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Commission seeks views on capital input methodologies costs

Commission seeks views on cost of capital input methodologies

20 February 2014

The Commerce Commission is now inviting views on whether it should consider reviewing or amending the input methodologies for the cost of capital that apply to electricity lines services, gas pipeline services and specified airport services regulated under Part 4 of the Commerce Act 1986.

In a recent judgment the High Court questioned the Commission’s use of the 75th percentile estimate of the weighted average cost of capital (WACC) to set price-quality paths. The Court considered doing so might be at odds with the Part 4 objective to limit the ability of regulated suppliers to earn excessive profits.

“As signalled by the Commission on 7 February, we are now seeking views on the cost of capital input methodologies,” said Commerce Commission Chairman Dr Mark Berry. “We currently use the 75th percentile WACC estimate when setting price-quality paths to promote incentives for efficient investment but given the issues raised in the High Court judgment it is now important that we take feedback on the way forward.”

“The Commission places a high value on the regulatory certainty and predictability that Part 4 provides. As a result it is important that we take steps to ensure regulated suppliers, investors and the market get a clear picture of whether the concerns raised by the Court will result in the 75th percentile being retained or reduced. It is also important consumers have confidence that they are not paying too much for regulated services,” said Dr Berry.

Once the Commission has considered submissions, it will decide whether to bring forward a full review of the cost of capital input methodologies, consult solely on amending the WACC percentile, or defer any consideration of changes to a later date.

The Commission is expected to announce its decision on next steps before the end of March.

The full document requesting views can be found at http://www.comcom.govt.nz/regulated-industries/input-methodologies-2/further-work-on-wacc/

Submissions close at 5pm on 12 March 2014 and can be sent via email to regulation.branch@comcom.govt.nz

Background
What are input methodologies?

Input methodologies involve setting upfront regulatory rules, processes and requirements that apply under Part 4 of the Commerce Act 1986. For example, input methodologies cover things such as the valuation of assets, the treatment of taxation, the allocation of costs, and the cost of capital.

Input methodologies were determined by the Commission in December 2010, following a two year process with multiple rounds of consultation with interested parties. Part 4 requires the Commission to review each input methodology no later than seven years after its date of publication and, after that, at intervals of no more than seven years.

For more information on input methodologies http://www.comcom.govt.nz/input-methodologies-2/

What are the cost of capital input methodologies and how are they applied?

The cost of capital is the financial return that investors require from an investment given its risk. Investors have choices, and will not invest in an asset unless the expected return is at least as good as that they would expect to get from a different investment of similar risk. The weighted average cost of capital (WACC) reflects the cost of debt and the cost of equity, and the respective portion of each that is used to fund an investment.

The current cost of capital input methodologies require that the Commission must apply the 75th percentile estimate of the WACC range (‘75th percentile’) when setting default or customised price-quality paths applying to electricity distribution businesses and gas pipeline businesses, or the individual price-quality path applying to Transpower.

The cost of capital input methodologies also require the Commission to publish 75th percentile WACC estimates, mid-point WACC estimates and 25th percentile WACC estimates for all suppliers that are subject to information disclosure regulation. ‘Consumer-owned’ electricity distribution businesses and the three main international airports are subject to information disclosure regulation only. In the Commission’s recent reports on how effectively information disclosure regulation is promoting the Part 4 purpose in respect of specified airport services, we assessed airport profitability against a WACC range from the mid-point to the 75th percentile.

What were the appeals of input methodologies to the High Court?
Twelve parties appealed against various aspects of the Commission’s input methodologies in February 2011. Three parties subsequently withdrew their appeals. The appeals were heard in the High Court in September, October and December 2012, and in February 2013, over a total of 39 days.

The judgment was issued on 11 December 2013. The Court upheld all the Commission’s decisions except in two minor respects – one relating to an appeal as to when regulated prices may be reviewed and the other, an appeal as to the date at which airport land is to be valued for the first time under information disclosure regulation.

In the judgment, although the Court upheld the Commission’s decisions on the cost of capital input methodologies, it questioned the Commission's selection of the 75th percentile of the cost of capital range for price-quality regulation of electricity lines and gas pipeline businesses (see Wellington International Airport Ltd and others v Commerce Commission [2013] NZHC 3289).

On 14 February 2014, the Major Electricity Users’ Group (MEUG) sought leave from the High Court to appeal the Court’s decision not to amend the use of 75th percentile of the WACC range in the cost of capital input methodologies. Parties have until 28 February 2014 to cross-appeal MEUG’s application.

ENDS

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