Envestra Limited- Cost Pass-Throughevent Application for the South Australian Gas Distribution

Decision

Envestra Limited- cost pass-throughevent application for the South Australian Gas Distribution System - (Public)

June 2012

© Commonwealth of Australia 2012

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AER reference: 48683/D12/94596

1Summary

On 27 April 2012, the Australian Energy Regulator (AER) received a cost pass-through event application from Envestra Limited (Envestra), which owns and operates a gas distribution network in South Australia.Revisions to this application were submitted to the AER on 8 June and 14 June 2012. In addition to an annual reference tariff variation to reflect the approved price path in the access arrangement, Envestra has sought recovery of costs associated with the Australian Government’s introduction of a carbon pricing mechanism under the Clean Energy Act2011 (Cth)(Clean Energy Act) and related legislation (Clean Energy Legislative Package) for the period from 1 July 2012 to 30 June 2016. The costs to Envestra of the carbon pricing mechanism arise from the imposition of charges for fugitive gas emissions from Envestra’s network, the administrative cost of complying with the scheme and the increased cost of unaccounted for gas (UAG).

The AER is the economic regulator of gas distribution service providers in all jurisdictions except Western Australia. The AER must assess Envestra’s cost pass-through application in accordance with the procedures set out in clause 4.5 of the Access Arrangement for Envestra’s South Australian gas distribution system for 2011-2016 (Access Arrangement).[1] In particular, the AER must decide whether the relevant cost pass-through event has occurred, and if so, the pass-through amount.

The AER has determined that Envestra’s cost pass-through event application satisfies the requirements of a ‘tax change event’ as defined in section 4.5 of the Access Arrangement. The Clean Energy Act imposes a requirement that falls within the Access Arrangement’s definition of a ‘tax change event’ which materially increases the cost of Envestra reference services. Further, the AER broadly determined that:

• the forecast pass-through amount for 2012-2013 is $4.497m.
• the subsequent forecast pass-through amounts are $4.446m in 2013-14, $4.481m, in 2014-15 and $4.908m in 2015-16.
• a true up mechanism is to be applied to adjust overs and unders from two regulatory years prior to the year tariffs are adjusted.
• the pass through amount is to apply as a fixed charge of $0.03 per customer per day for Tariff R, C and D customers in 2012-13. As the Tariff D structure does not contain a $/day component, the charge will apply to the first block (50GJ) of GJ MDQ. This equates to an additional $0.90 per First 50GJ MDQ/mth.
• Background

Under the National Gas Law (NGL) and National Gas Rules (NGR) the AER is responsible for assessing gas distribution tariff variation proposals, including cost pass-through proposals. This decision document relates to the cost pass-through proposed by Envestra for the period from 1 July 2012 to 30 June 2016.

This decision does not establish the final tariffs to be offered by Envestra for gas pipeline services. Final tariffs are determined by the combination of cost pass-throughs and annual tariff variations.

As this cost pass-through application has been approved before 1 July 2012, higher tariffs to recover the forecast pass-through amount for 2012-2013 will take effect from 1 July 2012.[2] Envestra’s printed 2012-13 tariffs, available via the AER website, do not incorporate the above cost recovery tariff. The above cost recovery tariff is additional to the printed 2012-13 tariffs available via the AER website.

The Clean Energy Legislative Package sets out the method for the introduction of a carbon price in Australia. The carbon pricing mechanism requires liable entities to pay for each tonne of carbon pollution emitted from 1 July 2012.[3]

The central piece of legislation in the Clean Energy Legislative Package, the Clean Energy Act, received Royal Assent on 18 November 2011, with the relevant substantive provisions of the Act taking effect from 2 April 2012.

Envestra’s proposed pass-through amount comprises:

• the cost of carbon permits that Envestra will need to purchase, and
• the administrative costs to Envestra of compliance and reporting under the carbon pricing mechanism, and
• the increase in UAG costs Envestra will incur as a consequence of the carbon pricing mechanism.

