Decision

Envestra (Vic) change in taxes event pass through application

May 2012

© Commonwealth of Australia 2012

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AER reference: 48202/D12/43467

1Summary

On 26 April 2012 Envestra Limited (Envestra),which operates a gas distribution network in Victoria through its subsidiary Vic Gas Distribution Pty Ltd, applied to the AER for a change in taxes event pass through of $2,135,673 in costs associated with the introduction of a carbon pricing mechanism under the Clean Energy Act2011(Cth)and related legislation (the Clean Energy Legislative Package). The costs to Envestra of the carbon pricing mechanism arise from the imposition of charges for fugitive gas emissions from Envestra’s network, and the administrative cost of complying with the scheme.

The AER is the economic regulator for gas distribution service providers in all jurisdictions except Western Australia. The AER must assess Envestra's pass through application in accordance with the procedures set out in clause 8 of Envestra's Access Arrangement for its Victorian gas distribution system for 2008-2012 (Access Arrangement). In particular, the AER must decide whether the relevant pass through event has occurred, and if so, the pass through amount and the basis on which the pass through amount is to apply.

The AER has determined that Envestra's pass through application satisfies the requirements of a change in taxes pass through event.The Clean Energy Legislative Package introduces a "Relevant Tax" as defined in the Access Arrangement[1] which has a material impact on the costs to Envestra of providing reference services. Further, the AER has determined that:

  • the pass through amount is $2,135,673
  • the pass through amount is to be recovered in the period from 1 July 2012 to 31December 2012
  • the pass through amount is to apply as a fixed charge added to Envestra's base charges for Tariff V customers, and block 1 charges for Tariff D customers.
  • Background

The Clean Energy Legislative Package sets out the method for the introduction of a carbon price in Australia. The carbon pricing mechanismrequires liable entities to pay for each tonne of carbon pollution emitted from 1 July 2012.

The central Actof the Clean Energy Legislative Package, the Clean Energy Act 2011, received Royal Assent on 18 November 2011, with the substantive provisions of the Act taking effect from 2 April 2012.

On 26 April 2012, Envestra applied to the AER to pass through to users the costs associated with compliance with the Clean Energy Legislative Package for the period from 1July 2012 to 31 December 2012. The proposed pass through amount of $2,135,673 comprises:

  • the estimated cost of carbon permits that Envestra will need to purchase in relation to fugitive gas emissions from Envestra’s network in the pass through period ($2,040,673)
  • the share of Envestra’s administrative costs for compliance and reporting under the carbon pricing mechanism allocated to the Victorian network ($95,000).

2Regulatory requirements

Clause 8 of Part B of the current Access Arrangement states that the Service Provider (Envestra) may apply to the Regulator (now the AER) for approval to increase reference tariffs whenever the Service Provider determines that its costs have or will increase materially as a result of a relevant pass through event.

A relevant pass through event is defined in section 6 of Part A of the Access Arrangement as:

  1. a change in taxes event;
  2. the financial failure of a retailer event; or
  3. a declared retailer of last resort event.

Clause 8.2 of Part B of the Access Arrangement sets out the obligations of the AER in considering a pass through application. The AER must decide whether the relevant pass through eventhas occurred, will occur or is continuing and, if so, must decide:

  1. the pass through amount; and
  1. the basis on which the pass through amount is to apply.

Under clause 8.4 of Part B of the Access Arrangement, in deciding the pass through amount and the basis on which the pass through amount is to apply the AER must ensure that the financial effect on Envestra associated with the relevant pass through event is economically neutral, taking into account:

  1. the relative amounts of reference services supplied to each user;
  1. the time cost of money for the period over which the pass through amount is to apply;
  2. the manner in which and period over which the pass through amount is to apply;
  3. the financial effect to Envestra associated with the provision of reference services directly attributable to the relevant pass through event concerned, and the time at which the financial effect arises;
  4. if the relevant pass through event is a change in taxes event the amountof any change in another tax which, in the AER’s opinion, wasintroduced as complementary to the change in taxes event concerned;
  5. the effect of any other previous relevant pass through event since thelater of the date of:
  1. the Access Arrangement; and
  2. the last decision made under clauses 8.2 and 8.3 of the Access Arrangement;
  1. any pass through amount relating to a previous relevant pass through event which resulted in Envestrarecovering an amount either more or less than the financial effecton Envestra of that previous relevant pass through event; and
  2. any other factors the AERconsiders relevant.

3Consultation

The procedures set out in the Access Arrangement for the AER’s consideration of pass through applications do not require a public consultation process. The AER has 30business days to make decisionson pass through applications, a timeframe which cannot be extended. The AER has not sought submissions on Envestra’s change in taxes event pass through application.

