Final Decision
Australian Gas Network’s
cost pass through event variation
application of 31 July 2014
for
Costs proposed for
AGN’s Victorian distribution network
mains replacement program
21 November 2014
© Commonwealth of Australia 2014
This work is copyright. Apart from any use permitted by the Copyright Act 1968, no part may be reproduced
without permission of the Australian Competition and Consumer Commission. Requests and inquiries
concerning reproduction and rights should be addressed to the Director Publishing, Australian Competition
and Consumer Commission, GPO Box 3131, Canberra ACT 2601.
Inquiries about this final decision should be addressed to:
Australian Energy Regulator
GPO Box 520
Melbourne Vic 3001
Tel: (03) 9290 1444
Fax: (03) 9290 1457
Email: AERInquiry@aer.gov.au
AER reference: 54684, D14/16923
Contents
Contents ..................................................................................................................................... 1
1
Summary .......................................................................................................................... 2
2
Background ...................................................................................................................... 4
3
Regulatory requirements .................................................................................................. 5
4
AGN’s application ............................................................................................................. 8
5
Occurrence of the pass through event............................................................................ 10
6
Approved costs to be passed through ............................................................................ 13
7
Conclusion...................................................................................................................... 24
AER Decision
AGN mains replacement cost pass through variation application
1
1
Summary
On 31 July 2014, the Australian Energy Regulator (AER) received an application for a mains replacement
cost pass through event tariff variation from Australian Gas Networks (AGN), formerly Envestra, for its
Victorian gas distribution network. 1
The current five year access arrangement for AGN contains a cost pass through mechanism allowing
approved reference tariffs to be adjusted in certain circumstances, including if a mains replacement pass
through event occurs. AGN’s application is, in effect, a request to pass through to customers costs which
were not included in its access arrangement.
AGN’s application is for costs expected to be incurred to complete 331 km of mains replacement in addition
to that approved in its 2013–17 access arrangement. AGN is replacing low pressure distribution mains with
high pressure polyethylene mains. The replacement is expected to reduce safety risk, operating costs and
improve supply reliability. This is consistent with AGN’s Gas Safety Case which sets a date of 2020–21 for
the replacement of all low pressure distribution mains within its network.
We are required to approve a cost pass through event variation if it satisfies the relevant requirements in
the access arrangement. We must assess AGN’s pass through application in accordance with the
procedures set out in clause 4.5 of its access arrangement.
We consider AGN’s proposed pass through event variation satisfies the requirements of its access
arrangement. We approve:

an additional 331 km of mains replacement, which takes the total volume to 696 km over the
2013–17 access arrangement period

an additional $117.1 million ($2012) in capital expenditure to complete the additional 331 km of
mains replacement
1
Envestra was acquired by the Cheung Kong Consortium in October 2014 and changed its name to Australian Gas Networks.
AER Decision
AGN mains replacement cost pass through variation application
2