2Regulatory requirements

The NGL and NGR establish high level requirements for gas distribution (and transmission) network reference tariff variation mechanisms. Detailed provisions for the identification of cost pass through events, calculation of pass through amounts, and assessment of pass throughs by the AER are provided in access arrangements pertinent to specific networks.

Rule 97 of the NGR establishes the basis for Envestra’s annual reference tariff variation and cost pass through mechanisms. Rule 97(1) of the NGR provides for reference tariffs to be varied according to a schedule, formula or cost pass through event (or a combination of those mechanisms). Rule 97(2) provides for tariff regulation in the form of either revenue caps or tariff basket controls. Rule 97(3) of the NGR guides the AER’s assessment of tariff variation mechanisms when assessing a proposed access arrangement. Rule 97(4) and 97(5) of the NGR establish that the AER must have adequate oversight over reference tariff variations and that reference tariffs may not be varied other than via approved mechanisms.

Clause 4.5 of the Access Arrangement states that subject to the approval of the Regulator under the NGR reference tariffs may be varied, after one or more cost pass-through events occur, in which each individual event materially increases or materially decreases the cost of providing the reference services.

The cost pass-through events identified in clause 4.5 of the Access Arrangement are:

• regulatory change event
• service standard event
• tax change event
• terrorism event
• network user failure event
• insurer credit risk event
• an insurance cap event
• natural disaster event.

A ‘tax change event’ is also defined in clause 4.5 of the Access Arrangement as:

A tax change event occurs if any of the following occurs during the course of an access arrangement period for Envestra:

(a) a change in a Relevant Tax, in the application or official interpretation of a Relevant Tax, in the rate of a Relevant Tax, or in the way a Relevant Tax is calculated;

(b) the removal of a Relevant Tax; and

(c)the imposition of a Relevant Tax; and

In consequence, the costs to Envestra of providing reference services are materially increased or decreased.

The materiality threshold is defined in clause 4.5 of the Access Arrangement. Under this definition an event will be considered to materially increase or decrease costs where that event has an impact of one per cent of the smoothed forecast revenue specified in the access arrangement information in the years of the access arrangement period that the costs are incurred.

In assessing cost pass-through events from gas network service providers, the AER is required to take into account a number of factors listed under clause 4.5 of the Access Arrangement. These are listed and addressed in section 5 below.

3Consultation

The procedures set out in the Access Arrangement for the AER’s consideration of cost pass-through applications do not require a public process of consultation. The AER has 90business days to make a decision on a cost pass-through event application. This timeframe can be extended for the time taken by the AER to obtain information from Envestra, obtain expert advice or consult about the application. The AER has not sought submissions on Envestra’s cost pass-through event application.

In assessing Envestra’s cost pass-through application, the AER liaised with Envestra on the detail of its cost pass-through application. Issues on which the AER consulted Envestra Energy include the pass-through amount and the proposed cost recovery methodology.

4Occurrence of cost pass-through event

4.1Cost pass-through event

Envestra has submitted a cost pass-through application to the AER for a 'tax change event.[4]

The term ‘Relevant Tax’ is defined in the Access Arrangement as:[5]

...any royalty, duty, excise, tax, impost, levy, fee or charge (including but without limitation any goods and services tax) imposed by the Commonwealth of Australia, any State or Territory of Australia, any local government or statutory authority or any other body (authorised by law to impose such an impost, tax or charge) on or in respect of the Network (or any part of it) or on or in respect of the operation, repair, maintenance, administration or management of the Network (or any part of it) or on or in respect of the provision of any Network Service (other than a levy, fee or charge that arises as a result of Envestra’s breach of a law or failure to pay a tax or charge by the due date for payment.:...

The Clean Energy Legislative Package introduces a carbon pricing mechanism, which requires liable entities to buy and surrender eligible emissions units for each tonne of carbon dioxide equivalent (tCO2e) emitted. An entity will be a liable entity if it passes the threshold test of emitting at least 25000tCO2e in the eligible financial year. The carbon pricing mechanism will apply to emissions of greenhouse gases from 1July 2012. The cost of each carbon unit in the 2012-13 year is to be fixed at $23/tCO2e.

