Commerce Commission proposes further price reductions for controlled gas distribution businesses

In its Draft Authorisation released today, the Commerce Commission is proposing to authorise prices for the supply of Powerco Limited and Vector Limited's gas distribution services which would represent reductions of 42% and 15%, respectively, if implemented.

These are further to preliminary price reductions of 9% and 9.5 %, respectively, under a Provisional Authorisation issued in 2005.

The Commission is now seeking submissions on its Authorisation for supply of the controlled gas distribution services of Powerco and Vector.

"The Commission takes the approach that consumers should expect prices and quality from monopoly businesses commensurate with what prices and quality would result if the market were competitive," said Commerce Commission Chair Paula Rebstock.

"Our preliminary view is that, despite the impact of the average price reductions under the Provisional Authorisation, Powerco and Vector are still making significant excess returns in respect of the supply of the controlled services. These excess returns should be limited further", Ms Rebstock said.

"The Commission expects gas retailers to pass on the full effect of any price reductions in the Final Authorisations to consumers, and we will be monitoring this to ensure it happens in a timely manner."
"The Commission is mindful of the need to preserve incentives for the two businesses to invest in their gas networks and has therefore decided, for the purpose of the draft decisions, to use a post-tax Weighted Average Cost of Capital of 9.1% to 9.3% in calculating the return on capital for Powerco and Vector. This allowance is higher than comparable allowances currently proposed by regulators in Australia and the UK", Ms Rebstock said.

"The process of determining what is fair and reasonable pricing has been hampered by the poor provision of information by the companies, particularly in the case of Powerco, said Ms Rebstock. "Additional supporting information from the companies may result in significant changes to the final figures".

The key findings in the Draft Decisions Paper, subject to consultation, are:
 Powerco's and Vector's controlled gas pipeline businesses, which accounted for 17% of Powerco's and 6% of Vector's total revenue in 2006, are continuing to make significant excess returns, despite the impact of the average price reductions of 9% and 9.5% for Powerco and Vector respectively under the Provisional Authorisation.
 Further initial average price reductions for Powerco's and Vector's controlled gas distribution services of 42% for Powerco and 15% for Vector are necessary to limit excess returns. These price changes would take effect upon implementation of the Authorisation, which the Commission anticipates to be 1 April 2008.
 For each pricing year thereafter (commencing 1 October 2008), Powerco and Vector could change their prices, on average, by CPI-2%. This price path will have effect until 2012, at which time the terms of the Authorisation will be reset for a further four years to 2016.
 The controlled services make up a significant portion of the delivered price for gas, on average approximately 40%. It is therefore expected that the proposed average price reductions would result in average reductions to the delivered gas price for consumers of the controlled services of up to 17% for Powerco and 6% for Vector.
 Excess returns that have been made while the Provisional Authorisation has been in effect will be recovered over two regulatory periods ending June 2016. This will minimise future price shocks to consumers.
 The Commission notes that the proposed initial price reduction for Powerco is significantly higher than it is for Vector. A key reason for this difference is the overall lack of supporting information provided by Powerco (as compared to Vector) for its proposed operating expenditure and capital expenditure allowances.
 The Commission has allowed both companies to revalue their assets. This has resulted in substantial revaluation gains which must be treated as income for the purpose of setting prices. Failure to treat revaluation gains as income would, in effect, disguise high returns as apparently low returns, therefore resulting in unwarranted windfall profits to the companies.
Submissions on the Commission's draft decisions for the Authorisations are invited from all interested parties. The Commission is also releasing a copy of the model on which it has based its draft decisions. Submissions on the model are also welcomed.

Submissions are due by 12pm, 12 November 2007.

A conference on the Draft Decisions Paper is planned for the week commencing 3 December 2007. The purpose of the conference is to enable the Commission to test those written submissions and to further the Commission's understanding of key issues so that it can make its Final Decisions for the Authorisations. The submissions, conference and cross-submissions following the conference will inform the Commission's decisions. The Commission anticipates that its Final Decisions will be presented in February 2008 and that the Authorisations will be implemented by 1 April 2008.

The document's full title is: Authorisation for the Control of Supply of Natural Gas Distribution Services by Powerco and Vector Limited – Draft Decisions Paper

The public version of the Commission's Draft Decisions Paper and the model can be found on the Commission's website www.comcom.govt.nz under Regulatory Control Enquiries/Regulated Gas Control.
Vector proposes outline undertaking
Section 72 of the Commerce Act enables parties to offer undertakings for consideration as an alternative to making authorisations under section 70 of the Act. Recently, the outline of an offer of an undertaking was received from Vector Limited which suggested a price increase of 15% in the first year followed by increases of CPI +7% in subsequent years. In order for the Commission to consider whether to accept an undertaking, instead of making a final authorisation under section 70 of the Act, the Commission would require the full terms of the proposed undertaking, provided with supporting information, relevant assumptions, and reasoning. The Commission has responded to Vector to this effect. The companies need to provide any documents and undertakings in a timely manner in light of the Commission's timeline for the Final Authorisations.

Consideration of an undertaking by the Commission would be as part of a transparent consultative process. Vector Limited's correspondence dated 14 September 2007 and subsequent correspondence on this matter can be found along with the Draft Decisions Paper on the website. The Commission's website will be further updated on such matters and process over time.


Background

On 30 April 2003, the Minister of Energy requested the Commerce Commission to report on whether goods and services supplied in markets directly related to gas transmission and distribution systems should be subject to control and hence whether an Order in Council under section 53 of the Commerce Act should be made in relation to gas pipeline services.

On 27 July 2005 the Minister of Energy announced the decision to impose control over the gas distribution services of Powerco and Vector. Control was implemented by way of an Order in Council (the Control Order), and took effect on 25 August 2005.

Section 55 of the Act requires the Commission to authorise the supply of the controlled goods and services. The Commission has issued a Provisional Authorisation which took effect from 25 August 2005 reducing average prices by 9% for Powerco and 9.5% for Vector.

The terms of the Provisional Authorisation will remain in effect until such time as a further provisional authorisation under section 71 or the Authorisation under section 70 of the Act is determined (or an acceptance of an undertaking).

The Commission is currently determining a final authorisation (the Authorisation) for the controlled services pursuant to section 70 of the Act. Section 70(1) of the Act enables the Commission to make an authorisation in respect of all or any component of prices, revenues, or quality standards that apply in respect of the controlled services using whatever approach it considers appropriate.