless of the capacity management system.  It seems likely that an independent system operator is a pre-requisite for a market carriage pipeline and that it would be impractical to allocate network costs on the basis of users’ stated preferences.  The related issue of whether the tariffs paid by users of VENCorp services comply with the reference tariff principles and other Victorian Access Code requirements is addressed in chapter 3 of the Draft Decision.
4.3	Terms and conditions 
4.3.1	Victorian Gas Code requirements
Section 3.8 of the Victorian Gas Code requires an access arrangement to include the terms and conditions on which a service provider will supply each reference service.  Based on the relevant regulator’s assessment, these terms and condition must be reasonable. 
Where applicable and to the extent legally possible, the terms and conditions for part of a covered pipeline situated outside Victoria must conform with the Victorian Access Code and must not differentiate between the terms and conditions of that part of the pipeline within Victoria merely because they are located in different jurisdictions.
4.3.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
The terms and conditions of the proposed Access Arrangements for PTS and WTS relate to the provisions of services by TPA and TPAA only.  A separate access arrangement has been submitted by VENCorp regarding the terms and conditions supplied by VENCorp for the PTS.  
The Access Arrangements state that the terms and conditions under which each reference service will be supplied are set out in the following documents: 
•	Victorian Access Code;
•	MSOR (for the PTS only);
•	Tariff Order;
•	Pipeline Operating Agreement (for the PTS); 
•	TUoS agreement (for the PTS); 
•	transmission connection agreement; and 
•	transmission services agreement (for the WTS).  
EPD has advised the Commission that a single document containing all the terms and conditions is not required by the Victorian Access Code.  It argues that a list referring to the documents which include the terms and conditions is sufficient.  In relation to the MSOR, EPD has stated that all of the MSOR are terms and conditions to ‘the whole of the extent they apply to the market participant in question’ and that the extent of application to a particular market participant can be determined from the MSOR themselves.  Similarly, all of the Tariff Order is claimed to contain terms and conditions.  
The Commission has been provided with four agreements on a confidential basis.  These are: 
•	Pipeline Systems Deed; 
•	Western Transmission System Agreement (draft); 
•	Transmission-Westar Distribution System Connection Agreement; and
•	TUoS and LNG Services Agreement.  
EPD has stated that all key documents have been provided and are complete.  It considers that the disclosure of details has been sufficient and complies with the Victorian Access Code.  
The services policies for the PTS and WTS identify three services that are provided by TPA.  These are:
•	tariffed transmission services (which includes injection and withdrawal services);
•	excluded transmission services; and
•	competitive transmission services.  
The WTS services policy also states that VENCorp will provide tariffed transmission services for the WTS on behalf of TPA.  Although these services have been identified in the Access Arrangements, the terms and conditions have not been provided for each individual service.  Instead, the terms and conditions have been presented to apply to the reference services as a group.  
The Access Arrangements state that the terms and conditions on which access is provided do not differ according to the location of the pipeline.  The PTS Access Arrangement states in clause 5.4.3 that it is anticipated that an identical access arrangement for the PTS will be submitted in NSW once the Gas Pipeline Access Law takes effect in that state.  EPD has commented that this particular clause of the Access Arrangement is not relevant to the present extent of the Access Arrangement.  
Submissions by interested parties
BHPP raised concerns that there is no single document where the terms and conditions of service can be accessed.  BHPP has also commented that clause 2.1(e)(6) of the MSOR requires a market participant to have ‘entered into an agreement with the transmission pipeline owner’.  However, the agreement referred to by the MSOR is not specified further and the terms and conditions are not provided as required under the Victorian Access Code.  
BHPP submits that there are no terms and conditions included in the Tariff Order although it has been named as a document where such information is contained.  BHPP also raised concerns that the Pipeline Operating Agreement is also named as a relevant document for the PTS but it has not been made available for public consideration.  
In a subsequent submission, BHPP asserts: 
... by failing to define key elements such as the method by which authorised MDQ will be allocated, the level of service which VENCorp will seek to provide, the likely availability, cost and firmness of capacity for new or expanding users, the total cost of commercially firm transportation, and the definition and allocation method for Transmission Rights, the Access Arrangements fail to define the Reference Service that is being provided.  BHPP submits that the ACCC should not and cannot approve the Access Arrangements until these most fundamental elements of the service provided have been defined and debated.  
BHPP continues, that in having such a number of elements incomplete, the Victorian Access Code requirement for the service provider to provide terms and conditions in an access arrangement is not met.  
BCA put forward similar views to that of BHPP.  It claims that there are no terms and conditions for each of the services on offer and as such, the Access Arrangements proposed do not meet the requirements under section 2.6 of the National Access Code.  It also claims that this, among other things, makes an assessment of the impact of the arrangements on business difficult.  
Commission’s considerations
The concept of terms and conditions is a contractual one and as such does not sit well with the proposed market carriage model for the PTS.  In a contract carriage market system it would be expected that the terms and conditions of access would be available in a single contractual document.  However, the Commission acknowledges that in the case of market carriage, this format may not always be suitable.  
Nonetheless, the Commission is concerned that the Access Arrangements do not clearly identify the relevant terms and conditions.  This may cause difficulty in determining what elements of the external documents listed in the Access Arrangements are terms and conditions applicable to TPA in relation to the PTS and WTS.  The Commission also considers it is unlikely that all of the details contained in the external documents would be terms and conditions.  While the use of external documents is not a matter that would render the entire Access Arrangements invalid, the current circumstances may create a situation where the Access Arrangements are unworkable.  In that case, the Commission would find it difficult to agree with TPA that the terms and conditions are reasonable and that the Access Arrangements meet the Victorian Access Code requirements.  
The Commission has raised the issue of supplying the terms and conditions in one document with EPD.  It has also requested advice from EPD as to what portions of the MSOR and the Tariff Order are relevant terms and conditions.  
Proposed Amendment - A4.1
	In order for TPA’s Access Arrangements for the PTS and WTS to be approved, the service provider should clearly specify the terms and conditions of access to the PTS and WTS in a guide for users and in the Access Arrangements.  

The Commission is also concerned that upon lodging the Access Arrangements for approval, TPA did not include all relevant material.  The late arrival of particular agreements in relation to terms and conditions and the lack of opportunity for interested parties to assess these documents due to their confidential nature is of concern to the Commission.  
The Commission considers that all relevant documents should be provided to the Commission (and in general, the public) on submitting an access arrangement for approval.  A full and proper assessment can only be made if the public and the Commission have the opportunity to review all related items.  The Commission notes that in considering the Access Undertaking proposed by AGL for its NSW distribution network, IPART required AGL to provide a standard contract with their information package.  The Commission considers that it is important that the information currently contained in the confidential documents be publicly available as far as practicable as this will enhance the capacity of users and prospective users to form their own views as to compliance of the Access Arrangements with the Victorian Access Code.  
Proposed Amendment - A4.2
	In order for TPA’s Access Arrangements for the PTS and WTS to be approved, generic or pro forma documents should be developed by TPA and included in the Access Arrangements so that information currently contained in various confidential documents can be made available to users and potential users.  

TPA has included external documents in the Access Arrangements.  The Commission understands that this is allowed under the Victorian Access Code.  However, the Commission is concerned that the use of external documents may create confusion and difficulties in understanding the Access Arrangements.  This may arise as the external documents change over time, particularly where the Access Arrangements themselves are not changed through the process established by section 2 of the Victorian Access Code.  For these reasons, the Commission will require the following amendments to be made to the Access Arrangements prior to their approval.  
Proposed Amendment - A4.3
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, Access Arrangements should be amended to provide that all amendments to the external documents referred to in the Access Arrangements will not be incorporated in the Access Arrangements unless the procedure in section 2 of the Victorian Access Code is satisfied.  
Proposed Amendment - A4.4
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, the Access Arrangements should be amended to provide that all amendments to the external documents referred to in the Access Arrangements will trigger an obligation on the service provider to submit revisions under section 2 of the Victorian Access Code. 

