“PUBLIC SUBMISSION ON THE TERMINATION FEE SECTION OF THE CHARGE RULES ISSUES PAPER FOR IRRIGATION INFRASTRUCTURE OPERATORS”
MURRUMBIDGEE IRIGATION LTD
15July 2008
General Comments
Since before the introduction of the Federal Water Act, private irrigation corporations in NSW and South Australia have maintained that the ACCC has no role in regulating the process and quantum of price setting inside these businesses. The ACCC acknowledges in this report that the natural checks and balances created by our structure, where customers are typically shareholders, “reduces the incentive to maximise monopoly profits”. Given the sorts of advances that have been achieved in NSW and SA corporations prior to ACCC involvement, the question must be asked, “what benefits will accrue through greater regulation?” On the other side, the compliance costs for our business are increasing exponentially.
Below is a graph of MI’s cost performance since privatisation in 1999, in comparison to CPI and bulk water costs. Real reductions of 35% have been achieved in this time. This is becoming increasingly difficult under the new regulatory regime.
It would appear from this discussion paper that the ACCC envisages a role in regulating not only the establishment of market rules, but also price setting, infrastructure planning, customer consultation, service standards, dividend policy and financing. MI directors and management have the ultimate responsibility to the customer / shareholders to govern the business to acceptable standards including the functions described above. We see no role for the ACCC in regulating how these functions are undertaken in private sector companies such as ours, where there are effective, self-regulating checks and balances.
It is somewhat perplexing that in the interests of competition the ACCC is seeking such high levels of uniformity across a range of issues in the rural water sector – we would have expected a focus on competitive diversity instead of uniform mediocrity. The only legitimate role for the ACCC is to regulate the pricing of service termination and related impacts on trade, presumably for the broader national interest. This can be done quite independently of the annual business processes described.
Response to questions raised in the accc paper
Question 1 Are there any matters not mentioned above that are relevant inestablishing a methodology for determining prices consistent with theobjectives and principles of the Act?
We have addressed this matter in general terms above.
Question 2 Are there any issues the ACCC should be aware of in relation to servicestandards? Provide details including:
a)to what extent the proposed level of service is or should becommunicated to customers during the price-setting process
b)the role of customers when establishing service standards
c)the role of customers in determining the balance between thelevel of prices and the standard of service
d)the extent to which service standards are, or should be,reported publicly
e)the extent to which service standards form, or should form, partof a customer service contract
f)the types of service standards that currently exist.
We do not consider this to be a matter for the ACCC. The nature and extent of consultation with customers is a matter for each operator.
MI has a commitment to define, monitor and report service standards to our customer/shareholders and in so doing strive to improve such services over time. We see no obligation to report such standards to anyone else. Ultimately, if standards drop, our customers will firstly exercise their democratic right to change company direction and in the absence of success they can remove their investment from the district.
Question 3 Are there any issues the ACCC should be aware of in relation tolegislative and regulatory obligations? Provide details, including:
a)to what extent obligations are, or should be, clearly articulatedby regulators and government
b)the types of obligations placed on operators
c)how the obligations currently placed on operators are, orshould be, funded
d)the extent to which obligations are applied consistently acrossthe basin?
MI is concerned about the excessive burden that new regulations are imposing on our business and therefore our customers. The increase in costs through federal regulation is of particular concern.
MI is confident that private diverters and other infrastructure operators, due to their different structure, are not facing the same regulatory and administrative burden.
MI and other private operators now have over a decade of demonstrated success regarding efficiency reform, service improvement, water trading development and commitment to regional environmental protection. All of this has been achieved in the absence of significant regulation. It is unfortunate that MI and other private operators are now having to accommodate the lowest common denominator when it comes to regulatory intervention and policy reform.
Question 4 In transitioning towards upper bound pricing:
a)What factors may influence the path or pace of transition? Howmight these factors be addressed?
b)Are there circumstances in which upper bound pricing cannotor should not be achieved?
MI will provide detailed comments on this issue in an addendum to this submission.
Question 5 To what extent are the two approaches applied consistent with theconditions listed above? Are there any issues that the ACCC should beaware of when considering the two approaches? Provide details, suchas:
a)the current approach, or what might be considered anappropriate approach, for determining forward-looking capitalexpenditure need
b)whether forward-looking expenditure programs areindependently audited and, if so, at what frequency
c)what type of expenditure is suited to the renewals annuityapproach
d)the period over which the renewals annuity and regulatoryasset base expenditures are discounted and included in prices
e)how often the renewals annuity and associated bank surplusesor deficits are adjusted
f)what discount rate (or rate of return) is used under bothapproaches
g)what factors should be taken into account in determining thediscount rate
h)whether there are any inhibitors to using the weighted averagecost of capital as the discount rate and whether it is appropriateto use this approach
i)whether any operators recover a value of past investments infuture prices
The approach taken is a matter for each operator and will be determined by expenditure profiles, preferences to risk and consideration of intergenerational equity.