recovering the additional capital expenditure by adjusting the X factor to apply in 2015 from
-2.0% to -5.1% in our final decision post-tax revenue model (PTRM). The X factors for 2016 and
2017 remain unchanged.
AER Decision
AGN mains replacement cost pass through variation application
3
2
Background
The AER regulates gas distribution businesses in Victoria. We do so under the National Gas Law (NGL)
and the National Gas Rules (NGR). We made our final decision on the 2013–17 access arrangement for
AGN’s Victorian Gas Distribution System on 15 March 2013. As part of that decision, we determined a
mains replacement cost pass through provision. The effect of the provision is, if we approve the cost pass
through, AGN may vary its reference tariffs to pass through the costs of the event to its customers.
This pass through provision was implemented in the context of the Victorian gas distribution businesses
proposing and receiving funding for large volumes of mains replacement but not completing the volumes
during the previous access arrangement period. Our decision was to approve a lower volume of mains
replacement than that proposed by AGN for the 2013–17 access arrangement, based on the amount of
mains replacement undertaken in the previous access arrangement period. This is referred to as the
‘historical volumes’. We approved expenditure for AGN to undertake 365 km of mains replacement. In
setting this allowance for a lower volume, we acknowledged that the objective of the mains replacement
program is to remove all cast iron mains over the longer term, consistent with the businesses’ Gas Safety
Cases, approved by Energy Safe Victoria (ESV). We therefore provided for a pass through to enable the
gas distribution businesses to receive further funding, once they had delivered a specified volume of mains
replacement.
Our decision provided for AGN to apply for a mains replacement pass through once it completed 268 km of
its mains replacement program. For the pass through to be approved, AGN must also demonstrate its
intention to complete the total 365 km of mains replacement we approved in the 2013–17 access
arrangement, and the additional volume of mains replacement proposed in the pass through application.
AER Decision
AGN mains replacement cost pass through variation application
4
3
Regulatory requirements
The NGR allows a reference tariff variation mechanism to provide for a variation of a reference tariff as a
result of a cost pass through for a defined event.2 Detailed provisions for the identification of cost pass
through events and how we are to assess them are provided in each service provider’s access
arrangement. In this case, they are set out in clause 4.5 of AGN’s access arrangement.
Clause 4.5 states that, subject to our approval, reference tariffs may be varied after one or more cost
pass through event/s occurs. One of those events is a mains replacement event.3
A mains replacement event is defined as the event whereby AGN:
(a)
completes 268 km of its planned total completion of historical volumes of mains replacement
during the course of the fourth access arrangement period
(b)
costs are incurred, or are to be incurred, by AGN in the remainder of the fourth access
arrangement period to complete a volume of mains replacement in excess of the historical
volumes.
Historical volumes means 365 km, being the volume of mains replacement completed by AGN for the
2008–2012 access arrangement period, with reference to our decision to approve the fourth access
arrangement and our reasons as set out in our final decision.
Mains replacement means mains replacement for low pressure to high pressure block rollout, which
involves the replacement of:
(i)
low pressure distribution mains with high pressure polyethylene mains through a process of
dividing a low pressure region into smaller areas (referred to as blocks) which are then
subject to systematic low pressure to high pressure replacement, and
(ii)
includes the minimum amount of replacement of medium pressure supply mains necessary to
undertake the proposed low pressure mains replacement in the 2013-2017 access
arrangement period, as specified in (i).
Costs are to be determined in accordance with the pre-approved unit rates set out in our decision to
approve the fourth access arrangement and our reasons as set out in our final decision or, where unit
rates have not been pre-approved, are to be determined as otherwise set out in our final decision.4
2
Rule 97(1)(c) of the NGR.
3
Access Arrangement for AGN’s Victorian Gas Distribution System 2013 – 2017, April 2013, clause 4.5(j).
AER Decision
AGN mains replacement cost pass through variation application
5
In determining whether to approve the proposed cost pass through event variation, we must take into
account the following:
(a)
the costs to be passed through are for the delivery of pipeline services
(b)
the costs are incremental to costs already allowed for in reference tariffs
(c)
the total costs to be passed through are building block components of total revenue
(d)
the costs to be passed through meet the relevant NGR criteria for determining the building block for
total revenue in determining reference services
(e)
the efficiency of the service provider’s decisions and actions in relation to the risk of the relevant
pass through event occurring, including whether the service provider has failed to take any action
that could reasonably be taken to reduce the magnitude of the costs incurred as a result of the
relevant pass through event and whether the service provider has taken or omitted to take any
action where such action or omission has increased the magnitude of the costs
(f)
any other factors we consider relevant and consistent with the NGR and the NGL.5
The other factors we consider relevant to our assessment of AGN’s proposed tariff variation are those
set out in the mains replacement section (section 4.4.1) of part 2 of our final decision for AGN’s
2013–17 access arrangement.6
Under clause 4.6.2 of the access arrangement, we must notify AGN of our decision to approve or reject the
proposed variation within 90 business days of receiving its application and all necessary supporting
information.7
4
Access Arrangement for AGN’s Victorian Gas Distribution System 2013 – 2017, April 2013, pages 12-13.
5
Access Arrangement for Envestra’s Victorian Gas Distribution System 2013 – 2017, clause 4.5.
6
AER, Access Arrangement for Envestra’s Victorian Gas Distribution System 2013 – 2017, Final Decision, Part 2, Section 4.4.1
Mains Replacement, April 2013, pp. 39-65.
7
90 business days from AGN’s application date of 31 October 2014 is 4 December 2014.
AER Decision
AGN mains replacement cost pass through variation application
6
Where we approve the variation, it is to take effect from 1 January of the next regulatory year unless
we agree otherwise.
AER Decision
AGN mains replacement cost pass through variation application
7
4
AGN’s application
AGN submitted its application for a mains replacement pass through tariff variation on 31 July 2014. The
key features of its pass through application are:

AGN submitted the mains replacement event was triggered on or around 25 June 2014 when it
completed 268 km of its mains replacement program.