Section 3.9 of the Victorian Access Code requires no discrimination between portions of the pipeline system located in different jurisdictions on the basis of their location.  It appears that the Access Arrangement does comply with this section of the Victorian Access Code.  However, at present there are no transmission pipelines covered by this Access Arrangement which lie outside Victoria.  
Subject to all the issues identified in this section, the Commission considers that the terms and conditions for access to the PTS and WTS appear to be reasonable.  
4.3.3	VENCorp’s Access Arrangement for the PTS
Service provider’s proposal 
This Access Arrangement has been submitted in conjunction with an Access Arrangement from TPA for the PTS.  However, access to services performed by VENCorp in relation to the PTS are only available through this particular Access Arrangement which sets out the terms and conditions on which such access will be provided.  Services provided by VENCorp on behalf of TPA for the WTS are available through TPA’s Access Arrangement for the WTS.  
VENCorp’s Access Arrangement states that the terms and conditions relating to the provision of reference services are set out in the MSOR and the Tariff Order.  The services policy for VENCorp identifies two services - tariffed VENCorp services and competitive VENCorp services.  As with the TPA Access Arrangements, the terms and conditions have been presented to apply to VENCorp services as a group.  According to clause 1.2.1 of the MSOR, tariffed transmission services for VENCorp include:
•	operation of the transmission system and the market;
•	publication and maintenance of a register of market participants;
•	development and updating of system security guidelines;
•	consideration of the likely costs of compliance for the procedures it develops under the MSOR; and 
•	compliance with requirements and obligations set out in the MSOR.  
While VENCorp’s Access Arrangement states that the terms and conditions are contained in the MSOR, not all of the procedures and policies identified in the MSOR have been developed.  The MSOR give VENCorp some discretion in the development of such procedures.  EPD notes that the MSOR also contain requirements for VENCorp to develop guidelines and procedures in consultation with market participants and/or in accordance with the MSOR.  It also notes that publication of such details is required.  
One of those issues identified is the allocation of MDQ, clause 5.3.2(a) of the MSOR requires that VENCorp allocates authorised MDQ for: 
•	all customers who withdraw gas at Tariff V withdrawal to the extent of any such withdrawals; and
•	all Tariff D customers on the basis of past and/or existing contractual arrangements, or on some other basis that VENCorp considers appropriate.  
As part of this process, VENCorp has drafted procedures on the initial allocation of authorised MDQ and has embarked on a public consultation process as part of the authorised MDQ allocation project.  
Like TPA’s Access Arrangement for the PTS, this Access Arrangement states that the terms and conditions on which access is provided do not differ according to the location of the pipeline.  EPD has commented that this clause of the Access Arrangement is not relevant to the present extent of the Access Arrangement.  
Submissions by interested parties 
AGL states that the level of discretion given to VENCorp in the MSOR is high and questions whether that is a satisfactory level of disclosure of terms and conditions under the Victorian Access Code.  AGL claims that VENCorp has discretion over:
•	development and updating system security guidelines;
•	developing gas scheduling procedures;
•	establishing an algorithm for withdrawal allocations at SAW points; and 
•	determination of the basis to allocate authorised MDQs. 
BHPP also comments on these elements, stating: 
... BHPP acknowledges that these missing pieces [including development of a queuing policy] are not as fundamental to the service as issues such as MDQ allocation.  We perhaps even would acknowledge that it would be difficult to argue that any single one of these pieces being missing would constitute a failure to define the service being offered.  We would contend quite strongly, however, that by having so many elements of the Access Arrangement terms and conditions not defined, the Access Arrangement itself fails the requirement of Section 3.8 of the Code.  
Commission’s considerations 
The Commission’s views on the adequacy of the provision of the terms and conditions in relation to the PTS and WTS for TPA can be found earlier in this section.  These comments apply equally to VENCorp in relation to its Access Arrangement.  In summary, the following amendments are required by the Commission prior to the approval of the VENCorp Access Arrangement.  
Proposed Amendment - A4.5
	In order for VENCorp’s Access Arrangement for the PTS to be approved, the service provider should clearly specify the terms and conditions of access to the PTS in a guide for users and in the Access Arrangement.  
Proposed Amendment - A4.6
	In order for VENCorp’s Access Arrangement for the PTS to be approved, the Access Arrangement should be amended to provide that all amendments to the external documents referred to in the Access Arrangement will not be incorporated in the Access Arrangement unless the procedure in section 2 of the Victorian Access Code is satisfied.  
Proposed Amendment - A4.7
	In order for VENCorp’s Access Arrangement for the PTS to be approved, the Access Arrangement should be amended to provide that all amendments to the external documents referred to in the Access Arrangement will trigger an obligation on the service provider to submit revisions under section 2 of the Victorian Access Code. 

In addition, the Commission has considered the concerns raised in submissions regarding incomplete elements of the terms and conditions and the consequential discretion given to VENCorp in the development of these elements.  The Commission is also mindful that it does not approve the Access Arrangement when there are material items that are incomplete.  The element raising most concern has been the initial allocation of authorised MDQ.  The Commission agrees that this matter is material to VENCorp’s Access Arrangement.  
Proposed Amendment - A4.8
	In order for VENCorp’s Access Arrangement for the PTS to be approved, the procedures for the initial allocation of authorised MDQ should be finalised and included in VENCorp’s Access Arrangement.  

