Political decisions to reach a net-zero carbon economy by phasing out use of natural gas leaves the industry with a ‘stranded asset’ problem; who bears the cost of writing off a soon-to-be worthless gas pipeline network? Major gas users argue consumers should not bear the cost through increased prices. It is a business risk network owners should bear, they say.
Major gas users from primary industry and manufacturing sectors challenged a 2022 Commerce Commission decision allowing gas suppliers to increase depreciation allowances, with a resulting uptick in prices charged to maintain profitability.
Increasing depreciation accelerates that portion of the capital cost of building the network charged against current revenue; adjustments that are necessary to reflect the possibility that the gas supply network will be shut down before the end of its economic life, the Commission said.
Major users challenged this decision. Wait and see, they said. Political imperatives may change. No shut-down date has been set.
Failing that, let suppliers bear the cost, they argued. Building the network is a sunk cost. Suppliers take the risk.
The gas network is a natural monopoly. No one is going to construct a rival network and compete head-to-head on price. This economic reality is reflected in the Commerce Act.
The Commerce Commission has power to set price levels and quality controls. Administrative decisions attempt to mimic market forces.
Decisions on price turn on an ‘input methodology;’ a wheels-within-wheels formula in which a number of variables are calculated to determine an appropriate return for a monopoly supplier: the value of the monopoly asset; a return on capital; depreciation; and, expenditure including operating costs and tax.
Profitability for a monopoly supplier can be moved by adjustment to any of the variables.
The Commission has accommodated black swan events in the past where a monopoly supplier has faced a sudden, unexpected, event.
Electricity lines company Orion was on its knees having to rebuild its network following the Christchurch earthquake sequence. In 2013, Orion was given Commission approval for a large increase in retail prices for the period of its expected rebuild.
The political decision to phase out use of natural gas has economic effects the Commission has not previously faced. This decision has potential to strand assets for an entire industry.
The High Court was told the Commerce Commission decision to allow an increase in gas network depreciation allowances will result in a nominal increase for household gas bills of 3.8 per cent per year over the next four years.
The Court dismissed claims by major gas users that the risk of asset stranding is already built into pricing methodology when calculating a return on capital. Gas users say this already compensates suppliers for the risk; subsequently adjusting depreciation allowances is double counting.
Risks unrelated to day-to-day operations, arising from infrequent events that could produce large losses, do not form part of a cost of capital calculation, the court ruled.
These un-costed risks include natural disasters, pandemics, terrorist threats and unexpected major shifts in government policy. There is no uplift built into cost of capital to cover these black swan events. Such costs are difficult to estimate and can lead to monopoly suppliers concocting extreme scenarios, gaming the rules to justify price increases, the Court said.
The Commission’s decision to have consumers bear the cost provided certainty, the Court ruled. There is an implicit expectation that consumers must ultimately bear the cost should monopoly networks have to write off stranded assets. If these losses were to now fall on network owners, future investors would be unwilling to incur the substantial capital costs of building any new monopoly network.
Network stranding risks are implicitly left with customers, the Court said. Customers benefit from lower prices than would otherwise be levied, unless and until the risk becomes a reality.
The major users challenge to the Commission’s decision was dismissed.
Assisting Justice Radich in ruling on the case were economic specialists Professor van Zijl and Dr Walker.
Major Gas Users Group v. Commerce Commission – High Court (29.04.24)
24.105