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Focus: Energy – October 2007High Court puts infrastructure valuations back on the railsIn brief:
The High Court of Australia has held unanimously that the Australian Competition and
Consumer Commission had acted incorrectly and unreasonably in adopting its own
methodology for determining the value of the Moomba-Sydney gas transmission
pipeline.1
Partner David Maloney
BackgroundEast Australian Pipeline Pty Limited (EAPL), which is owned by the Australian Pipeline Trust, acquired the Moomba-Sydney Pipeline (the pipeline) from the Federal Government in 1994 for $534.3 million. The pipeline is regulated by the Australian Competition and Consumer Commission (ACCC), and EAPL was required to submit a proposed access arrangement for the pipeline for approval by the ACCC. Among other things, the access arrangement sets the tariff that may be charged by EAPL to third parties requiring access to the pipeline (the reference tariff). The reference tariff is calculated by a number of criteria, of which the key is the value of the capital assets of the pipeline (the initial capital base). The National Third Party Access Code for Natural Gas Pipeline Systems (the Gas Code) sets out the methodology to be used in calculating the initial capital base. After a number of revisions by EAPL and the ACCC to the proposed access arrangement, the ACCC ultimately rejected EAPL's proposal and substituted its own access arrangement, which it was entitled to do under the Gas Code. Under EAPL's proposed access arrangement, the initial capital base was initially valued at $666.7 million, and then later revised to $756.9 million. The ACCC's final access arrangement set an initial capital base of $545.4 million. However, in substituting its own access arrangement, the ACCC employed a novel methodology for calculating the initial capital base of the pipeline that was, by the ACCC's own admission, 'idiosyncratic'.
Review of the ACCC's decisionEAPL sought review of the ACCC's decision by the Australian Competition Tribunal (the Tribunal), which held that the ACCC had acted incorrectly by substituting its own access arrangement by rejecting known valuation methodologies by devising a methodology of its own. The ACCC adopted a novel approach to calculating depreciation. The Tribunal varied the ACCC's access arrangement and substituted an initial capital base of $834.7 million. The ACCC successfully appealed to the Full Court of the Federal Court. The Full Court concluded that the ACCC had not made an error in substituting its own access arrangement and utilising a novel method for calculating the initial capital base because the ACCC's approach was a permissible method of determining the appropriate amount of depreciation. Further, the ACCC was not prohibited from blending the various elements of the methodology set out in the Gas Code.
Appeal to the High CourtIn the High Court, the question for determination was how the methodology stipulated in the Gas Code for calculation of the initial capital base should be interpreted and applied. EAPL argued that the ACCC did not comply with the requirement to follow the specified methodology, whereas the ACCC submitted that it had complied with the methodology. The Gas Code mandates reference to known valuation methodologies as the starting point for setting an initial capital base, and the High Court, in its decision handed down on 27 September 2007, noted that this was entirely consistent with the reasons for setting an initial capital base in the first place – to establish a fair rate of return on the value of the asset that reflects prevailing market conditions. The three essential steps for setting an initial capital base were summarised by the High Court to be:
The High Court did not accept the argument that the ACCC could reject the DORC methodology and proceed to blend an implied depreciation methodology with the factors that may be considered when adjusting a value produced by the chosen methodology. According to the High Court, the ACCC's approach sought to put aside the methodology mandated by the Gas Code, and this would render it difficult, if not impossible, for either service providers or the consuming public to treat the Gas Code methodology as a certain list of factors to be taken into account in setting an initial capital base. The High Court found that the Tribunal had been correct in its construction of the Gas Code methodology, as this construction best attains the purpose of the legislation, which is to allow efficient costs recovery while also ensuring competitive pricing arrangements, despite the monopolistic conditions of the market. The High Court concluded that the orders made by the Tribunal should not have been set aside by the Full Federal Court. The matter has now been returned to the Full Federal Court for a final decision.
Implications of the decisionThe High Court's decision will clearly impact on the Australian eastern gas industry and the prices that may be charged for access to gas transmission pipelines, and will also affect the prices paid for gas by gas-fired electricity generators. However, the decision is also significant as it has highlighted the need for certainty and predictability in the regulatory process, particularly in the broader context of investment in critical infrastructure (such as ports, airports, railways and other infrastructure that cannot be economically replicated) as a whole. If the ACCC were to be permitted to deviate from recognised valuation methodologies, the High Court noted that 'the task of establishing a rate of return on investment, for regulatory purposes, commensurate with prevailing market conditions for funds and the risk involved would be rendered a much less certain process than it is already'. The High Court's decision will constrain regulators to stipulated criteria and avoid 'creativity' that could have the potential to distort future investment decisions about essential infrastructure and to increase the perceived risk of investment (which, in turn, would lead to inefficient outcomes where higher returns are sought by investors). Footnotes
For further information, please contact:
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