Proposed Optimised Depreciated Replacement Methodology for Valuation of Powerco System Fixed Assets

Transcription

1 1 Proposed Optimised Depreciated Replacement Methodology for Valuation of Powerco System Fixed Assets DISCUSSION DRAFT As amended by Powerco 27 February 2006 NOTE: This document contains Powerco s proposed amendments to the Commerce Commission s draft ODRC Requirements Methodology. It represents part of Powerco s submission on the draft methodology. This version of the submission has the tracked changes removed for ease of reading. The wording from the original document has been retained for consistency, however Powerco is aware that some of the wording, for example in the Preface, may give readers the impression that this changed document was issued by the Commission. Readers should be aware that this version of the draft ODRC Requirements Methodology is not a Commerce Commission document.

2 2 Draft ODRC Requirements Methodology PREFACE...3 Rationale for Draft Methodology...3 Coverage of this Methodology...3 PART ONE: INTRODUCTION...5 PART TWO: OVERVIEW OF THE ODV VALUATION APPROACH...6 Introduction...6 The Optimised Depreciated Replacement Cost Methodology...6 Optimised Depreciated Replacement Cost (ODRC)...7 PART THREE: PRACTICAL VALUATION PROCEDURES...8 Introduction...8 Valuation of the System Fixed Assets at Replacement Cost (RC)...8 Valuation of the System Fixed Assets at Depreciated Replacement Cost (DRC)...10 Optimisation: Valuation of the System Fixed Assets at Optimised Depreciated Replacement Cost (ODRC)...12 ODRC Valuation Report...16 APPENDIX A: ASSET TYPES, GROUPS AND SUBGROUPS FOR GAS PIPELINE CONTROLLED BUSINESSES...20 APPENDIX B: VALUING ASSETS AND ASSET COSTS AND LIVES...23 APPENDIX C: OPTIMISATION FOR GAS PIPELINE BUSINESSES...31

3 PREFACE 3 Draft ODRC Requirements Methodology Rationale for Draft Methodology 1 This draft methodology has been prepared by the Commerce Commission for use (once finalised) by Powerco (the controlled business) in determining suitable valuations, using the ODRC methodology, for the system fixed assets of their gas distribution networks for the purposes of price control. 1 It draws strongly on ODRC methodology material that was drafted by the Ministry for Economic Development (MED) for an intended Gas ODV Handbook 2 and has been adapted by the Commission to reflect the Commission s current views regarding the application of an ODRC methodology for such purposes. 2 The Commission understands that the MED draft Handbook material was in turn based on the Electricity ODV Handbook at that time and that there was consultation with the industry and interested parties. However the intended handbook was not subsequently completed or published. This draft methodology also draws on ODRC methodology material set out in the Commission s Electricity ODV Handbook, adapted as required for gas distribution services. 3 This draft methodology has been prepared for discussion purposes only at this stage and should be read in conjunction with the associated Discussion Paper. 3 Following consultation, the Commission will modify this draft and will issue a Letter of Instruction to Powerco to undertake valuations of their relevant assets for the purposes of regulatory control, in accordance with this methodology. 4 The Commission stresses that this draft methodology does not constitute a draft of a future valuation handbook for general use. If the Commission is required to develop a general gas network valuation handbook, it will undertake a more detailed review and re-drafting process, as it did when it assumed responsibility for the electricity ODV Handbook from the MED. For pragmatic reasons, and for its current purposes only, the Commission has decided to largely utilise the existing ODRC methodology material from the MED s draft, changing it only where the Commission has a different view in regard to a particular aspect of the methodology or where the Commission considers that the draft material was not sufficiently clear in regard to the Commission s requirements. Coverage of this Methodology 5 This draft methodology covers the valuation of those system fixed assets that are to be valued using the ODRC methodology. It does not cover the valuation of metering assets, valuation of easements, valuation of non-system fixed assets that the controlled business may own and which may be used (wholly or in part) to provide gas distribution 1 Commerce (Control of Natural Gas Services) Amendment Order (Order in Council) 2005, gazetted 28 July Ministry of Economic Development, Handbook for Optimised Deprival Valuation of System Fixed Assets of Gas Pipeline Businesses; Second Edition (Draft) September Authorisation for the Supply of Natural Gas Distribution Services by Powerco and Vector, Valuation of the Regulatory Asset Base, Methodology Discussion Paper

