Commerce Commission decision on WACC used for disclosures

Commission releases final decision on the WACC used for information disclosure

The Commerce Commission has released its final decision on the weighted average cost of capital (WACC) that will apply to information disclosure for electricity lines and gas pipeline businesses.

The Commission will continue to publish the 25th to 75th percentile WACC range as required by the cost of capital input methodologies, but will also publish the 67th percentile point estimate. This is in line with the Commission’s October decision to reduce the WACC percentile that applies to price-quality regulation to the 67th percentile, and confirms its revised draft decision for information disclosure regulation.

The annual publication of WACC estimates is important because over the long-term it will help people understand whether regulated suppliers are limited in their ability to achieve excessive profits. This kind of analysis will be an important part of the ongoing role that the Commission has in summarising and analysing supplier performance.

This decision does not cover the information disclosure WACC for regulated airports. A process paper relating to the review of the WACC percentile for airports will be issued in the first quarter of 2015.

Background
Read the media release regarding the Commission’s October decision to reduce the WACC percentile that applies to price-quality regulation to the 67th percentile - http://www.comcom.govt.nz/the-commission/media-centre/media-releases/detail/2014/commerce-commission-reduces-the-margin-that-it-applies-to-regulated-businesses-cost-of-capital

Part 4
Part 4 of the Commerce Act 1986 regulates a number of markets where competition is limited, including electricity lines services, gas pipeline services and specified airport services. The intention of Part 4 is to ensure that suppliers have incentives to innovate, invest, improve efficiency and produce quality services for consumers, while also limiting their ability to extract excessive profits.

Some of the services regulated under Part 4 are subject to price-quality paths (electricity lines services and gas pipeline services). This means the Commission restricts the revenue a regulated business can earn or sets the maximum average prices it can charge, as well as setting service quality standards that must be met. Other regulated services (Wellington, Auckland and Christchurch airports, and electricity distribution businesses exempt from price-quality regulation) are only subject to information disclosure which means they must publish certain information about their performance.

Part 4 also requires input methodologies to be set to promote certainty for regulated businesses and consumers. More information on input methodologies is provided below.

Input methodologies
Input methodologies are a range of upfront regulatory rules, processes and requirements covering matters such as the valuation of assets, the treatment of taxation, the allocation of costs, and the cost of capital. Part 4 of the Commerce Act requires the Commission to set input methodologies for specified airport services, electricity distribution and transmission, and gas pipelines. The Commission must 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.

WACC percentile estimate
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 on that asset is at least as good as that they would expect to get from a different investment of similar risk. The WACC reflects the cost of debt and the cost of equity, and the respective portion of each that is used to fund investments in the assets used to supply regulated services.

The WACC cannot be observed; it must be estimated, so there is a risk that the estimate is higher or lower than the true (but unobservable) WACC. To mitigate this risk the Commission calculates a distribution around the mid-point WACC estimate based on the standard errors of some of the key parameters. This defines a WACC range. A percentile in this WACC range distribution is then chosen, based on what best meets the purpose of Part 4.

In October this year, the Commission made a change to the percentile that is applied to the WACC for price-quality paths for electricity lines and gas pipelines. The decision shifted the percentile from the 75th percentile to the 67th percentile.

ENDS

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