The ODV Draft Handbook

1
The ODV Draft Handbook

• Submisssion to the Commerce Commission on behalf
  of the
• Electricity Networks Association
• Stuart Shepherd
• 14 April 2004

2
Context

• The Commission has made a draft decision to allow
  lines businesses to use
• Valuations based on ODV for their opening
  positions
• Either valuations based on ODV or DHC thereafter
  (but not the option to change from one to the
  other)
• The Commission has also stated it intends to use
  the valuations derived from the application of
  the ODV Handbook
• For the information disclosure regime (subpart 1,
  Part 4A)
• For the targeted control regime, which includes
  investigating post breach if control should be
  imposed (subpart 3, Part 4A)
• It appears such valuations may also be used to
  determine price levels for goods and services
  that are controlled (Part 5)

3
Context (contd)

• When evaluating valuation methods in 2002 the
  Commissions analysis assumed each method would
  be implemented consistent with that methods
  principles
• And the Commission based its draft decisions on
  that analysis
• Thus a key test for the ODV draft Handbook is
  whether or not it would implement the ODV method
  as assumed in the Commissions original analysis
• I therefore consider whether the draft Handbook
  would implement the ODV method consistent with
  its principles

4
Two key issues

• I wish to focus on two key principles of the ODV
  method that the draft Handbook would not
  implement consistently
• The ODV method starts with a service that is to
  be delivered, and then incorporates all assets
  required to deliver that service
• The ODV method requires market prices to be used
  for asset values

5
Start with service, include all assets

• The ODV method
• assumes that the value of assets to a business
  is equal to the cost the business would incur if
  it were deprived of the use of its assets and
  then took action to restore its operating
  position to the pre-deprival situation by
  replacing its old asset base, at the lowest
  possible cost, with an asset base providing an
  equivalent service potential (para 1.2 of draft
  Handbook)
• Thus the test as to which assets are included in
  the valuation is determiend by the requirement
  that the asset base must be capable of delivering
  the equivalent service

6
Start with service, include all assets (contd)

• The draft Handbook does not use this equivalent
  service test to determine the set of assets to
  be included in the valuation
• It covers system fixed assets only
• Some other fixed assets are covered by the
  current disclosure requirements, but these are
  not covered in the draft Handbook e.g. office
  buildings equipment, asset management systems
  (GIS), and computing systems.
• It excludes assets on the basis of
• The ability to shift the assets geographically,
  e.g. mobile sub-stations and generators
• The service the asset provides being contestable,
  e.g. generators
• The asset being intangible in nature, e.g. some
  easements, databases and intellectual property
• None of these exclusions are consistent with the
  ODV method

7
Start with service, include all assets (contd)

• This issue could be addressed by modifying the
  Handbook
• To allow all types of assets to be included that
  are required to deliver the service, and not just
  system fixed assets
• To ensure any tests for excluding assets are
  based directly on whether the asset is required
  to deliver the equivalent service
• To remove the tests that exclude assets in a
  manner inconsistent with the ODV method

8
Market prices required for asset values

• The lowest possible cost aspect of the ODV
  method reflects the need to optimise the network
  from an engineeering and economic perspective
• The cost for the optimised set of assets should
  be market prices
• The draft Handbook sets out maximum values that
  may be used for many assets
• However lines businesses have provided evidence
  that these draft maximum values are in many cases
  below the prices at which they themselves can
  purchase the assets
• E.g. the PwC submission on behalf of 19 lines
  businesses, Orion and Vector
• The Commission has not publicly responsed to
  those claims, and to date has revealed neither
  the method its advisers used to arrive at the
  draft maximum values, nor the actual prices they
  used or their sources
• Thus on the evidence so far it appears the draft
  schedule does not reflect market prices

9
Market prices required for asset values (contd)

• This situation raises two issues
• The extent to which a mandated schedule of prices
  is a reliable method for identifying market
  prices for the assets
• To the extent that a schedule is used, whether
  the process relied upon by the Commission to date
  has delivered a credible result
• Regarding (1), we understand the reason for a
  schedule is to aid consistency of valuation
  across lines businesses
• For installations that are similar across lines
  businesses this consistency is probably desirable
• Where the installations are not similar it is
  incorrect to expect the costs (or valuations) to
  be similar
• This suggests there are limits to the extent to
  which a mandated schedule of prices will result
  in a reliable valuation

10
Market prices required for asset values (contd)

• The limits to the reliability of using a mandated
  schedule could be addressed by allowing lines
  businesses to also use their actual costs in the
  valuation, subject to appropriate audit criteria
• We note some lines businesses have already
  adopted this approach in their statutory
  accounts, demonstrating it can in practice be
  used under FRS-3
• We also note that the use of actual costs would
  (presumably) be allowed under the DHC valuation
  method, and that (other than for optimisation
  reasons) there appears no good reason why the
  same approach could not be used under ODV

11
Market prices required for asset values (contd)

• Regarding (2), it is usual for the Commission to
  expose its quantitative estimates to public
  scrutiny
• And where there are confidentiality concerns, to
  restrict the flow of information appropriately
• However in developing the draft schedule neither
  the methodology nor the prices have been
  subjected to scrutiny
• There is evidence from lines businesses that the
  draft schedule is not a reliable reflection of
  the prices in practice available to lines
  businesses
• And the Commission has not responded publicly to
  this evidence
• This procedural issue raises concern not only for
  the development of the current schedule, but also
  in relation to how the schedules will be revised
  in the future

12
Market prices required for asset values (contd)

• This procedural issue could be addressed by
• Documenting the methodology to be used to update
  the schedules and issuing it for comment
• Documenting the prices used and their sources and
  issuing them (if necessary as restricted
  information) for comment
• Revising the schedules, taking into account the
  comments received
• Committing in advance to updating the schedules
  on a regular basis (e.g. every 5 years), and to
  following a well specified and transparent
  procedure when doing so

13
Summary suggested way forward

• The ODV method starts with a service that is to
  be delivered, and then incorporates all assets
  required to deliver that service
• But the draft ODV Handbook excludes assets that
  are required to deliver the electricity
  conveyance service
• The ODV method requires market prices to be used
  for asset values
• But lines businesses appear unable in many cases
  to acquire and install assets at the stated
  prices in the draft ODV Handbook
• Thus in my view the Commission does not have at
  this stage a Handbook that would implement ODV in
  a manner consistent with its principles

14
Summary suggested way forward (contd)

• In order to take the draft ODV Handbook forward I
  suggest the Commission consider the following
  approach
• Revise the draft Handbook to take account of the
  issues raised in submissions, at this conference,
  and in cross-submissions, and ensure that the
  Handbook would implement the ODV method
  consistent with its principles
• Document how each issue raised in submissions has
  been addressed in the revised draft, or why it
  hasnt been addressed
• Document the method used to revise the schedules,
  and the actual prices used
• Issue all the above for comment (recognising the
  prices used in the schedule may be restricted
  information)
• Finalise the Handbook, taking into account the
  comments recevied from the above process