SNOWY MOUNTAINS HYDRO-ELECTRIC AUTHORITY 
TRANSMISSION ASSET BASE REVIEW

Prepared for
Australian Competition & Consumer Commission
Document Reference	:	\\nzwf2\project\52483\SMHEA Report Final.doc
Report Revision	:	Final
Prepared by	:	
	I. Hunt/S. Wightman/G. Brown
Reviewed by	:	
R. C. Millard
Approved by	:	
G. Brown
Date	:	4 August 1999

TABLE OF CONTENTS

Sections
1.	Introduction	3
2.	Summary of findings	4
3.	BACKGROUND	5
3.1	The Consortium Valuation	5
3.2	The SKM Valuation	5
3.3	National Electricity Code Requirements	6
3.4	Historic Cost Valuation	7
4.	Asset Definition and Identification	8
4.1	General	8
4.2	Validation / Verification of Data	8
4.3	Minimum Classifications	9
4.4	Separation of Regulated from Non-Regulated Assets	9
5.	Asset Replacement costs	10
5.1	General Comments on Guideline Standard Replacement Costs	10
5.2	Replacement Overhead Line Costs	10
5.3	Switchyard Costs	11
5.4	Assessment of Materiality	11
5.5	Easements	11
6.	Asset Lives and Age Profiles	13
6.1	General	13
6.2	Application of Effective Lives in the ODRC Valuation	13
6.3	Transmission Line Asset Lives	14
6.4	Switching Station Asset Lives	15
6.5	Assessment of Materiality	15
6.6	Capital Expenditure Programme.	15
7.	Optimisation	17
7.1	General	17
7.2	Transmission Line Optimisation	17
7.3	Switching Station Optimisation	18
8.	Indexing the TRANSMISSION  capital base forward	19
9.	1998 Valuation DIFFERENCES from 1997 Valuation	20
10.	CONCLUSION	21

APPENDIX A	Australian Competition & Consumer Commission TERMS OF REFERENCE
APPENDIX B	ASSET CATEGORIES AND PERCENTAGE CONTRIBUTION TO ODRC FOR EACH CATEGORY

Introduction
The Australian Competition & Consumer Commission (the Commission) is currently conducting an inquiry into the appropriate revenue cap to be applied to the non-contestable elements of the transmission services provided by the Snowy Mountains Hydro-electric Authority (SMHEA) transmission network.
The most recent valuation of the SMHEA’s transmission assets is contained in a February 1999 Report prepared for the New South Wales Treasury by a consortium consisting of Arthur Andersen, GHD and Worley International (the Consortium).  Other asset valuations for the SMHEA were undertaken in 1991 by GHD Black & Veatch and more recently in 1997 by Sinclair Knight Merz (SKM).
The Commission has engaged PB Power to review the optimised depreciated replacement cost (ODRC) valuation conducted by the Consortium.  In particular the Consultant is required to review the appropriateness of the assumptions, methodologies and findings of the Consortium’s 1999 valuation of the SMHEA’s transmission asset base in terms of meeting the requirements of the National Electricity Code (Code).
Furthermore PB Power has been asked, as part of this review, to consider the following matters:
•	reconciliation of variations between past and revised ODRC valuations and the most recent valuation;
•	the appropriateness and the results of using alternative valuation methodologies where such alternatives are consistent with the requirements of the Code; and
•	other matters as are necessary to enable the Commission to make a Code-compliant valuation of the non-contestable assets of the SMHEA expected to be in service on 1 July 1999.
The SMHEA’s transmission grid assets include:
•	330 kV and 132 kV transmission lines;
•	330 kV and 132 kV switching stations;
•	Group control centre at Lower Tumut.  Group control centres are also located at Murray and Upper Tumut;
•	Support systems including protection, control and metering systems;
•	Power line carrier communications systems; and
•	Land and easements.

Summary of findings
The following comments summarise the results of our examination of the Consortium’s report on the ODRC Valuation of the SMHEA Network Assets:-
•	The ODRC Valuation was undertaken on the understanding that as part of the corporatisation of the SMHEA the transmission grid, assets and support systems would be transferred to TransGrid, and therefore the valuation was undertaken in accordance with the NSW Treasury Guidelines.
•	The Consortium’s ODRC Valuation is based on recent construction costs experienced by TransGrid for similar assets and not on the standard costs contained in Table 1 of the Guidelines.  The current accuracy of these costs has been considered by the Consortium and PB Power and the costs have been found to be reasonable.
•	We consider the asset lives used by the Consortium in the valuation are in some cases conservative, given the current condition and expected remaining life of the assets. Increasing the life of the 330 kV steel line from the 50 years used by the Consortium to 70 years, and increasing the life of switchyards from 40 to 45 years, increases the ODRC valuation to approximately $63 million.  This represents an increase of approximately $16 million.
•	At 0.5% of the total valuation of the SMHEA’s transmission assets a revaluation of the easements held by the SMHEA over privately owned land will not have a material impact on the overall valuation.  Additionally, we do not recommend that easements in National Parks or State Forests be included in the ODRC valuation.
•	The Consortium does not give adequate consideration to the level of optimisation to be built into the valuation.  On the basis of the information available to us, we believe that more study is needed to determine whether it would be appropriate to further optimise switching station configurations. 
•	Due to the uncertainties surrounding the forecasting of costs and pricing trends we do not recommend that the 1998 ODRC valuations be indexed forward to July 1999.
•	The SMHEA’s transmission assets are readily and separately identifiable from the SMHEA financial asset register.  However the written down value of the assets is not based on historic costs, which are not available.  Concerns have also been raised as to the accuracy of the ages given for some assets in the register.
•	We have not undertaken a full review of the SMHEA’s capital expenditure proposals.  However, on the basis of the very limited information available to us, the proposed capital expenditure on the transmission system would seem to be appropriate.