4 4 Draft ODRC Requirements Methodology services nor any other components of the Regulatory Asset Base that the Commission may allow. For discussion of the Commission s proposals in this regard, please see the associated Discussion Paper. Next Steps of Draft Methodology 6 The Commission will finalise the draft methodology following consideration of the submissions received on the matters raised in the associated Discussion Paper. The final methodology will then form part of the Letter of Instruction issued by the Commission to the businesses informing them how to undertake the required valuations for the purposes of price control.

5 PART ONE: 5 Draft ODRC Requirements Methodology INTRODUCTION 7 This methodology has two principal sections: Part Two: General Overview of the ODRC Valuation Approach; and Part Three: Practical Valuation and Mandatory Procedures. 8 Part Two gives a general description of the approach to valuing system fixed assets using the Optimised Depreciated Replacement Cost (ODRC) methodology, while Part Three (which is supported by a series of appendices) gives the details of the practical approach which must be applied to valuation. Part Three also contains the reporting requirements. 9 It is mandatory that both Parts Two and Three be followed.

6 PART TWO: APPROACH 6 Draft ODRC Requirements Methodology OVERVIEW OF THE ODRC VALUATION Introduction 10 It is proposed that Powerco is required to value their gas distribution system fixed assets using the ODRC methodology as prescribed here. The aim of applying the ODRC methodology is to value the assets at the level at which they can be economically sustained in the long term, and no more. The resulting value should be equal to the loss to the owner if it was deprived of the assets and then constructed network to minimise the loss. 11 It is recognised that the value of the assets derived in this way may differ from their current book value. The Optimised Depreciated Replacement Cost Methodology 12 The ODRC is the replacement cost of the existing system fixed assets, which have been optimised from an engineering standpoint and depreciated according to their age. 13 The ODRC methodology involves the following steps: (i) preparing a detailed asset register (ii) calculation of the Replacement Cost (RC) (iii) assessment of depreciation (DRC) (iv) system optimisation (ORC) (v) determination of the Optimised Depreciated Replacement Cost (ODRC)

7 7 Draft ODRC Requirements Methodology Optimised Depreciated Replacement Cost (ODRC) 14 The ODRC measures the cost of replicating the system in the most efficient way possible, from an engineering perspective, given its service capability and the age of the existing assets. Preparing a Detailed Asset Register 15 The basis for undertaking an ODRC valuation is the collation of a comprehensive asset register (or registers) of the controlled business system fixed assets and their configuration. The asset register(s) should contain data on the quantity, location, physical condition, age and maintenance of the controlled business assets. Determination of Replacement Cost (RC) 16 The next step is to value the network at replacement cost. The replacement cost is determined as the cost of replacing the existing assets with modern equivalent assets (MEA). It is important that objective values be applied consistently for the Contolled business. Assessment of Depreciation to Determine Depreciated Replacement Cost (DRC) 17 Once the quantities and replacement costs of assets have been determined, costs need to be depreciated in cases when the existing asset's remaining life is less than the total life (TL) expected from an MEA asset. The depreciation recognises the limited remaining life (RL) of the existing assets. 18 The RL of an asset can be determined as the (TL Age of Asset). Part Three prescribes maximum TLs for assets that are to be used. This is done to prevent aged assets being over-valued. 19 In cases where the TL of an MEA is lower than the service life of the existing asset then the TL shall be the expected total life of the existing asset. System Optimisation 20 Optimisation attempts to answer the question: Given the required level of service, in terms of capacity and quality of supply, what is the most cost-effective set of assets to achieve that supply? 21 The purpose of optimisation is to determine a value of system fixed assets that is the counterpart to the market value of the assets of a business in a competitive market that is the value of the assets on which such a business could earn a normal rate of return commensurate with the systemic risk that investors in that business face. 22 Optimisation consists of determining an appropriate network configuration and appropriate design and rating of sub-systems or segments of the network taking into account factors such as usage, likely future usage and security of supply, health and safety requirements, as well as the assets already in place. In theory, in considering reconfiguration it would be possible to consider the "green fields" design of an entirely new network. In practice such an exercise would not be warranted, because of the time

