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Revised draft decision: Initial default price-quality paths for gas pipeline services Briefing for financial market analysts 24 October 2012 Overview • Revised draft decision to set initial default price-quality paths 1. Proposed approach and context 2. The paths we have proposed for suppliers 3. Details on the approach we have used to set the paths 2 Proposed approach • 3 The proposed default price-quality paths apply to: – Three distribution businesses under price caps (GasNet, Powerco, and Vector) – Two transmission businesses under revenue caps (Maui Development and Vector) • Paths apply for a regulatory period of 4 years, 3 months from 1 July 2013 to 30 Sept 2017 • We expect to make a final decision by 28 February 2013 Proposed approach • 4 Key features of the proposed default price-quality paths – Prices based on current and projected profitability using recently redetermined input methodologies (decisions NZCC27 and NZCC28) – Quality standards based on emergency response times – Overall reduction in prices/revenue for industry – Significant price reductions for Vector – Building blocks approach the same as that used for electricity distribution revised draft reset 2012 Context for change in prices • • 5 Changes brought about by new Part 4 regime – New purpose statement to guide us in setting prices – Input methodologies define key “building blocks” – Price path set base on current and projected profitability Prior to Part 4 – Powerco and Vector distribution services (excluding network purchased from NGC) subject to Authorisation – Maui Development, Vector transmission services, Vector distribution services (excl. NGC) and GasNet not subject to the Authorisation Context - Authorisation • 6 Authorisation used a building block approach. Differences between then and now include: – WACC for Authorisation on average 10.45% compared to 7.53% now – Authorisation used tax payable (now using deferred tax approach for distribution, tax payable for transmission) – Authorisation prices included claw-back of 50% of previous overrecovery of revenues – The initial default price-quality paths use updated projections for opex, capex and revenue growth Proposed adjustments Forecast revenues minus forecast costs - 1 July 2013 to 30 September 2017 (if no reset) GasNet: +$0.8m Powerco: -$8.7m Vector (Distribution): +$48.4m Maui Development Limited: -$15.3m Vector (Transmission): +$110.9m 7 Proposed adjustments Adjustments for the first full pricing year of the regulatory period Maui Development Limited 2% Powerco 5% GasNet -2% Vector (Distribution) -16% This chart provides an indication of the prospective change in revenue in the first year of the regulatory 8 Vector (Transmission) -25% These figures may change following consultation. Other features – clawback • We propose claw-back for GasNet – Claw-back applies for the over-recovery of revenues for the period 1 January 2008 to 30 September 2012 compared to CPI increases – Negates effect of delay to establishing the initial paths – GasNet is the only supplier to have over-recovered during this period • Claw-back could still apply to other suppliers – Before making a final decision we will assess revenues from 1 October 2012 to date of determination • Recovery of claw-back – Claw-back will occur across the regulatory period 1 July 2013 to 30 September 2017 9 No alternative rates of change proposed • We have not proposed any alternative rates of change at this point – Increases for Powerco and Maui Development are below the levels we have previously considered for price shocks to consumers – We do not have sufficient evidence to conclude that the proposed downward adjustment for GasNet and Vector will result in undue financial hardship • If suppliers believe the proposed price adjustment will cause undue financial hardship, they should provide evidence in their submissions 10 Quality Standards • Quality Standards set for emergency response time – suppliers of gas pipeline services must take 180 minutes or less to respond to any emergency; and – gas distributors must take 60 minutes or less to respond to 80% of emergencies • Our preferred option is to also establish quality standards based on reliability – we consider reliability as the most important measure of the level of service that suppliers should be providing to consumers – however, we currently have little data to establish robust reliability targets • 11 By contrast response times to emergencies targets can be set independently of historical time series data, and are based on industry knowledge The approach to adjusting prices Overview of our proposed approach Step One Forecast costs over the regulatory period Step Two Set forecast revenues equal to forecast costs over the regulatory period Step Three Determine starting prices for each supplier Step Four Apply an alternative rate of change if necessary or desirable 12 Building blocks allowable revenue • Derive present value of building blocks allowable revenue based on costs Main building block cost categories 13 Return on capital (net of any revaluations of the Regulatory Asset Base) Return of capital (to allow recovery of depreciation) Operating expenditure (excluding pass through costs and recoverable costs) Tax costs WACC • We have used a vanilla WACC of 7.53% (cost of capital determination for information disclosure decision NZCC20) • We will estimate a WACC for our final decision by 1 Dec 2012 – risk-free rate and debt premium using data from the month of November 2012 The paramaters used to estimate the WACC for GPB SPA (As at July 2012 (to be updated prior to finalisation)) Estimate Risk