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Issues
Paper

Access Arrangement by
East Australian Pipeline Limited for the
Moomba to Sydney Pipeline System

4 June 1999

	File No:  C1999/3

Preface
On 5 May 1999 East Australian Pipeline Limited (‘EAPL’) submitted to the Australian Competition and Consumer Commission (‘the Commission’), for approval under the National Third Party Access Code for Natural Gas Pipeline Systems (‘the Code’), a proposed access arrangement and access arrangement information for the Moomba to Sydney Pipeline System (‘MSP’).  
The access arrangement and access arrangement information describe the terms and conditions on which EAPL will make access to its pipeline available to third parties.  The Commission will assess the access arrangement and access arrangement information against the principles in the Code.
Interested parties are invited to make submissions to the Commission on any issues relevant to this access arrangement by Friday 2 July 1999.  The issues identified in this Issues Paper are only indicative and are not meant to be exhaustive.  Parties making submissions are free to identify other relevant issues for consideration by the Commission.  All submissions must be in writing.  
Unless submissions are marked confidential, they will be placed on the public registers maintained by the Commission and the Code Registrar and made available to any person or organisation on request.  If a submission contains confidential material, a non-confidential version should also be supplied.  Reasons for confidentiality should also be provided.  Under the Code, the Commission must not disclose confidential information except if it is of the opinion that disclosure would not be unduly harmful to the legitimate business interests of the service provider, a user or a prospective user.
It would assist the Commission if four hard copies of each submission could be provided and if it could also be supplied in electronic format compatible with Microsoft Word 97 for Windows.  Submissions should be addressed to: 
Mr Mark Pearson
Senior Assistant Commissioner
Gas Group
Australian Competition and Consumer Commission
PO Box 1199
Dickson    ACT    2602
Copies of the access arrangement, access arrangement information and this Issues Paper are available from the Commission’s website at http://www.accc.gov.au (under ‘Gas’).  Copies in printed form or on computer disk may be obtained from the Commission by contacting Cyril Loa (phone 02 9230 9146, fax 02 9231 5652, email cyril.loa@accc.gov.au).  
Any other inquiries should be directed either to John Bastick on (02) 9230 9151 or Cyril Loa (02) 9230 9146. 

Contents

1.	Introduction	1
1.1	Purpose	1
1.2	The current assessment process	1
1.3	Key issues	2
2.	The NSW gas industry structure and regulatory framework	3
2.1	Structure of the gas industry in NSW	3
2.2	Regulatory framework	3
2.3	Moomba to Sydney Pipeline System	4
2.4	Ownership structure of EAPL	4
3.	Criteria for assessing access arrangements	5
4.	Issues for consideration	6
4.1	Compliance with the Code	6
4.1.1	The content of the access arrangement	6
4.1.2	Information disclosure	6
4.1.3	Services policy	6
4.1.4	Trading policy	7
4.1.5	Queuing policy	8
4.1.6	Extensions/expansions policy	8
4.1.7	Terms and conditions	9
4.1.8	Commencement and review of an access arrangement	9
4.1.9	Ring fencing	10
4.1.10	Existing contractual rights and spare capacity	11
4.2	Pricing principles and related issues	11
4.2.1	Introduction	11
4.2.2	Forecast revenue	12
4.2.3	Initial capital base	13
4.2.4	Capital expenditure	14
4.2.5	Cost of capital	14
4.2.6	Depreciation methodology	15
4.2.7	Other assets	16
4.2.8	Total operating and maintenance costs	16
4.2.9	Cost allocation	17
4.2.10	Forecast volumes	18
4.2.11	Reference tariffs	18
4.2.12	Other charges	20
4.2.13	Incentive mechanisms	20
4.2.14	Key performance indicators	21
Appendix:	Attachment A to the Code	23

Abbreviations and glossary of terms

Access arrangement	Arrangement for third party access to a pipeline provided by a pipeline owner/operator and submitted to the relevant regulator for approval	
AGL	The Australian Gas Light Company	
AGLGN	AGL Gas Networks Limited 	
CAPM	Capital Asset Pricing Model	
the Code	National Third Party Access Code for Natural Gas Pipeline Systems	
Commission	Australian Competition and Consumer Commission 	
Covered pipeline	Pipeline to which the provisions of the Code apply	
CPI	Consumer Price Index	
DHC	Depreciated historical cost	
DORC	Depreciated optimised replacement cost	
EAPL	East Australian Pipeline Limited, owner and operator of MSP 	
GJ	Gigajoule	
MSP	Moomba to Sydney Pipeline System, comprising a mainline and laterals	
NPV	Net present value	
ORC	Optimised replacement cost	
PJ	Petajoule (equal to 1,000,000 GJ)	
TJ	Terajoule (equal to 1,000 GJ)	
WACC	Weighted average cost of capital	