8 8 Draft ODRC Requirements Methodology and cost involved, and because of the constraints imposed by factors such as the given positions of points of supply and historical supply authority boundaries. In Part Three the required approach to optimisation is described, and worked examples are provided in Appendix C. 23 It should be stressed that optimisation is not concerned with improving the system from its current state. The system should not be notionally re-designed to be better than it is (whether in terms of capacity, or other standards) where this would increase the replacement cost of the system. Optimisation leads only to reductions in the replacement cost of the system for valuation purposes. 24 Where optimisation has taken place there is the question of what depreciation to apply to the notional replacement assets. Part Three specifies that the notional replacement assets be depreciated assuming that they have the same proportion of their TL remaining as do the assets they are replacing. Determination of Optimised Depreciated Replacement Cost (ODRC) 25 When optimisation leads to an existing system fixed asset being notionally replaced, the replacement asset shall be depreciated for the same proportion of its TL as the existing asset was depreciated. When optimisation involves groups of assets being reconfigured, the replacement assets shall be depreciated as a group to reflect the RL of the existing group as a proportion of that group s TL, calculated on a weighted average basis, with the weighting factor being replacement cost. Aggregating the ODRC values of the individual system fixed assets in the optimised network will produce the total network ODRC. PART THREE: PRACTICAL VALUATION PROCEDURES Introduction 26 The valuation procedures presented here in Part Three differ from those given in Part Two in that more detail of the steps are included. 27 The reporting requirements set out in Preface section of this Methodology, require reporting of the following: i. replacement cost of the network; ii. depreciated replacement cost of the network; iii. optimised replacement cost of the network; and iv. optimised depreciated replacement cost of the network. 28 Disclosure of the individual items listed in paragraph 85 is designed to provide for transparency of the valuation process carried out by the controlled business by making clear the effect of optimisation on the ODRC valuation. Valuation of the System Fixed Assets at Replacement Cost (RC) 29 There are two steps in the determination of replacement cost: (i) preparing a detailed asset register; and

9 9 Draft ODRC Requirements Methodology (ii) valuing the assets at modern equivalent asset cost. Preparing a Detailed Asset Register 30 Powerco should have a comprehensive database for their assets. Ideally, for the purposes of carrying out optimisation, the database should be computerized to facilitate sorting and reporting according to various numbers and levels of sort key (e.g., asset type, pressure, capacity, network segment or location, installation dates). 31 In order to carry out adequate optimisation it will generally be necessary that the network register is built up from or can be divided into relatively small segments. 32 Appendix A gives the minimum classification of system fixed assets expected to be used by the controlled business. 33 As well as system fixed assets, stores and spares of network equipment should be valued as part of the ODRC. The controlled business should have a record of stores and spares, preferably in a computerised ledger system. In cases where complete records are not kept, or are unreliable, it may be necessary to undertake a stock-take for valuation purposes. 34 Asset registers should be checked for consistency and sample checks should be carried out in the field to verify that the quantities and ages recorded are accurate within reasonable limits. Guidance as to what constitutes reasonable limits should be taken from the significance of each item and its effect on the accuracy of the overall valuation. Exclusion of Assets 35 Assets such as head office buildings, office furniture and equipment, motor vehicles, tools, plant and machinery, works under construction, and non-network land and nonnetwork stores and spares should not be included in the asset register of system fixed assets that is used as a basis for preparing the ODRC valuation of system fixed assets. Also gas measurement systems to individual consumers should be excluded from the Gas Networks valuation. Meters that are required for network operations should be included. Accessibility of Information 36 The system fixed asset register should be in a form that facilitates scrutiny of the register and a ready understanding of how it is composed. Spreadsheet presentations are appropriate. Valuing the Assets 37 The system fixed assets are to be valued using the Replacement Costs (RC) of Modern Equivalent Assets (MEA) that would be installed today in order to provide the same level of installed capacity and service potential as the assets in place. The MEA should not reflect improvements required by legislative changes made since the assets were first built or installed, if such improvements result in higher replacement costs and if the existing assets have not yet had to comply with the additional requirements e.g. where grandfathering provisions apply. (The values for MEA for Powerco are being developed separately and are not included in this draft methodology paper). Appendix B will