A number of other elements of VENCorp’s terms and conditions were also identified in submissions as being incomplete.  However, in light of further submissions, the Commission considers that these elements do not  warrant further amendments to VENCorp’s .  Consequently, the terms and conditions in VENCorp’s Access Arrangement may be found to be reasonable despite some items remaining incomplete at the time of approving the Access Arrangement.  However, the Commission urges that these elements be finalised as soon as practicable.  
4.4	Capacity Management Policy 
4.4.1	Victorian Access Code requirements
Section 3.10 of the Victorian Access Code requires an access arrangement to include a statement that the covered pipeline is either a contract carriage pipeline or a market carriage pipeline.
4.4.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
TPA has provided a statement that the PTS is a market carriage pipeline. 
TPA has provided a statement that the WTS is a contract carriage pipeline.  TPA has stated that the WTS may be reclassified as a market carriage pipeline in the future.  
Submissions by interested parties
While some parties supported the choice of a market carriage model for the PTS, others raised a number of concerns as to its complexity, novelty and impact on interstate trade.  As an alternative, BHPP has proposed a hybrid market and contract carriage model.  
One party in its submission raised concerns about what it considered to be inadequate details in the capacity management policy in section 1 of the Access Arrangement Information.  
Commission’s considerations
As the Access Arrangement includes a statement that the PTS is a market carriage pipeline, it satisfies the requirements of Section 3.10 of the Victorian Access Code.
The concerns raised by interested parties are addressed in the context of the Commission’s consideration of the market carriage model in chapter 2 and relevant sections of this Draft Decision. 
The Victorian Access Code requires no more than a statement that the covered pipeline is either a market carriage or a contract carriage pipeline.  As the WTS Access Arrangement includes a statement that the WTS is a contract carriage pipeline, it satisfies the requirements of Section 3.10 of the Victorian Access Code.
4.4.3	VENCorp’s Access Arrangement for the PTS
The comments made by interested parties concerning the adoption of the market carriage model in regard to the PTS have been noted above in the discussion on TPA’s Access Arrangements.  
4.5	Trading Policy
4.5.1	Victorian Access Code requirements
If a pipeline is a contract carriage pipeline, the access arrangement must include a trading policy which explains the rights of a user to trade its right to obtain a service to another person.  The trading policy must, amongst other things, allow a user to transfer capacity:
•	without the service provider’s consent, if the obligations and terms under the contract between the user and the service provider remain unaltered by the transfer; and
•	with the service provider’s consent, in any other case.  Consent may be withheld only on reasonable commercial or technical grounds and the trading policy must specify conditions under which consent will be granted and any conditions attaching to that consent.  
4.5.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
The Victorian Access Code does not require a market carriage pipeline such as the PTS to have a trading policy, and none has been proposed.  However, clause 5.3 of the MSOR and the associated summary document discuss, inter alia, transfer of authorised MDQ.  Authorised MDQ is not generally tradeable under the initial single zone model.  An exception is where a party has entered into an agreement with TPA to augment the system.
However, the WTS must have a trading policy as it is a contract carriage pipeline.  It is proposed that, in certain circumstances, a user may transfer or assign all or part of any capacity in the WTS which it has reserved pursuant to a contract between it and the TPA (contracted capacity) as set out in clauses 5.6.2 and 5.6.4 of the Access Arrangement.  
Under the proposed Trading Policy, TPA will not unreasonably withhold its consent to any changes requested to the existing contract which: are commercially and technically feasible; do not interfere with TPA’s ability to satisfy its obligations to other users; and do not adversely affect the operational control of the system by VENCorp.
Clause 5.6.7 deals with any request by a transferee to change a delivery point or receipt point defined in an existing contract between TPA and the user.  Under the proposal, the tariff payable by the user will be adjusted accordingly but not downward.  
Submissions by interested parties
BHPP and Ecogen, in particular, raised concerns about the proposals relating to trading of capacity in respect of the PTS.  Ecogen considers that the trading of authorised MDQ is unclear and questions whether, in the event of sale of assets of a gas customer, the MDQ allocated to the business would be transferable as a right.   While BHPP acknowledges that a trading policy is not required for market carriage systems, it considers that it ‘ ... is a very important component of efficiency on contract-based gas transmission systems and hence must be a part of the Commission’s evaluation of market carriage’.  
BHPP argues that there are two problems with the trading policy proposed for the WTS.  First, TPA can block a capacity trade on the grounds that it would ‘adversely affect the operational control of the system by VENCorp’.  BHPP suggests that ‘ ... this is a very loose clause, prone to subjective interpretation’, and gives the example of a user who wants to purchase firm capacity for some purpose that VENCorp sees as a commercial threat to its own power.  BHPP considers that it is not clear how a regulator would be able to constrain TPA’s and VENCorp’s scope to block all such trades.  Second, BHPP states that there is no discussion on how transferred capacity is to be defined.  As an example, BHPP suggests it is not clear whether a contract is specific to unique injection and delivery points, in which case it could be traded only if the buyer wished to use the same points.  
Commission’s considerations
The Commission notes that the PTS does not require a trading policy to meet the minimum requirements of the Victorian Access Code as it is a market carriage pipeline.
The Commission has considered the services and polices that are generally available under both a market and contract carriage model in chapter 2 of this Draft Decision.  In that context the Commission further notes that the Victorian Access Code at Section 2.24 states: 
The Relevant Regulator must not refuse to approve a proposed Access Arrangement solely for the reason that the proposed Access Arrangement does not address a matter that sections 3.1 to 3.22 do not require an Access Arrangement to address. 
The Commission has considered the issues raised by BHPP regarding the trading policy for the WTS, and EPD’s response to these concerns.  
The concern has been raised that service providers could block a trade to further their own commercial interests.  The Commission notes that the Access Arrangement provides that a service provider will not unreasonably withhold its consent, and that a user denied capacity trade has the option to refer the matter for arbitration under the dispute resolution mechanism set out in section 6 of the Victorian Access Code.
Regarding the issue of defining capacity for the purposes of trading capacity, under clause 5.6.7, the TPA will deal with any request by a transferee to change a delivery point or receipt point defined in an existing contract between TPA and the user under the queuing policy (set out in clause 5.7) and that the tariff payable by the user will be adjusted accordingly but not downward.  This differs from the ‘example of reasonableness’ given in section 3.13 (b) of the Victorian Access Code whereby the service provider would receive the same amount of revenue that it would have received before the change.  
However, the Commission notes that changing a delivery point or receipt point may involve additional costs to the service provider (for example, moving the delivery point downstream), in which case it may be in the legitimate business interests of the service provider to recover these costs.  In other cases a reduction in haulage distance may not lead to any significant reduction in the service provider’s costs as the service provider has already incurred expenditure to configure its capacity to meet the user’s original needs.
No concerns have been raised by users of the WTS regarding this provision.  
The Commission considers that the trading policy in the Access Arrangement for the WTS accords with the Victorian Access Code.
4.5.3	VENCorp’s Access Arrangement for the PTS
The comments made by interested parties concerning the proposed trading policy by VENCorp have been noted above.  As with the TPA’s Access Arrangement for the PTS, the Commission considers that VENCorp does not require a trading policy to meet the minimum requirements of the Victorian Access Code as the PTS is a market carriage pipeline.  
4.6	Queuing Policy 
4.6.1	Victorian Access Code requirements
Sections 3.14 to 3.17 set out the Victorian Access Code’s requirements for a queuing policy.  An access arrangement must include a queuing policy for determining the priority given to users and prospective users for obtaining access to a covered pipeline and for seeking dispute resolution (under section 6).  
The Policy must: set out sufficient detail to enable users and prospective users to understand in advance how it will operate; accommodate, to the extent reasonably possible, the legitimate business interests of the service provider and of users and prospective users; and, to the extent reasonably possible, generate economically efficient outcomes. 
4.6.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
TPA states in its Access Arrangement for the PTS that its queuing policy is described in the MSOR.  Clause 5.3.4 of the MSOR is titled ‘Subsequent allocations and deemed allocations of authorised MDQ - other circumstances’.  It provides that, in the event that there is insufficient available authorised MDQ to satisfy the requirements of all customers or prospective customers who have requested an allocation of authorised MDQ, VENCorp must conduct an auction amongst all customers or prospective customers from whom it has received requests for authorised MDQ.  It must allocate the available authorised MDQ to the customer or prospective customer who offers the highest amount for that authorised MDQ and that allocation of authorised MDQ will be effective in respect of a delivery point at which that customer or prospective customer withdraws gas. 
Specifically, clause 5.3.4(h) of the MSOR states ‘ ... the principles and procedures VENCorp develops and applies to effect an allocation of available authorised MDQ , comprise the queuing policy of VENCorp as required under the Access Code’.  
Clause 5.3.4(g) provides that all monies received by VENCorp as a result of allocating authorised MDQ under clause 5.3.4(e) are to be used by VENCorp to offset its costs for the next financial year calculated in accordance with the Tariff Order. 
EPD has advised that the initial allocation of MDQ is likely to entail the allocation of all available MDQ and hence there will be no opportunity in the short term for VENCorp to allocate spare capacity by auction.
The queuing policy only directly affects Tariff D customers as there is no limit on Tariff V customers’ access to the system. 
TPA’s proposed queuing policy for the WTS is fully described in clauses (5.7.1-5.7.9) of the WTS Access Arrangement.  It addresses how a prospective user obtains access to existing capacity, both in the case where there is spare capacity and in the case where there is potential to expand capacity.  Furthermore, it sets out the process by which TPA will: administer requests by a prospective user seeking access (the applicant); and determine the priority that a prospective user has, as against any another prospective user, to the services offered in this Access Arrangement and the developable capacity of the pipeline.  
The WTS queuing policy also sets out the application procedure, evaluation policy, response to applicant, response from applicant, dispute procedure, amended offers and applicant obligations.  Under the applicant obligations (clause 5.7.9 of the WTS Access Arrangement), TPA will not make any commitments to capital expenditure on a proposed project until an enhanced facilities agreement has been executed.  
Clause 5.7.3 of the WTS Access Arrangement stipulates that an applicant will obtain access to the queue by completing an application form and paying a prescribed fee.  Under clause 5.7.5 of the WTS Access Arrangement, an excluded service charge will be borne by an applicant to recover the incremental costs to add capacity under an enhanced facilities agreement.  The enhanced facilities agreement will provide that, in the event an applicant terminates that executed contract, the applicant will be obligated to reimburse TPA for all expenditure incurred on the facilities under construction to meet the obligations under that contract, or if the service has commenced, to reimburse TPA with the depreciated asset value of that facility.  
Submissions by interested parties 
A large number of interested parties, including BHPP, AGL, Amcor, AEG, Consumer Law Centre of Victoria (CLCV) and BCA raised concerns with the proposed queuing policy for the PTS in their submissions.  Central themes were dissatisfaction with the level of detail provided, and costs and uncertainty associated with the auction process.
AGL contends that there is no information as to what conditions will qualify users or prospective users to participate in an auction or how the auction will be conducted.  AGL also states that it is questionable whether the amount of detail in clause 5.3.4 (e)(2) of the MSOR meets the Victorian Access Code’s requirements for ‘sufficient detail’ to allow an understanding ‘in advance’ of how the queuing policy will operate.  
Amcor is also concerned about the information available regarding the auction process, and notes that ‘ ... [T]he proposal does not clarify when an auction would take place, nor its frequency’.  Amcor further argues that the proposed queuing policy fails to meet the requirements of the National Access Code because the auctioning of spare capacity ‘ ... means that the cost for a reference service must be higher than the tariff for the reference service’.  
BCA is also concerned that the auctioning of spare capacity could mean that the cost of a reference service would be greater than the reference tariff.  On a similar point, EAG contends that the auctioning of MDQ on the sale of gas consuming businesses is unacceptable as it will add to consumer costs, a proposal that CLCV considers ‘ ... is not realistic’.
According to BHPP, the queuing policy in the Access Arrangements for both VENCorp and TPA fails to meet the requirements of the Victorian Access Code in two areas.  Firstly, the MSOR are excessively vague about how the queuing policy will work.  The queuing policy proposed under clause 5.3.4 of the MSOR is inadequate.  Secondly, by denying the ability to purchase, a ‘space’, that is, a defined service, in the transmission pipeline at specific prices, that is, contract capacity, the Access Arrangements do not generate the ‘reasonably possible, economically efficient outcomes’ that section 3.15 (c) of the Victorian Access Code requires the Commission to ensure.  BHPP argues that the queuing policy cannot be assessed by the regulator until the principles and procedures have been promulgated by VENCorp.
Furthermore, BHPP submits that there does not appear to be a queuing policy in relation to LNG storage, in contravention of sections 3.14-3.17 of the Victorian Access Code.  
No submissions were received from users of the WTS.  However, BHPP has criticised the proposed queuing policy on two grounds.
First, BHPP states that a weakness in the evaluation process of the queuing policy is that it requires TPA to make a unilateral and subjective assessment of available capacity.  In order to decide how much capacity is available for new contracts, TPA must guess how much capacity demand growth there will be from holders of existing contracts.  Second, BHPP considers that it is a weakness of the WTS’s queuing policy that the contract carriage system will disappear when the WTS and PTS are integrated.  BHPP contends that contractual rights on the WTS are therefore seriously constrained, to the point of being meaningless. 
Commission’s considerations
The purpose of a queuing policy is to allocate spare capacity where there is insufficient capacity to satisfy the needs of all users and potential users who have requested capacity.  
The Commission has noted the concerns expressed in submissions about the adoption of an auction (instead of a traditional, literal ‘first come, first served’ queue under a contract carriage system), and about the amount of detail currently available on the principles and procedures governing the auction process.
In principle, the Commission sees merit in the concept of an auction process rather than a queue.  Queuing can be an inefficient way of allocating scarce resources.  An auction provides a market mechanism which is more likely to lead to an efficient allocation of the potentially scarce and valuable spare capacity of the pipelines.  An auction can deliver a competitive outcome in that the market value of connection may be determined.  While successful bidders would in effect pay more than the reference tariff for a service, the additional amount would reflect the value they place on gaining access to the system.  Any revenues raised through the auction process will be used to offset VENCorp costs in the subsequent financial year and will benefit users as a whole.
EPD has advised that:
The result of the MDQ allocation project is likely to be an allocation of total available capacity and hence no short term opportunity for VENCorp to allocate spare capacity by auction.
The Commission understands that priority has not yet been given to the development of the details of the auction process because it is unlikely that there will be any spare capacity in the short term.
While the Commission understands the practical nature of EPD’s prioritisation of policy development, this must be balanced against the uncertainty of users and potential users concerned that clause 5.3.4 of the MSOR only provides broad guidance for VENCorp to follow in conducting an auction process. 
Other specific issues raised in submissions included the contention that the Victorian Access Code requires that there be a queuing policy for LNG storage, and that growth in Tariff V demand may take authorised MDQ from Tariff D customers.
The Commission is of the view that the Victorian Access Code does not require a queuing policy for the LNG facility and does not consider that it would be reasonable to require one to be included in the Access Arrangement.  
Proposed Amendment - A4.9
	In order for TPA’s Access Arrangement for the PTS to be approved, the Queuing Policy for the PTS should be finalised.  