BACKGROUND
The Consortium Valuation
The Consortium valuation report was completed in February 1999.  The valuation was undertaken in accordance with the NSW Treasury Policy Guidelines for the Valuation of Network Assets of Electricity Network Businesses (Guidelines) to assist in the determination of a revenue cap determination in accordance with the Code.  The ODRC valuation was $46.6 million.  With the national electricity market in operation, it will progressively become the responsibility of the ACCC, rather than the state regulatory authorities, to make revenue cap determinations in respect of all EHV transmission businesses.
The Guidelines are a NSW Treasury document and therefore do not necessarily apply to the ACCC or jurisdictions outside of NSW.  They appear to have been developed primarily for the valuation of lower voltage distribution networks but are nevertheless applicable to transmission systems.  The methodology to be used for valuing the assets is tightly prescribed and schedules of standard lives and replacement costs are included.  Interestingly, these schedules include standard lives and replacement costs for extra high voltage (EHV) transmission lines but not for transmission substations.
The Guidelines state that the replacement costs for transmission systems can usually be determined with more precision than distribution networks.  The standard costs provided in the schedules are to be taken as benchmarks only.  The standard lives are to be used except in rare cases where a group of assets may have a different useful life because of different service conditions.  A minimum remaining life of three years is to apply for all assets still in service.
The SKM Valuation
The SKM valuation report was completed in April 1997 and provided two different valuations.  The first valuation, completed in accordance with the Guidelines, except that a 5-year residual life was assumed, was $46.1 million.  This is comparable to the Consortium valuation.
The valuation was completed as part of the process of corporatisation of the SMHEA.  At the time it was planned that the transmission assets of the Snowy scheme would transfer to TransGrid and a primary purpose of the valuation was to determine an appropriate transfer value.
However this report included a second valuation, ($77.2 million) based on all assets having a minimum 20-year remaining life.  The transmission assets of the Snowy scheme were constructed in the late 1950s and 1960s and many of the assets were, by 1997, approaching the end of their standard useful life.  The valuers evidently concluded, after inspection of the assets, that the remaining life indicated by use of the NSW Treasury standard lives, was not a true reflection of the asset condition and hence the value of the assets to their owner.  The Guidelines were therefore inappropriate as the basis for the determination of a transfer price.

National Electricity Code Requirements
Section 6.2.3 of the Code requires that, for the determination of a revenue cap for transmission network businesses, assets in existence and generally in service on 1 July 1999, be valued at the value determined by the jurisdictional regulator, provided that this valuation does not exceed the deprival value.  However the Code does allow the ACCC to independently verify this valuation, through a process agreed to with the National Competition Council.
The deprival value of a network asset is a measure of the economic loss the network owner would suffer if it were deprived of the use of the asset.  This is generally taken to be the lower of the ODRC or the economic value of the asset, where the economic value is the present value of the future revenue stream resulting from the use of the asset.
In assessing deprival values the ODRC generally prevails, except in cases where the provision of a grid supply is uneconomic due to the high cost of the connection required.  This can apply, for example, in the case of long rural feeders where the revenue stream is small in relation to the capital cost of the feeder.
It should be noted that, if the ODRC is to give a fair reflection of the actual economic loss a network owner will suffer if deprived of the use of the asset, the valuation must reflect the actual physical life of the assets involved.  For example, the valuation will not be a fair reflection of potential economic loss if it assumes that the useful life of the asset has, for practical purposes, been expended when, in reality, there is a significant remaining economic life.
Application of the economic value test is problematic in regulated environments, as the asset valuation requires a forecast of the future income stream.  However the future income stream is, in itself, determined by the regulator, generally on the basis of the value of the assets employed.  The logic is circular, as the assessment of the potential income stream is not independent of the valuation process.
Irrespective of the above, PB Power is required to comment on whether it is appropriate or necessary to apply the economic value test in the determination of the asset deprival value, in the context of the code.  In respect of the SMHEA transmission assets two factors are relevant:
•	The assets are an integral part of the Snowy scheme in that they are necessary to export the power generated by the scheme.  On this basis it is inappropriate to analyse the economic value of the transmission system in isolation from consideration of the economic merit of the scheme as a whole.
•	The assets form the interconnection between the NSW and Victorian grids and are therefore essential to the effective operation of the national electricity market.
As both the Snowy scheme and the national electricity market are important to the Australian electricity industry as a whole, the issue, in determining an appropriate deprival value for the transmission assets, is not whether it is necessary to apply the economic value test, but whether the capacity of the transmission network is appropriate.  This is more properly taken into account in the optimisation process inherent in the assessment of ODRC.