1.	Introduction
1.1	Purpose
Chapter 2 of the National Third Party Access Code for Natural Gas Pipeline Systems (‘the Code’) specifies that the service provider of a gas pipeline covered by the Code is required to establish an access arrangement and submit it to the relevant 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’.  East Australian Pipeline Limited (‘EAPL’) owns and operates the Moomba to Sydney Pipeline System (‘MSP’).  In this instance the Australian Competition and Consumer Commission (‘the Commission’) is the relevant regulator for the purposes of the Code.
The purpose of this Issues Paper is to: 
•	list a number of issues that the Commission has identified as relevant to its role in assessing the access arrangement and access arrangement information for the MSP (which comprises the mainline and lateral pipelines) submitted by EAPL; and
•	invite interested parties to make submissions on these and other relevant issues that they consider the Commission should examine in its assessment of the access arrangement. 
1.2	The current assessment process
The proposed access arrangement and access arrangement information describe the terms and conditions on which EAPL will make access to the MSP available to third parties during the initial access arrangement period, which EAPL proposes will last five years. 
Under Section 2 of the Code, the Commission is required to:
•	inform interested parties that it has received the access arrangement and access arrangement information from EAPL; 
•	publish a notice in a national daily paper which describes the covered pipeline to which the access arrangement relates and states how copies of the documents may be obtained.  A date by which submissions are to be lodged must also be specified in the notice;
•	after considering submissions received, issue a draft decision which proposes either to approve the access arrangement or not to approve the access arrangement and states the amendments (or nature of the amendments) which have to be made to the access arrangement in order for the Commission to approve it.  Submissions will be sought again following the release of the Commission’s draft decision;
•	after considering any additional submissions, issue a final decision that either approves or does not approve the access arrangement (or revised access arrangement) and states the amendments (or nature of the amendments) which have to be made to the access arrangement (or revised access arrangement) in order for the Commission to approve it; and
•	if the amendments are satisfactorily incorporated in a revised access arrangement, issue a final approval.  If not, the Commission must draft and approve its own access arrangement.
1.3	Key issues
The Commission has identified a range of issues (refer to Chapter 4) which are likely to be relevant to its assessment of the proposed access arrangement and for which it invites comments.  Key issues that the Commission will focus on during its assessment include:
•	the proposed asset valuation methodology based on depreciated optimised replacement cost (‘DORC’);
•	the proposed rate of return (a real pre-tax weighted average cost of capital (‘WACC’) of 8.4 per cent), the parameters forming the WACC and the framework in which the WACC is applied;
•	other components of EAPL’s revenue requirements (depreciation, operating and maintenance costs);
•	level and structure of tariffs, including distance-based pricing; 
•	the segregation of the MSP into the mainline and laterals for the purpose of setting reference tariffs; 
•	the reasonableness of volume forecasts; and 
•	incentive mechanisms, including a price path approach.

2.	The NSW gas industry structure and regulatory framework
2.1	Structure of the gas industry in NSW
Briefly, the gas industry in NSW has the following key characteristics: 
•	almost the entire natural gas market in NSW is currently supplied by the Cooper Basin Production Unit in South Australia from the Moomba processing plant, which has supplied natural gas to NSW since 1976; 
•	the MSP, owned and operated by EAPL, transmits gas from Moomba to the city gate at Wilton, with laterals and spurs to several regional centres; 
•	the Interconnect pipeline which links the NSW and Victorian natural gas systems was commissioned in 1998 and provides a further potential source of gas supply into NSW from the Gippsland Basin in Victoria.  However, as a result of the Longford processing plant explosion in 1998, gas flows are likely to be mainly southwards in the short term;  
•	Duke Energy has announced plans to construct the Eastern Gas Pipeline to ship gas from Bass Strait in Victoria to Port Kembla and Sydney with operation expected by September 2000;
•	AGL Gas Networks Limited (‘AGLGN’) distributes natural gas to most major centres in NSW, including Sydney, Newcastle and Wollongong; and 
•	there are 21 authorised gas suppliers, including retailers, and five authorised gas reticulators.  
2.2	Regulatory framework
The main legislation and relevant documents regulating access to gas transmission pipelines in NSW are: 
•	the Code, under which transmission service providers are required to submit access arrangements to the Commission for approval;
•	the Gas Pipelines Access (South Australia) Act 1997; and
•	the Gas Pipelines Access (New South Wales) Act 1998.
Code bodies and appeals bodies in NSW with respect to transmission pipelines are:
•	the Commission – regulator and arbitrator; 
•	the National Competition Council – Code advisory body;
•	the Commonwealth Minister – coverage decision maker;
•	the Federal Court – judicial review; and
•	the Australian Competition Tribunal – administrative appeal.
2.3	Moomba to Sydney Pipeline System
The Moomba to Sydney natural gas pipeline system is comprised of the 1,299 km, 864 mm diameter pipeline which extends from Moomba in South Australia to Wilton on the outskirts of Sydney, where it connects with AGLGN’s distribution networks.  The MSP also includes the pipelines shown below and two compressor stations that operate to augment system capacity.  
(i)	Young to Wagga Wagga	(131 km and 324 mm diameter)
(ii)	Dalton to Canberra		(58 km and 273 mm diameter)
(iii)	Young to Lithgow		(269 km and 168 mm diameter)
(iv)	Junee to Griffith		(179 km and 168 mm diameter)
(v)	Wagga Wagga to Culcairn	(88 km and 457 mm diameter)
The MSP was originally constructed in the mid 1970s to deliver natural gas from the Cooper Basin in South Australia to Sydney.  Initially, the pipeline was owned and operated by the Pipeline Authority, a Commonwealth agency.  Capacity on the pipeline is committed to certain third parties including those under agreements put in place when the Commonwealth sold the MSP to EAPL.  
Previously EAPL offered transportation services on the MSP to third parties under the provisions of the Moomba-Sydney Pipeline System Sale Act 1994 (Cth) (‘MSPSS Act’), Part 6 (now repealed) of which contained regulatory provisions relating to the MSP.  
2.4	Ownership structure of EAPL
EAPL was established in June 1994 and acquired the assets of the Pipeline Authority for $534m.  It is owned by AGL Pipelines Investment NSW Pty Limited (51%), a member of the Australian Gas Light Company (‘AGL’) group, and Gasinvest Australia Pty Limited (‘Gasinvest’) (49%).  The latter is owned by NOVA Gas Australia Pty Ltd (52%) and Petronas Australia Pty Limited (48%).  
East Australian Pipeline Marketing Pty Limited (‘EAPM’) is the sole agent for marketing transportation and related services on behalf of EAPL.  It is owned by AGL and Gasinvest.  EAP Operations Pty Limited, which is also owned by AGL and Gasinvest, is contracted by EAPL to maintain the pipeline system and to provide manpower and services to EAPM. 