AGN intends to replace a total of at least 696 km of mains during the 2013–17 arrangement
period. It stated that this level of mains replacement is consistent with the objective of eliminating
all aged mains in the network by 2020–21 consistent with its Gas Safety Case.8

The pass through application is to fund 331 km of mains replacement in excess of the 365 km we
approved in the 2013–17 access arrangement. The total program of 696 km is 60 km more than
the 636 km AGN initially proposed for its 2013–17 access arrangement.

The additional capital expenditure to replace the additional 331 km of mains is $117.1 million
($2012).

AGN proposed to recover the additional costs by adjusting the X factor to apply on 1 January 2015
from -2.0% to -5.1% in our final decision PTRM.
Table 1 summarises AGN’s proposed expenditure in each regulatory year during 2013–17.
Table 1
AGN proposed mains replacement expenditure requirements ($m 2012)
Pass through amount
Source:
2013
2014
2015
2016
2017
Total
31.1
31.4
28.7
11.9
13.9
117.1
AGN, Cost pass-through application: Mains replacement event, 31 July 2014, p.14.
As part of its application AGN provided:
8
Envestra, Cost pass through application: Mains replacement event, 31 July 2014, p.12.
AER Decision
AGN mains replacement cost pass through variation application
8

Evidence that it has completed the ‘historical volumes’. This included internal weekly mains renewal
reports and a record of all paid invoices for mains replacement works carried out in for its Victorian
network between January 2013 and May 2014.

Evidence for the intended completion of volumes in excess of the trigger point of 268 km. This
included contracts and tender documentation.

Details of the calculation of the additional capital expenditure and required adjustment to reference
tariffs in response to the mains replacement event. This included an updated version of the AER’s
capital expenditure model and PTRM with updated inputs and proposed adjustments.
AER Decision
AGN mains replacement cost pass through variation application
9
5
Occurrence of the pass through event
We are satisfied AGN’s pass through application meets the definition of a mains replacement event as
specified in section 4.5 of its access arrangement. This is because AGN provided evidence that:

it has completed 268 km of mains replacement during the current access arrangement period,
which constitutes the trigger event

it has, or will incur costs, in the remainder of the access arrangement period to complete a volume
of mains replacement in excess of the historical volumes (365 km).
5.1
Completion of 268 km of mains replacement
We are required to verify that AGN has triggered the mains replacement event.
The trigger event is defined as AGN completing 268 km of mains replacement during the
2013–17 access arrangement period. As evidence of triggering the mains event, AGN submitted:

our mains replacement pass through model

four weekly mains renewal reports9

a Maximo report (an excel spreadsheet) listing the records for 18,690 paid invoices for mains
replacement works carried out in Victoria between January 2013 and May 2014. 10
After considering this material we requested that AGN provide for each mains replacement area:
9
Envestra, Cost pass through application: Mains replacement event, 31 July 2014, Attachment G1 - MRP pass through - Weekly
Mains Renewal Reports.xlsx.
10
Envestra, Cost pass through application: Mains replacement event, 31 July 2014, Attachment G2 - MRP pass through - Maximo
Report Mains Renewals, January 2013.xlsx.
AER Decision
AGN mains replacement cost pass through variation application
10

the start invoice, where the mains replacement commenced after 1 January 2013, or the invoice
closest to 1 January 2013

the completion invoice or the invoice closest to the date of the trigger event

the contract and any subsequent contract variation that showed the mains replacement work had
been awarded to the contractor named on the invoice.
This allowed us to verify the kilometres of low pressure to high pressure mains replacement AGN had
undertaken between 1 January 2013 and 27 June 2014. Based on our review of this information, we are
satisfied that AGN completed 268 km of mains replacement around the date of 25 June 2014.
5.2
Intent to complete mains replacement in excess of historical volumes
We are required to verify that AGN intends to incur costs to:

complete the outstanding mains replacement for which we approved an allowance in its
2013–17 access arrangement