Historic Cost Valuation
The use of depreciated historic costs as the basis for asset valuation assumes a pricing strategy based on cost recovery.  In our view this is incompatible with the economic philosophy that underlies the electricity industry structure in Australia today.  This assumes that energy prices should be set, not on the basis of costs, but by market forces.  We note that the underlying premise for the deprival valuation methodology is that assets should be valued in terms of the economic loss suffered if deprived of the use of the asset.  This loss is measured either on the basis of the cost of replacing the asset with a modern equivalent or, if this is not economic, on the basis of the future income stream foregone.  In our view this approach, while not perfect, is more consistent with modern economic thinking.
The SMHEA asset register gives the 1998 depreciated historic cost of the financial assets as $130.5 million.  This figure has been derived by adding back the past year’s depreciation of $6.1 million to the current written down value of $124.4 million.
This written down value is against a base cost of $270.6 million.  We understand this to be  the asset replacement cost assessed in a 1991 valuation undertaken by GHD Black and Veatch.  This 1991 valuation appears excessive when compared to present day replacement costs, even if it is assumed that the assets are to be replaced on a like for like basis with no optimisation.
We understand that the actual historic costs of the transmission assets are not available since, during construction of the Snowy scheme, the transmission assets were considered an integral part of the generation system and not costed separately.
Even if it is accepted that an historic cost valuation is a legitimate basis for regulatory pricing, and we are not suggesting this to be the case, then we consider the valuation basis should be actual historic costs.  The available 1991 valuation bears no known relationship to historic costs and its use would be arbitrary and inconsistent with the approach taken to the pricing of other network businesses.

Asset Definition and Identification
General
The starting point for the asset valuation is the type and number of assets owned by the SMHEA.  These details are drawn from the asset register provided to us by the SMHEA.  The source of the asset base value data in the register is a valuation done in 1991 by GHD Black & Veatch.
The accuracy of the asset register has a significant effect on the accuracy of the final valuation figure and as such the process used to verify the asset register is an important consideration in reviewing the valuation report.  In commenting on the approach taken to defining and identifying transmission assets for this valuation, the following items, which are considered to prudent steps in the validation process, have been considered:
•	what validation of the asset registers was undertaken during the valuation process;
•	have sample field visits been carried out by the SMHEA or the Consortium to verify asset data;
•	was the sample selected to provide a suitable cross section of assets owned by the SMHEA;
•	are the assets listed in the registers divided appropriately according to the minimum classifications stated in section 2.2.3 of the Treasury guidelines;
•	are methods used to estimate asset details reasonable, where accurate data has not been provided; and
•	was there a check on the definition of system boundaries.
An independent assessment of the accuracy of the SMHEA’s transmission asset records is outside of the scope of this review.  The level of validation carried out is therefore reviewed only on the basis of the comments made in the Consortium’s report.  A review of the consistency, type and thoroughness of the validation of the asset registers is set out in the following sections.
Validation / Verification of Data
The Consortium recognised the considerable effort that the SMHEA had put into ensuring the accuracy of the financial asset register in its “Quality Statement” with the majority of elements making up the asset register being assigned a “High” or “Excellent” Quality Level.  The subsequent valuation outcome was assigned an overall Quality Rating of High Quality (90-95%).
Because there were only a relatively small number of assets the Consortium verified the financial asset register against the single line diagrams and project files.  The confidence levels expressed are 95% or better in respect to the component break-up of the asset register and asset description, and 90% or better for the management of the data, identification and categorisation, data verification, age profiles, replacement/optimised values, and depreciated values.  The data verification indicates the ability of the valuer to check the accuracy and consistency of data provided but does not give a direct indication of the accuracy of the data for quantity or age.
There is no evidence supplied that any sample field visits were carried out by the Consortium to verify any changes to the asset listings or their condition.  There is also no evidence that a range of assets was investigated to give a reasonable cross-section for verification of different categories in the asset register.
Minimum Classifications
The data used by the Consortium for the valuation exercise was supplied from the SMHEA’s asset register of the company and an asset spreadsheet derived for the exercise.  The asset categories listed match with the minimum classifications prescribed by the Guidelines.
Information on asset lives in the SMHEA’s financial asset register differs from the standard lives listed in Table 1 of the Guidelines.  The Consortium used TransGrid’s asset lives (section 7.1 of the Consortium’s report) for the ODRC valuation in order to be consistent with the approach taken in the valuation of TransGrid assets.  There are some differences between the asset lives used by the Consortium and the standard lives in the guidelines but these will have only a minor effect on the valuation.  The validity of the standard lives used in the Consortium valuation is discussed in Section 5. 
The Consortium comment on the asset condition, maintenance practices, and the replacement of control, protection and metering systems and some of the circuit breakers.  While a field check of these assets against the database may be useful, we believe that the Consortium has used acceptable methods to value the changes to the assets that have occurred since they were constructed.
Separation of Regulated from Non-Regulated Assets
The Consortium’s valuation report covered the transmission assets that had been identified for transfer to TransGrid, while our review of the Consortium’s valuation is on the basis that the ownership of the transmission assets will remain with the SMHEA.  Our assessment of the separation of the regulated and non-regulated activities in the SMHEA is as follows.
•	PB Power was provided with a listing of the transmission assets from the SMHEA financial asset register.  This clearly demonstrated that the transmission assets are easily and separately identifiable from those assets used in the contestable business of power generation.
•	The SMHEA asset register is very detailed and gives a comprehensive listing of transmission assets.  We have not independently reviewed the accuracy of this listing but note that the Consortium report gives a 90-95% confidence rating to the accuracy of asset identification and categorisation.
•	As noted in Section 3.4 the actual historic costs of the transmission assets used for regulated activities are not separately identifiable and are not available.  The SMHEA’s written down asset value is therefore based on a 1991 replacement cost valuation rather than the historic costs of the assets concerned.
•	The SKM report expressed concern about the accuracy of asset ages as recorded in the SMHEA asset register.  This concern is not reflected in the Consortium report, which gives a 90-95% confidence rating to the asset ages as shown in the register.  We are unable to comment further on this aspect except to note that UTSS-MSS line, which SKM claim was commissioned in 1959, is still shown in the register as having a 1969 commissioning date.

