1. Regulatory Risks for Electricity Lines Businesses 3 November 2011 Regulatory Risks for Electricity Lines Businesses James Every-Palmer

2. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 2 Landscape Part 4 Electricity Authority processes Consumer Law Reform Bill Consolidation?

3. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 3 Part 4 Purposes: Include promoting investment and limiting excessive returns Financial Capital Maintenance (FCM) Model: – Limit actual revenue to a "normal" return – Allowable revenue = (RAB x WACC) + Depreciation + Opex + Tax - Revaluation Gains – New RAB = Old RAB - Depreciation + Revaluation Gains + Capital additions - Capital disposals Two main forms of regulation – Information disclosure (ID) – Price path (DPP/CPP and IPP) Airports and exempt EDBs: ID Non-exempt EDBs and Gas transmission and distribution businesses: ID and DPP/CPP Transpower: IPP

4. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 4 Jargon ABAAABCACAMAEMCAERAMPs AVDAAVnDABBARCAACAMSCCAPM CDACnDACPICOS CPP DAC DCFDHC DPP DRCEBITEBITDA EBSSECM EDBs EIRAELBsESC EV FCM FDC GAAPGDN GDPCRGPBsGFCGPSHCHP ICICP ID IDVIFRSIHC IMs IP IPP IRIRISIRR LIBORLRMCMARMEAsMPMPOC MRPNICNEMNPVNZSOCDA OCnDAODRCODVOEMOVABAAPBR PV RAB ROI RPI-X SACSAIDI SAIFISCPSBLSPASRMCSSNIP TAMRPTPMTSOVIXVTC WACC

5. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 5 Part 4 versus Part 4A Previous Part 4A: – Commission setting rules "as it goes" – Too uncertain - not conducive to incentives to invest – Accountability limited to judicial review Review of Act: – Commission argued regime worked well – Government rejected this and decided reform required Resulting reform: New Part 4 enacted in 2008: – Purpose statement specifically includes incentives to invest – Commission required to set rules in advance for the first time (IMs) – Merits review of input methodologies

6. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 6 Part 4 - input methodologies Key regulatory rules - the "building blocks" for regulated prices Key part of Part 4 reforms – Purpose is "to promote certainty for suppliers and consumers..." (s 52R) – Certainty promotes investment (Part 4 purpose) Merits appeals – Alternative methodology that is "materially better" at meeting Part 4 purpose and/or purpose of IMs can be substituted – Frozen record - appeal limited to "documentary information and reviews that were before the Commission when it made its determination?

7. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 7 Where are we up to? IMs for ID and DPP/CPP: – Set in December 2010 DPP: – Old Part 4A thresholds used to set 2010-2015 DPP – Will be reset (with potential claw back) based on new IMs ID: – ID Determination expected April 2012 and will apply from 2011/12 disclosure year

8. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 8 Legal challenges 1.DPP judicial review 2."Record" judicial review 3.Merits review of IMs: Parties involved: Commerce Commission, Vector, Wellington Electricity, Powerco, MEUG, Transpower, AIAL, CIAL, WIAL and Air NZ

9. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 9 1. DPP judicial review Default Price-path (DPP): – "Starting prices" set every 5 years – In other years, prices rolled over at CPI - X – Low-cost "partial building blocks" - relatively unique internationally and many ways of doing it Vector argued that the Commission had set an incomplete set of IMs for DPP regulation

10. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 10 DPP judicial review (cont) Wide range of outcomes for Vector depending on method chosen: ±$150m per 5 year period Vector argued this level of uncertainty cannot have been intended: – Defeat purpose of Part 4 reforms – Would mean no merits review of Commission's most important decisions – Commission acted ultra vires sections 52R (purpose of IMs), 52A (purpose of Part 4), 52T(2) (suppliers able to reasonably estimate effects on their business, and Commission must set out "how" IMs will be applied) Input Methodologies Asset valuation Cost Allocation TaxCost of capital Rules & processes Starting Price Adjustments IDYes -- DPP---Yes -

11. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 11 DPP judicial review (cont) Vector wins at High Court – Vector Ltd v Commerce Commission, High Court, Wellington CIV-2011-485- 536, 26 September 2011, Clifford J Clifford J relied on: – The words of s 52T – The purpose of the Part 4 reforms – Importance of merits review Relief: – Commission has to set input methodologies for DPP starting prices – No existing input methodologies invalid – Requires new consultation process Commission has appealed

12. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 12 DPP judicial review (cont) Consequences – Non-exempt EDBs: new DPP IMs – Exempt EDBs: no existing IMs invalid or amended

13. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 13 2. "Record" judicial review Suppliers understood that Commission running sector-specific consultation process In its final decisions, Commission stated that it had considered all material across sectors Important because fixed record means no opportunity to respond Decision pending Consequences: Merits review delayed

14. Regulatory Risks for Electricity Lines Businesses 3 November 2011 SLIDE 14 3. Merits review of IMs One judge and two lay members Appeals on foot for key input methodologies (eg, WACC, asset valuation, cost allocation) On hold until process JR finally determined – Existing IMs may be quashed (unlikely) – Alternatively, process JR will determine the record / separate tribunals Still faint hope of Q3 2012 hearing dates Consequences: – Substitution of materially better IMs and / or further consultation by Commission – Re-opening of price paths for non-exempt EDBs