10 10 Draft ODRC Requirements Methodology contain the standard unit replacement costs to be used by Powerco for standard assets. Appendix B also contains other details regarding the valuation of particular types of assets. 38 When determining MEA there are indicators that can be used to determine what asset to select for costing. Such indicators include: (i) equivalent capacities, (ii) reliability of the technology, (iii) functional compliance with operating requirements, (iv) meeting statutory and industry safety requirements, (v) least lifetime costs (taking account of all aspects of performance e.g. UFG); and (vi) Equivalent metric pipe sizes. 39 Where existing pipeline assets do not have a direct metric MEA then the next higher pipe diameter MEA size shall be used. 40 When the tables in Appendix B do not provide guidance on how to value particular assets, such as station compressors for example, valuers should obtain cost estimates from manufacturers or suppliers. Valuers should explicitly identify in the valuation report each asset that does not fall within Appendix B, together with the replacement cost and the total life assumptions that have been used for valuation purposes. 41 Construction cost estimates should be based on knowledge of the work involved, assuming a significant scale of construction and on efficient industry practice, with competitive costs such as would be charged by private contractors. 42 Any grants or contributions that have been received should be ignored, as it is the valuation of assets that is required and not the actual investment. 43 Aggregation of the RCs for all the system fixed assets will produce the network RC. Valuation of the System Fixed Assets at Depreciated Replacement Cost (DRC) Approach to Depreciation 44 Asset replacement costs should be depreciated when the existing asset s remaining service life is less than the life that would normally be expected from a new asset. The depreciation effectively recognises the limited Remaining Life (RL). The MEA costs should be depreciated according to the RLs of the existing assets. 45 The straight line method of depreciation should be used such that the Depreciated Value (DV) is determined as: DV = UDV x RL/TL where: UDV = Undepreciated Value (i.e. Replacement Cost (RC)) RL = Remaining life TL = Total Life.

11 11 Draft ODRC Requirements Methodology It is clear from the above that both the Total Life and the Remaining Life need to be assigned for all assets. Determining Asset Total Lives 46 The TLs of Modern Equivalent Assets (MEA) which are to be used are set out in the tables in Appendix B. These lives are to be used, except as provided for in the following paragraph and in the appendix. The appendix also contains other details regarding the TLs to be used for particular types of assets. 47 TLs lower than the specified standard TLs may be used and may be appropriate in certain circumstances such as specified in Appendix B. Determining Asset Remaining Lives 48 The basic procedure for determining RLs is to subtract the age of assets from their TLs except where the RL is less than three years, then Paragraph 55 will apply. 49 The age of assets should be determined for initial ODRC valuations, either from records establishing the age, or where necessary from engineering assessments of the age. 50 In cases where materiality of the value of assets is not an issue, and where data availability and calculation complexity would not warrant the determination of age and RL of individual assets, grouping of assets and the assessment of weighted average RLs, using an objective and transparent statistically robust assessment methodology is acceptable. 51 Appendix B provides procedures for assessing RLs in cases where assets have been refurbished. 52 When an asset may be retired early from service because it may become redundant as part of a development of the system, this should not be taken into account in assessing the RL of that asset. However, when a class of assets is routinely replaced as part of the evolution of the system before its technical life expires, then this should be taken into account in assessing the TL for that class of assets. Assets with Residual Value 53 In some cases assets will have a Residual Value (RV) at the end of their TL, or after allowing for the costs of recovery a Net Residual Value (NRV). When this is the case an adjustment is required to the formula given in Paragraph 45. With the adjustment the Depreciated Value (DV) is determined as: DV = (UDV NRV) x RL/TL + NRV 54 Generally the NRV of GPB fixed system assets, once the cost of recovery is netted off, is low and can be set aside as not of material value is which case the formula in Paragraph 45 will apply. Minimum Residual Life Assets whose remaining lives are less than three years shall be deemed to have a residual life of three years. That is, no asset that is still in service will be ascribed a Remaining Life

