Report critics question call for gas regulation

Friday 27th July 2001

By Campbell McIlroy

Simon Terry Associates' politically charged Pipeline Profits report into the gas industry will do nothing to help encourage the level of investment the country's infrastructure desperately needs, highly placed industry sources said yesterday.

"One only has to look at roading, rail, water and waste water," one said in reference to an appalling record. Regulation would only threaten the industry's ability to raise money for infrastructure upgrades as returns to investors would be constrained. It would also lead to a drop in asset values, a fall in share prices and a flood of capital out of the sector.

But report author Simon Terry rubbished these claims and said investors could be guaranteed a set return and questioned whether they thought double and triple the recommended rates of return were sustainable.

Critics of the report said returns in gas should be higher as gas was a more discretionary energy source and customers could easily switch to electricity.

"We have to have a regime that encourages people to roll out pipe lines and constantly improve our infrastructure," one said.

The debate boils down to an argument that has plagued the industry since deregulation - the best way to value the assets.

Mr Terry said much of the problem came about because companies were able to value their assets on an optimised deprival valuation basis (ODV). This uses an assessment of replacement cost as its starting point.

The pipeline report said the use of ODV valuations diluted profits to single digit rates of return on assets and thus remained below the threshold level for regulatory attention. The only reason companies appeared to have adopted ODV was because it had been used in the electricity sector.

"When these companies ask normal rates of return on these higher valuations they receive monopoly profits," Mr Terry said.

Critics questioned whether it was fair to change. One of NGC's and United Networks' competitors, Nova Gas, said the returns were excessive but it didn't see the need for regulation.

Nova Gas director Hans van der Voorn said regulation stifled entrepreneurial behaviour and innovation.

If it had not been for the monopoly characteristics of his competitors his company would not have been able to enter the market.

He suggested one alternative might be to separate the national transmission network from the local distribution networks.

Cap Gemini Ernst & Young partner John Hancock raised the possibility of a low-cost regulatory regime similar to the one his company proposed in its 2000 New Zealand Electricity Distribution Company Analysis.

The regime is a penalty point system based on price, cost, service quality and profit. In each category companies would accumulate penalty points and if a certain threshold was breached the company concerned would attract closer regulatory scrutiny.

But Mr Terry said he believed the middle road had been tried and had failed. His company's report added heat to the government's gas review with some stating it was orchestrated to inflame the debate in a politically slanted manner.

Mr Terry confirmed his company had helped one industry participant with its submission but refused to name it. He said the report was only intended to contribute a background document to the government's gas sector review.

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