The queuing policy proposed by TPA for the WTS sets out mechanisms for processing requests for service where spare capacity is available but inadequate to satisfy all users and potential users.  It defines the priority that prospective users have to negotiate for access.  This is consistent with the requirements of the Victorian Access Code.  
The Commission notes the issues raised by BHPP.  However, the Commission understands that current and expected future excess capacity of the WTS pipeline mean that it is unlikely that capacity will be constrained and that there is little likelihood in practice that a queue will eventuate on the WTS.
4.6.3	VENCorp’s Access Arrangement for the PTS
The comments made by interested parties concerning the queuing policy have been noted.  The assessment of TPA’s queuing policy for the PTS is essentially the same for VENCorp with the exception of the initial allocation of MDQ.  
Service provider’s proposal
In relation to the allocation of MDQ, clause 5.3.2(a) of the MSOR requires that VENCorp make an allocation of authorised MDQ for: 
•	all customers who withdraw gas at tariff V withdrawal to the extent of any such withdrawals; and
•	all tariff D customers on the basis of past and/or existing contractual arrangements, or on some other basis that VENCorp considers appropriate.  
As part of this process, VENCorp has drafted procedures on the initial allocation of authorised MDQ and has embarked on a public consultation process as part of the authorised MDQ allocation project.  
Submissions by interested parties
AGL states that the level of discretion given to VENCorp in the MSOR is high.  The company notes that one of the elements VENCorp has discretion over is determining the basis on which to make the initial allocation of MDQ.  
Commission’s considerations
The Commission has considered the concerns raised in submissions regarding the incomplete elements of the Access Arrangement and the consequential discretion given to VENCorp in the development of these elements.  The Commission is also mindful that it does not approve the Access Arrangement when there are material items that are incomplete.  The Commission considers that the procedures for the initial allocation of MDQ are material to VENCorp’s Access Arrangement.  
Proposed Amendment - A4.10
	In order for VENCorp’s Access Arrangement for the PTS to be approved, the procedures for the initial allocation of authorised MDQ should be finalised and included in the VENCorp Access Arrangement.  

4.7	Extensions and expansions policy
4.7.1	Victorian Access Code requirements
The Victorian Access Code requires an access arrangement to have an extensions/expansions policy (section 3.18).  The policy is to set out the methodology to assess whether any extension or expansion (called augmentation under the Victorian Access Arrangements) of the system will be treated as part of the covered pipeline.  A service provider is also required to specify the impact on reference tariffs of including an extension or expansion with the covered pipeline.  In addition, an extensions/expansions policy must outline under what conditions the service provider will fund new facilities and provide a description of those new facilities. 
4.7.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
Clauses 5.7 of the PTS Access Arrangement and 5.8 of the WTS Access Arrangement set out the extensions/expansions policies for TPA.  These two policies  have the same effect.  Firstly, extensions or augmentations that are included in the service envelope are covered by the Access Arrangements and are rolled-in to the reference tariffs.  
Alternatively, TPA must seek Commission approval to include in the Access Arrangements any extensions and augmentations which it proposes be included and are currently outside the service envelope (clauses 5.7.2 of the PTS Access Arrangement and 5.8.2 of the WTS Access Arrangement).  If the Commission agrees to include a particular project in the service envelope (and hence the Access Arrangement), the project may be rolled-in to the reference tariffs.  If the Commission does not agree to amend the Access Arrangement to include such projects then the cost of the project is to be recovered as an excluded service.  Such services are subject to regulation to the extent that they are ‘fair and reasonable’ in the view of the Commission.  TPA is not required to seek Commission approval if it decides to exclude an extension or augmentation from the Access Arrangement. 
In the situation where an application to review an Access Arrangement is on the grounds that the particular extension or augmentation will not result in changes to reference tariffs, the Commission has the discretion to dispense with the requirement that TPA produce Access Arrangement Information relating to that expansion or augmentation.  The Commission also has the discretion to make a decision without public consultation.  
However, clause 5.7.4 of the PTS Access Arrangement (and clause 5.8.4 of the WTS AA) specifies that TPA must provide Access Arrangement Information in two cases.  Firstly, where TPA is proposing to apply a surcharge on the basis that a new facility has system wide benefits and, secondly, where the extension in question will result in a material change to the covered pipeline.  
Generally, extensions and augmentations will not result in changes to reference tariffs for reference services under clauses 5.7.3(e) and 5.8.3(e) of the PTS and WTS Access Arrangements.  However, this is subject to the Commission approving a surcharge for a new facilities investment that is considered to provide system wide benefits under clause 5.7.3(f) of the PTS Access Arrangement (or clause 5.8.3(f) of the WTS Access Arrangement).  
Subject to clauses 5.7.3(a) to (f) of the PTS Access Arrangement (and clauses 5.8.3(a) to (f) of the WTS Access Arrangement), the principles stated in sections 8.15 to 8.19 of the Victorian Access Code will apply to new facilities investment by TPA.  Specifically, the following apply: 
•	an investment should not exceed that which would be carried out by a prudent service provider (see also section 8.16(a) of Victorian Access Code); 
•	the present value of the incremental tariff revenue from the investment should exceed the investment costs (this is referred to as the roll-in test, see section 8.16(b)(i) of the Victorian Access Code).  Alternatively, the regulator is to be satisfied that the investment produces system-wide benefits that would justify a surcharge resulting in TPA meeting the roll-in test; 
•	if the roll-in test is not met, the shortfall may:
•	be held as a speculative investment fund (as specified under section 8.19 of the Victorian Access Code); or 
•	be recovered as a surcharge (as allowed under section 8.19(a) of the Victorian Access Code). 
•	new facilities investment may be added to the capital base when there is a review of reference tariffs for the upcoming regulatory period or at the approval of a variation to the access arrangement.  
Thus, as provided under section 8.18 of the Victorian Access Code, and highlighted by clause 5.3.4 of the Access Arrangements, the extensions/expansions policies do allow TPA to undertake new facilities investment even though the requirements of section 8.16 of the Victorian Access Code are not met.  In addition, under section 8.19 of the Victorian Access Code, the reference tariff policies provide that the balance of a new facilities investment may be subsequently added to the capital base of the reference tariffs (see clause 5.3.4 of the PTS and WTS Access Arrangements).  
TPA’s Access Arrangement Information lists its planned major capital projects.  These are:  
•	Murray Valley extension (which was subject to a competitive tender process under GTC and has an incremental tariff set in the Tariff Order);
•	Brooklyn-Corio project (which is considered to meet each of the section 8.16(b) requirements of the Victorian Access Code and is necessary to meet projected load growth);
•	automation of compressor stations;
•	minor capital expenditure on the pipeline and compressor stations to cover ongoing load growth; and 
•	non-system capital expenditure to meet information technology requirements.  
While these are all listed in the Access Arrangement Information, only the Murray Valley project is included in the service envelope.  The Murray Valley system will have an incremental charge while the other items listed above are rolled-in to the reference tariffs.  In addition, rather than applying for the service envelope to be revised to include the Interconnect, TPA will establish an incremental tariff to the Victorian portion of the pipeline.  
The extensions/expansions policy also outlines the relationship between the Tariff Order and the service envelope.  The Tariff Order limits TPA’s transmission services to those provided from the existing and forecast assets specified in the Access Arrangement Information.  These services are provided according to the set geographical parameters such as area code details and the established service standards.  
Submissions by interested parties
BHPP claims that the present extensions/expansion policy for the PTS provides TPA with complete discretion as to what investment projects will be rolled-in to the reference tariffs and consequently, is inefficient.  It is also concerned that the Access Arrangement does not outline the impact of extensions or expansions that are not covered by the Access Arrangement and that definitions of extensions, expansions, augmentation or rolled-in are not provided.  BHPP also claims that in enabling roll-in to occur, the Access Arrangement allows incumbent pipelines to subsidise new projects with existing customers which BHPP considers makes it ‘virtually impossible for new pipeline companies to enter the market’. 
The Access Arrangement allows for the Commission to consult only with TPA when considering a submission to vary the Access Arrangement in relation to extensions/expansions.  BHPP prefers that this process be open to all market participants regardless of the impact on reference tariffs.  It also suggests that potential areas of competition in relation to extensions/expansions exist but have not been addressed by the Access Arrangement.  
In light of these comments, BHPP argues that the extensions/expansions policy provided in the Access Arrangement is 
...defective and should be revised, consistent with providing contract carriage choices on TPA. ... That is, the policy should ring-fence new investment costs to be charged to those who create the demand for that new capacity.  
No submissions were received from users of the WTS.  However, BHPP suggests that the ‘system wide benefits’ test outlined in clause 5.8.6(a)(2) of the WTS Access Arrangement is ‘defective for a contestable transmission system’.  It argues that users do not have a standard with which to compare any claimed benefits.  
While not commenting directly on the proposed extensions/expansions policies in the Access Arrangements, Ecogen does note that augmentation of the gas system needs incentives that ensure timely and efficient investment in infrastructure.  Ecogen suggests that, in the main, competitive processes should prevail and that the regulator should ensure that only genuinely needed investments are rolled-in to the asset base for tariff setting purposes.  The organisation is also concerned that there are insufficient incentives for producers to invest in peak day production capacity.  
EAPL has not commented on the extensions/expansions policies themselves.  However, it expressed concern that the Interconnect is not included in the service envelope and hence the PTS Access Arrangement.  AGL also expressed concern about the proposal that the Interconnect will be incrementally priced.  Like EAPL, AGL considers such a policy will become a barrier to interstate trade.  
Amcor notes in its submission that the pipelines needed to connect the proposed UGS to the transmission system have been rolled-in to the current tariffs.  The company argues that this is not appropriate and would prefer that the extension be assessed on its merits as part of the whole UGS project. ACA views the inclusion of the UGS pipelines in the asset base as inequitable and feels that the UGS should compete on its own merits with the costs borne by those participants who use it.  
In relation to the Brooklyn to Corio looping, BHPP claims that building this project before UGS will not ensure that UGS goes ahead.  BHPP asserts that the $30 million looping project is only necessary if the UGS project proceeds.  
Commission’s considerations
Under section 3.18 of the Victorian Access Code, an extensions/expansions policy must set out the method to be used in determining whether a particular extension or expansion will be included in a covered pipeline.  An example of a method is provided in the Victorian Access Code which indicates that the service provider may elect, with the regulator’s consent, whether to include an extension or expansion as part of the covered pipeline.  While this example may not seem like a conventional ‘method’, this appears to be consistent with the option adopted for the PTS and WTS.  The Commission is satisfied that the extensions/expansions policies proposed for the PTS and WTS do contain a method and are sufficiently specific to meet the requirement of the Victorian Access Code.  
The Access Arrangements provide for TPA to seek approval from the Commission as to whether an extension or expansion is able to be included in the existing Access Arrangements.  However, the Access Arrangements state that TPA is only required to seek Commission approval of its decision to include an extension/expansion in the Access Arrangement.  The Commission does not consider that this is the intention of the Victorian Access Code.  The concerns brought to the Commission’s attention regarding TPA’s discretion on the exclusion of extensions and expansions from the Access Arrangement and the possibility of TPA subsidising new projects should be overcome by enforcement of the Victorian Access Code.  The Commission considers that in general, extensions and expansions should be included in the relevant Access Arrangement unless the Commission accepts a proposal by TPA to exclude a particular project.  
Proposed Amendment - A4.11
	In order for the TPA’s Access Arrangements for the PTS and WTS to be approved, clause 5.7.2(b) of TPA’s Access Arrangement for the PTS and clause 5.8.2(b) of TPA’s Access Arrangement for the WTS should be amended to provide that any extension or expansion that is outside the service envelope is incorporated into the Access Arrangements unless the Commission decides otherwise.  

