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A decision by the Full Federal Court supports the Australian Competition Tribunal’s February 2016 findings: that there may be a different benchmark efficient entity for each service provider, and defining its characteristics will require a consideration of whether the service provider’s debt management practices are efficient.
On 24 May 2017, the Full Federal Court handed down its decisions regarding the NSW/ACT electricity price determinations for 2016-2019 and the Jemena Gas Networks (NSW) access arrangement decision for 2015-2020. The AER had sought judicial review of the Australian Competition Tribunal’s February 2016 decisions in favour of the networks on the following issues:
The AER was unsuccessful on all grounds except gamma.
The key findings by the Full Court were:
In determining the networks’ forecast operating expenditure (opex), the AER developed an econometric model which included data obtained from Australian networks through regulatory information notices (RINs), as well as information from NZ and Ontario. The AER used the model to benchmark the networks and in deriving its base year opex.
The Tribunal found that there were a number of issues with the model relied upon by the AER, including inadequacies in the data set, comparability issues and reliance on qualitative analysis rather than a bottom-up quantitative assessment. The Tribunal directed the AER to re-make its forecast opex decision, including by assessing whether the forecast opex proposed by the networks reasonably reflects the criteria in the Rules, using a broader range of modelling and benchmarking against Australian businesses and including a “bottom-up” review of forecast opex.
The Full Federal Court upheld the Tribunal’s decision that the AER’s approach to forecast opex was in error.
The NSW electricity networks proposed an immediate implementation of the trailing average approach to the return on debt. Jemena Gas Networks proposed a hybrid transition to the trailing average (transitioning only the base rate component of the cost of debt). The Tribunal found error in the AER’s decision insofar as it defined the benchmark efficient entity as a regulated entity. Because this error formed the starting point for the AER’s debt transition, it remitted the return on debt decision to the AER to re-make on the basis the benchmark is not necessarily regulated.
The Full Federal Court found no error in the Tribunal’s decision, but clarified that it considers the allowed rate of return objective (ARORO) does not require the benchmark efficient entity to be defined as either regulated or unregulated. It supported the Tribunal’s findings that there may be a different benchmark efficient entity for each service provider, and defining its characteristics will require a consideration of whether the service provider’s debt management practices are efficient. That question is left to the AER to determine.
The Tribunal construed the Rules as requiring the use of market studies to estimate gamma and on that basis directed the AER apply a gamma of 0.25 in place of its estimate of 0.40. The Full Federal Court found error by the Tribunal on this critical issue.
The Court accepted the AER’s conceptual approach, applying a post-company tax, pre-personal tax and pre-personal cost approach. The Full Court found that “…it was not … a reviewable error for the AER to prefer one theoretical approach to considering the determination of gamma over another. This means that it is not an error of construction for the AER to focus on utilisation rather than on implied market value”.
On 14 June 2017, the AER and the networks filed consent orders to give effect to the Full Court’s decision. The effect of the orders is that the Tribunal’s decision finding error by the AER in relation to gamma is set aside, but the Tribunal decision is otherwise affirmed.
Practically, this means the AER’s gamma decision and estimate of 0.4 stands and the remitter directed by the Tribunal in relation to forecast opex and debt transition must now be carried out by the AER. This remitter process may take some time to complete, following which the outcome could be subject to further applications for review to the Tribunal or the Courts (subject to foreshadowed changes to the merits review framework. The COAG Energy Council is to address the issue at its July 2017 meeting - further update will follow!).
The possibility of applications for special leave to appeal to the High Court against the Full Federal Court’s decision remains. The parties will have 28 days after final orders are made by the Full Court to file any such application. In our view a High Court challenge would be difficult and appears unlikely given the consent orders agreed by the parties.
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