Envestra's National Greenhouse and Energy Report for 2010-11 indicates direct emissions from Envestra’s South Australian gas distribution network of 158 711 tCO2e. These emissions relate to fugitive gas, directly emitted byEnvestra as a result of the operation of the network, not the totality of gas transported by way of the network. The AER is satisfied that Envestra’s South Australian gas distribution network is a facility which meets the 25 000tCO2e threshold under the Clean Energy Legislative Package and will incur a liability for the purchase of carbon units.

The definition of a ‘Relevant Tax’ contained in the Access Arrangement is fairly broad as it includes any royalty, duty, excise, tax, impost, levy, fee or charge (including but without limitation any goods and services tax). The charges for carbon units as a result of the Clean Energy Act fall within the ordinary meaning of the words ‘fee’ or ‘charge’ in the definition. None of the exclusions in the definition apply to charges for carbon units. The fugitive gas emissions which give rise to Envestra’s carbon unit liability and associated administrative costs, arise in respect of Envestra’s operation of its South Australian gas distribution system. The increase in Envestra’s UAG costs are also a result of charges/fees imposed under the Clean Energy Act and are in respect of Envestra’s operation of the gas distribution system.

Under the Access Arrangement there can be a ‘tax change event’ if any of the following occurs during the course of the access arrangement period:

(a) a change in a relevant tax, in the application or official interpretation of a relevant tax, in the rate of a relevant tax, or in the way a relevant tax is calculated;

(b) the removal of a relevant tax; and

(c)the imposition of a relevant tax; and

The AER is of the view that the introduction of the carbon pricing mechanism under the Clean Energy Legislative Package would be regarded as the ‘imposition of a relevant tax’. The AER considers the Clean Energy Legislative Package introduces a ‘Relevant Tax’ as defined in Envestra's Access Arrangement. The AER therefore considers that the Clean Energy Act requirements imposed upon Envestra meet the definition in clause 4.5 of the Access Arrangement of a tax change event.

4.2Material impact on the costs of providing reference services

A tax change event must materially increase or decrease the costs of Envestra providing reference services.

The access arrangement specifically defines the materiality threshold in clause 4.5 of the Access Arrangement. Under this definition an event will be considered to materially increase or decrease costs where that event has an impact of one per cent of the smoothed forecast revenue specified in the access arrangement information in the years of the access arrangement period that the costs are incurred.

Envestra submitted that the cost pass-through event for the period from 1 July 2012 to 30 June 2016 creates costs of over 2% of its total estimated smoothed revenue for each regulatory year during the period from 1 July 2012 to 30 June 2016. The AER is satisfied that the proposed costs associated with the pass-through meet the ‘one per cent of the smoothed forecast revenue’ materiality threshold established by clause 4.5 of the Access Arrangement. The AER has calculated that the total forecast costs associated with the pass-through for the period from 1 July 2012 to 30 June 2016 equate to 2.01% of the smoothed forecast revenue over the period from 1 July 2012 to 30 June 2016.

5Factors which the AER must consider

Clause 4.5 of the access arrangement sets out the factors the AER must take into account when making its decision whether to approve a cost pass-through event reference tariff adjustment. These factors are:

• the costs to be passed through are for the delivery of pipeline services
• the costs are incremental to costs already allowed for in reference tariffs
• the total costs to be passed through are building block components of total revenue
• the costs to be passed through meet the NGR criteria for determining the building block for total revenue in determining reference services
• any other factors which the AER considers relevant and consistent with the NGL and NGR.

These factors are considered in turn below.