As part of the proposed arrangements, particular extension and expansion projects have been identified and some included in the tariff structure.  Submissions have noted the absence of the Interconnect and UGS from this list while the pipelines consisting of the Murray Valley extension and those relating to the UGS system are included in the present arrangements.  The reasoning behind this apparent differential treatment of projects currently planned (or started) has not been provided to the Commission.  
The Commission is particularly concerned over the exclusion of the Interconnect and EPD’s intention not to include it in the future.  It notes the concerns raised by interested parties in submissions and agrees that this project is considered to be vital for the development of interstate trade between Victoria and NSW.  
Proposed Amendment - A4.12
	In order for the TPA’s Access Arrangement for the PTS to be approved, the Access Arrangement should be amended to provide that the Interconnect is to be incorporated into the Access Arrangement unless the Commission decides otherwise.  

4.7.3	VENCorp
Service provider’s proposal 
VENCorp’s Access Arrangement states: 
The Extensions/Expansions Policy for the Principal Transmission System is described in clause 5.7 of TPA’s Access Arrangement.  
Detailed comments on the extensions/expansions policy for TPA are located in an earlier segment of this section.  
The related topic of connection to the transmission pipeline system under clause 4.1 of the MSOR is discussed in the Draft Determination of the MSOR.  
4.8	Review and expiry of the Access Arrangement
4.8.1	Victorian Access Code requirements
Section 3.19 of the Victorian Access Code requires an access arrangement to include a date when the service provider must submit to the relevant regulator a revised access arrangement (revisions submission date) and a date when the revisions are intended to commence (revisions commencement date).  An access arrangement may also include an expiry date (section 3.22).
Section 2.48 of the Victorian Access Code states that the Revisions Commencement Date is not a firm date for the revisions to commence but is an intended date which can be varied by the relevant regulator.  This section states that: 
2.48 ... Subject to the Gas Industry Act, revisions to an Access Arrangement come into effect on the date specified by the Relevant Regulator in its decision to approve the revisions (which date must not be earlier than either a date 14 days after the day the decision was made or ... the Revisions Commencement Date).  
The relevant regulator’s assessment of the appropriateness of the two dates will include reference to the objectives contained in section 8.1 of the Victorian Access Code.  The relevant regulator may require an amendment to the proposed access arrangement to include earlier or later dates.  Furthermore, the relevant regulator may require specific major events to be defined as a trigger, which compels the service provider to submit revisions prior to the revisions submission date.
An access arrangement period may be of any duration.  However, if the period is greater than five years, the relevant regulator must consider whether mechanisms should be included in the access arrangement to address the potential risk that forecasts, on which terms of the proposed access arrangement are based, prove incorrect (section 3.20).
4.8.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
TPA proposes that the revisions submission date will be 30 June 2002 and the revisions commencement date be 1 January 2003 for both the PTS and WTS.
Chapter 9 of the Tariff Order supports the revisions commencement date set by clause 5.8.2 of the PTS Access Arrangement and clause 5.9.2 of the WTS Access Arrangement.  It states that the initial Tariff Order ceases on 31 December 2002 and the subsequent Tariff Order will operate for five years from 1 January 2003.  Moreover, clause 9.2 of the Tariff Order sets out a framework to guide the Commission in its decisions on the price regulation arrangements for the period 1 January 2003 to 31 December 2008, including the use of an incentive based model.  
Despite these provisions in the Tariff Order, the Revisions Commencement Date is set as the date upon which revisions to the Access Arrangement are intended to commence.  
Submissions by interested parties
ACM considers that there is insufficient information disclosed at present to know if the system would operate effectively over five year periods.  On this basis, the ACM suggests that a three year review period would be more appropriate nearer the start of the market.  
CLCV considers that: 

There is difficulty in establishing the initial appropriate cost/price path for the proposed arrangements, given that the historical information related to integrated businesses. ... A short time-frame for initial review ... would be favoured by the CLCV.  
AGUG notes that future costs have been estimated for specific businesses when there is no historical information available for those businesses on which to base the estimates.  It considers that each of the businesses need to be benchmarked against similar operations overseas.  AGUG states: 
In our view the uncertainty with the estimates is best handled by the imposition of a shorter initial review period than the five years proposed in the undertakings as this would mean that any errors that are made in year zero are not locked in for five years. 
BHPP claims that section 3.20(a)(ii) lays the groundwork for a review to be held if there is a change to locational and/or hourly pricing.  
Commission’s considerations
TPA’s proposal for the revisions submission date is consistent with section 3.19(a) of the Victorian Access Code in that it includes a date upon which the service provider must submit revisions to the access arrangement and a date upon which those revisions are intended to commence.  
Section 3.19 allows the Commission to require, if it considers necessary:  
•	an earlier or later revisions submission date and revisions commencement date than that proposed by TPA; and
•	that specific major events be defined as a trigger for TPA to submit revisions of the Access Arrangements before the set revisions submission date.
The proposed revisions submission date is currently 30 June 2002, six months prior to the proposed commencement date of the second regulatory period.  However, the Commission considers that this would not allow the Commission to extend the review process under section 2.44 of the Victorian Access Code, if required, and would not provide sufficient time for TPA to respond to the decisions made by the Commission.  The Commission also considers that a six month period would not provide adequate time for a complete and successful public consultation process.  
Alternatively, the Commission is able to change the revisions commencement date from 1 January 2003.  EPD claim that the cost of altering the revisions commencement date would outweigh any benefits due to the increased regulatory uncertainty.  However, as noted earlier, the revisions commencement date is the date on which the second regulatory period is intended to commence.  The Commission also notes that due to the current assessment process, the initial regulatory period will be short of five years.  Accordingly, the revisions commencement date will remain as 1 January 2003. 
Proposed Amendment - A4.13
	In order for TPA’s Access Arrangements for the PTS and WTS to be approved, the revisions submission date should be amended to 30 March 2002.  

The BHPP submission supports the regulator defining trigger factors such as a change to locational and/or hourly pricing.  This would be possible by reference to section 3.19 of the Victorian Access Code.  
The Commission agrees that a change from daily pricing to a multi-zone, hourly pricing model is significant.  As discussed in the Commission’s Draft Determination of Authorisation of the MSOR, the change (if required by the market) to multi-zone hourly pricing will be subject to Commission scrutiny according to the established authorisation process.  The Commission considers that the provisions of section 2.28 of the Victorian Access Code are sufficient to allow TPA to submit any necessary revisions to the Access Arrangements at the time a change to the pricing system of the spot market occurs.  Accordingly, the Commission does not consider that a trigger for review under section 3.19 of the Victorian Access Code is required for a change to a multi-zone hourly pricing model for the spot market.  
4.8.3	VENCorp’s Access Arrangement for the PTS
Service provider’s proposal 
VENCorp proposes that the revisions submission date will be 30 June 2002 and the revisions commencement date be 1 January 2003 for the PTS.  These dates are the same for TPA’s Access Arrangements.  
Commission’s considerations
As the same dates have been nominated as the revisions submission date and the revisions commencement date by the service providers, the issues raised in submissions relate to both TPA and VENCorp.  The Commission considers that the dates required under section 3.19 of the Victorian Access Code for these entities should be the same.  As a consequence, the Commission requires an amendment to VENCorp’s Access Arrangement prior to its approval.  
Proposed Amendment - A4.14
	In order for VENCorp’s Access Arrangement for the PTS to be approved the revisions submission date should be amended to 30 March 2002.  