Asset Replacement costs
General Comments on Guideline Standard Replacement Costs
The Consortium note that the SMHEA assets to be valued are in large not covered by the standard costs given in the Guidelines.  For example, standard replacement costs are not provided for transmission substations in the Guidelines.  In the case of transmission lines, standard costs are given for benchmarking purposes only and are not mandatory.  Hence the Consortium’s ODRC valuation is not based on the standard costs contained in Table 1 of the Guidelines but on TransGrid’s recent construction costs.  A terrain factor is applied to account for the additional costs of building lines in the mountainous regions of the Snowy scheme.  This approach is consistent with Guideline requirements.
A comparison of the standard costs given in the Guidelines and the replacement costs assumed in the Consortium report in given in the table below.

Asset Category	
Unit	Standard
Replacement Cost
Guidelines
($,000)	Consortium Report
Replacement Cost

($,000)	
330kV S_circuit steel tower	km	$206	$280	
132kV D_circuit steel tower	km	$302	$185	
132kV woodpole
(heavy conductor rural “H” pole)	km	$88
	$120	
Circuit Breaker (SF6), 330kV	No.		$311	
Switching Station 330kV
11/2 CB double bus, line bay)  switchgear & infrasturucture, excl protection, controls & CBS. 	
No.	
	
$569	
Our approach has been to make an independent assessment of the replacement costs of the asset based on information available to us.  Where this assessment comes within 10% of the Consortium estimate, we have generally accepted the Consortium value without further comment.  This recognises that cost estimation is not an exact science, and that there is no valid reason to suggest that our estimate of replacement costs would be any more accurate than that of the Consortium.
More specific comments on the costs assumed for the Consortium valuation are given in the sections below.
Replacement Overhead Line Costs 
The Consortium used a comparison with TransGrid costs for constructing similar 330kV lines and added factors for the ruggedness, access roads and climatic conditions.  The details of this review or breakdowns of the cost components are not provided in the reports and we are therefore unable to review this part of the work in detail.  
The Consortium’s assumed replacement cost for 330 kV steel tower lines ($280,000 per km) is approximately 36% higher than the standard replacement costs in the Guidelines and we assume this difference to be primarily due to the application of a terrain factor.  The proportion of 330 kV lines constructed in mountainous terrain is not clear but we assume it to be high.  The terrain factor used in the Consortium valuation is not stated but, on the basis of the above comparison, it is likely to be similar to the 1.4 used in the SKM report.
In New Zealand, the Transpower ODV valuation uses a terrain factor of 1.23 for overhead lines constructed in mountainous regions.  Our European experience also indicates high voltage transmission lines constructed in mountainous regions are typically 25% more expensive that lines built over flat terrain.  We therefore consider a terrain factor of 1.25 to be appropriate.
Our independent estimate of the present day costs of constructing a 330 kV single circuit steel tower transmission line in mountainous terrain similar to the Snowy is $253,000 per km, using a terrain factor of 1.25.  This would indicate that the standard cost, as given in the Guidelines is reasonable.  As our estimate is within 10% of the Consortium’s, we accept that the Consortium figure is reasonable for asset valuation purposes. 
Our estimate on the replacement cost of the 132kV double circuit steel tower line is $182,000 per km.  This compares very favourably with the Consortium’s cost of $185,000 per km.  However we are unable to explain the standard replacement cost of $302,000 per km given in the Guidelines.
Switchyard Costs 
The Guidelines call for modern equivalent replacement costs.  PB Power concurs with the Consortium’s rationale to use the replacement value of a 330 kV SF6 type breaker for the replacement cost of circuit breakers.  The cost of $311,000 for a 330 kV circuit breaker is reasonable.
The Consortium’s cost for a 330 kV 11/2 CB, double bus line bay of $569,000 is close to our estimate of $560,000.
Assessment of Materiality
If the 330kV costing were inaccurate by +/-10%, then the overall ODRC valuations would be affected by 7%.
Similarly, if the switching station costs were inaccurate by 10%, then the affect on the overall ODRC valuation would be 3%.
Some of these figures may be considered significant.
Easements
The contribution to total ODRC for land and easements is 0.5%.  The materiality of any inaccuracies in this area is not considered to be significant to the overall ODRC value.