12 12 Draft ODRC Requirements Methodology in the formula in Paragraph 45 or Paragraph 53 above, that is less than three years. Determining the Depreciated Replacement Cost (DRC) 55 Aggregation of the DVs for all the system fixed assets will produce the network DRC. Optimisation: Valuation of the System Fixed Assets at Optimised Depreciated Replacement Cost (ODRC) Introduction 56 Optimisation is an essential aspect of the ODRC Process. It should be undertaken only after the RC and the DRC of the existing network asset base has been calculated. 57 The determination of the MEA that would replace existing individual network components is NOT part of the optimisation process. This must be done prior to calculating the RC and, for most network components, will have already been taken into account in the replacement costs to be prescribed in Appendix B. 58 Optimisation of the GPB s system fixed assets must be carried out to ensure that only assets (or elements thereof) that would be required and fully used in an optimised design of the network are valued. The resulting ODRC valuation should be based on an optimal, modern efficient design that: i. provides a quality and capacity of supply similar to that which currently exists and which does not exceed the GPB s standard quality of supply criteria and design pracitces; and ii. is depreciated to the same degree as the existing assets 59 Optimisation consists of three stages: i. identifying stranded assets; ii. optimising the system configuration; and iii. optimising elements in the system. Constraints on Optimisation 60 The optimisation must be carried out subject to the following constraints. i. the optimised network must not exceed the existing level of supply security and design practices, and no part of the network may exceed the controlled business quality of supply criteria or design practices unless non-standard contracts with customers exist that guarantee an enhanced quality of supply; ii. the location of transmission receipt points and gate stations can be assumed to be fixed. However, where a gate station can be by-passed and this allows a reduction in the replacement value of GPB assets, then that gate station must be deleted for valuation purposes; iii. the location and number of connections points should be assumed fixed;

13 13 Draft ODRC Requirements Methodology iv. the optimised network should only use the standard gas pressure ratings and pipeline sizes used on the existing network 4 ; and v. the existing geographic boundaries of Powerco s supply area should be assumed to be fixed. The Process of Optimisation 61 Optimisation of the network should be undertaken on a systematic basis. The optimisation process must ensure that all excess capacity that will materially affect the replacement value of the network is optimised out. 62 Optimisation must be undertaken systematically on the following parts of the network: (i) (ii) Compressors, Gate Stations, (iii) Intermediate Pressure (IP) pipelines, (iv) Pressure Reducing stations, (v) Medium Pressure (MP) and Low Pressure (LP) pipelines, and (vi) Stores and Spares. Future Load Growth 63 The maximum capacity of any part of the optimised network shall be determined by the forecast load growth at the end of the relevant optimisation period. Allowances should be made, where possible, for different growth rates in different parts of the network. (i) Gate stations, 10 years; (ii) For IP networks and pressure reducing stations, 20 years (iii) For MP & LP distribution and other network assets, 10 years. Quality of Supply 64 The optimised network must be designed to supply the existing load, and allowed load growth, with a quality of supply that matches the level that currently exists for each part of the network except where this is greater than the determined quality of supply criteria. 65 A GPB will disclose, in its valuation report, the quality of supply criteria that it currently uses as a basis for network design. This should be based on the business analysis of customer requirements and its assessment of network maintenance requirements and costs. 66 Relevant quality of supply standards include: i. the degree of security (redundancy) in different circumstances or localities; ii. target reliability indices for different areas of the network (CBD, suburban); iii. supply pressure criteria. 4 This does not preclude existing equipment being optimised down to a lower standard network pressure. However, there is no requirement to optimise down to a non-standard pressure rating.