4.9	Information provision
4.9.1	Victorian Access Code requirements
In conjunction with its proposed access arrangement, a service provider is required to submit access arrangement information, which must contain sufficient information to enable users and prospective users to understand the derivation of the elements in the proposed access arrangement and to form an opinion as to compliance of the access arrangement with the provisions of the Victorian Access Code (section 2.6). 
The access arrangement information may include any relevant information, but must at least contain the information described in Attachment A to the Victorian Access Code (section 2.7),  which is included as Appendix C to this document.  A summary is contained in Box 4.1 below.
Box 4.1:	Summary of Attachment A information
The information required is divided into six categories:
Category 1: access and pricing principles
Tariff determination methodology; cost allocation approach; and incentive structures.
Category 2: capital costs
Asset values (by, e.g. pricing zone) and valuation methodology; depreciation and asset life; committed capital works and planned capital investment (including justification for); rates of return for equity and debt; and debt/equity ratio assumed.
Category 3: operations and maintenance costs
Fixed versus variable; cost allocation between, e.g. pricing zone, and cost categories.
Category 4: overheads and marketing costs
Costs at a corporate level; regulated versus unregulated; cost allocation between, e.g. pricing zone, and cost categories.
Category 5: system capacity and volume assumptions
Description of system capabilities; map of piping system; average and peak demand; volumes; system load profiles; customer numbers.
Category 6: key performance indicators
Indicators used to justify ‘reasonably incurred’ costs.

Information included in the access arrangement information may be categorised or aggregated to the extent necessary to ensure that disclosure of the information is not, in the opinion of the relevant regulator, unduly harmful to the legitimate business interests of the service provider, a user or prospective user (section 2.8).
If the relevant regulator is not satisfied that the access arrangement meets the requirements of the Victorian Access Code, it may, of its own volition, require the service provider to make changes to the access arrangement information.  Likewise, if requested to do so by any person, the relevant regulator must review the adequacy of the access arrangement information.  However, the relevant regulator must not request information which, if released publicly, may unduly harm the legitimate interests of the service provider or users and prospective users (section 2.9).
If the relevant regulator requires the service provider to change the access arrangement information, it must specify the reasons for its decision and allow the service provider a reasonable time to make the changes and resubmit the access arrangement information.
A summary of the responsibilities of the relevant regulator and procedures to be followed are contained in Box 4.2 below.
Box 4.2:	Information disclosure - regulator’s responsibilities and procedures
1)	The regulator must decide as soon as practicable whether the access arrangement information meets the requirements of sections 2.6 and 2.7.  That is, whether the access arrangement information includes:
•	the information described in Attachment A (section 2.7); and
•	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
•	form an opinion as to the compliance of the access arrangement with the provisions of the Victorian Access Code (section 2.6).
2)	The regulator must also consider whether changes to the access arrangement information are required.  This in turn, requires the regulator to consider:
•	whether the disclosure of the information could be unduly harmful to the legitimate business interests of the parties; and thus
•	the extent to which the information needs to aggregated or categorised (or possibly excluded).
3)	In making this decision:
•	the regulator must correctly interpret sections 2.6 & 2.7;
•	take into account relevant considerations (submissions received); and
•	provide procedural fairness to the service provider and other parties.
4)	If the regulator requires the service provider to make changes to the access arrangement information, then under section 2.9, the regulator must:
•	specify the reasons for its decision; and
•	specify a reasonable time for the service provider to make the changes.
5)	When the regulator makes its draft decision and proposed amendments to the access arrangement have been released for public comment, as a requirement of procedural fairness, the regulator should consider:
•	whether parties have received sufficient information to enable them to understand and make submissions on the proposed amendments; and
•	whether amendments must also be made to the access arrangement information.	

4.9.2	TPA’s Access Arrangements for the PTS and WTS
Service provider’s proposal
While TPA submitted separate Access Arrangement proposals for the PTS and WTS, it submitted combined Access Arrangement Information covering both gas transmission systems.  The Access Arrangement Information was submitted in three stages:
•	the Access Arrangement Information originally submitted in conjunction with the Access Arrangements on 3 November 1997;
•	revised supplementary information submitted on 13 March 1998; and
•	additional supplementary information submitted on 16 March 1998.
Contained in Box 4.3 below is a summary of the additional information which was appended by TPA to the original Access Arrangement Information.
Box 4.3:	Summary of additional Access Arrangement Information
Original Information	Additional Information	
Target Revenue		
Description of the components of target revenue.	Each item quantified by pricing zone.	
Cost allocation		
Description of the methodology used to allocate costs to services.	Quantified by each service.	
Historical costs		
No details.	TPA advised that historical costs split in accordance with the new industry structure were not available.  As a proxy, the acquisition value as at 11 December 1997 (based on DORC) was submitted.	
Depreciation		
Can be deduced from asset values and economic lives of assets.	Quantified by each pricing zone.	
Planned capital expenditure		
Total annual figures provided and description of the process for determining investment requirements.	Disaggregated by asset types.  Description of and justification for planned capital expenditure provided.	
Return on assets		
Details of the components of WACC.	Quantified by each pricing zone.	
Working Capital		
No details.	Quantified by each pricing zone.	
Operations and maintenance costs		
An aggregated figure provided with a description of the costs included.	Costs disaggregated by pricing zone and cost categories.	
Key Performance Indicators		
Comparison of costs ($m/1 000km and c/GJ) and tariffs (c/GJ) for the system as a whole with other pipelines in Australia.	Additional information provided according to pricing zone.	