complete the 331 km of mains replacement it proposed in its pass through application in addition to
the historical volumes of mains replacement we approved in its 2013–17 access arrangement (a
total of 696 km).
AGN stated in its application that it intends to complete the outstanding historical volumes by the end of
2014.11 As evidence, AGN provided details of the awarded contracts, including when the work is to be
undertaken, the location, volume, volume type and the cost of the mains replacement, and a sample of
tender and contract documentation.
AGN stated in its tariff variation application that it intends to complete the additional 331 km during the
remaining three years of the access arrangement period. As evidence of its intent to complete the 331 km
within the access arrangement period, AGN submitted:
11
Envestra, Cost pass through application: Mains replacement event, 31 July 2014, Table 2, p. 8.
AER Decision
AGN mains replacement cost pass through variation application
11

details of the awarded contracts

where contracts have not been awarded, extracts of the minutes from the Board meetings
approving the award of additional contracts.
Based on this information, we are satisfied AGN intends to complete volumes of mains replacement it
proposed in excess of the historical volumes in the remainder of the access arrangement period.
AER Decision
AGN mains replacement cost pass through variation application
12
6
Approved costs to be passed through
Once we determine a mains replacement pass through event has occurred, we must approve:

the additional mains replacement volume

the additional capital expenditure to complete the additional mains replacement

the tariff variation to recover the additional capital expenditure.
We approve the proposed additional mains replacement of 331 km and an increase in capital expenditure of
$117.1 million ($ 2012) to complete that mains replacement. We consider this expenditure meets the capital
expenditure criteria under the NGR.
The costs will be passed through by adjusting the X factor to apply in 2015 from -2.0% to -5.1% in our final
decision PTRM. The X factors for 2016 and 2017 will remain unchanged.
We have made this decision having regard to the factors listed in clause 4.5 of AGN’s access arrangement.
Our consideration of each factor is set out below.
6.1
The costs to be passed through are for the delivery of pipeline services
We are satisfied that the costs to be passed through are for the delivery of pipeline services. This is
because the costs relate to capital expenditure for the provision of gas pipeline mains infrastructure relevant
to the delivery of pipeline services.12
12
NGL, Chapter 1 - Preliminary, Part 1- Citation and interpretation, Definitions, ‘pipeline services’, p. 43.
AER Decision
AGN mains replacement cost pass through variation application
13
6.2
The costs are incremental to costs already allowed for in reference tariffs
We are satisfied the costs are incremental to the costs already allowed for in reference tariffs as the costs
are specifically to complete mains replacement volumes in excess of the mains replacement volume we
approved in AGN’s access arrangement.
6.3
The total costs to be passed through are building block components of
total revenue
We are satisfied that the total costs to be passed through are building block components of total revenue as
they comprise capital expenditure relevant to the following building blocks:
6.4

return on projected capital base

the depreciation on the projected capital base

the estimated cost of corporate income tax.13
The costs to be passed through meet the relevant NGR criteria for
determining the building blocks
We are satisfied AGN’s proposed cost of $117.1 million to undertake the additional 331 km of mains
replacement meets the capital expenditure criteria under r.79(1) of the NGR. Our assessment focuses on
AGN’s proposed volumes of mains replacement because we assessed the applicable unit costs against the
capital expenditure criteria in our final decision for AGN’s access arrangement.14
13
NGR, rule 76(a), (b) and (c).
14
AER, Access Arrangement for Envestra’s Victorian Gas Distribution System 2013 – 2017, Final Decision, April 2013, Part 1, p.
22 and Part 2, Section 4.4.1 Mains Replacement, p. 53-59.
AER Decision
AGN mains replacement cost pass through variation application
14
AGN’s access arrangement specifies that costs are to be determined in accordance with pre-approved unit
rates set out in ‘the AER’s decision to approve the access arrangement and its reasons set out in its final
decision or, where unit rates have not been pre-approved, are to be determined as otherwise set out in the
final decision’.15 Therefore, the capital expenditure required to undertake the proposed additional volume of
mains replacement is calculated by multiplying:

the proposed volume of additional mains replacement by suburb

the unit rates as per our final decision for AGN’s access arrangement.16
Volumes
We are satisfied that the proposed 331 km of mains replacement is consistent with the capital expenditure
criteria under r.79(1) of the NGR. In reaching this view we had regard to:

AGN’s Gas Safety Case and the end date of 2020–21 for it to replace all mains within its network,
including those in the CBD

the views of the ESV on AGN’s proposed volumes, given the underlying safety driver for the mains
replacement program

