Gas default price-quality path reset 2017 Current views on forecasting expenditure 31 October 2016 #2653039

Purpose This presentation updates stakeholders on our current views on setting expenditure forecasts for the Gas DPP reset 2017. We are providing it to: Set out changes we have made to aspects of our approach to setting expenditure forecasts (‘our approach’) in response to submissions on our 30 August 2016 policy paper Foreshadow how we will implement this approach in our draft decision, which will involve supplier participation

Purpose This presentation is not a substitute for the draft decision: We are not inviting submissions on this material at this stage Stakeholders will have an opportunity to submit on the framework and the resulting expenditure forecasts following our draft decision in February 2017 We are still considering the details of our approach, and we may make changes before the draft decision We will meet with suppliers to discuss next steps in implementing this approach for the draft decision

Outline Overview of our initial proposed approach as set out in the policy paper Summary of issues raised in submissions Changes we are proposing to the assessment framework Step-by-step explanation of the assessment framework

Proposed approach in policy paper The next two slides set out the approach we proposed in the policy paper We are providing this for comparison with the updated framework as set out in the rest of this presentation The framework should provide incentives for suppliers to supply objective, unbiased asset management plan (AMP) expenditure forecasts

Proposed approach in policy paper

Proposed approach in policy paper Key features of this approach included: An expenditure objective, same as for customised price- quality paths (CPPs) Business-as-usual (BAU) assessment AMP scrutiny Supplier scrutiny Options for fall backs Our revised approach retains all these aspects, but we have updated how they are implemented following submissions

Key issues in submissions The perceived high cost of this approach The level of discretion exercised by the Commission Use of the CPP expenditure objective Suppliers have not prepared AMPs for this purpose Assessment should be done in aggregate, not by category Base level of expenditure should be a multi-year average Information for supplier scrutiny not available BAU tolerances need to be specified Fall back needs to be specified

Key changes to our approach Step 1: Aggregate BAU variance checks New step in the assessment process Base level of expenditure changed from a single lowest year to a multi-year average Fixed variance applied to all suppliers, intended to reflect historic volatility Tolerance currently set at 5% for opex and 10% for capex

Key changes to our approach Step 2: Category BAU variance checks Base level of expenditure changed from a single lowest year to a multi-year average Tolerance currently 5% for opex, 10% for capex Categories of expenditure within variance accepted

Key changes to our approach Step 3: Materiality check Step was implicit in the supplier scrutiny step, now an explicit check in the process We assess the materiality of any category expenditure above the BAU tolerance If this expenditure is less than 3% of that year’s total opex or capex, we may not scrutinise it further

Key changes to our approach Step 4: Quantitative AMP evidence Name changed to reflect purpose of this step Dashboard metrics used to look for justification of expenditure Step 5: Qualitative AMP evidence Desktop review of targeted aspects of AMPs to assess expenditure not explained by dashboard metrics

Key changes to our approach Step 6: Supplier evidence Name changed to better reflect the purpose of this step Supplier engagement with this step remains voluntary, with the onus on the supplier to provide whatever supporting information was used to prepare the forecast The kinds of supporting documentation cited in the policy paper (business cases or board papers) are only examples and are a sufficient but not necessary requirement for justification Our intention is not to require the production of new documentation

Aggregate BAU variance check Supported expenditure Assessment approach Step 1 Aggregate BAU variance check Supported expenditure Supplier AMP forecast used for that year/category Changes/notes New step introduced Multi-year average 5% tolerance for opex 10% tolerance for capex

Assessment approach Supported expenditure Step 1 Step 2 Aggregate BAU variance check Step 2 ID category BAU variance check Supported expenditure Supplier AMP forecast used for that year/category Changes/notes Multi-year average 5% tolerance for opex 10% tolerance for capex

Assessment approach Supported expenditure Step 1 Step 2 Step 3 Aggregate BAU variance check Step 2 ID category BAU variance check Step 3 Materiality check Supported expenditure Supplier AMP forecast used for that year/category Changes/notes Moved from part of supplier scrutiny Threshold 3% of total opex/capex Expenditure below materiality threshold accepted

Assessment approach Supported expenditure Step 1 Step 2 Step 3 Step 4 Aggregate BAU variance check Step 2 ID category BAU variance check Step 3 Materiality check Step 4 Quantitative AMP evidence Supported expenditure Supplier AMP forecast used for that year/category Changes/Notes Relies on the metrics in the dashboard to justify out-of-BAU expenditure Separated from ‘qualitative’ step for clarity

Assessment approach Supported expenditure Step 1 Step 2 Step 3 Step 4 Aggregate BAU variance check Step 2 ID category BAU variance check Step 3 Materiality check Step 4 Quantitative AMP evidence Step 5 Qualitative AMP evidence Supported expenditure Supplier AMP forecast used for that year/category Changes/notes Relies on a review of AMP for justification of non-BAU expenditure

Assessment approach Supported expenditure Step 1 Step 2 Step 3 Step 4 Aggregate BAU variance check Step 2 ID category BAU variance check Step 3 Materiality check Step 4 Quantitative AMP evidence Step 5 Qualitative AMP evidence Step 6 Supplier evidence Supported expenditure Supplier AMP forecast used for that year/category Changes/notes Supplier participation remains optional Unsupported expenditure moves to fall back at a category level

Assessment approach Supported expenditure Step 1 Step 2 Step 3 Step 4 Aggregate BAU variance check Step 2 ID category BAU variance check Step 3 Materiality check Step 4 Quantitative AMP evidence Step 5 Qualitative AMP evidence Step 6 Supplier evidence Fall back Unsupported expenditure Supported expenditure Supplier AMP forecast used for that year/category

Fall backs We are providing more detail on fall backs where expenditure is outside BAU variance and not supported by the AMP or supplier evidence: We term this expenditure ‘unsupported expenditure’ For categories that are unsupported, the forecasts will revert to the upper bound of the BAU variance (currently using the 5% tolerance for opex and 10% for capex) We term the combination of these fall backs with other categories that were supported the ‘adjusted AMP forecast’

Fall backs There is an additional check applied for opex: The present value (PV) of the entire adjusted AMP forecast is compared to the PV of our opex step and trend modelling (incorporating a positive partial productivity parameter) Where the adjusted AMP forecast is MORE than the step and trend forecast, we use the adjusted AMP forecast Where the adjusted AMP forecast is LESS than the step and trend forecast, we use the step and trend forecast This additional check is not performed where the supplier’s AMP forecast is below the step and trend forecast

Fall backs Final expenditure forecasts Capex Capex Capex Capex Opex Supported capex Capex ID category for that year is ‘unsupported’ Capex Forecast reverts to BAU+10% variance upper bound Capex Unsupported expenditure Capex Adjusted AMP forecast Final expenditure forecasts Opex ID category for that year is ‘unsupported’ Opex Forecast reverts to BAU+5% variance upper bound Opex Unsupported expenditure Opex Adjusted AMP forecast Opex PV of adjusted AMP forecast compared to PV of step and trend. Larger used. Supported opex

Implications of this approach The implications of our overall approach are: The maximum expenditure allowance (in any case) will be the supplier’s own opex and capex forecasts: The minimum capex allowance will be the lesser of the supplier’s own forecasts or an average of 2013-2015 total capex, +10% The minimum opex allowance will be the lesser of: our step and trend forecast