3.	Criteria for assessing access arrangements
The Commission may approve an access arrangement only if it is satisfied that the access arrangement contains the elements and satisfies the principles set out in sections 3.1 to 3.20 of the Code, which are summarised below.  An access arrangement cannot be opposed on the basis that it does not address a matter that section 3 of the Code does not require it to address.  Notwithstanding, the Commission has a broad discretion in accepting or opposing an access arrangement.  
An access arrangement must include the following elements:
•	a services policy which must include a description of one or more services that the service provider will offer to users and prospective users;
•	reference tariffs and reference tariff policy, including one or more reference tariffs.  Tariffs must be determined according to the reference tariff principles in section 8 of the Code;
•	terms and conditions on which the service provider will supply each reference service;
•	a statement that the covered pipeline is either a contract carriage or market carriage pipeline (capacity management policy);
•	a trading policy that enables a user to trade its right to obtain a service (on a contract carriage pipeline) to another person; 
•	a queuing policy to determine users' priorities in obtaining access to spare and developable capacity on a pipeline; 
•	an extensions/expansions policy to determine the treatment of an extension or expansion of a pipeline under the Code; and
•	a date by which revisions to the access arrangement must be submitted, and a date by which the revisions are intended to commence.  
In considering whether an access arrangement complies with the Code, the Commission must take into account, pursuant to section 2 of the Code:  
•	the legitimate business interests of the service provider;
•	firm and binding contractual obligations of the service provider or other persons (or both) already using the covered pipeline;
•	the operational and technical requirements necessary for the safe and reliable operation of the covered pipeline;
•	the economically efficient operation of the covered pipeline;
•	the public interest, including the public interest in having competition in markets (whether or not in Australia);
•	the interests of users and prospective users; and
•	any other matters that the Commission considers are relevant.  