MI uses the annuity approach to future CAPEX planning. The model was developed by an external consultant with the close involvement of MI technical and financial staff. The policy concept has the broad support of our customer/shareholders. MI provided details on this model to the ACCC in our last submission, including the assumptions used therein.
The annuity will be reviewed and adjusted every five years in the absence of major changes to the underlying assumptions, in which case a specific review will be undertaken.
Our current accelerated CAPEX program, using what remains of the NSW Government asset funding deed for deferred maintenance, is externally audited by the NSW Government. This process includes an ex-ante review of forward estimates of 2 years, a detailed ex-ante review of the annual works program and an ex-post audit of works completed.
MI does not recover the value of past investments in future prices, unless specific cost sharing agreements were reached to provide levels of service above the standard. Such agreements are few in number.
Question 6 Are there any issues that the ACCC should be aware of in relation toasset valuation? Provide details, such as:
a)how operators currently finance capital investments—whetherit is solely through the renewals annuity or through acombination of the annuity and separate contracts with certaincustomers (maintaining a separate asset base for pricingpurposes)
b)under the regulatory asset base approach how existing assetsshould be valued
c)in what circumstances might it be reasonable to revalue assetsunder the regulatory asset base approach?
d)Are there any characteristics of irrigation assets that lendthemselves to any particular asset valuation methodology?
MI predominantly uses the annuity approach to capital finance. Decades of mismanagement by successive governments precipitated the changed approach under local ownership. MI is confident that the current approach provides the greatest security and equity for current and future generations. Our system is characterised by long life assets and “lumpy” expenditure profiles. The annuity approach suits this CAPEX profile.
Where specific assets are required over and above standard levels of service, MI has and will continue to seek developer contributions towards such assets.
MI will provide additional comments on this issue in an addendum to this submission.
Question 7 Are there any issues that the ACCC should be aware of in relation totaxation? Provide details, including:
a)whether operators are subject to either the Federal Income Taxor National Tax Equivalent Regimes?
b)the implications for prices where varying tax obligations applyacross the Basin
c)the extent to which taxation liabilities are calculated in amanner similar to the table above and details of any differences
d)any relevant issues, rulings, or tax laws that may influence theestimation of taxable income for the purpose of constructing arevenue requirement for pricing
e)examples of where a significant, inexorable, real tax timingdisadvantage has been experienced from the receipt oftermination fees
MI will provide detailed comments on this issue in an addendum to this submission. MI is subject to the federal income taxation regime.
Question 8 To what extent do operators prepare, or should operators prepare, plansand undertake consultation processes for future capital and operatingexpenditure requirements? Where possible, provide details, includingdetails of:
a)the consultation process undertaken by operators whendeveloping capital and operating plans, and the role ofcustomers in this process
b)independent review of asset management plans and operatingand capital plans, and to what extent these reviews ensure thatprices are based on prudent and efficient expenditure
c)how often independent reviews are undertaken
d)the role, if any, of independent consultants in the preparation ofplans
e)to what extent the results of independent reviews are, or shouldbe, made public and reflected in prices
f)programs currently in place, or that should be in place, toimprove productivity and efficiency over time.
We do not consider this to be a matter for the ACCC. The process for developing capital and operating plans is a matter for Directors of MI and these processes are broadly supported by our customer/shareholders. How other operators undertake such planning is a matter for them. Time is the best judge of success and we are confident that our long term performance in terms of efficiency and service improvements speaks for itself.
Question 9: What principles and approaches are most appropriate when allocatingfixed or common costs of irrigation delivery services (i.e. those coststhat do not vary with the volume of water supplied)? Provide details,including:
a)to what extent embedded cross-subsidies or community serviceobligations (CSOs) currently exist within irrigation networks;in what circumstances and to what extent such cross-subsidiesor CSOs should be maintained in perpetuity; and whatprocesses are, or could be, used to reduce or eliminate crosssubsidiesand CSOs
b)to what extent current charges do, and whether they should,reflect a uniform or postage stamp pricing policy
c)to what extent current charges do, and whether they should,reflect the costs of providing services to different segments ofthe market
MI has sought to remove, as far as practicably possible, cross subsidies in its pricing of services. In the absence of 3200 individual unit rates, a different rate for each customer, it is impossible to completely eliminate cross-subsidies. In MI’s view, supported by our customers, the new system successfully groups those customers that demand similar services and therefore drive similar costs within the business. Within these groups, which combine elements of service levels, geography and system type, postage stamp pricing is the only practical means of sharing costs without a massive increase in the administrative burden for MI. Even with additional intellectual effort and improved data collection, many aspects of cost in a highly integrated network are simply not black and white as to key drivers.