Neither the Consortium nor SKM have included the value of easements within the National Parks or State Forests, and PB Power has been asked to comment on whether these easements should be included in the valuation.
The Guidelines state that initially easements should be valued at cost.  A transition period of five years is allowed for businesses to identify and value their easements, but the Guidelines provide no specific information on valuation methodology.
In its recent pricing report to the NSW government IPART has recommended that easements not be included in the asset bases of distribution businesses.  Their argument is that inclusion is of no economic value and the resulting price shocks would be unacceptable.
The replacement cost of an easement is determined by the value of the loss of amenity in respect of the affected land, by virtue of the encumbrance.  This can be measured in terms of the difference in the value of affected land with and without the easement.  The problem is that the value placed on loss of amenity is subjective in nature and its value often cannot be measured rationally in terms of, for example, loss of productivity.  In this situation recourse is made to the market to allow a value to be determined.  This presupposes that the land affected can be bought and sold on an open market, which is not the case for a National Park.
The amenity value of a National Park is in its undisturbed natural environment.  Society places a high value on this amenity as is evidenced by the fact that it is willing to ring fence such areas from conventional economic activity, often at enormous cost in terms of lost economic potential.  We suspect that any attempt to assign a value to easements within National Parks on the basis of classical economic theory would, assuming it was possible, produce a result that would overwhelm other considerations to the extent that the resulting valuation would become meaningless as a tool for regulatory pricing.
In such a situation it would be possible to have recourse to economic value.  However, as discussed in Section 3.3 this would generate circular logic with the result that any revenue cap would need to be imposed on a very arbitrary basis.
The reality is that any value placed on an easement within a National Park or State Forest would be dictated by political rather than economic considerations.  For this reason we would recommend that, for the purposes of regulatory pricing, such easements be treated as if they had no economic value.

Asset Lives and Age Profiles
General
The Snowy scheme was commissioned between 1959 and 1973 and those parts of the transmission system commissioned during the early days of the scheme are now forty years old and approaching the end of their standard useful life, as defined in the Guidelines.  The Guidelines require that all assets still in service be valued on the basis of a minimum remaining life of at least three years.  As part of its 1997 valuation SKM undertook an inspection of the assets and concluded that the assets, including those currently reaching retirement were still in good condition.  On this basis the report included two valuations, one based on the Guidelines and one assuming a minimum remaining life of 20 years.
Nevertheless, there is some indication that some assets are approaching the end of their useful life.  For example, the 1997 SKM report noted a potential for transmission line conductor damage due to aeolion vibration.
The difference between the two valuations included in the SKM report illustrates that the ODRC valuation is particularly sensitive to the asset lives assumed.  The use of standard asset lives, as favoured by the Guidelines, is often encouraged by Regulators on the basis that it ensures a consistency of approach, and allows the asset valuations to be used as a basis for normalising the performance of different network businesses for the purpose of comparison.  Nevertheless we believe it is important that valuations provide a fair reflection of existing asset condition if they are to be useful as an indicator of the financial position of the business.
The Guidelines require standard asset lives to be used except in “rare” cases where assets may have different useful lives because of different service conditions.  Variations from standard lives are to be made in a transparent and consistent fashion, and justified and documented by the valuer.
There is much discussion within the industry as to the appropriate asset lives to use for valuation purposes and this is reflected in the tables below. Some of the reasoning behind the selection of asset lives is also discussed below.  In the Consortium valuation, the TransGrid asset lives, as listed in the table below, were used.

Application of Effective Lives in the ODRC Valuation
A comparison of the asset lives used for asset valuation purposes in different jurisdictions in given in the tables below.