On 10 May 2012, the AER requested further information from Envestra. The AER sought information concerning:

  • the basis of the customer number forecasts used in the pass through application
  • a breakdown of the administrative compliance costs included as part of the pass through amount.

Envestra responded to the request for further information on 22 May 2012.

4Occurrence of the relevant pass through event

Clause 8.2(a) of Part B of the Access Arrangement requires the AER to decide whether the relevant pass through eventhas occurred.

Envestra has submitted a pass through application for a change in taxes event. A change in taxes event is defined in the Access Arrangement as:

a variation, withdrawal or introduction of a Relevant Tax, or a change in the way or rate at which a Relevant Tax is calculated, which has a material impact on the costs to the Service Provider of providing the Reference Services or which has a direct and material impact on the revenue received (after payment of Relevant Taxes) by the Service Provider for providing the Reference Services.

To determine whether a change in taxes event has occurred, the AER has considered:

  • whether theClean Energy Legislative Packagehas resulted in the introduction of a "Relevant Tax"'
  • whether theintroduction of the fees and charges under the Clean Energy Legislative Packagehas a material impact on the costs to Envestra of providing reference services.
  • Variation, withdrawal or introduction of a relevant tax

A change in taxes event stems from the variation, withdrawal or introduction of a "Relevant Tax" as defined in the Access Arrangement. The term "Relevant Tax" is defined as:

any royalty, duty, excise, tax, impost, levy, fee or charge, (including, but withoutlimitation, any GST) imposed by any Authority in respect of the repair, maintenance,administration or management of the Distribution System (or any part of it) or inrespect of the provision of Reference Services, but excluding:

(1) income tax (or State equivalent income tax) and capital gains tax;

(2) stamp duty, financial institutions duty, bank account debits tax or similar taxes orduties;

(3) penalties and interest for late payment relating to any tax, royalty, duty, excise,impost, levy, fee or charge

(4) costs associated with changes in service standards, except where arising because the Service Provider has been directed, ordered or required as a result of legislation or other Regulatory Instruments to make such a change in service standards;

(5) fees and charges payable for a Distribution Licence

(6) voluntary membership fees or voluntary contributions payable to membershipbodies (that is, fees and contributions in respect of membership bodies which theService Provider is not required by legislation or other Regulatory Instruments tojoin);

(7) any tax or charge which replaces the taxes and charges referred to in (1) to (5) above.

TheClean Energy Legislative Packageintroduces a carbon pricing mechanism, which requires liable entities to buy and surrender eligible emissions units for each tonne of carbon dioxide equivalent (tCO2e) emitted.An entity will be a liable entity if it passes the threshold test of emitting at least 25,000tCO2e in the eligible financial year. The carbon pricing mechanism will apply to emissions of greenhouse gases from 1July 2012. The cost of each carbon unit in the current access arrangement period is fixed at $23/tCO2e.

Envestra's National Greenhouse and Energy Report for 2010-11 indicates direct emissions from Envestra’s Victorian distribution network of 172,230 tCO2e. These emissions relate to fugitive gas, directly emittedbyEnvestra as a result of the operation of the network, not the totality of gas transported by way of the network. The AER is satisfied that Envestra’sVictorian distribution network is a facility which meets the 25,000tCO2e threshold under the Clean Energy Legislative Packageand will incur a liability for the purchase of carbon units.

The definition of a "Relevant Tax" is broad, and includes any royalty, duty, excise, tax, impost, levy, fee or charge. The charges for carbon units to be incurred by Envestra as a result of theClean Energy Legislative Packagefall within the ordinary meaning of the words "fee" or "charge". None of the exclusions in the definition apply to charges for carbon units.

The AER therefore considers theClean Energy Legislative Packageintroduces a "Relevant Tax" as defined in Envestra's Access Arrangement, and that this element of the definition of a change in taxes event has been satisfied.

4.2Material impact on the costs of providing reference services

A change in taxes event must have a material impact on the costs to Envestra of providing reference services.

Envestra’s Access Arrangement is silent on the meaning of the word "material" in the context of a cost pass through event. The AER has taken the word "material" to have its ordinary meaning. The Macquarie dictionary defines material as 'of substantial import or much consequence'.[2]

In previous considerations on materiality in the context of electricity distribution, the AER has stated:[3]

The AER considers a finding of materiality is ultimately a matter of judgement. However, the AER has sought assistance in exercising this judgement by having regard to various ratios that place the [costs] within a broader context.