MI does not have any “formal” community service obligations although we have previously reported on a range of activities that the company undertakes which arguably go beyond the realm of good corporate citizenship.
Question 10 To what extent and in what circumstances should the setting of fixed andvolumetric charges be allowed to deviate from the underlying (fixed andvariable) cost structure of the operator?
This is a matter for each operator and they should be free to determine pricing policy that best suits their own needs. If other providers wish to include or exclude various pricing elements to the benefit or detriment of their customers it is of no concern to MI. However, to the extent that operators seek to use pricing policy to bias termination fees and trade then it is a matter for the ACCC and a matter of concern to MI.
MI has identified a mechanism which effectively allows operators to determine an annual pricing system independent of termination fee regulations. This is described later in our response and deserves more serious consideration by the ACCC.
Question 11 To what extent is pricing used as a cash management tool or insurancefund for irrigators? Are operators best placed to provide this service?What are the practical implications for the trade of water under such apricing arrangement?
Since before privatisation MI has been using a price stablisation matrix whereby funds from good years are set aside in cash deposits for use in difficult years. This system has been fundamental to the survival of the Company and our customer/shareholders during the recent extended drought. Only after 5 years of drought did the company exhaust the funds that had been set aside in prioryears and customers have been appreciative of the stability that this has helped facilitate in otherwise difficult circumstances. MI is committed to retaining a reserve system and has factored in a revised scheme to its new pricing system, again with the broad support of customers.
No-one is better placed than MI to manage such a fund for our customers. Our Directors are able to effectively balance the risks and rewards to the Company and customers, including decisions on investment policy. Directors have a responsibility under the Corporations Act to develop sound risk management strategies and given the reliance of the business on one major income source we would argue that such a fund demonstrates sound practice.
MI does not believe that the operation of the reserve fund has any substantive impact on water trade. Even if it did this would be insufficient reason to abandon a policy that is both effective and broadly supported. From a public perspective the operation of the reserve helps to alleviate the pressure on public assistance during difficult times such as the current drought.
MI does not believe that this is a matter for the ACCC.
Question 12:What progress has been made in the implementation of the access, exit and termination fee protocol to schedule E of the Murray darling Basin Agreement – specifically in relation to the creation of delivery entitlements?
MI is concerned that re-opening or reviewing previous decisions about termination fees in too short a time frame creates unnecessary uncertainty and costs for irrigation farmers and their infrastructure service providers.
The Company therefore recommends that the primary focus on termination fees should be to ensure compliance and investigate low cost ways of achieving compliance for irrigation infrastructure operators.
Murrumbidgee Irrigationis compliant with the termination fee protocol to schedule E. It has created Delivery Entitlements (DE’s) in practice but further changes to water supply contracts and the constitution are needed.These changes are are scheduled for shareholder consideration in November 2008.
The current situation is therefore as follows :-
- For internal permanent trades, DE’s must be traded with the Water Entitlements (WE’s) pending legal definition of DE’s in the contracts / constitution.
- For external permanent trades, customers have the choice of retaining the “notional” residual DE’s and continuing to pay annual fixed charges, or cancellation of their delivery service and payment of the Termination Fees.
Question 13To what extent and in what circumstances does the creation of explicit delivery entitlements impact the operation of irrigation networks?
The introduction of delivery entitlements has created a significant increase in complexity and transaction costs for operations. It has the potential to impact onthe investment and trading decisions of customers and potential customers. MI is very concerned that we mitigate such negative impacts.
(a)MI does not expect significant benefits through trade in delivery entitlements. The driving factor in making these changes is compliance. The disadvantages lie in the complexity, transaction costs and unlikely benefits of DE’s in a highly integrated common service system. However, the main costs potentially lie in impacts on trade and investment decisions. For example, there is much more uncertainty involved with buying farms and water (given the additional need to specify the status of delivery entitlements).
(b)MI must now introduce an additional register and set of contracts to deal with delivery entitlements (and prospective trade in those entitlements – temporary or permanent). Definition of the entitlement is quite simple at a theoretical level based on service standards (flow rate shares), however in practice the theory can be unworkable at times from a property rights perspective. Great care needs to be taken to ensure that previous and potential investments by customers and shareholders are not compromised at a practical level in the transition period.
Question 14To what extent have the specific provisions of schedule E for dealing with explicit delivery entitlements been met by operators?
Until constitutional changes have been approved by shareholders, internal trades of WE’s carry with them the requirements in relation to DE’s. MI has no alternative at present.