4.	Issues for consideration
4.1	Compliance with the Code
4.1.1	The content of the access arrangement
The required contents of an access arrangement were listed in broad terms in Chapter 3.  The Commission must be satisfied that EAPL’s access arrangement meets the content requirements of the Code before it can approve the access arrangement.  It must also be satisfied of the reasonableness of the terms and conditions on which reference services will be offered.
4.1.2	Information disclosure
The Code requires that a proposed access arrangement must be supported by access arrangement information.  Section 2.6 specifies that access arrangement information must contain such information that in the opinion of the regulator would enable users and prospective users to understand the derivation of the elements in the proposed access arrangement and to form an opinion as to the compliance of the access arrangement with the provisions of the Code.  Section 2.7 states that the access arrangement information may include any relevant information but must include at least the categories of information described in Attachment A to the Code (refer to the Appendix to this Issues Paper). 
While ensuring that sufficient information is available to users and prospective users, the Commission must also ensure that any information disclosed is not, in its opinion, unduly harmful to the legitimate business interests of the service provider, users or prospective users.   
Issues for consideration
(a)	Is the information disclosed in the access arrangement and the access arrangement information sufficient to enable users and prospective users to understand the derivation of the elements in the proposed access arrangement?
(b)	Is the information sufficient to allow users and prospective users to form an opinion as to the compliance of the access arrangement with the provisions of the Code?
(c)	Are the items listed in Attachment A to the Code adequately addressed?  If not, what additional information (including any relevant information in addition to Attachment A) should be provided, and in what form?
4.1.3	Services policy
Sections 3.1 and 3.2 of the Code require an access arrangement to include a services policy which must include a description of one or more services that the service provider will make available to users and prospective users.  The policy must contain one or more services which are likely to be sought by a significant part of the market, and any service or services that in the regulator’s opinion should be included in the services policy. 
To the extent that is practicable and reasonable, a service provider should make available only those elements of a service required by users and prospective users and apply a separate tariff for each element if this is requested. 
EAPL proposes to offer the following classes of service under this access arrangement. 
Reference services
1.	Two reference services:
(i)	Firm Transportation Service: a reference service with a related reference tariff for firm transportation service (Class FT Service); and
(ii)	Small Take-Off Point Service: a reference service with a related reference tariff for firm transportation service intended to promote the development of small regional markets (Class STP Service).
Non-reference services
2.	Three rebatable services with biddable tariff features (Class WFT Service, Class OFT Service and Class IT Service).  These services are intended to promote the efficient growth of the gas market and increase the use of the pipeline; and
3.	Negotiable Service with negotiable terms and conditions, including tariffs. 
Issues for consideration
(a)	Are one or more of the proposed services likely to be sought by a significant segment of market participants?
(b)	Are there any other services that should be included in the services policy?  If so, please specify. 
4.1.4	Trading policy
Sections 3.9 to 3.11 of the Code set out the requirements for a trading policy.  If a pipeline is a contract carriage pipeline (as is proposed by EAPL for the MSP), the access arrangement must include a trading policy which explains the rights of a user to trade its right to obtain a service with another person. 
For a bare transfer, EAPL is proposing that the transferee must notify EAPL beforehand that it wishes to utilise the portion of the contracted quantity subject to the bare transfer, and the nature of the contracted quantity subject to the bare transfer.  For other transfers, EAPL proposes that a user may transfer or assign all or part of its contracted capacity with the prior written consent of EAPL.  Further, EAPL may only withhold its consent on reasonable commercial or technical grounds.    
Issues for consideration
(a)	Does the proposed trading policy sufficiently explain the rights of a user to trade its right to obtain a service with another person?
4.1.5	Queuing policy
Sections 3.12 to 3.15 of the Code set out the requirements for a queuing policy.  An access arrangement must include a queuing policy that determines the priority given to users and prospective users for obtaining access to a covered pipeline and for seeking dispute resolution under section 6 of the Code.  
The policy must set out sufficient detail to enable users and prospective users to understand in advance how it will operate and, to the extent reasonably possible, accommodate the legitimate business interests of the service provider, users and prospective users, and generate economically efficient outcomes.   
EAPL is proposing that it will establish and maintain a queuing process for the orderly allocation of capacity.  The proposed queuing policy is applicable to all registered applicants for Class FT Service, Class STP Service and Negotiable Service, but is not applicable to rebatable services (Classes WFT, OFT, and IT)  
When spare capacity becomes available, that capacity will be progressively offered to each prospective user in the queue in order of registration.  Further, clause 7.2 of the access arrangement states that the queuing process and the availability of capacity is at all times subject to any preserved contractual rights pursuant to section 2.25 of the Code.  
Issues for consideration
(a)	Are there sufficient details in the proposed queuing policy that would enable users and potential users to understand how the queuing policy will operate?
(b)	Does the proposed queuing policy accommodate the legitimate business interests of the service provider, users and prospective users? 
4.1.6	Extensions/expansions policy
Section 3.16 of the Code requires an access arrangement to include an extensions/expansions policy that sets out the method to determine which extensions and expansions will be treated as part of the covered pipeline and, if covered, how they will affect reference tariffs.  
EAPL proposes that new facilities investment, including the Interconnect pipeline between Wagga Wagga and Culcairn (already in operation) and the looping of a section of the Canberra lateral, be included in the capital base for the purposes of this access arrangement.   It further states that EAPL will decide, with the Commission’s approval, whether any new extension or expansion will be part of the covered pipeline.     
In addition to the applicable reference tariffs, EAPL has elected to apply a tariff surcharge to users of expansion/extension facilities where the net present value (‘NPV’) of revenue based on a reference tariff is less than the NPV of the cost of owning and operating the facilities plus a contribution for the use of existing facilities.  
Issues for consideration
(a)	Does the proposed access arrangement adequately specify how extensions and expansions will affect reference tariffs?  
(b)	To what extent, if any, would tariffs associated with roll-in likely result in incumbent users subsidising new customers?
(c)	Is the NPV criteria for new facilities investment likely to generate efficient economic outcomes?
4.1.7	Terms and conditions 
Section 3.6 of the Code requires an access arrangement to include the terms and conditions on which a service provider will supply each reference service.  To be approved, these terms and conditions must be considered reasonable by the regulator.  
In section 13 of its access arrangement EAPL proposes that its reference services will be provided under a service agreement on terms and conditions consistent with the principles contained in Attachment 3 to the access arrangement.  Key terms and conditions of supply of reference services include nominations, transfer of receipts and delivery points, and gas quality.  The terms and conditions also include the operational principles and procedures to the MSP as contained in Attachment 4 to the access arrangement. 
A service agreement has not been included as part of the access arrangement, and therefore may be changed without the approval of the regulator.
Issues for consideration
(a)	Does the access arrangement clearly identify the relevant terms and conditions, which enable a prospective user to be sufficiently well informed before making a specific access request?
(b)	Should a generic service agreement be included as part of the access arrangement? 
(c)	Are the proposed terms and conditions reasonable?  
4.1.8	Commencement and review of an access arrangement
Commencement of the access arrangement
EAPL has proposed that the commencement date of this access arrangement will be the later of:
•	1 July 2000; and
•	the date specified by the Commission in its approval of this access arrangement.
Review of the access arrangement
The Code requires an access arrangement to include a date by which the service provider must submit revisions to the access arrangement, and the commencement date for those revisions.  EAPL is proposing that revisions to the access arrangement will be submitted to the Commission for approval on or before 1 January 2005 (the revisions submission date).  The revisions to this access arrangement will commence on the later of: 
•	six months after the revisions submission date; and 
•	the date on which the approval by the Commission of the revisions to the access arrangement takes effect under the Code.  
Issues for consideration
The Commission recognises the need to balance the rapidly changing nature of the natural gas industry and the uncertainty which naturally arises in such an environment (which suggests a short access arrangement period) against the need for business certainty (which typically coincides with longer periods).  
(a)	The Commission is interested in views as to the appropriate timing of the commencement date of this access arrangement.
(b)	The Commission is interested in views as to the length of the initial access arrangement period.
Section 3.17(ii) of the Code makes provision for specific major events to be defined that trigger an obligation on the part of the service provider to submit revisions to the access arrangement prior to the revisions submission date.  
(c)	Should a trigger for a review of the access arrangement be included? If so, please specify.
(d)	EAPL is proposing to pass through to users any new or increased taxes, including the GST if applicable.  Likewise, any reductions in such imposts would be reflected in tariffs accordingly.  Should new taxes or changes to existing taxes be defined as a major event triggering a review of the access arrangement?
4.1.9	Ring fencing 
Ring fencing is a term used to describe the segregation of one activity from another within a business.  For regulatory purposes, this results in the regulated activities being separated from any non-regulated activities within the one business. 
Regulators require adequate ring fencing to ensure that service providers do not indulge in anti-competitive cross subsidisation between different regulated activities or between regulated and non-regulated activities.  Ring fencing is also an attempt to ensure that unwarranted disclosure of commercially sensitive information obtained from users and prospective users by the service provider does not occur. 
Section 4 of the Code imposes minimum ring fencing obligations on service providers.  It also provides for the Commission to impose additional requirements or waive minimum requirements through a public consultation process. 
Section 2.4 of this Issues Paper briefly outlined the ownership structure of EAPL.  The majority owner of EAPL is AGL, which is also the major customer for haulage services.  
EAPL has advised that at this stage its ring fencing requirements have not been completed.  As ring fencing arrangements are not a mandatory element of an access arrangement per se, EAPL’s ring fencing arrangements, when finalised, will be reviewed separately by the Commission.
4.1.10	Existing contractual rights and spare capacity
EAPL advises that capacity on the MSP is committed to certain third parties under existing agreements, including the Gas Transportation Agreement between EAPL and AGL Wholesale Gas Pty Limited.  
Section 2.25 of the Code provides:
The Relevant Regulator must not approve an Access Arrangement….any provision of which would, if applied, deprive any person of a contractual right in existence prior to the date the proposed Access Arrangement was submitted…..
Clause 1.4 of the access arrangement information provides an indication of the extent of committed capacity under existing contracts and excess capacity on the MSP.  In addition, EAPL has informed the Commission that it currently has approximately 443 TJ/day of firm capacity committed under existing contracts and approximately 470 TJ/day of system capacity.  The key segment of the system is that from Moomba to Young where approximately 27 TJ/day of spare capacity is available.  Between Young and Wilton capacity is less constrained. 
Over the access arrangement period the level of available capacity increases to approximately 57 TJ/day by winter 2003 and to approximately 150 TJ/day by 2005.  Total capacity of the Moomba to Wilton segment could be expanded to more than 800 TJ/day with the addition of up to 6 more compressor stations.
4.2	Pricing principles and related issues
4.2.1	Introduction
The pricing of transportation services is the core element of an access arrangement.  Accordingly, section 8 of the Code establishes pricing principles for setting the prices of transportation services.  While these principles provide for considerable flexibility, nevertheless they are designed to achieve the key objectives listed in section 8.1 of the Code. 
In broad terms, these objectives require the tariffs to generate sufficient revenue to enable the service provider to make a commercial return on its investment in pipeline assets over the life of those assets, and to provide it with an appropriate incentive to expand the system in a timely manner.  At the same time the return needs to be set so that revenues do not reflect the exercise of market power often available to an unregulated natural monopoly operation.  In addition tariffs need to be cost reflective to promote economic efficiency in the use of the system.  Finally, the Code recognises the dulling effect revenue constraints can place on efficient pipeline operations and provides for the inclusion of mechanisms to provide incentives for the service provider to strive for efficiency improvements. 
It remains for the Commission to determine whether the proposed pricing methodology is consistent with the principles outlined in the Code.  The methodology proposed for the setting of reference tariffs is contained in the access arrangement and access arrangement information.  EAPL has applied the following approach to the development of its proposed reference tariffs: 
•	a current cost accounting methodology is used to determine the revenue requirement;
•	the initial capital base is valued by the application of the depreciated optimised replacement cost methodology (‘DORC’);
•	a real pre-tax rate of return of 8.4 per cent is applied to the initial capital base;
•	the rate of return is set to provide EAPL with a return commensurate with prevailing conditions in capital markets and with the risks involved in providing the reference services;
•	reference tariffs are structured to reflect the costs of providing the reference services;
•	total costs are to be recovered from users of Class FT Service and Class STP Service which will be eligible to rebates from rebatable services; 
•	reference tariffs are to reflect the distance the gas is transported through the pipeline; and  
•	a portion of the proceeds from the rebatable services will be applied to a depreciation reserve to reflect the increased usage of the pipeline.       
These factors are discussed in more detail below.
4.2.2	Forecast revenue
Forecast revenue is set at a level over the life of the asset that allows the service provider to earn a reasonable rate of return on assets employed in providing tariffed transmission services.  The key parameters in establishing forecast revenue are: 
•	regulatory asset values;
•	cost of capital; and
•	non-capital costs.
Table 1 shows EAPL’s forecast revenue and its components over the initial access arrangement period.  Each component is considered in more detail later in this section. 
Table 1:	Forecast revenue and its components: 2001 to 2005 (July 2000 $ ’000)
Year ending 30 June	2001	2002	2003	2004	2005	
Return on Assets	55 157	53 429	52 090	50 811	48 930	
Depreciation	24 032	24 125	24 674	25 032	25 115	
O&M Costs	12 264	13 255	12 406	13 636	12 430	
Total Revenue	91 453	90 809	89 170	89 478	86 475	
Source:  Access Arrangement Information, p. 21.
EAPL is proposing a current cost accounting methodology to determine its revenue requirements.  This involves the expression of the revenue components in real or constant dollars and indexing the capital base and depreciation for inflation.
Issues for consideration
(a)	Is the use of a current cost accounting methodology appropriate for determining the revenue stream?  If not, what methodology should be used?
4.2.3	Initial capital base
In establishing the value of the initial capital base, the Code requires the regulator to consider the depreciated historical cost (DHC), DORC and other factors outlined in section 8.10 of the Code.  In practice, DHC may be considered to set the lower boundary of valuations and DORC the higher.  EAPL proposes to adopt the DORC methodology.  Table 2 shows the DORC values proposed by EAPL and economic life assumptions.
Table 2:	Total asset values (July 2000 $ ’000)
Asset Types	ORC	DORC	Original Life (years)	Remaining Life at 1 July 2000 (years)	
Pipelines – mainline	879 310	542 298	60/801	36/68	
Pipelines – laterals	90 841	76 874	80	68	
Compressors	58 100	32 923	30	17	
Metering	14 050	4 683	15	5	
Plant, machinery, equipment	10 310	4 811	15	7	
Mobile equipment	6 000	3 000	10	5	
Total	1 058 611	665 975			
Source:	Access Arrangement Information, p. 27.
Note:	1. An economic life of 60 years is proposed for the Moomba to Wilton pipeline, and 80 years for the Young to Culcairn pipeline.
Issues for consideration
(a)	Is EAPL’s approach for valuing the initial capital base consistent with the requirements of the Code?
(b)	Do the DORC values represent the most rational, optimal configuration? 
(c)	EAPL appears to have depreciated ORC on a straight line basis to arrive at its DORC valuation for the initial capital base.  However, EAPL has adopted a kinked depreciation methodology (see later) to calculate depreciation over the access arrangement period.  Should the two approaches be consistent?  
(d)	Is DORC the most appropriate asset valuation methodology for the MSP?  Is the valuation likely to result in inefficient consumption or investment decisions?
(e)	If DORC is not considered appropriate, what would be a fair and reasonable value for the MSP?  What is the basis of your estimate?
(f)	When establishing the value of the initial capital base, the Code allows the regulator to take into account the purchase price paid by the service provider.  In this instance is it relevant to consider the purchase price of $534m paid by EAPL in 1994?  If so, was the purchase price of $534m fair and reasonable?
(g)	Who should carry the risk of stranded assets?  How and when should this be determined?
(h)	Should lower operating and maintenance (‘O&M’) costs associated with the replacement assets (used to determine ORC) be reflected in the DORC valuation?  If so, how should this be implemented?
4.2.4	Capital expenditure
The Code requires that new expenditure be prudent and within the bounds of good industry practice.  The forecast capital expenditure to be undertaken during this access arrangement is provided in Table 3. 
Table 3:	Forecast capital expenditure: 2001 to 2005 (July 2000 $ ’000)
Year ending 30 June 	2001	2002	2003	2004	2005	
Partial looping of the Canberra lateral	3 458	-	-	-	-	
Uranquity Compressor	-	-	13 919	-	-	
Operating Capital Expenditure	1 886	1 676	1 306	1 321	1 333	
On Line Inspections	-	-	-	2 707	-	
Total	5 345	1 676	15 226	4 028	1 333	
Source: Access Arrangement Information, p. 30.