The additional information submitted in March 1998 by TPA followed criticism from interested parties of the adequacy of the original information.  Although TPA agreed to release the additional information, it maintains that in its opinion the Access Arrangement Information as originally submitted meets the requirements of the Victorian Access Code.
Submissions by interested parties
Interested parties who commented in their submissions on the adequacy of information disclosure were critical of certain aspects of the Access Arrangement Information and considered the Access Arrangement Information as originally submitted to be deficient and not to satisfy the requirements of the Victorian Access Code.  More specific issues arising from the submissions were:
•	the lack of disaggregated cost data, for example, by pricing zone and cost categories, as required by Attachment A to the Victorian Access Code;
•	depreciation was not quantified;
•	although a description of the methodologies used, for example, cost allocation methodology, was provided, the lack of quantitative data meant it was not possible to verify the implementation of those methodologies or the conclusions reached, such as the derivation of the reference tariffs;
•	details of committed capital works and capital investment, and a description of the nature and justification for planned capital investment as required by the Victorian Access Code were not provided;
•	although the target revenue required a return on net working capital, no value was given for this component of the capital base;
•	details of the historical costs of assets were lacking;
•	inadequacy of the key performance indicators.  Previous costs of the Victorian gas industry for 1995/96 and 1996/97 should have been provided to enable comparison with current costs; and
•	the withholding of the confidential reports of the consultants engaged by TPA.
On 7 January 1998 BHPP lodged a formal request under section 2.9(b) of the Victorian Access Code that the Commission consider whether in its view the Access Arrangement Information met the requirements of the Victorian Access Code.  
Following the release of additional information by TPA, on 4 March 1998 the Commission decided to extend by two months the time period for assessment of the proposed Access Arrangements to allow interested parties the opportunity to make further submissions in light of the additional information.
Although those parties who made additional submissions commented that the additional information addressed many of the issues identified by them as deficiencies in the original information, some criticism was still directed at the level of disclosure.  Among the issues raised were:
•	the limited amount of benchmarking undertaken by TPA to justify costs, with some parties calling on TPA to undertake an international benchmarking study.
•	in some instances additional information was sought which, in the Commission’s opinion, exceeded the minimum requirements of the Victorian Access Code.  For example, AGUG argued that TPA should provide projected financial statements.
•	not all operational data is provided by pricing zone.  TPA has stated that the current metering equipment is inadequate to provide such data, for example, monthly throughput by zone.
Other issues raised by some interested parties as evidence of an inadequacy in information disclosure seem more related to provisions of the proposed Access Arrangements themselves rather than the Access Arrangement Information and are dealt with in the appropriate sections of this Draft Decision.
Commission’s considerations
BHPP’s request under section 2.9(b) of the Victorian Access Code required the Commission to consider whether the Access Arrangement Information was adequate and the requirements of sections 2.6 and 2.7 had been satisfied, and whether to require the service provider to make changes to the Access Arrangement Information.
On 29 April 1998, the Commission assessed the information provided by TPA in its entirety and concluded that the original Access Arrangement Information, together with the additional information submitted, satisfied the requirements of the Victorian Access Code with respect to the proposed Access Arrangements as they stood at that time.  However, the Commission acknowledged that a final decision on the Access Arrangement Information could not be made then because of the potential impact on the Access Arrangement Information of any amendments to the proposed Access Arrangements required by the Commission in its draft decision. 
In its assessment of the adequacy of the Access Arrangement Information, an issue which the Commission needed to consider was the level of detail required to satisfy the condition of the Victorian Access Code that the Access Arrangement Information should contain sufficient information to allow users and prospective users to understand the derivation of the elements of the Access Arrangements.
Of contention is whether service providers only need to provide sufficient information to allow users and prospective users to understand the methodology used (for example, allocation of costs), or whether users and prospective users are given sufficient financial data to allow them to replicate the service provider’s tariff calculations.  It is the Commission’s opinion that the Victorian Access Code does not require the service provider to provide such information to enable users and prospective users to replicate the service provider’s tariff calculations.  
Nevertheless, the Victorian Access Code is quite explicit in that Attachment A defines the minimum information that must be submitted by the service provider.  Any other relevant information may also be submitted in addition to the Attachment A information.  Attachment A requires the provision of a broad spectrum of financial and operational data at a disaggregated level.
The Commission acknowledges that in many cases the information provided by a service provider in accordance with Attachment A may be sufficient to allow a user to replicate tariff calculations.  However, this may not always be the case, particularly in the more complex cases, such as the current proposals for the Victorian gas transmission systems.  The Commission notes that the supplementary information provided by the TPA contained considerable financial and operational data at an disaggregated level.
The only option for aggregating the Attachment A information, or omitting certain items, is to ensure that disclosure of the information is not, in the opinion of the relevant regulator, unduly harmful to the legitimate business interests of the service provider, a user or prospective user.  It is the Commission’s view that the onus is on the service provider to supply, in conjunction with its proposed Access Arrangement, all relevant Access Arrangement Information and in the appropriate level of detail as required by Attachment A.  If the service provider considers that the information should be categorised or aggregated, or the release of any of the information may unduly harm its legitimate business interests or those of any user or prospective user, the service provider should provide compelling reasons to support its arguments.
The Commission considers that transparency is an important aspect of any access arrangement and that the service provider is required to provide a considerable amount of data which should be sufficient, where practical, to allow market participants to make their own assessment of the reasonableness of the elements of the access arrangement, particularly the reference tariffs.  This process should aid interested parties in making submissions to the relevant regulator which in turn assists the relevant regulator in its assessment of the proposed access arrangement.
In the Commission’s opinion, a description of the methodology applied alone is insufficient and should be accompanied by underlying financial data.  However, as the amount of information released increases, so does the risk that the legitimate interests of the service provider or users and prospective users will be jeopardised.  Therefore, the Commission will always bear this in mind when considering the release of information and will aggregate, or withhold, information if necessary.
The confidential provisions of sections 2.8, 2.9 and 7.12 of the Victorian Access Code suggest that the relevant regulator is likely to have access to more information from the service provider than other market participants.  Nevertheless, the Commission recognises that monopolies are not subject to the same commercial disciplines of a competitive market and therefore the commercial sensitivity of publicly releasing information would be less.
The Commission notes the concerns in submissions about the lack of benchmarking in the Access Arrangements.  Benchmarking in any industry is complex and this is certainly the case with the gas industry.  Comparisons need to account for the impacts of differences in climate, topography, population density, regulatory controls, pipeline sizes and length, pipeline age, relative energy prices, and many other variables.  This makes it difficult to use benchmarks in a precise manner and they are at best indicative.
The Commission has used additional benchmarks to those provided by TPA by way of financial indicators to check on business performance and international comparisons of variables for the WACC analysis.  The Commission also intends to develop a series of performance standards to monitor the performance of TPA and VENCorp over time and other transmission service providers.  
4.9.3	VENCorp’s Access Arrangement for the PTS
Service provider’s proposal
VENCorp submitted the Access Arrangement Information in two stages:
•	the Access Arrangement Information originally submitted in conjunction with the Access Arrangements on 3 November 1997; and
•	supplementary information submitted on 6 March 1998.
The additional information provided by VENCorp expands on the original information in two basic areas:
•	more disaggregated data of costs incurred; and 
•	more information of the methodology of allocating those costs to the relevant functions.
Although the original Access Arrangement Information submitted by VENCorp listed the various cost components, they were not quantified.  The supplementary information provided more detail by way of projected profit and loss statements.  Costs were also attributed to their relevant functions.
In the original Access Arrangement Information, VENCorp stated that costs are allocated in accordance with what end users could bear and based on guiding principles.  Those principles are; that allocation is done on a commercially reasonable and economically efficient basis, does not distort investment decisions and is cost reflective.  More detail of the cost allocation process was disclosed by VENCorp in its supplementary information.  In particular, VENCorp noted that its costs should represent about one per cent of total delivered energy costs for most customers.  According to VENCorp, where the one per cent rule is exceeded, that segment has a low price elasticity and hence can bear the charges with minimal distortion in usage.
The Victorian Access Code requires that the service provider should disclose the key performance indicators which it has used to justify ‘reasonably incurred’ costs.  In this regard, VENCorp stated:
The structure being established in Victoria is novel in the gas industry.  Direct equivalents of VENCorp are not therefore available for comparison.
Submissions by interested parties
BHPP and AGL were critical of the Access Arrangement Information originally submitted by VENCorp.  They argued that it contained deficiencies and failed to satisfy the requirements of the Victorian Access Code.  The main criticisms were:
•	the cost allocation methodology was not fully explained;
•	costs were provided at an aggregate level and not disaggregated by cost categories; and
•	the Access Arrangement Information contained no key performance indicators.
Both BHPP and AGL were critical of the lack of detail of the method of cost allocation employed by VENCorp.  They noted in particular that costs would be on the basis of ‘end-use customer bearable methodology’, but argued that the Access Arrangement Information lacked the underlying elements defining this broad principle.
While acknowledging that VENCorp would not incur the full range of costs set out in Attachment A of the Victorian Access Code, AGL still considers that the level of data provided does not satisfy the requirements of the Victorian Access Code.  AGL pointed to the provision in the Access Arrangement Information of only two costs figures, transmission control and market management costs.
BHPP argued that the lack of detail of disaggregated costs coupled with inadequate information about the cost allocation methodology meant that ‘we simply have no way of knowing what these costs represent, how they are incurred, or whether they are appropriately allocated’.
According to BHPP, a justification for requesting information on costs at a disaggregated level is to ‘make up’ for the lack of key performance indicators (KPIs) for VENCorp’s activities.  Furthermore, BHPP disputes VENCorp’s claim that novelty of the structure of the gas industry in Victoria means that direct equivalents of VENCorp are not available for comparison purposes.  According to BHPP, BG Transco’s Network Code regime is very similar to the proposed model for the Victorian gas industry.  BHPP also suggests that comparisons could be made with independent system operators (ISOs) in electricity industries, both local and international.
Commission’s considerations
The note above on performance standards is also relevant here with the added difficulty that there is no clear equivalent to which VENCorp can be compared.  It is also important to note that VENCorp is a non-profit organisation and that any excess earnings will be returned to the industry in the following year.
4.10	Ring fencing
The Victorian Access Code sets out certain requirements on the part of a service provider to segregate, or ‘ring fence’, its business.  Although not formally part of an access arrangement, a service provider must comply with the ring fencing requirements once its pipeline becomes covered by the Victorian Access Code.
4.10.1	Victorian Access Code requirements
Section 4 of the Victorian Access Code contains the ring fencing provisions.  Compliance is required six months after the date that the particular pipeline becomes a covered pipeline.  The Commission understands that the compliance date for the PTS and WTS is 11 June 1998.
Section 4.1 sets out the minimum ring fencing requirements.  Among other things, a service provider must be a legal entity incorporated under the Corporations Law, a statutory corporation, a government or an entity established by royal charter.  As well as maintaining separate accounts for each covered pipeline, a service provider must maintain a consolidated set of accounts for its entire business.  A service provider must not carry on a related business (essentially production, purchase or sale of natural gas).
If the relevant regulator has published general accounting guidelines, the service provider must comply with those guidelines.  Otherwise the relevant regulator may approve guidelines prepared by the service provider or apply its own specific guidelines to a service provider.
A service provider must maintain internal procedures to ensure that it complies with its ring fencing obligations.  The relevant regulator may require the service provider to demonstrate the adequacy of those procedures upon reasonable notice.  Furthermore, the service provider must provide to the relevant regulator (at reasonable intervals determined by the relevant regulator) a report that describes the measures it has taken to ensure compliance and contains an accurate assessment of the effect of those measures.  A service provider must also inform the relevant regulator of any breaches of its obligations.
In certain circumstances the relevant regulator may establish additional ring fencing obligations or waive some of a service provider’s obligations.
Commission’s considerations
Given the obligations of the service provider under the Victorian Access Code and the impending date on which these obligations commence, the Commission requires TPA, TPAA and VENCorp to provide initial reports as specified under section 4.12 of the Victorian Access Code by 30 June 1998.  Subsequent reports (as required under section 4.13 of the Victorian Access Code) will be required annually by 31 July of each year, commencing 31 July 1999 for the period 1 July 1998 to 30 June 1999.  
4.11	Key performance indicators
The Victorian and National Access Codes identify the need for KPI’s to be disclosed by service providers to interested parties.  The Access Arrangement Information states that the objectives of providing the KPI’s is to allow interested parties to confirm that operation costs included in the target revenue are reasonable when compared to costs in other Australian gas companies; and to monitor the service provider over time to confirm the overall reasonableness of the revenue and tariff setting approach.  The Access Arrangement Information notes, however, that there have been some restrictions on the availability of relevant information, including limited publicly available information and the difficulty in comparing like with like.
The Access Arrangements Information addresses this issue with a limited range of indicators, including comparison of operating and maintenance costs against other Australian pipelines on a $m/1 000km and cents/GJ basis and comparison of cents/GJ of transportation.
The Commission recognises the challenges in identifying KPI’s and benchmarks especially in a newly deregulated commercial environment such as the Victorian natural gas industry.  The Commission therefore intends to work closely with the Service Provider to establish appropriate KPI’s but in the short to medium term it will use financial indicators.  These include funds flow adequacy, funds flow interest coverage, funds flow net debt pay back, internal financing ratio, pretax interest coverage, total debt/total capital, PATBI/funds employed, PBIT/sales volume ($/gj), PBIT/total revenue, PBITD/sales volume ($/gj), PBITD/total revenue, PBIT/funds employed, operating cash flow, and EBIT/operating assets.
Furthermore, the Commission intends to use benchmarks such as load factor and energy delivered per employee which are set out by the Steering Committee on National Performance Monitoring of Government Trading Enterprises as a basis for developing non-financial indicators for TPA.  VENCorp on the other hand, is a unique body and there is therefore no point of comparison at present which may be used to develop KPI’s or benchmarks.  The Commission, however, intends to work closely with VENCorp to develop these, particularly in light of market development and experience.

5.	Draft decision 
5.1	PTS Access Arrangement 
The Commission does not propose to approve TPA’s Access Arrangement for the PTS in its present form.  In order for the Commission to grant approval to the proposed Access Arrangement, the amendments outlined in the Draft Decision must be made or substantially complied with or the Commission must be satisfied that the issues identified in the Draft Decision have been met.  
5.2	WTS Access Arrangement
The Commission does not propose to approve TPA’s Access Arrangement for the WTS in its present form.  In order for the Commission to grant approval to the proposed Access Arrangement, the amendments outlined in the Draft Decision must be made or substantially complied with or the Commission must be satisfied that the issues identified in the Draft Decision have been met.  
5.3	VENCorp Access Arrangement
The Commission does not propose to approve VENCorp’s Access Arrangement for the PTS in its present form.  In order for the Commission to grant approval to the proposed Access Arrangement, the amendments outlined in the Draft Decision must be made or substantially complied with or the Commission must be satisfied that the issues identified in the Draft Decision have been met.  

