Gas Authorisation will further reduce prices

The Commerce Commission has today released the Authorisation for the Control of Supply of Natural Gas Distribution Services by Vector Ltd and Powerco Ltd, which will result in further reductions in prices for gas distribution services.

The key public policy concern underpinning the regulatory provisions in the Commerce Act is the potential for abuse of market power by suppliers of monopoly services where competition is limited.

In particular, concerns about gas consumers being overcharged led to the Minister of Energy to request the Commission to undertake an inquiry under Part 4 of the Commerce Act and to recommend whether any gas pipeline services should have their prices, revenues and/or quality controlled under Part 5 of the Act.

In the Inquiry, the Commission found that Powerco and Vector had been earning significant excess profits and that control would be likely to result in significant reductions in gas distribution prices (on average) to consumers. Gas distribution prices typically comprise around 40 percent of gas consumers’ bills. In November 2004 the Commission recommended to the Minister of Energy that the gas pipeline services of Powerco and Vector should be controlled. On 27 July 2005 the Minister of Energy announced the decision to declare control over those services.

A Provisional Authorisation has been in place since control took effect in 2005. The Provisional Authorisation imposed average price reductions of 9 percent for Powerco and 9.5 percent for Vector. Since those reductions were imposed, prices have been held constant in nominal terms. As a result, real price reductions under control to date have been approximately 19 percent for each business.

The Authorisation requires further average price reductions of 11.1 percent for Powerco and 3.7 percent for Vector. Prices will then be held constant in real terms for the remainder of the control period to 1 July 2012.

Commerce Commission Chair Paula Rebstock said, “When combined with earlier price reductions imposed by the Commission in October 2005, the reductions announced today as part of the Authorisation will result in total price cuts of 30 percent for Powerco and 22 percent for Vector on average. The size of the price reductions highlights the importance of the regulatory provisions in the Commerce Act.”

The price reductions under the Authorisation require further average distribution price reductions of 11.1 percent for Powerco and 3.7 percent for Vector. Prices will then be held constant in real terms for the remainder of the control period to 1 July 2012.

These reductions are in addition to average price reductions imposed by a Provisional Authorisation in 2005 of 9 percent for Powerco and 9.5 percent for Vector. Since those reductions were imposed, prices have been held constant in nominal terms. As a result, real price reductions under control to date have been approximately 19 percent for each business.

“The Commission recognises that there are a number of trade-offs between safeguarding the interests of consumers through lower prices and promoting efficiency. We believe the Authorisation will not only limit monopoly profits, but will still maintain appropriate investment incentives, so that consumers receive safe and reliable gas supply,” said Ms Rebstock.

“A key aspect of maintaining investment incentives is providing a commercially realistic rate of return on capital. In regulating prices under the Authorisation, the Commission has therefore decided to use a post-tax Weighted Average Cost of Capital of 9.59 percent per annum for Powerco and Vector going forward. This allowance is higher than comparable allowances currently proposed by regulators in Australia and the UK and takes into account the impact of the current financial crisis on the cost of raising debt,” Ms Rebstock said.

In reducing their prices on average on 1 January 2009, the businesses have the flexibility to determine the appropriate balance between different customer classes. This will mean some customers may receive higher reductions than others, some may see no change, and some customers may pay more, depending on how each business decides to apply the reductions.

“The Commission expects gas retailers to pass on the full effect of any price reductions to gas consumers and will be monitoring this to ensure it happens in a timely manner,” said Ms Rebstock.

The reductions are lower than those proposed in the Commission’s October 2007 Draft Decisions Paper on the Authorisation, primarily due to both companies providing additional information on their planned operating and capital expenditure.

The operating and capital expenditure reviews for the Authorisation were a significant exercise due to the volume of new information provided in consultation on the Draft Decisions. “Although quality of information issues have persisted with Powerco, the Commission has had to draw a line and make a decision based upon the information that it has available to it,” Ms Rebstock said.

Ms Rebstock emphasised that in doing so, the Commission has nevertheless taken a prudent and conservative approach to determining the operating and capital expenditure allowances for the Authorisation, mindful of the need to provide investment incentives and to maintain safety and reliability on the gas networks.

Both companies will also be subject to annual information disclosure on quality performance, as part of the Authorisation.

The Commerce Act provides that the Commission may accept an undertaking from a supplier of controlled services, instead of making an authorisation. In April 2008, the Commission received offers of undertaking from Powerco and Vector.

Having considered the offers and submissions received on its preliminary view, the Commission’s view is that Vector’s and Powerco’s offers should not be accepted. Based on current inflation forecasts, these offers, if accepted, would have resulted in average price increases of 22 percent for Powerco and 31 percent for Vector by 2012. Given the likely magnitude of the benefits to gas consumers from making the Authorisation relative to accepting the Offers, the Commission considers that neither Offer provides an acceptable alternative to the Authorisation.

The Authorisation remains in force until it is revoked or until it expires on 1 July 2012, whichever is the earlier. At that time, the controlled gas pipeline services will become subject to the new regulatory provisions provided for under the Commerce Amendment Act 2008.

The Authorisation can be found on the Commission’s website www.comcom.govt.nz under Industry Regulation/Gas/Commission Reports and Documents/authorisation

Background
Powerco is New Zealand’s second largest electricity and gas distribution company, with gas and electricity networks throughout the North Island. Powerco’s controlled gas distribution and metering businesses (to which this Authorisation relates) accounted for approximately 14 percent of Powerco’s total revenue in 2008.

Vector is New Zealand’s largest energy infrastructure company and is listed on the NZX. As well as its natural gas distribution business, Vector’s business activities include electricity distribution, natural gas transmission, liquefied petroleum gas supply, gas and electricity metering services, and telecommunications. Vector’s controlled Auckland gas distribution business (to which this Authorisation relates) accounted for approximately 4 percent of Vector’s total revenue in 2008. Vector’s former NGC transmission and distribution business units, which were acquired in 2004, are not subject to the Authorisation.

On 4 October 2007, the Commission released its Draft Decisions for the Authorisation. Since that time the Commission has been consulting with interested parties on the terms of the Authorisation. The Commission held a conference on the Draft Decisions in February 2008.

Media contact:
Allanah Kalafatelis, Communications Manager
Phone work (04) 924 3708, mobile 021 225 4417

Felicity Connell, Senior Communications Adviser
Phone work (04) 924 3709, mobile 021 225 4454

Commission media releases can be viewed at www.comcom.govt.nz