Issues for consideration
(a)	Are the capital expenditure forecasts for the MSP fair and reasonable? 
(b)	Is the capital expenditure program consistent with that of a prudent investor?  Is it consistent with the volume forecasts (refer to Table 7 below)?  
(c)	If such expenditures do not take place what adjustment, if any, should be made to the residual asset valuation for the commencement of the next regulatory period?
4.2.5	Cost of capital
EAPL’s rate of return is based on the Capital Asset Pricing Model (‘CAPM’) and Weighted Average Cost Of Capital (‘WACC’) approaches.  EAPL is proposing a real pre-tax WACC of 8.4 per cent.  EAPL considers the Commission’s 1998 decision on the Victorian transmission access arrangement (7.75 per cent for a real pre-tax WACC) to be an appropriate benchmark.  EAPL considers that the risk associated with the MSP is higher than the Victorian system and justifies a higher rate of return.  
The parameters listed in Table 4 form the basis for EAPL’s proposed WACC.
Table 4:	Components of CAPM and WACC inputs
Parameter	Value	
GENERAL PARAMETERS: 		
Real Risk Free Rate1	3.3%	
Inflation	2.5%	
Nominal Risk Free Rate	5.85%	
GEARING: 		
Debt to total Assets	60%	
TAXATION:		
Effective tax rate	36%	
Value of imputation credits (Gamma)	0.4-0.5	
COST OF EQUITY:		
Asset beta	0.55-0.65	
Debt beta	0.12	
Equity beta (derived)	1.2-1.45	
Market premium	6.0%	
Nominal cost of equity	13.1%-14.6%	
COST OF DEBT:		
Debt margin	1.3%-1.4%	
Nominal cost of debt	7.3%-7.4%	
COST OF CAPITAL (WACC)		
Post-tax nominal WACC	6.9%-7.6%	
Real pre-tax WACC2	8.0%-9.1%	
Source:	 Access Arrangement Information, p. 32.
Notes:	1. Based on 10-year bond rates.
	2. Converted from post-tax nominal WACC by grossing-up for the assumed taxation liability and then deducting inflation (through the Fisher conversion).

