Lifting pipes

Risks are there but not all can see

CEO Steve Davies has been inspired by a recent speech to think about what regulators are looking at and to write about it on LinkedIn. Here's the post.

I was at the APPEA conference a couple of weeks ago and have found myself frequently reflecting on the presentation by Rod Sims, the Chair of the ACCC.

Given I am still thinking about it, I thought I’d put those thoughts down and share them around. This will be the first in a series of articles on the subject.

In a speech entitled “State of the East Coast Gas Industry” that extolled the need for more investment and lower prices, there was a big focus on transparency, which is not unusual for policy makers in recent years. There were some somewhat ominous words regarding pipelines, which we should all pay attention to:

The ACCC has concerns with some of the information published in October last year by pipeline operators that are subject to the new information disclosure requirements.”

“For example, some of the financial information published by pipeline operators seems to suggest that they have not recovered any of their original capital investment. This is very surprising given pipeline operators have previously provided information indicating investments are normally fully underwritten by shippers through contracts and they do not tend to build pipeline capacity on a speculative basis.”

This is not the first time the ACCC has said words to this effect. In December last year it said a similar thing, pretty much ‘the only reason we thought pipelines were fully depreciated is because pipeline companies told us they were’.

I find the ACCC’s surprise very surprising, given that the final report of the 2015 East Coast Gas Inquiry (delivered in April 2016, https://www.accc.gov.au/regulated-infrastructure/energy/east-coast-gas-inquiry-2015) does not say that pipeline operators provided information that investments are normally fully underwritten by shippers through contracts.

To be fair to the ACCC, historically, pipeline operators have not tended to build speculative capacity. By speculative capacity, we mean capacity for which there is no immediate demand (ie no foundation contract). The ACCC appears to think that avoiding speculation means pipeline investments have no risk and are fully underwritten. If this is the case, a simple conversation could have avoided the ACCC’s surprise.

It could have also paid more attention to written submissions to the 2015 East Coast Gas. I co-ordinated the pipeline industry’s submission and recall APGA saying:

 “Firstly, contrary to perception, pipeline investments always retain some risk for the investor. It is unusual that a pipeline investment’s foundation contracts will cover the full cost of capital expenditure and debt servicing. Pipeline investors must make decisions regarding the long-term viability of gas markets being served by new investments and the likelihood they will remain in place over the 80-year design life of an asset. This level of risk is increasing under the prevailing market conditions of the Eastern Australian Gas Market which are seeing a decrease in the duration of gas supply and transportation contracts.”

The submission also explained that the typical exceptions to this are lateral connections to main pipelines and single user pipelines.

APGA’s submission was made on 5 July 2015 and is available from the ACCC website.

In its report, the ACCC used examples related to expansions (p118), as well as anecdotal evidence (p114 and p131) and some simple modelling (p134) to draw conclusions on capital recovery. The ACCC’s views on the level of capital recovery of pipeline assets (and the tariffs that should result) have embarked the industry on three years of major reforms. When the ACCC is analysing infrastructure sectors, it is critical it forms its views factually, transparently and with an understanding that it has a regulator’s perspective. Resources are a major driver of the Australian economy. All resource industries rely heavily on infrastructure investment. It is vital that regulatory frameworks for infrastructure are established and reviewed with a full understanding of the facts.

There is a further disconnect between the ACCC’s view of risk and capital recovery and the reality of building pipelines in a competitive market, which I will cover in my next post.

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