Category	SMHEA	Treasury Guidelines	TransGrid	
Transmission Lines Tower 
Pole	
50
-	
50
35	
50
50	
Transformers	40	50	35 to 40	
HV Switching
Equipment	
40	
40	
40	
Controls/Protection
Electromechanical
Electronic	
20
15	
40
-	
40
-	
Auxiliary & Ancillary
Equipment	
20	
35-40	
40	

Category	TransPower
NZ	Treasury Guidelines	Average life PB Power UK	
Transmission Lines Tower 
Pole	
70 (inland)
	
50
35	
68
53	
HV Circuit Breakers
Airblast	
35	
40	
50	
Auxiliary & Ancillary
Equipment	
20	
35-40	
40	
Transmission Line Asset Lives
The Guidelines stipulate a steel tower transmission line asset life of 50 years, with no subclassification for environmental position; i.e. exposure to pollution and wind.  In our experience the environment of a steel tower transmission line significantly affects its life. For instance in New Zealand the normal life is considered to be 55 years, but in a coastal environment this is reduced to 35 years.  For inland lines, in an environment similar to that of the Snowy scheme the useful life is considered to be 70 years.  Our U.K. experience parallels this observation.  
The Guidelines also do not subdivide such assets into different components, but state that the standard life is the weighted average useful life of all components making up the line.  We believe that the conductors and fittings generally have a shorter life than the steel towers, particularly in adverse environmental conditions.  It is  reasonable to expect that a steel tower line will be re-insulated and reconductored at least once during the life of the line.  On this basis it may be more reasonable to model a steel tower line as a composite of two asset types, conductors and fittings with a useful life of 40-45 years and steel towers and foundations with a useful life of 75-80 years.
It is noted that the SKM capital expenditure plan makes provision for possible reconductoring of lines from 2002.  While the main reason given is to increase line rating, this would also address maintenance problems noted in the SKM report.  It is also consistent with our international experience that conductors and insulators in a steel tower line are generally replaced, for one reason or another, at least once during the life of the line.
Given the present condition of the SMHEA steel tower transmission lines and their expected remaining life, as assessed from the SKM report, we consider that a 50 year asset life for steel tower lines is too short if the valuation is to be a fair reflection of economic deprival value.  We would propose using a useful life of 70 years.  Alternatively a life of 80 years could be assumed for the towers and foundations, and 40 years for the conductors and fittings.
Switching Station Asset Lives
Both the Consortium and the SKM valuations used a high voltage air blast circuit breaker and auxiliary equipment life of 40 years.  In NZ air blast breakers are considered to have a life of 35 years, after which replacement is usually carried out with modern technology breakers that do not require expensive ongoing maintenance.  In the U.K. this type of high voltage breaker is given a life of 50 years, after which they are refurbished.  The refurbishment cost is cheaper than the replacement cost.
The SMHEA’s capital expenditure plan includes the ongoing replacement of air blast breakers with SF6 units.  The program is expected to be completed by 2007 and would seem to be appropriate.
Both valuations also used a switchgear infrastructure and busbar life of 40 years.  Our NZ and UK experience indicate that 50 years could be more appropriate, especially for the Snowy environment.
Items like batteries, battery chargers, and some protection and control equipment can have asset live considerably less than 40 years and typically of the order of 15 years. However the cost of these items is small with respect to the total substation asset costs, and so these item will not have a material affect on the overall valuation.
It is noted that major transformers have been omitted from the scope of the valuations.
It is also noted that both valuations appear to have allowed for a building life of 40 years. Our experience is that a building life of 50 years could be more relevant and the New Zealand building code requires all buildings to have a minimum design life of 50 years.   
Considering the above factors for the Snowy situation, we believe that an average switching station asset life of 45 years would be appropriate.
Assessment of Materiality
Increasing the life of the steel tower lines from the 50 years used by the Consortium to 70 years and increasing the life of switchyards from 40 to 45 years increases the ODRC valuation to approximately $63 million.  This represents an increase of approximately $16 million above the Consortium valuation.
Capital Expenditure Programme.
The SMHEA has submitted a capital expenditure programme totalling approximately $10 million over the 5-year price review period.  Proposed projects include the replacement of air blast circuit breakers with SF6 units, the upgrade of the lines between the Upper and Lower Tumut switching stations and improvements to sewage treatment facilities and fire protection systems.
A review of the SMHEA capital expenditure programme was not included in the terms of reference for this report.  Therefore PB Power has not carried out an inspection of the asset base, discussed the need for the expenditure with management staff or independently costed the proposals.  We are therefore unable to comment in detail on either the quality or quantity of the proposed expenditure.
Nevertheless, for this desktop review, the proposals appear reasonable on the basis of the written justifications provided by the SMHEA.