AGN’s current level of completed mains replacement in the 2013–17 access arrangement period
and its evidence of future works to be undertaken.
AGN stated that it is planning to replace 756 km of mains during the 2013–17 access arrangement period,
consistent with its 2014 Mains Replacement Plan. However AGN is only seeking to receive funding under
the pass through to undertake 696 km across the 2013–17 access arrangement period (Table 2).17
15
Access Arrangement for Envestra’s Victorian Gas Distribution System 2013 – 2017, April 2013, pp 12-13.
16
AER, Access Arrangement for Envestra’s Victorian Gas Distribution System 2013 – 2017, Final Decision, Part 2, Section 4.4.1
Mains Replacement, April 2013, p. 61.
17
Envestra, Cost pass through application: Mains replacement event, 31 July 2014, p.13.
AER Decision
AGN mains replacement cost pass through variation application
15
Table 2 sets out AGN’s total mains replacement volumes included in its 2014 Mains Replacement Plan for
2013 to 2017, compared to the total mains replacement volumes for which pass through approval is sought.
Table 2
AGN’s total mains replacement volumes, 2013 to 2017 (km)
2013
2014
2015
2016
2017
Total
Planned volume – 2014 MRP
195
171
171
118
100
756
Volume for which approval is sought
195
172
148
90
89
696
Source:
Envestra, Cost pass through application: Mains replacement event, 31 July 2014, p. 13.
AGN submitted that the ESV has approved its mains replacement program as a prudent way of minimising,
as far as practicable, the hazards and risks to public safety and the risk of property damage arising from the
supply of gas. It also noted that the mains replacement program is efficient as it is undertaken on a “block
insertion” basis and consistent with lowest sustainable costs. 18 AGN submitted that the completion of its
mains replacement program is therefore consistent with r.79(1) under the NGR.
We note that AGN has a general statutory obligation under s.32 of the Gas Safety Act to "manage and
operate each of its facilities to minimise as far as practicable" the hazards and risks to the safety of the
public and customers arising from gas, interruptions to the conveyance or supply of gas and the
reinstatement of an interrupted gas supply. The obligation also includes minimising hazards and risks of
damage to public property and the property of customers.
AGN must submit a Gas Safety Case (or a revised Gas Safety Case) to the ESV every five years. A Gas
Safety Case sets out the systems and processes the distribution business has in place to identify network
risk and mitigate the identified risk. The ESV must accept a Gas Safety Case if it is satisfied that it is
appropriate and it complies with the Gas Safety Act and regulations. 19 AGN must comply with the accepted
18
Envestra, Cost pass through application: Mains replacement event, 31 July 2014, public version p.11.
19
Gas Safety Act 1997 s.40.
AER Decision
AGN mains replacement cost pass through variation application
16
Gas Safety Case20 and compliance is monitored by the ESV.21 AGN’s Mains Replacement Plan and Asset
Management Plan is a key part of the suite of measures AGN has to manage safety risk under its Gas
Safety Case.
We note that AGN’s current end date of 2020–21 for the removal of low pressure mains from AGN’s
network is included its 2012 Mains Replacement Plan and its Asset Management Plan, approved by the
ESV and referenced in its Gas Safety Case. AGN’s 2014 Mains Replacement Plan also references an end
date of 2020–21.22 This end date is a critical factor in considering what is an efficient and prudent volume
of mains replacement under r.79(1) given the long term safety objective of removing all cast iron and
unprotected steel mains from AGN’s network. We noted in our final decision that the mains replacement
pass through provides a means by which AGN can complete the mains replacement program by 2020–
21.23
Therefore we have had regard to AGN’s ability to meet this timeframe for completing its mains
replacement in considering the efficiency and prudency of the proposed volumes.
AGN is seeking funding under the pass through to undertake an additional 60km of mains replacement
within the access arrangement period, compared to that in its 2012 Mains Replacement Plan. AGN stated
that bringing forward this additional volume of mains replacement would provide it the best opportunity to
achieve the objective of replacing all mains by 2020–21.
AGN has therefore been targeting a higher level of replacement than the 635 km set out in the 2012 MRP.
This is to ensure that the objective of completing the mains replacement program by 2020–21, as set out in
the ESV approved Gas Safety Case, is achieved regardless of any unexpected events occurring. Unlike in the
previous period, where progress with the MRP was interrupted by the global financial crisis, the Mains
Replacement Plan is being delivered without any material delay. This has also been facilitated by the long
term tendering and contracting processes established by AGN towards the end of the previous regulatory
20
Gas Safety Act 1997 s.44(2).
21
Gas Safety Act 1997 s.10.
22
Envestra, Victorian Network Mains Replacement Program, May 2014, Executive summary.
23