Appendix A:	Interested parties consulted by the Commission
User consultations
Amcor Ltd
Australian Gas Users Group
Business Council of Australia
Ecogen Energy
ACI Operations Pty Ltd
Broker Consultations
Exco Energy
Government Consultations
Energy Projects Division, Department of Treasury and Finance, Victoria
Producer Consultations
BHP Petroleum Pty Ltd
Network Business Consultations
East Australian Pipeline Limited
Boral Energy Holdings Limited
Retailer and Interstate Consultations
Australian Gas Light Company

Appendix B:	Submissions
The following parties made submissions in relation to the access arrangements:
ACI Operations Pty Ltd, 16 January 1998
Allgas Energy Ltd, 30 March 1998
Amcor Ltd, 26 January 1998, 19 March 1998
Australian Chamber of Manufactures, 30 January 1998
Australian Cogeneration Association, 17 February 1998, 9 April 1998, 22 April 1998
Australian Gas Light Company, 12 January 1998, 3 April 1998, 28 April 1998, 6 May 1998
Australian Gas Users Group, 27 January 1998, 9 April 1998
BHP Petroleum Pty Ltd, 12 January 1998, 13 February 1998, 27 March 1998, 8 April 1998
Boral Energy Holdings Limited, 13 February 1998
BTR Asia Pacific, 6 February 1998
Business Council of Australia, 2 February 1998, 15 April 1998
Carlton and United Breweries Limited, 14 January 1998
CitiPower Pty, 12 January 1998
Coastal Gas Australia Pty Ltd, 13 February 1998
Consumer Law Centre of Victoria Limited, 2 February 1998
Department of Energy (NSW), 16 January 1998
East Australian Pipeline Limited, 12 January 1998
Ecogen Energy, 12 February 1998
Energy Action Group, 27 January 1998, 30 January 1998
Energy Projects Division of the Department of Treasury and Finance (Victoria), 6 February 1998, 11 February 1998, 20 February 1998, 10 March 1998, 11 March 1998, 26 March 1998, 31 March 1998, 2 April 1998, 14 April 1998, 17 April 1998.
Esso Australia Resources Ltd, 30 January 1998
Nova Gas Australia Pty Limited, 13 February 1998
Optima Energy, 25 February 1998
Santos Ltd, 16 January 1998, 13 February 1998
South Australian Minister for Primary Industries, Natural Resources and Regional Development, 27 January 1998, 13 February 1998
South Australian Office of Energy Policy, 12 February 1998
Texas Utilities Australia Pty Ltd, 27 March 1998
Uncle Tobys Company Limited, 2 February 1998

Appendix C:	Attachment A of the Victorian Access Code 

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	

Appendix D:	Explanation of EPD model
EPD provided the Commission with a computer model of its tariff calculations.  The input is various Gascor/TPA forecasts (volumes, costs) and estimates (asset values, WACC) and the output is the reference tariffs proposed in the Tariff Order.  The following is a summarised explanation of the model.  It is similar to the summary of the service provider’s Access Arrangement Information in the body of this Draft Decision but contains more detail.
Volumes
Volume forecasts, supplied by Gascor, are changed to add seller’s own use, adjust specific points which are known to be incorrect in the Gascor data and adjust for unaccounted-for-gas.  
Operating & Maintenance Costs
TPA’s starting point for forecast O&M is the GTC corporate plan.  Costs (such as labour, materials, communications, motor vehicles, etc.) are allocated to departments.  Some costs (relating to ‘Gas Control’ and ‘GTSO’) are removed as being appropriate to VENCorp.  Total O&M (after removal of the VENCorp costs, and not including compressor fuel costs) is $24.3 million in 1998, rising to $25.4 million in 2002.  
Each department’s costs are then allocated to one or more of 54 activities in various proportions (either based on the proportion of net labour used in those activities or on advice received).  Each of these activities’ costs is then categorised as commodity (for example, odourisation costs), distance allocation (for example, operations costs for open access pipelines), direct allocation (for example, costs for system performance/control, engineering and operations for compressors and LNG) or common (for example, costs for commercial, financial and management activities, and systems planning).  Relevant costs are also allocated between PTS and WTS on various bases as considered appropriate.  
Costs associated with the LNG system, customer delivery facilities and receipt point facilities are removed, while the cost of compressor fuel gas is added to produce a total O&M figure relevant to the reference services.  This figure is the aggregate of common costs (for both PTS and WTS), direct costs for each of the three compressors, and direct costs associated with pipelines (for both PTS and WTS).  EPD then reduced these total forecast figures by an expected productivity saving.  
Table A below shows, for each year in the initial regulatory period, the proportion of the O&M forecast by GTC which EPD’s model allocates to be recovered by the reference tariffs.  It also lists for each year the result of reducing this forecast by the required productivity factor.  These reduced figures are the input to the revenue allocation model from which the reference tariffs are developed (see below).  The forecast O&M for Murray Valley is added to these figures to derive the figures listed in the Access Arrangement Information.
Table A:	Forecast operations and maintenance costs
	1998	1999	2000	2001	2002	
	$m	$m	$m	$m	$m	
GTC forecast 	19.5	19.9	20.1	20.1	20.5	
GTC forecast less productivity factor	19.3	19.4	19.2	18.9	19.0	
Murray Valley	0.2	0.2	0.2	0.2	0.2	
AAI forecast	19.5	19.6	19.4	19.1	19.2	
	%	%	%	%	%	
Productivity Factor	0.77	2.56	4.31	6.10	7.73	
Source:	EPD model supplied to the Commission
A regulatory fee for the Commission, and an Office of Gas Safety charge, are included in the O&M costs.
Revenue allocation
Total depreciation and return figures allocated to pipelines are allocated to asset groups in proportion to each group’s pipeline ORC.  Depreciation and return for other direct assets (compressors, odourising plants and Dandenong terminal) are allocated directly to the asset group in which they reside.
The total figure for each asset group (also referred to as a zone) is split between users in that zone and users upstream in proportion to the GJ of MDQ/km relevant to each.  These are then divided by the relevant volumes to get a per GJ pass through rate and a per GJ/km zone rate.  The ‘upstream rate’ for each asset group consists of the sum of the pass through rates for each asset group between that particular asset group and the hub.  
In 2001 and 2002 these calculations assume that the take-off points in the Calder price zone and the western half of the Metro price zone receive all their gas from the UGS.  Pass-through rates are calculated on the basis that transportation is along this route.  
For asset groups 1-5 (those on the injection side of the hub) depreciation and return are split between zone and upstream as above except that the basis is the 5 day maximum demand (rather than MDQ).  These figures are divided by the pass through volume (5 day maximum) to give a per GJ rate.  The pass through rates for asset zones 1, 2 and 5 (the direct line from Longford to the Hub) are added together to get an injection rate.  The injection rate applicable to the three delivery points in asset group 1, and to asset groups 3 and 4 are a reduced proportion of the standard injection rate to reflect only the proportion of the Longford to Pakenham line used by those items.
Pipeline locational O&M is allocated to asset groups in proportion to each group’s pipeline length (which totals 1330.7 km).  O&M for compressors is allocated directly to the asset group in which they reside.  Each asset group’s O&M is allocated to asset zone and up-stream using the same method as for depreciation and return except that it is based on total annual volume and not MDQ.  
Common O&M for both PTS and WTS (forecast separately) are divided by the relevant total volume to give a per GJ rate for each system.  Return and depreciation for indirect assets are divided by total volume to give a per GJ rate (there is no split between PTS and WTS).  This rate is added to the relevant common O&M rate to give a total common rate for each of PTS and WTS.
For each delivery point, each relevant asset zone rate is multiplied by each distribution volume (or volume x distance as appropriate) to derive six target revenues associated with: MDQ, locational commodity, common commodity (assets), common commodity (O&M), injection and injection discount for each distribution point.
Tariff Order
To provide an allocation between Tariff D and Tariff V customers an average for the initial regulatory period is used.  Volumes forecast by Gascor are allocated to price zones for each year.  The five year data is summed and the proportion of daily metered customers to total customers calculated for each price zone.
The six revenues by delivery point (listed two paragraphs above) are imported from each of the revenue allocation spreadsheets for each of the five years.  These six revenues are re-allocated to five categories.  Capacity (MDQ) revenue is split between demand and volume on the basis of the ratio of daily metered customers to non-metered customers (calculated as in the above paragraph), except for the three specific take-off points where daily metered load is assumed to be 100 per cent.  The revenue related to locational O&M, common O&M and common assets is summed into anytime volume.  Injection charge and injection discount remain unchanged.  For each tariff for each delivery point, the NPV is calculated based on a WACC of 13.02 per cent for each of the five revenue streams.  The delivery point data are aggregated into pricing zones.
For each of the five categories, for each delivery point, a tariff is calculated that, when increased by CPI-X over years 1999-2002, will produce revenues each year (when multiplied by the forecast volume) with the same NPV as the NPV calculated in the above paragraph.  These are then aggregated for each pricing zone (net of the transmission supply points) to produce zone tariffs and transmission supply points tariffs.  This approach is applied to the calculation of tariffs for peak demand, peak volume, anytime volume, injection charge and injection discount (though injection charge is the same figure for all zones and the discount applies to only two pricing zones).