Issues for consideration
(a)	Are the parameters and the formulae (and conversion process from post-tax nominal WACC to pre-tax real WACC) employed to calculate the WACC consistent with current thinking for application to a regulated asset base?  
(b)	Do the various components of WACC accurately reflect prevailing market rates? 
(c)	Is the resulting rate of return appropriate?  If not, what alternative would more likely represent the risk profile of the MSP assets? 
4.2.6	Depreciation methodology
EAPL is proposing a ‘5/8:3/8 kinked’ depreciation schedule, which will result in 5/8 (62.5 per cent) of the real value of assets being returned in the first half of the projected economic life of the assets and 3/8 (37.5 per cent) being returned in the second half.
The economic lives of the assets are set out in Table 2 above.
Issues for consideration
(a)	Is the proposed depreciation schedule appropriate?  Does it reflect changes in the expected economic value of the assets?
(b)	Would an alternative depreciation methodology be appropriate?  If so, please specify.
(c)	Are the economic lives of the various assets appropriate?
4.2.7	Other assets
Other asset values and remaining lives are shown in Table 5.  
Table 5:	Value of other assets (July 2000 $ ’000)
Asset Types	Value	Remaining Life at
1 July 2000 (years)	
Access arrangement costs	1 385	5	
Working capital (in 2001)	  767	n/a	
Linepack	n/a	n/a	
Total	2 152		
Source: Access Arrangement Information, p. 28.