Optimisation 
General
The Guidelines require an “incremental optimisation approach to be followed in which the existing system is to be examined and changes made to ratings, configurations, designs or materials having regard to such issues as excess capacity, redundancy or over design”.  In the case of transmission networks a 15 year planning period is indicated.  However the Guidelines are vague when discussing appropriate levels of security and reliability.  We believe these need to be defined and agreed before an optimisation process begins.
The Guidelines also constrain the level to which a transmission network can be optimised.  In particular:
•	Only existing easements and line routes should be used.
•	The optimised network should have an import/export capacity similar to that of the existing system.
The Guidelines also specify that the scope of the optimisation include two separate aspects:
•	Optimisation of network configuration.
•	Optimisation of assets in the network.
The question of asset optimisation (as distinct from configuration optimisation) is, to a large degree, taken into account when determining the modern equivalent asset to be used as the basis for estimating the cost of a modern equivalent asset.  The discussion below will therefore focus on configuration and capacity considerations.
Transmission Line Optimisation
Neither the SKM nor the Consortium reports show evidence of any real consideration being given to transmission line optimisation issues.
The Consortium report notes that the network was built for a certain capacity and has essentially remained unchanged since construction ended 25 years ago.  No consideration is given to whether this installed capacity is appropriate in terms of modern engineering standards and no consideration is given to whether the built-in levels of security and reliability are still appropriate.  These omissions could be significant, given that one purpose of optimisation is to eliminate over-design.
The SKM report noted that parts of the 330 kV network normally operate at light loads.  However no optimisation was considered necessary on the basis that all lines were required for effective operation of the interconnected network at high load transfers with the appropriate level of security.  There was no quantitative data provided to support this statement and no analysis of what was considered to be an appropriate level of security.
The Snowy transmission system performs two distinct functions:
•	It serves as a means of export for power generated from the Snowy system power stations.
•	It serves as the main transmission interconnection between the NSW and Victorian Grid and is therefore important to the operation of the national electricity market.
The spur lines connecting the power stations to the main switching stations should be optimised in terms of the required power export capacity.  It is noted that these lines are short and any optimisation may not be material in the context of the overall asset valuation.
The lines interconnecting the main switching stations should be optimised in terms of their utilisation as an interconnection between Victoria and NSW.  Ideally a load flow study should be undertaken to determine the required interconnection capacity.  However in the absence of such a study, it is reasonable to assume that the existing capacity is appropriate.  This assessment takes the following factors into account.
•	Optimum energy prices are only achieved in a market environment if transmission is unconstrained.  This would indicate a high capacity requirement.
•	For such an important interconnection it is reasonable to assume that a high level of security would be appropriate.
•	The Guidelines require that the optimised network have an import/export capacity similar to the existing system.  This would appear to limit the scope for capacity optimisation, irrespective of the interconnection capacity required.  We note, however, that the Guidelines are not binding on the ACCC.
•	The SMHEA capital expenditure plan states that the physical rating of sections of the LTSS-MSS lines and the MSS-UTSS lines may constrain levels of power transfer between NSW and Victoria.  This indicates that further capacity reduction would be inappropriate.
Switching Station Optimisation
It is noted that the three switching stations in the Snowy scheme each have different configurations.
•	Lower Tumut has a double bus–double breaker arrangement for all circuits.
•	Murray has a double bus arrangement.  Outgoing lines are connected using a double breaker system.  Connections to the Murray 1 station (5 circuits) use a single breaker arrangement while those to Murray 2 (2 circuits) use a double breaker.
•	Upper Tumut has a single bus, single breaker arrangement, with the ability to switch to a reserve bus in the event of a bus failure.
The SKM report considered that a one and a half bus arrangement was appropriate but the only justification given was that this is current practice in Australia.  The Consortium report appeared to use a similar logic, with the result that a total of five breakers were optimised out of the Murray and Lower Tumut switching stations.  Significantly, the Upper Tumut station does not meet the breaker and half criteria.
Neither report provided a satisfactory justification to support their assumption that a breaker and a half was appropriate.  Further switching station optimisation is possible, and it may be that such optimisation would not produce unacceptable reductions to the level of security.
We recommend further study be undertaken to determine the appropriate configuration for switching station optimisation.

Indexing the TRANSMISSION  capital base forward
The issue of indexing the capital base forward to July 1999 so that the ODRC valuation reflects current costs has no simple answer.  The replacement costs quoted in the Guidelines are based on estimated prices in 1995, when the Guidelines were written.  These have been checked by both the Consortium and PB Power and found to be comparable with current price levels.  This in itself infers that the prices are not linked directly to the CPI and this is demonstrated by the UK experience.
This view is reinforced by the fact that the 1991 GHD Black and Veatch valuation estimated the replacement costs of the transmission assets as $270.6 million, approximately twice the value of more recent assessments.  This large difference cannot be explained entirely by differences in the asset base, assessments on the basis of modern equivalent assets and optimisation.
In the United Kingdom the average prices of the general transmission equipment including transmission switchgear, metering and protection, overhead line conductors, and wood poles decreased by 7% during the period 1996 to 1998. These price trends were wholly consistent with prevailing market conditions and the introduction of foreign competition. Suppliers have been forced to be more commercially innovative, stocks have been kept to a minimum and until mid to late 1996 supply had exceeded demand - certainly in European markets.
During the recession much of the European market had undergone mergers, joint ventures and outright acquisition which has resulted in fewer vendors of electrical transmission equipment.
In addition, many of the construction and refurbishment contracts put in place in the restructured and/or privatised supply industries are likely to require the successful contractor to purchase materials.  Transmission businesses are employing more and more contractors and the labour rather then the material costs are becoming more relevant to capital budgeting.
In the current UK Transmission Price Review the transmission businesses are conceding a 1% per annum reduction in procurement costs over the period of the price review.
However, indications are that the situation is dynamic.  Market conditions suggest a healthy export market for plant and that supply is mirroring demand. Raw material costs are beginning to rise (e.g. copper, aluminium, and steel) and current market testing has indicated the following price trends in Europe for future purchases:
Line conductors and fittings	+6% on current prices;
Primary Transformers	+5% on current prices; 
Transmission  Switchgear		+7% on current prices;
The above trends may not be directly applicable to the Australian electricity transmission industry but some of the principles will certainly apply here as the regulatory regime drives the transmission companies to strive for efficiencies in purchasing and procurement.
Due to the uncertainties surrounding the forecasting of costs and pricing trends we do not recommend that the 1998 ODRC valuations be indexed forward to July 1999.

