1. Orion’s Response to the Commerce Commission’s Draft ODV Handbook Roger Sutton Chief Executive Officer Rob Jamieson Commercial Manager Neville Ross Commercial Contracts and Pricing Manager John O’Donnell Network Asset Manager Greg Houston NERA Mark Berry Counsel Friday 16 April 2004

2. Slide 2 Purpose  Purpose of ODV valuations in the context of electricity lines regulation, now administered by the Commerce Commission  Disclosure regime requires an appropriate Handbook, that is, an updated version of the MED’s Handbook  The Commission’s threshold and control regime involves the use of ODV asset values, and the Handbook requires complete review in this context

3. Slide 3 Decisions on ODV  Some ODV-related decisions have already been made in the context of the threshold and control regime  ODV as an input parameter into the price path threshold via the Meyrick analysis  ‘opening asset value’ at 1 April 2004  ‘starting point’ for inquiries into threshold breaches  ‘likely to be relevant’ for control  ODV or DHC going forward – businesses still need to choose

4. Slide 4 Outstanding Clarifications on Role of ODV  Roles of ODV yet to be clarified under the threshold and control regime  On what basis might it be appropriate to depart from the 1 April ’04 ODV during inquiries into breaches?  On what basis might it be appropriate to depart from the 1 April ’04 ODV in determining control parameters?  How should changes in asset values be accounted for under both the threshold and control elements (to determine economic income)?

5. Slide 5 Changing Role of the Handbook  Originally designed for the purpose of the disclosure regime  Now required for the purpose of the threshold and control regime  This raises two questions: in what way do the ODV Handbook revisions need to reflect its new purpose? what is the role of information disclosure within the regime?

6. Slide 6 The Underlying Concept of ODV  ODV is the cost to an ELB of replacing all its assets, assuming it is deprived of them, and that replacement is optimal given current knowledge and technology  ODV is the appropriate concept for deciding whether an ELB is earning monopoly rents (because a new entrant could not supply the service at lower cost) and so whether it should be subject to control

7. Slide 7 Why ODV is Appropriate  ODV is the most appropriate asset valuation methodology because it  consistent, practicable basis for assessing “excess profits”  consistent with requirements of Part 4A

8. Slide 8 The Draft Handbook  Problems with the draft ODV Handbook, given its new purpose  Assumptions in the derivation of maximum unit costs are unexplained  Although the concept is well defined, some of the proposed rules and prescribed data are inappropriate for determining ODV  The “best of the best” basis is inappropriate  Unrealistic unit costs compromise investment incentives and encourage sub-optimal behaviour

9. Slide 9 The Draft Handbook  The “best of the best” criterion is inappropriate “ The proposed replacement costs represent PB Associates’ best estimate of the costs that would be paid by an efficient distribution business using the most cost effective methods to establish the optimised design of network, and purchasing all items (equipment and services) at the best possible rates. This envisages building the network in the most effective fashion, and obtaining the lowest material and labour costs by bulk (and/or term) purchases, but not paying any premium for materials or labour for speed of construction.”  By contrast, the NSW Treasury’s guidelines define MEA as: “the minimum that it would cost, in the normal course of business, to replace the existing assets…”

10. Slide 10 ODV as a ‘Starting Point’  The Commission has indicated ODV will be a ‘starting point’ for inquiries into breaches with adjustments for business- specific circumstances  Two ODVs raises the prospect of needless breaches, with inquiry proving reasonable costs and returns  Objective should be to get it right from the beginning, and derive robust ODVs  This raises the potential for two different ODVs:  A low ODV for thresholds and information disclosure, based on unrealistic unit costs; and  A more realistic ODV following inquiry into a threshold breach, based on reasonable unit costs

11. Slide 11 Handbook Revisions for Robust ODVs  Some flexibility in deriving unit costs and asset lives – the Handbook cannot cover every eventuality  Prescribed unit costs and asset lives (with underlying assumptions made clear) should provide a consistent basis from which departures are allowed where costs are materially different due to business-specific circumstances and verified by professional valuers  Where valuers recommend deviations, these should be justified by disclosing:  the reason for the variation; and  the impact of the variation on valuation  ODVs should be audited

12. Slide 12 Dynamic Issues  Dynamic issues must be addressed now  Unit replacement costs in the MED’s Handbook have not been changed in a decade. Out-of-date unit costs compromise the usefulness of ODVs  ELBS are more likely to fail legal/economic tests during investigation following a breach of thresholds if unit costs are not updated regularly The Handbook should be updated every 3 years

13. Slide 13 Future of the Disclosure Regime  Original disclosure regime was part of the former light-handed approach to regulation  Imperfections were less important, since no regulatory decisions were made using the Handbook  Disclosure regime must now fit within the threshold and control framework

14. Slide 14 Concluding Remarks  The purpose of the ODV Handbook has changed since Part 4A was enacted:  This new purpose must be reflected in the new Handbook  The rules and data in the Draft Handbook will not determine ODV accurately  The Handbook needs to incorporate the following principles:  Stated assumptions behind unit costs and asset lives to allow understanding of differences with actual costs  Allow departures from unit costs and asset lives where materially different