Issues for consideration
(a)	Are the values for access arrangement costs and working capital reasonable?
(b)	EAPL is proposing to apply a nominal rate of return on working capital of 11.1 per cent and include that amount in operating and maintenance costs.  Is this a reasonable rate of return for working capital?
(c)	Is it appropriate to treat access arrangement costs as an asset, or should these be treated as O&M costs?
4.2.8	Total operating and maintenance costs
EAPL’s forecast O&M costs are shown in Table 6 below.
Table 6:	Forecast of O&M Costs: 2001 to 2005 (July 2000 $ ’000)
Category	2001	2002	2003	2004	2005	
Labour	5 393	5 546	5 699	5 783	5 868	
General Administration	3 249	3 265	3 280	3 297	3 313	
Materials	1 285	2 202	1 180	2 369	1 059	
Communications System	1 163	1 168	1 175	1 180	1 186	
Gas Used	900	797	799	727	730	
Licences	189	184	185	185	187	
Working Capital (Return)	85	92	86	95	86	
Total 	12 264	13 255	12 406	13 636	12 430	
Source: Access Arrangement Information, p. 41.
Issues for consideration
(a)	Are the forecast operating and maintenance costs reasonable?
(b)	Do they represent the efficient costs of delivering the reference services, in accordance with industry best practice in Australia and overseas, taking account of pipeline age, size and industry structure?
(c)	Are the implied productivity improvements consistent with reasonable expectations?
4.2.9	Cost allocation
As a general principle under the Code, the costs of operating and maintaining the transmission assets should be allocated to users according to their use of those assets, where attributable.  Costs that cannot be directly attributed should be allocated to various users in an efficient and equitable manner.  Moreover, tariffs for a reference service should reflect the costs of providing that service.
Features of EAPL’s cost allocation are:
•	88 per cent of O&M costs are allocated to mainline services and 12 per cent to lateral services; 
•	all capital costs are considered fixed costs, whereas a proportion of non-capital costs have been classed as fixed and the remainder as variable;
•	rather than allocate costs between the Class FT Service and Class STP Service, for tariff-setting purposes all costs and volumes are assigned to the Class FT Service (on the basis that Class STP services are a very minor source of revenue compared to Class FT services and the formula for calculating Class STP tariffs is directly related to Class FT tariffs); and
•	cost allocation to users is volume and distance-based. 
Issues for consideration
(a)	Are attributable costs properly determined and allocated between users?  Are there any classes of customers or services that bear an inequitable proportion of total costs?
(b)	Is the allocation of costs between mainline and lateral pipelines appropriate?
(c)	Is the proportion of costs allocated between fixed costs and variable costs appropriate?
(d)	Is the allocation of costs in relation to Class FT and Class STP services reasonable for tariff-setting purposes?
(e)	Is the distance-based allocation of costs fair and reasonable?
4.2.10	Forecast volumes
Forecast volumes of gas are an important parameter in determining EAPL’s reference tariffs.  Table 7 below shows EAPL’s annual volume forecasts to 2014.  Volumes supplied by EAPL are predicted to fall from their current levels of 115.8 PJ for 1999 to 97.9 PJ in 2005, the end of the initial access arrangement period.  On page 14 of its access arrangement EAPL outlines those factors that it considers will have an impact on volumes, including the Eastern Gas Pipeline commencing operations in the third quarter of 2000 with an initial load of 20 PJ/pa.
Table 7:	 Forecast volumes by market and source: 2001 to 2014 (PJ/per annum)
Year  ending 30 June	1999	2001	2002	2003	2004	2005	2006	2008	2010	2012	2014	
NSW/ACT Demand 	109.3	109.4	113.3	117.4	124.1	138.9	159.1	179.7	196.4	204.2	211.2	
Deliveries ex Moomba into NSW/ACT/Vic	115.8	97.4	86.8	87.4	79.9	80.9	98.1	108.7	123.4	147.2	175.2	
Interconnect deliveries into NSW/ACT	0.0	2.0	3.0	4.0	10.0	17.0	20.0	22.0	24.0	23.0	23.0	
Total Qty. Transported by EAPL 	115.8	99.4	89.8	91.4	89.9	97.9	118.1	130.7	147.4	170.2	198.2	
Source: Access Arrangement Information, p. 13.