In the context of gas distribution, recent decisions of the AER on access arrangements in South Australia and Queensland (2011), and New South Wales and the Australian Capital Territory (2010) have defined materiality for the purposes of cost pass through events. In those decisions, the AER typically defined a material increase or decrease in costs as one which exceeds one per cent of the smoothed forecast revenue in the years of the access arrangement period in which the costs are incurred. However, while this definition can inform consideration of this matter, it is not included in Envestra’sAccess Arrangement and has therefore not been applied directly to determine whether the proposed pass through amount is material.

Envestra proposed that the impact of the change in taxes event on the costs of providing reference services was material, as the annualised carbon pricing costs equate to 7 per cent of Envestra’s allowed operating expenditure for 2012. While the AER agrees this is a substantial increase in operating expenditure, the AER considers the materiality of an increase in the costs of providing reference services should be assessed in the context of the full building block cost of providing those services.

The AER's preferred approach to assessing materiality is reflected in table 4.1. This analysis compares the proposed change in taxes event costs to Envestra's expected revenue (building block costs) in 2012.

Table 4.1Change in taxes event costs as a proportion of expected revenue

2012
Change in taxes event costs ($m) / 2.14
Expected annual revenue ($m) / 182.4
Change in taxes event costs / Expected revenue / 1.17 %

The costs Envestra is seeking to pass through are equal to 1.17 per cent of its expected revenue in the year in which the costs are incurred.

The AER has given significant weight to table 4.1. The AER considers a comparison of the pass through amount to expected building block revenues provides a good indicator of the overall size of the distribution business, the revenues available to meet the costs of uncontrollable events and therefore the service provider's capacity to manage the costs of unexpected events occurring within an access arrangement period.

The analysis presented in table 4.1 also has the benefit of accounting for the effect that the timing of a pass through event can have on the event’s materiality. For example, a pass through event which results in an ongoing increase in costs (such as the introduction of the carbon pricing mechanism) will give rise to a larger total pass through amount if it occurs earlier in the access arrangement period than if the same event occurs later in the access arrangement period. However, a pass through event which results in a one-off increase in costs will typically lead to the same pass through amount irrespective of the timing of the event. Assessing the pass through costs against the revenues available in the year(s) in which the costs are incurred ensures the materiality of all pass through events is assessed on a consistent basis.

The AER also notes the definitionof materiality appliedin recent gas access arrangements made by the AER in other jurisdictions. In those access arrangements, the materiality of any pass through costs will be assessed against the forecast revenue in the years of the access arrangement period in which the costs are incurred, as provided in the access arrangements. The AER considers that it is good regulatory practice to be consistent across jurisdictions when considering matters such as materiality, to the extent possible and taking into account the provisions of the applicable access arrangement. However, the AER has not directly applied any specific percentage threshold to determine the materiality of Envestra’s proposed pass through amount as this is not specified in the Access Arrangement.

The AER has determined that since the costs identified in table 4.1 are substantial relative to Envestra's expected revenues in 2012, the costs associated with the introduction of the carbon pricing mechanism established by theClean Energy Legislative Packagemeet the definition of a change in taxes event under Envestra's Access Arrangement.

5Factors which the AER must consider

Clause 8.4 of the Access Arrangement sets out the factors which the AER must consider in deciding the pass through amount and the basis on which the pass through amount is to apply. The AER must ensure that the financial effect on Envestra associated with the change in taxes event is economically neutral, taking into account:

  1. the relative amounts of reference services supplied to each user
  1. the time cost of money for the period over which the pass through amount is to apply;
  2. the manner in which and period over which the pass through amount is toapply;
  3. the financial effect to Envestra associated with the provision of reference services directly attributable to the relevant pass through event concerned, and the time at which the financial effect arises;
  4. if the relevant pass through event is a change in taxes event, the amountof any change in another tax which, in the AER’s opinion, may have beenintroduced as complementary to the change in taxes event concerned;
  5. the effect of any other previous relevant pass through event since the later of the date of the Access Arrangement; andthe last decision made under clauses 8.2 and 8.3 of the Access Arrangement;
  6. any pass through amount applied under clause 8 relating to a previous relevant pass through event which resulted in Envestra recovering an amount either more or less than the estimated financial effecton Envestra of that previous relevant pass through event; and
  1. any other factors the AERconsiders relevant.

These factors are considered in turn below.

5.1Relative amounts of reference services supplied to each user

Envestra's pass through application allocates pass through costs to network users on the basis of their market shareon the Envestra network. The users of Envestra’s network (gas retailers) will pay a relative share of the pass through costs that reflects their customer base. Individual end users will experience the same increase in fixed charges, regardless of their gas usage.