14 14 Draft ODRC Requirements Methodology 67 The degree of security shall be disclosed by reference to the minimum operating pressure at maximum load for different parts of the network. This requires modelling of the networks and continuous monitoring of pressures at critical points. Isolated weak parts of the network that unduly impact on the operating pressures required in the distribution system may need to be reinforced on a notional basis to a level that provides the minimum overall network cost. 68 Existing assets that provide a quality of supply greater than the determined criteria must be optimised, except where the assets are required in order to meet the business contractual obligations to provide an improved level of security to specific customers. Identifying Stranded Assets 69 Any system fixed assets that are not required to supply gas transport services to customers should be identified and excluded from the optimised network. Such assets are known as Stranded Assets. Optimising the System Configuration 70 Optimisation of system configuration should be carried out in conjunction with the business s Planning Engineer or another suitably qualified person. A good current knowledge of gas network analysis is required as optimisation is concerned with the redesign of the system configuration, where the existing configuration exceeds the disclosed supply criteria, and not just with the replacement of individual components. 71 Optimisation of system configuration must be carried out by considering and recording the most viable alternative configurations subject to the constraints on optimisation and in accordance with the relevant criteria relating to quality of supply. The optimised configuration is the one that satisfies the relevant optimisation criteria at minimum overall replacement cost. 72 In optimising the configuration of the intermediate pressure distribution system, the routes of existing pipelines may be considered fixed, provided they are still required to give supply to existing customers. However assets over and above those required to meet the disclosed quality of supply criteria must be optimised out. In the process of optimising the system configuration, certain assets or groups of assets may become excess to requirements and should be valued at nil, while other new assets may need to be brought in on a notional basis. This should of course not give rise to situations where the overall optimised cost of the group of assets increase because of the addition of the notional assets. 73 Issues with the optimisation of the system configuration for the controlled business are discussed further in Appendix C. Optimising Elements in the System 74 After the configuration of the system has been optimised, the elements within it must be optimised by considering whether lower capacity elements with a lower replacement cost would be adequate. When optimising the elements within the system the business must individually consider, intermediate pressure pipelines and the material assets within them. Valuers must record the optimisation methodology and assumptions so that they can be audited. Issues with the optimisation of elements of business systems are discussed further in Appendix C.

15 Optimising Network Equipment Spares 15 Draft ODRC Requirements Methodology 75 Network equipment spares may be included in the ODRC as long as the spares are capable of replacing existing assets installed in the network. Further, the quantity of the spares, to be valued in the ODRC, must not exceed a reasonable quantity required to meet the determined quality of supply criteria. 76 Stranded assets may be valued as network spares, subject to the criteria set out in the previous paragraph. Determining the Optimised Depreciated Replacement Cost (ODRC) 77 Once the optimised system has been determined those parts of the optimised network that are different from the existing network must be re-evaluated. This entails applying the cost of the modern equivalent assets (to be set out in Appendix B) and ensuring that these are depreciated to reflect the service potential of the existing assets. 78 Stranded Assets not required as network equipment spares, shall be assigned a zero value for the purposes of ODRC. 79 When assets are brought into the system through optimisation on a notional basis they should be valued at their replacement cost, with reference to the costs to be prescribed in the Appendix B tables. 80 When optimisation leads to existing assets being notionally replaced, the replacement asset shall be depreciated for the same proportion of its TL as the existing asset was depreciated. When the optimisation involves groups of assets being re-configured, the replacement assets shall be depreciated as a group to reflect the RL of the existing group as a proportion of that group s TL, this being calculated on a weighted average basis. 81 Aggregation of the ODRC values of the fixed assets in the optimised system will produce the network ODRC. In addition, for those assets where optimisation has occurred, it will be possible to record all the DRC, ORC and the ODRC. Summary of the Optimisation Process 82 Figure 3.1 summarises the steps that should be taken in carrying out optimisation and shows how they fit together.