AER, Access Arrangement for Envestra’s Victorian Gas Distribution System 2013 – 2017, Final Decision, Part 2, Section 4.4.1
Mains Replacement, April 2013, p.50.
AER Decision
AGN mains replacement cost pass through variation application
17
period. As a result, AGN has significantly exceeded the targets set out in the 2012 Mains Replacement Plan
and now expects to complete around 760 km of mains replacement over the 2013 to 2017 Access
Arrangement period.24
We consulted with the ESV on the merits of bringing forward this additional volume of mains replacement.
The ESV was supportive of AGN’s proposal having regard to AGN’s recent performance in undertaking
mains replacement and the critical need to replace mains within the CBD areas as a priority. The ESV
considered that bringing forward this volume of work would provide an important buffer to deal with mains
replacement in the next access arrangement period, especially in CBD areas where work is complex and
time-consuming. We acknowledge that AGN is responsible for supply in the CBD and that this area is a
safety priority for the ESV. The ESV noted that AGN is yet to submit its finalised strategic plan for the CBD
and stated that it would expect to see the fact that AGN has received funding for these additional volumes
reflected in its strategy and timing for undertaking the mains works in the CBD. 25
In considering the proposed volumes we have also had regard to the information AGN provided on its rate
of mains replacement to date, and evidence to show it intends to complete the outstanding mains
replacement it proposed over the remainder of the access arrangement period. As discussed above, AGN
has completed more than 295 km to date and has committed (through the award of contracts or Board
approvals) to completing a total of 616 km of the proposed 696 km mains replacement by the end of 2017.
Based on this information, we consider AGN has the intention and processes in place to undertake the
proposed volumes of mains replacement in the remainder of the access arrangement period, consistent with
its objective of replacing all mains in its network by 2020–21.
Unit rates
The mains replacement pass through event requires us to apply the unit rates approved in our final
decision, when we calculate the capital expenditure needed to complete the approved additional mains
24
25
Envestra, Cost pass through application – Mains replacement event, p.12
ESV noted that AGN will need to undertake continued monitoring of safety risk in the CBD to ensure risks are maintained at
ALARP (as low as reasonably practicable) until such time as CBD mains works commence.
AER Decision
AGN mains replacement cost pass through variation application
18
replacement. As part of our final decision, we assessed these unit rates against the capital expenditure
criteria under the r.79(1) of the NGR.26
Where volumes are undertaken in suburbs where unit rates have not been pre-determined in our final
decision, the distribution business is required to submit a proposal to the AER for those unit rates as part of
its pass through application.
The only area where there is no pre-determined unit rate is in Benalla. AGN plans to replace 22.7 km in
Benalla. It stated it has already replaced 7 km in the area and all of the work is being undertaken under one
contract, so the actual contract cost provides evidence in determining the cost for the completion of this
area. AGN also provided supporting documents that provide evidence of a competitive tender process in
rewarding these works. We have also compared the unit rate specified in the contract to comparable
regional areas and consider it reflects an efficient and prudent cost.
Building block costs
AGN used our access arrangement final decision capital expenditure model to determine the capital
expenditure required to complete the additional mains replacement. AGN adjusted the model to reflect the
actual kilometres of mains replaced through to 30 June 2014 and the forecast kilometres for the remainder
of the access arrangement period. In other words, it used a total volume of mains replacement of 696 km
as an input into the capital expenditure model, instead of 365 km as per the access arrangement. It also
made an adjustment to include Benalla which had not been identified at the time of the access
arrangement.
Table 3 shows AGN’s revised capital expenditure is $521 million ($ 2012), which is $117 million more than
the amount we included in its access arrangement.
26
AER, Access Arrangement for Envestra’s Victorian Gas Distribution System 2013 – 2017, Final Decision, April 2013,
Part 2, pp. 71-78; Part 4 Confidential appendix, pp. 43-44.
AER Decision
AGN mains replacement cost pass through variation application
19
Table 3
AGN’s proposed total mains replacement capex ($m 2012)
2013
2014
2015
2016
2017
Total
Capex included in access arrangement
87.3
88.7
77.6
84.4
65.9
403.8
AGN’s proposed capex
118.4
120.1
106.3
96.3
79.8
521.0
31.1
31.4
28.7
11.9
13.9
117.1
Pass through capital expenditure
Source: AGN, Cost pass-through application: Mains Replacement Event, 31 July 2014, table 3, p. 14.
We assessed and verified the inputs and adjustment AGN made to the capital expenditure model.
The increased capital expenditure of $117.1 million will flow through to a number of building blocks:

the return on the projected capital base building block

the depreciation on the projected capital base building block

the corporate income tax building block.
In an access arrangement we calculate the building blocks in accordance with the method in our PTRM.
Tariff variation calculation
To determine the tariff variation, AGN used our final decision PTRM with the updated capital expenditure
inputs.
To determine the revised reference tariffs AGN:

updated the PTRM to reflect the increased capital expenditure

held the X factors fixed for 2013 and 2014, reflecting the fact that the change in reference tariffs
will take effect from 1 January 2015

varied the X factor for 2015 to equate the net present value of the building block and reference
tariff revenue.
We consider AGN’s method is reasonable and we have verified the inputs AGN used in the PTRM.
AER Decision
AGN mains replacement cost pass through variation application
20
6.5
The efficiency of AGN’s decisions and actions in relation to the risk of the
Relevant Pass Through Event occurring
We have had regard to this factor in considering AGN’s obligations under its Gas Safety Case and its past
practice of mains replacement. We have no evidence to suggest that AGN’s decisions or actions in relation
to the mains replacement event occurring have been inefficient.
6.6
Any other factors the AER considers relevant
The other factors we consider relevant to our assessment of AGN’s proposed tariff variation are those
set out in the mains replacement section (section 4.4.1) of part 2 of our access arrangement 2013–17
final decision.
In our final decision we noted that in calculating the pass through amount we would make an adjustment for
the difference between:

the time value of money allowed for the capital expenditure approved in AGN’s access arrangement
for completion of historical volumes (the blue hatched area in figure 1)

the time value of money for the expenditure approved in AGN’s access arrangement for historical
volumes but undertaken in the timeframe that the volume was actually completed (the orange
shaded area in figure 1).
AER Decision
AGN mains replacement cost pass through variation application
21
Figure 1
Access arrangement expenditure profile versus actual completion profile
The time value of money adjustment means AGN is no better or worse off if the volume of mains
replacement was approved entirely upfront or via a combination of upfront funding plus the pass through.
AGN’s proposed PTRM adjustment incorporates this time value of money adjustment. It did this by including
the
higher
actual
capital
expenditure
for
2013
to
2014,
while
holding
the
X factors in these years fixed.
6.7
Timing
In accordance with clause 4.5 of AGN’s access arrangement, any cost pass through variation will take
effect from the next 1 January unless we agree otherwise. We agree the tariff variation will take effect from
the next 1 January which is 1 January 2015.
AGN proposed that the whole pass through amount be passed through in 2015 by adjusting the
X factor to apply in 2015 from -2.0% to -5.1%. We have considered AGN’s proposed tariff profile and we
accept its proposed pass through timeframe for two reasons:
1.
AGN is proposing to spend 78% of the pass through capital expenditure by the end of 2015, so we
do not consider it is unreasonable to pass through all of the relevant costs in 2015.
AER Decision
AGN mains replacement cost pass through variation application
22
2.
the proposed pass through timeframe will not create instability in the access arrangement price
path.
AER Decision
AGN mains replacement cost pass through variation application
23
7
Conclusion
We consider AGN’s proposed cost pass through event tariff variation satisfies the requirements of its access
arrangement. We approve:

an additional 331 km of mains replacement, which takes the total volume to 696 km over the
2013–17 access arrangement period

an additional $117.1 million ($2012) of capital expenditure to complete the mains replacement

the increased capital expenditure is to be recovered in the period from 1 January 2015 to 31
December 2015

the increased capital expenditure will be recovered by adjusting the X factor to apply in 2015 from 2.0% to -5.1% in our final decision post-tax revenue model. The X factors for 2016 and 2017
remain unchanged.
AER Decision
AGN mains replacement cost pass through variation application
24