Issues for consideration
(a)	Are EAPL’s forecast volumes reasonable?  If not, what would be reasonable volume forecasts?
(b)	What factors are likely to have an impact on volumes during the initial access arrangement and how will they affect the level of forecast volumes?
(c)	What provision, if any, should be made to allow changes to tariffs to cater for differences between forecast and actual volumes?
4.2.11	Reference tariffs
For tariff-setting purposes, EAPL has segregated the MSP into two pipeline groups.  They are:
•	mainline: Moomba to Young, Young to Wilton and Young to Culcairn; and 
•	laterals: all other pipelines.
Following is a summary of EAPL’s proposed reference tariff structure for its reference services.
Class FT Service
•	capacity charge based on MDQ and distance between receipt and delivery points;
•	throughput charge based on actual quantities delivered and distance between receipt and delivery points; and
•	other charges; overruns, odorisation and balancing (see later).
Class STP Service
•	both the capacity charge and throughput charge are based on actual quantities delivered;
•	the capacity charge in $/TJ/km is based on the Class FT Service capacity charge in accordance with a set formula (page 14 of the access arrangement);
•	the throughput charge in $/TJ/km is equal to the Class FT Service throughput charge;
•	a minimum charge of $6,000 per annum; and 
•	other charges; odorisation and balancing (see later).
Backhaul
Both the Class FT Service and Class STP Service are subject to backhaul credits, comprising:
•	a 50 per cent discount on the capacity charge; and
•	waiver of the throughput charge.
Other features of EAPL’s proposed reference tariff policy are:
•	the recovery of fixed costs by the capacity charge and variable costs by the throughput charge;  
•	higher tariffs for lateral pipelines than mainline pipelines to reflect higher per unit costs; and  
•	a price path over the regulatory period to avoid price shocks to users.  
Segregating the system into mainline and lateral pipelines for tariff-setting purposes represents a departure from EAPL’s current policy, whereby mainline and lateral pipelines are treated in the same manner.  EAPL states that if tariffs are based strictly on the costs allocated to lateral pipelines the price increase would be excessive.  Accordingly, EAPL is proposing to cap the lateral charges and phase them in over the access arrangement period.  
The initial mainline tariffs for Class FT Service users are $15.26 capacity tariff ($/TJ/d/km/month) and $0.0434 throughput tariff ($/TJ/km).  Tariffs for subsequent years will be indexed by the formula described in the access arrangement information (page 58), which is CPI-based and provides a smooth price path for users.
Table 8 shows the proposed tariffs for lateral pipelines for the initial access arrangement period.
Table 8:	Proposed lateral tariffs: 2001 to 2005 (July 2000 $/GJ)
	2001	2002	2003	2004	2005	
Capacity Tariff ($/TJ/d/km/mth)	$38.17	$61.04	$83.90	$106.76	$129.63	
Throughput Tariff ($/TJ/km)	$0.210	$0.336	$0.462	$0.588	$0.714	
Source:  Access Arrangement Information, p. 59.
Issues for consideration
(a)	To what extent are the reference tariffs likely to replicate the outcomes of a competitive market? 
(b)	Will the proposed tariff structure and principles encourage investment decisions congruent with a competitive market outcome?
(c)	Are the proposed level and structure of tariffs economically sound in terms of providing price signals for maximising the efficient utilisation of the system?  
(d)	Is the segregation between mainline and lateral pipelines for tariff-setting purposes appropriate?  
(e)	Are the reference tariffs sufficient to allow the safe and reliable operation of the facility?
(f)	Are the credits for backhaul appropriate?
(g)	Is the revenue generated from the proposed tariffs consistent with EAPL’s efficient costs?
4.2.12	Other charges
In addition to the charges outlined above, EAPL is proposing the following charges:
•	Overrun charges (not applicable to STP Service): for authorised overruns at the rate of 200 per cent of the capacity charge, and for unauthorised overruns at 350 per cent of the capacity charge. 
•	Odorisation charges: EAPL reserves the right to impose reasonable charges for odorisation, which is expected to be less than $0.01/GJ of gas delivered to the user.
•	Balancing charges: if an imbalance is not adjusted after notice from EAPL, EAPL may impose a charge of 150 per cent of the purchase price of gas paid by EAPL to restore the user to zero user inventory, plus a service fee of $2,000 per occurrence.  (Revenue received from balancing charges will be reimbursed to eligible users.)
Issues for consideration
(a)	Are these charges fair and reasonable?  
(b)	Is it likely that the revenue generated from overruns during the initial access arrangement period will be material?  If so, should this revenue be incorporated in the revenue model or in some other way used to reduce reference tariffs?
4.2.13	Incentive mechanisms
EAPL’s proposed incentive mechanism comprises two aspects.  First, EAPL states that its incentive mechanism will be implemented through its rebatable services.  These are designed to promote efficient growth of the gas market and increase the utilisation of the system.  Revenue generated from the rebatable services will be distributed in the following manner:
•	75 per cent to eligible users, distributed annually;
•	15 per cent to a depreciation reserve; and
•	10 per cent to EAPL.
Second, EAPL states that the price path approach to setting reference tariffs ‘provides EAPL with strong incentives to reduce costs and promote growth in gas transmission volumes’.
Issues for consideration
(a)	Do the incentive mechanisms encourage EAPL to increase sales volumes of all services, without providing an artificial incentive to favour the sale of one service over another? 
(b)	Do the mechanisms provide EAPL with sufficient incentive to reduce costs?  Are there adequate safeguards on service quality to ensure cost reductions are not achieved at the expense of quality?
(c)	Are the benefits of the incentive mechanisms shared equitably between EAPL and users?
4.2.14	Key performance indicators
EAPL has provided performance indicators which compare EAPL’s tariffs with selected overseas companies and compare EAPL’s operating costs with other Australian companies. 
Issues for consideration
(a)	Are the supplied performance indicators relevant?  Have they been interpreted correctly?  Are more appropriate measures available? 

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Appendix:	Attachment A to the Code
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