5.1Pass-through costs are for the delivery of pipeline services

5.1.1Carbon permit costs

The financial cost of the carbon pricing mechanism arises directly from the provision of the haulage reference services provided by Envestra, through the fugitive gas emissions associated with the operation of its pipeline network. Consistent with the requirements of the National Greenhouse and Energy Reporting (Measurement) Determination 2008, Envestra used a methodology (Method 2) to estimate emissionsin the period from 1 July 2012 to 30 June 2016for fugitive emissions from natural gas distribution activities.

Method 2 establishes that the level of emissions is proportional to the size and composition of the network, in accordance with the following formula:

Ej = ∑k (Qk x EFjk)

where:

Ejis the fugitive emissions of gas type (j) that result from the natural gas distribution during the year measured in tCO2e.

∑kis the total of emissions of gas type (j) measured in tCO2e and estimated by summing up the emissions from each equipment type (k) listed in sections 5 and 6.1.2 of the API Compendium, if the equipment is used in the natural gas distribution.

Qk is the total of the quantities of natural gas measured in tonnes that pass through each equipment type (k) or the number of equipment units of type (k) listed in sections 5 and 6.1.2 of the API Compendium, if the equipment is used in the natural gas distribution.

EFjk is the emission factor for gas type (j) measured in tCO2e for each equipment type (k) listed in sections 5 and 6.1.2 of the API Compendium, if the equipment is used in the natural gas distribution.

The methodology used by Envestra to estimate fugitive emissions in the pass through period is consistent with that used by Envestra in previous years to report in accordance with its obligations under the National Greenhouse and Energy Reporting Act 2007.

The cost of carbon emissions is calculated by multiplying the emissions figure determined by the Method 2 formula by the fixed carbon price set out in the carbon pricing mechanism ($23/tonne in 2012-13).

Table 5.1Estimated carbon unit costs

$ 2012/13 / 2012/13 / 2013/14 / 2014/15 / 2015/16
Carbon Permit Unit Cost (est.) $ / 23 / 23.58 / 24.16 / 26.93
Carbon Emissions Estimate (t) / 160,900 / 161,900 / 162,900 / 163,900
Carbon Permit Cost Estimate $m / 3.70 / 3.82 / 3.94 / 4.41

5.1.2Administrative and reporting costs

The AER recognises that the introduction of the carbon pricing mechanism will impose compliance costs on Envestra as a liable entity under the legislation. Envestra proposed to pass through $95,000, for its South Australian gas distribution network, relating to administrative and reporting costs in the pass through period.

Envestra advised that the proposed administration costs relate to:

• compliance and audit costs
• legal costs
• accounting and taxation advice costs
• FTE (staffing) costs
• billing system changes
• permit purchasing processes.

Envestra have also forecast recurrent costs for each network of $0.05 million. This will cover the costs associated with meeting Envestra’s Clean Energy Legislative Package obligations on an ongoing basis, including those relating to:

• accounting
• auditing
• compliance
• legal costs.

In addition, Envestra has proposed that when permit trading commences on 1 July 2015 it will include additional costs estimated as $0.05 million per year for each network from 2015/16 onwards. These proposed costs relate to:

• process controls
• management and administration of permit cost monitoring
• acquisition
• due diligence and auditing
• brokerage costs
• external legal and expert advice in relation to compliance and purchase options and strategies.

The total administrative costs sought by Envestra are set out in the table 5.2 below.

Table 5.2Estimated administrative costs associated with the carbon scheme

$ 2012/13 / 2012/13 / 2013/14 / 2014/15 / 2015/16
Network admin cost $m / 0.145 / 0.05 / 0.05 / 0.1

The AER is satisfied that the nature of the administrative costs proposed by Envestra is appropriate in the context of Envestra's compliance and reporting obligations in relation to the carbon pricing mechanism. The costs are directly attributable to the tax change event. Envestra has allocated its administrative costs equally between its three gas distribution networks in Queensland, South Australia and Victoria. Each of these facilities meets the 25,000tCO2e threshold under the Clean Energy Legislative Package and will incur a liability for the purchase of carbon units. The AER considers this allocation is appropriate given the costs are generic in nature and are incurred for each network irrespective of customer numbers and network size.