Proposal: Default PriceQuality Paths For Gas Services

Media Release
Issued 24 October 2012 Release No. 34

Commerce Commission Proposes Default PriceQuality Paths For Gas Pipeline Services

The Commerce Commission has today released its revised draft decision proposing the first default price-quality paths for gas pipeline services. Once finalised, these paths will set the maximum prices that gas pipeline businesses are allowed to charge customers for their services from 1 July 2013.

The affected gas transmission businesses are Vector Limited and Maui Development Limited. The affected gas distribution businesses are Vector Limited, Powerco Limited and Gasnet Limited.

Under the proposal, some businesses will be required to charge less for their services while some will be able to charge more. The proposed adjustments to average prices for individual businesses at the start of the regulatory period in 2013 vary in size from a reduction of 25% for Vector’s transmission business to an increase of 5% for Powerco’s distribution business. Following the initial price adjustment, the Commission proposes limiting price increases to no more than the rate of inflation for the remainder of the regulatory period to 2017. An estimate of the potential effect of the proposal on residential customers’ gas bills is attached.

“This is the first time that some of these businesses have been subject to price-quality regulation. We are now bringing the prices these businesses can charge their customers more into line with the costs of providing those services,” said Sue Begg, Commerce Commission Deputy Chair.

The default price-quality path must be set in a relatively low cost way. Most of the cost estimates for the regulatory period, including the cost of capital, are based on the input methodologies that the Commission set following more than two years of consultation with interested parties. To set the path in a low cost way, the Commission does not scrutinise the proposed investments or operating expenditure of the businesses in detail.

Where a business expects a significant increase in investment or operating expenditure during the regulatory period compared to what they have spent in the past (as is the case for Maui Development Limited and Vector Limited) then the business is able to apply for a customised price-quality path.

“Although substantial price reductions are necessary for Vector, we do not expect this to limit its ability to invest in or maintain its network. All of the gas businesses have the option of applying for a different price-quality path that is customised to the needs of their business,” said Ms Begg. “For the default paths we have provided for increases in proposed investments of up to 20% above what a business has spent historically. We have set a cap at a 20% increase because the investments are not subject to scrutiny. However, even if we used Vector’s own investment forecast for transmission, the proposed price reduction would still be 23%.”

Parties are able to make submissions on the revised draft decision until 7 December 2012, and cross-submissions are due 21 December 2012. Submissions can be emailed to: regulation.branch@comcom.govt.nz

The Commission expects to reach a final decision on the default price-quality paths by 28 February 2013. Changes resulting from the default price-quality path would apply to suppliers of gas pipeline services from 1 July 2013.

Background

What are price-quality paths?

Price-quality paths are a form of regulation applied to certain businesses that are regulated under Part 4 of the Commerce Act. They are intended to influence the behaviour of those businesses by setting the maximum average price or total allowable revenue that the businesses can charge. They also set standards for the quality of services that each business must meet. This ensures that businesses do not have incentives to reduce quality to maximise profits under their price-quality path.

For gas pipeline services, there are two types of price-quality paths that suppliers can have. All businesses start off on a ‘default’ path which is generic in nature to provide a low cost form of regulation. If the default path does not suit their particular circumstances however, a business can apply for a ‘customised’ price-quality path. Customised price-quality paths use more business specific information, and rely on more in-depth audit, verification, and evaluation processes.

What’s the difference between transmission and distribution?

Gas transmission services provided by Maui Development Limited and Vector Transmission meet the demand from large users which are often directly connected to the gas transmission network, such as electricity generation and large industrial users. The Vector and Maui pipelines also transport gas which is further distributed via gas distribution networks. A majority of the gas transported in the Vector pipeline, is first transported by the Maui pipeline. The Vector Transmission pipeline provides gas to large users directly connected to the network, and provides gas to the GasNet, Powerco and Vector distribution networks.

What are input methodologies?

Input methodologies are the upfront rules and processes of regulation set by the Commission which underpin Part 4 regulation. For example, input methodologies concern things such as the valuation of assets, the treatment of taxation, the allocation of costs, and the cost of capital.

To set price-quality paths (or any other form of Part 4 regulation), we are required to apply input methodologies where relevant. We first published input methodologies for gas pipeline businesses in December 2010. Since then we have re-determined these input methodologies in September 2012 to specify the existing methodologies for asset valuation, tax, and cost allocation as also applicable to default price-quality paths. For more information on input methodologies, including our reasons, visit http://www.comcom.govt.nz/input-methodologies-2/.

How have prices and quality been regulated previously?

Once finalised, the initial default price-quality paths will be the first time that gas pipeline businesses have been subject to price-quality regulation under Part 4. For Maui Development Limited and GasNet, it will be the first time they have been subject to any regulatory controls on their prices or quality. Powerco and Vector (certain services only) have been previously regulated under the 2008 Gas Authorisations. These Authorisations were the result of the 2004 Gas Control Inquiry and expired July 2012. For more information on the Gas Authorisations visit: http://www.comcom.govt.nz/vector-powerco-authorisation/

Why have we published a revised draft decision?

We began work on the initial gas default price-quality paths in April 2010, and anticipated making a final decision in 2011. This timing was to allow the Commission to apply the input methodologies published in December 2010 in making our final decision. However, in September 2011 the High Court found that further input methodologies needed to be specified for default price-quality paths.

In the absence of these input methodologies, we contemplated setting the initial default price-quality paths for gas pipeline services by rolling over the current prices for the gas businesses. This led to our November 2011 draft decision.

However, after further consideration, we decided instead—with the agreement of all interested parties—to defer setting the initial default price-quality paths until after the input methodologies were specified.

One of the key considerations in the decision to defer setting the initial default price-quality paths was our ability to ‘claw-back’ any price increases above CPI for the period from 1 January 2008 until we set the default price-quality paths. This claw-back effectively provides a price-cap at CPI from 2008 until the default price-quality paths are set.

ENDS

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