1. Default price-quality paths for gas pipeline services Briefing on the Commission’s final decision for financial market analysts 28 February 2013

2. Overview Default price-quality paths for gas pipeline businesses 1.Context for the default price-quality paths 2.Key components of our decision 3.The price paths we have set for each business 4.Differences between the revised draft and final decisions 5.The quality standards we have set for each business 6.Overview of the approach we have used to set the price paths 2

3. Context for the default paths We are required to set default price-quality paths under the new Part 4 regime – New Part 4 specific purpose statement to guide us in setting prices – Input methodologies define key “building blocks” we must use to set the default price-quality paths – Price path is set based on current and projected profitability of each supplier The default price-quality paths apply to: – GasNet, Powerco, and Vector’s gas distribution businesses; and – Maui and Vector’s gas transmission businesses. 3

4. Key components of our decision Regulatory period set at 4 years, 3 months to apply from 1 July 2013 to 30 Sept 2017. Price path applied as a revenue cap for transmission businesses and a price cap for distribution businesses – Starting prices set based on current and projected profitability using re-determined input methodologies – Rate of change for the price path: ‘X’ set at zero for CPI-X – No alternative rates of change or claw-back. Quality standards based on emergency response times. 4

5. Profitability assessment with no price reset 5 Forecast revenues minus costs (incl. capital costs) – 01/07/13 to 30/09/2017 (no reset)

6. Likely adjustments for each business 6 Adjustments for the first full pricing year of the regulatory period

7. No alternative rates of change & no clawback 7 Alternative rates of change are available to avoid price shocks to consumers, or to prevent undue financial hardship to suppliers – Increases for Powerco, GasNet and Maui Development are below the levels we have previously considered for price shocks to consumers. – Vector have not provided any evidence to suggest that the downward adjustment will result in undue financial hardship. Claw-back is available where suppliers have increased their prices above CPI over the period 1/1/2008 to 28/2/2013 – The revised draft proposed to apply claw-back to GasNet for increases above CPI over the period 1 January 2008 to 30 September 2012. – Our final decision has no claw-back as the assessment of GasNet’s current and projected profitability suggests these increases were necessary to maintain a reasonable rate of return.

8. Differences from the revised draft Changes to the price path between the revised draft decision and the final decision are minor. Distribution – little difference between the final and the revised draft decision. Transmission – MDL’s maximum allowable revenue in the first assessment period has increased by $2.6m, largely as a result of changes in the allowance for operating expenditure and our forecast of changes in revenue in constant prices. – Vector Transmission’s maximum allowable revenue for the first assessment period has decreased by $2.1m, largely as a result of changes in the allowances for capital expenditure and operating expenditure. 8

9. Differences from the revised draft Present value of revenues over the regulatory period from the revised draft decision to the final decision 9

10. Quality standards for each business 10 Quality Standards set for emergency response time – suppliers of gas pipeline services must take 180 minutes or less to respond to any emergency; and – gas distributors must take 60 minutes or less to respond to 80% of emergencies. Our preferred option is to also establish quality standards based on reliability – we consider reliability as the most important measure of the level of service that suppliers should be providing to consumers – however, we currently have little data to establish robust reliability targets. By contrast response times to emergencies targets can be set independently of historical time series data, and are based on industry knowledge

11. WACC 11 We have used a vanilla WACC of 7.44% (cost of capital determination NZCC38) – We estimated the vanilla WACC as at 1 December 2012 – Risk-free rate and debt premium using data from the month of November 2012

12. How we forecast capex 12 We use suppliers’ own forecasts of up to a 20% increase over historic levels for both network and non-network capex – We rely on each supplier’s capex forecast because suppliers are well placed to forecast required capex – We have used a 20% limit as solely relying on suppliers’ forecasts would create an incentive to bias their forecasts to increase their starting price – Non-network capex updated from draft based on each supplier’s historic expenditure – Change in input prices based on capital goods price index

13. Reasons for limiting increases in capex 13 Relying on suppliers’ forecasts would create an incentive to bias their forecasts to increase their starting price – Customised price-quality paths can address material step changes in capex Maui Development and Vector forecasts included capex increases over 20%. They have the option to either: – apply for a customised price-quality path – undertake these projects within the DPP price cap – defer these projects Note that even if we used Vector’s capex projections, its price decrease would still be 19%

14. Projected growth in network capex 14

15. How we forecast opex 15 Opex forecasts for both network and non-network are based on actual opex for 2010/11. We have – considered impact of changes in network scale on opex – assumed operating efficiency growth to be zero – based the change in input prices on weighted average of forecast of labour cost index and producer price index – included known factors not captured elsewhere in modelling (eg, insurance costs, compressor fuel, and compliance costs)

16. How we forecast opex 16 Distribution network scale – applied a scale elasticity of 0.98 based on forecasts in historic trends in network length and customer numbers (based on the relationship between scale and opex of gas distributors in Australia and NZ). Transmission network scale – assumed that operating expenditure is not affected by changes in scale.

17. Projected growth in opex 17 Projected growth in operational expenditure from 2012 to 2017

18. How we forecast constant price revenue for gas distributors 18 We forecast revenue from residential, commercial, and industrial users, broken down into the two types of billed quantity all three distributors use Forecasts of billed quantities of gas are based on the gas supply and demand scenarios for the Gas Industry Company Limited, and historic trends in distributors’ gas quantities Forecasts of the number of users billed for their connection are based on extrapolating each supplier’s historic trends

19. Constant price revenue 2012-2017 (distribution) 19 Projected constant price revenue growth for gas distribution businesses from 2012 to 2017

20. Role of constant price revenue for gas transmission 20 We have set revenue caps for both gas transmission businesses We do not require a forecast of constant price revenue for setting starting prices for gas transmission business However, we have developed forecasts for assessing compliance and to illustrate the size of starting price adjustments in percentage terms

21. How we derive smoothed price path 21 Calculate present value of building blocks allowable revenue from 1 July 2013 to 30 September 2017 (4 years 3 months) Derive a smoothed path taking account of forecast changes in – prices (CPI-X) where X = 0 – quantities (distribution only) derived from forecast of constant price revenue Compliance will be assessed on a pricing year basis – For all suppliers but Maui Development this results in a 15 month initial assessment period from 1 July 2013 to 30 September 2014 – For Maui Development 3 month assessment period at the end of the regulatory period (1 Jul 2017 to 30 September 2017)

22. Questions? 22 For more information Please contact:Karen Murray Regulation.branch@comcom.govt.nz Or visit:http://www.comcom.govt.nz/initial-default-price-quality-path/ For information on: The revised draft decision The 2013-17 default price-quality path Or visit:http://www.comcom.govt.nz/additional-input-methodologies-for- electricity-and-gas-dpps/ For information on: The re-determined input methodologies