Be careful what you wish for

After 18 months of debate and review, the thresholds regime for electricity lines businesses has been substantially changed, along with the more generic price control system. But have we really got much further in the quest for certainty and a stable investment environment, asks Gary Hughes of Chapman Tripp?

The Commerce Amendment Act was passed by Parliament in September as one of its last major pre-election commercial reforms. 

Electricity lines businesses (ELBs) are heavily affected, as are gas pipeline companies, Transpower, and indeed any infrastructure business (e.g. airports) potentially facing control by the Commerce Commission.

The new law is an attempt to find a better balance than achieved in the previous regulatory system, hopefully one offering something more predictable for energy businesses. Generally, it is to be welcomed as a step in the right direction, and most ELBs appear enthusiastic about the changes, but there is potential for some aspects to deliver considerable uncertainty in the next few years (despite initially appearing more liberal or ‘favourable’ towards the energy industry).

Some serious concerns with the previous threshold regime included the lack of weight apparently given to incentives to invest in networks, or to dynamic efficiency forces that look beyond short-term business returns or ‘excess profits’. 

Some of the Commerce Commission’s regulatory interventions had appeared to make rather unexpected or disproportionate use of the thresholds system. For example, the scenario that engulfed Vector in August 2006 where, only two days after the release of a new Government Policy Statement re-emphasising the need for investment incentives, the Commission threatened to take control of the electricity distribution business. Many observers perceived the underlying issue as a relatively modest, explicable breach of the thresholds path, and it left some wondering if the regulator had even read the Policy Statement.

Coming into effect from 1 April 2009, the reform introduces a number of important changes. The commission will be required to develop, as a priority, the rules, requirements and procedures known as “input methodologies”, for regulated goods and services. The aim is to promote certainty over the rules on crucial matters such calculating the cost of capital, asset values and common costs apportionment.

A more focused purpose statement is given, still seeking to promote the long term benefits of consumers but recognising that some markets face little or no competition. It tries to reconcile this broad goal by ensuring that incentives exist to make efficiency gains and quality improvements; suppliers share efficiency gains with consumers; excessive profit extraction is limited; and there are incentives to invest and innovate, including for replacement, upgraded and new network assets (this last point is new, but the weight to give to each remains initially with the commission).

A more flexible range of regulatory tools the commission can use includes: information disclosure rules; negotiate/arbitrate processes where suppliers must negotiate with buyers over price and service quality, and if agreement cannot be reached must enter into binding arbitration; and price-quality path regulation which looks more like the familiar thresholds system.

Price-quality paths are split into two types. The first is Default/customised and individual price-quality regulation (default price-quality paths are set for an industry, but individual suppliers may seek a customised path instead, for example if they want to make new investments). The second type is individual price-quality regulation (the commission sets a path for an individual regulated business).

Arguably the most important change is the extended appeal rights now available. Full merits review can be conducted by the High Court via a right of general appeal against input methodologies and the commission’s final decisions on customised and individual price paths. 

The previous regime only allowed judicial review of commission decisions to implement control, which is a very narrow strait-jacket compared to a full appeal.  Court scrutiny on judicial review is generally limited to whether a firm can demonstrate illegality, unfair process, or patently unreasonable conclusions. These are a high bar in many regulatory cases, arguably shielding the commission from full accountability for its decision-making.

Input methodologies for ELBs, gas pipelines and airports are supposed to be set by the commission by June 30, 2010 and it had better get cracking. The commission has had a consultative panel of experts looking at WACC issues since September 2006, following a draft discussion paper issued a year earlier, with no discernible progress yet. And issues around asset valuation, tax and other building block methodologies are not going to be much simpler than the vexed WACC problem.

When those input methodologies finally get set, there is now an appeal right available. This is a positive thing; accountability and Court oversight of those important matters is desirable. However, there is an overlap or timing problem for ELBs: the first new default price-quality path is meant to be published by the end of 2009 to take effect from April 1, 2010. That is some months before the input methodologies will be available (and possibly years before the dust settles on appeals against those input methodologies).

In the meantime, the 2010 ELB default path presumably will have to be based on some draft methodologies, or continuation of the commission’s current (sometimes controversial) views. That path only has a limited right of appeal on matters of law, whereas any customised path has a full merits appeal. Those rights might conceivably be used before, or in parallel with, input methodology appeals.

While the first-published input methodology remains on foot and applicable during any appeal, that measure of certainty could be short-lived. A successful appeal would throw things back to the drawing board and perhaps ensure the new ‘clawback provisions’ for over or under-recovery of prices get an early workout.

The Commerce Commission is no shrinking violet when it comes to defending its regulatory decisions. It is a tough litigant, as recent cases

involving Unison, Powerco and Vector, and others can attest.  If necessary in the circumstances, it may get away with arguing inconsistent things in parallel appeals involving methodologies on the one hand, and actual price-path outcomes on the other.  The appellate developments could be rather messy.

The new regime does have a welcome dose of flexibility and accountability built into it. Whether it can deliver much-needed market certainty, in amongst the likely litigation, remains to be seen.

• Gary Hughes is a principal at Chapman Tripp, specialising in competition and regulatory law. These views are his own, rather than those of the firm or its clients, but are informed by involvement in major energy cases such as the Gas Pipelines price control inquiry and judicial review.