free rate (5 year) 14 2.78% Debt premium (5 year) Leverage Debt issuance costs Asset beta Equity beta TAMRP 2.55% 44% 0.35% 0.44 0.79 7.0% Cost of equity Cost of debt 7.53% 5.68% Midpoint estimate of: Vanilla WACC Post-tax WACC 6.72% 6.02% 75th percentile estimate of: Vanilla WACC 7.53% Post-tax WACC 6.83% How we forecast capex • Capex forecasts – We use suppliers’ own forecasts of network capex up to a 20% increase over historic levels – Forecast of non-network capex is based on each supplier’s historic expenditure – Change in input prices based on capital goods price index • We propose to rely on each supplier’s capex forecast because suppliers are well placed to forecast required capex • We limit suppliers’ forecast average expenditure to a 20% increase over average historic expenditure – relying on suppliers’ forecasts would create an incentive to bias their forecasts to increase their starting price – Customised price-quality path can address material increase in investment requirements 15 Reasons for limiting increases in capex • Customised price-quality paths can address material step changes in capex • Maui Development and Vector forecasts included capex increases over 20%. The have the option to either: – apply for a customised price-quality path – undertake these projects within the DPP price cap – defer these projects • Note that even if we used Vector’s capex projections, its price decrease would still be 23% 16 Projected growth in network capex Constant price increase in network capex allowance (2012-2017) compared to the historical average (2008-2011) network capex GasNet 11.6% PowerCo Vector (Distribution) 17 20.0% -4.7% Maui 20.0% Vector (Transmission) 20.0% How we forecast opex • Opex forecasts (network and non-network) – Basis for projections is actual opex for 2010/11 – Considered impact of changes in network scale on opex – Partial productivity growth assumed to be zero – Change in input prices (using weighted average forecast of labour cost index and producer price index) • Network Scale – For distribution elasticities for network length and customer numbers applied to historic trend (approximately 0.35 each – taken from Ofgem analysis ) – For transmission initial view number of customers and length not appropriate drivers of network scale, elasticity for energy throughput assumed to be zero due to information/data issues 18 Projected growth in opex 2010-15 Projected growth in operational expenditure from 2012 to 2017 Gasnet Powerco Vector (Distribution) Maui Vector (Transmission) 0% 5% 10% 15% Total change in forecast opex (excl. Insurance adjustment) Change in opex input prices Change due to network scale effects 19 20% 25% Impact of opex and capex modelling – sensitivity analysis Adjustments for the first full pricing year of the regulatory period impact of suppliers’ own forecast of opex and capex (all other inputs as per draft decision) Price adjustments for ComCom vs supplier forecasts 30.0% ComCom forecasts 20.0% Supplier opex forecast, ComCom capex forecast 10.0% 0.0% GasNet Powerco Vector_Dist Maui Vector_Trans Supplier capex forecast, ComCom opex forecast -10.0% -20.0% -30.0% 20 Supplier opex forecast, Supplier capex forecast How we forecast constant price revenue for gas distributors • We forecast revenue from residential, commercial, and industrial users, broken down into the two types of billed quantity all three distributors use • Forecasts of billed quantities of gas are based on the gas supply and demand scenarios study for the Gas Industry Company Limited • Forecasts of the number of users billed for their connection are based on extrapolating each supplier’s historic trends 21 Constant price revenue 2012-2018 (distribution) Vector Distribution Powerco GasNet -2% 22 -1% 0% 1% 2% 3% 4% Change in constant price revenue Change from industrial users Change from commercial users Change from residential users 5% Role of constant price revenue for gas transmission • We propose to put both gas transmission businesses under a revenue cap • We do not require a forecast of constant price revenue for setting starting prices for gas transmission business • However, we have developed forecasts for assessing compliance and to illustrate the size of starting price adjustments in percentage terms 23 How we derive smoothed price path • Calculate present value of building blocks allowable revenue from 1 July 2013 to 30 September 2017 (4 years 3 months) • Derive a smoothed path taking account of forecast changes in – prices (CPI-X) where X = 0 – quantities (distribution only) derived from forecast of constant price revenue • Compliance will be assessed on a pricing year basis – For all suppliers but Maui Development this results in a 15 month initial assessment period from 1 July 2013 to 30 September 2014 – For Maui Development 3 month assessment period at the end of the regulatory period (1 Jul 2017 to 30 September 2017) 24 Next steps • We will be holding a ‘Q&A’ of the model underpinning the draft decision in November Milestone 25 Indicative date Submissions on revised draft Initial default pricequality paths 7 December 2012 Cross-submissions on revised draft Initial default price-quality paths 21 December 2012 Final decision on Initial default price-quality paths 28 February 2013 Questions? For more information Please contact: Karen Murray [email protected] Or visit: http://www.comcom.govt.nz/initial-default-price-quality-path/ For information on: •The revised draft decision •The 2013-17 default price-quality path Or visit: http://www.comcom.govt.nz/additional-input-methodologies-forelectricity-and-gas-dpps/ For information on: •The re-determined input methodologies 26