1998 Valuation DIFFERENCES from 1997 Valuation
The Consortium compared their 1998 ODRC valuation to the ODRC valuation prepared by SKM in 1997 using the same valuation Guidelines.  As stated in the Consortium report:
•	SKM report provided two values, one on the basis of standard Guideline lives and the other on estimated remaining life based on asset condition.  The Consortium noted that the latter was not in accordance with the Guidelines.
•	SKM used a residual life of 5 years.  The Guidelines refer to 3 years.
•	SKM report did not include transfer of Lower Tumut Group Control Centre.
•	SKM used a slightly lower value for spare holdings.
•	SKM included for the completion of circuit breaker replacement work, which had been completed when the 1998 valuation was undertaken.
The comparison of the two valuations on the same basis - ODRC using the Guidelines but with a residual life of 5 years - indicates that the Consortium’s valuation is $1,555,000 or 3.37% higher than SKM’s ODRC valuation.  $1,164,000 of the difference is explained by making allowance for the Lower Tumut Group Control Centre in SKM’s value.  With this adjustment, the difference between the two valuations is reduced to only 0.8%.
These small differences indicate that, if the assets are to be valued on the basis of the standard lives used in the Guidelines, an ODRC valuation of around $47 million would be appropriate.

CONCLUSION
PB Power has reviewed the Consortium ODRC valuation of the SMHEA’s transmission grid assets and while agreeing with the Consortium’s replacement costs used in the ODRC valuation considers that the asset lives used by the Consortium are in some cases conservative.  PB Power compared the asset lives of transmission assets used for valuation purposes in the UK, NZ and in a 1997 valuation study undertaken by SKM with those used by the Consortium.  The effect of increasing the asset lives on the overall ODRC valuation was then investigated.
In completing its 1997 valuation, SKM undertook an inspection and condition assessment of the assets.  The valuers concluded that the assets were generally in good condition and would have useful lives considerably in excess of the standard lives given in the Guidelines.  PB Power has not completed an asset inspection, but sees no reason to disagree with the SKM conclusion. International experience indicates that many transmission assets can be expected to last longer than the standard lives given in the Guidelines, particularly in the benign environmental conditions prevalent in the Snowy region.  
On this basis we accept that an ODRC valuation using the standard lives given in the Guidelines would not give a true reflection of the actual deprival value of the asset to its owner.
Asset lives of 70 years for steel tower transmission lines and 45 years for substations are not unreasonable.  If the Consortium ODRC model is amended to incorporate these revised asset lives, we calculate that the valuation asset base included in this model would increase to approximately $63 million.

APPENDIX A
ACCC TERMS OF REFERENCE

APPENDIX B
ASSET CATEGORIES AND PERCENTAGE CONTRIBUTION TO ODRC FOR EACH CATEGORY

Snowy Mountains Hydro-electric Authority
Transmission Asset Base Review

Description of Asset	

Replacement Cost (@30.6.98)	

Depreciated Replacement Cost	

Opt Replacement Cost (@30.6.98)	

Optimised Depreciated Replacement Cost	

Contribution to total ODRC %	
Guthega Power Station Switchyard	3,417	1,074	3,417	1,074	2.3%	
Lower Tumut Switching Station (excl land and control buildings)	17,287	6,835	16,043	6,369	13.7%	
Murray Switching Station (excl land and control buildings)	22,451	7,523	22,090	7,424	15.9%	
Upper Tumut Switching Station (excl land and control buildings)	14,371	3,313	14,371	3,313	7.1%	
330/132/66KV Transformer, MSS	5,480	939	5,480	939	2.0%	
330kV S_circuit steel tower	60,676	21,468	60,676	21,468	46.1%	
132kV D_circuit steel tower	2,109	717	2,109	717	1.5%	
132 kV Wooden Pole line	5,640	2,546	5,640	2,546	5.5%	
Lower Tumut Group Control	3,880	1,164	3,880	1,164	2.5%	
Communication Bearer Systems (Excludes Mobile)	1,653	708	1,653	708	1.5%	
Access (line) tracks	(included in	transmission lines)			0.0%	
Emergency Spares (Major Plant, Excludes Inventory)	612	612	612	612	1.3%	
Easements	99	99	99	99	0.2%	
Land	123	123	123	123	0.3%	
Totals (excluding Sales Tax)	137,797	47,121	136,192	46,555	100%