16 Figure 3.1: System Optimisation 16 Draft ODRC Requirements Methodology Define demand and load requirements Remove stranded assets Stranded assets Value at NIL System less stranded Assets. Determine DRC Optimise Configuration Excess assets Value at NIL Useful existing and new notional assets Optimise Elements Excess capacity Value at NIL Optimised System Value at DRC to give ODRC ODRC Valuation Report 83 It is important that ODRC valuations are transparent. Powerco are therefore required to provide an ODRC valuation report. Sufficient information should be included in the valuation report to enable the Commission to independently assess the validity and robustness of the reported valuation of system fixed assets in accordance with this methodology. 84 As a minimum, the ODRC valuation reports shall contain the following information: (a) the asset quantities in the valuation asset base, excluding stores and spares. This information shall be broken down into asset classes consistent with the asset classes contained in Appendix A;

17 17 Draft ODRC Requirements Methodology (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) the RC, ORC, DRC and ODRC for each asset class and for the valuation asset base as a whole. This information shall be shown separately for each geographically distinct, non-contiguous network. Stores and spares should be disclosed separately as separate line items and need not be disaggregated into asset classes; a description of the method used for the valuation of any assets where the business considers that the valuation method is not specifically prescribed by the valuation rules in this methodology ; a schedule of asset classes where asset quantities and/or asset ages have been estimated. For each such asset class the valuation report shall describe the methodology used to derive the estimates; a schedule of asset classes and asset quantities to which multipliers or other adjustments have been made to what might otherwise be considered to be standard replacement costs. In cases where a range of multipliers or other adjustments is allowed, the valuation report shall show the actual multiplier applied and describe the basis for the selection of a particular multiplier or other adjustment within the range; a schedule of replacement costs and asset lives used as the basis for valuing non-standard assets where standard replacement costs or asset lives are not provided, and a general description of the basis for determining the replacement costs or lives of those assets. This information shall include, where appropriate, the basis for selection of MEAs and the methodology used to determine the current replacement cost of the MEA; a schedule of asset classes and quantities for which standard asset lives have been extended or reduced, together with the actual lives used, and a schedule showing the date of return to service and remaining life applied to individual assets that have been refurbished since the last valuation; details of assets to which a reduction in standard lives is applied due to routine replacement as part of the evolution of the network; a general description of the methodology used to optimise the network; a general description of the analysis and assumptions used where life cycle cost analysis is relied upon to avoid the use of an asset with a lower replacement cost in an optimised network; the existing loads and the demand growth forecast used as a basis for optimisation. This information shall be reported to the level at which it has been disaggregated for optimisation analysis purposes and should report any specific new demands which are included in the forecasts and which exceed 5% of the business current total demand; a description of the quality of supply criteria used as the basis for optimisation;

18 18 Draft ODRC Requirements Methodology (m) a schedule of all network optimisations and details of the valuation impact of each optimisation, including details of the assets removed as stranded assets;

19 19 Draft ODRC Requirements Methodology ABBREVIATIONS USED IN THIS METHODOLOGY REQUIREMENT Abbreviation Term barg CBD DRC DV EV GAAP GPB IP LP MEA MP nb NPV NRV ODRC ODV ORC PV RC RL RV std.m 3 /hour TL UDV UFG WACC Bar (gauge) Central Business Districts Depreciated Replacement Cost Depreciated Value Economic Value Generally Accepted Accounting Practice Gas Pipeline Business Intermediate Pressure Low Pressure Modern Equivalent Assets Medium Pressure Nominal Bore Net Present Value Net Residual Value Optimised Depreciated Replacement Cost Optimised Deprival Value Optimised Replacement Cost Present Value Replacement Cost Remaining Life Residual Value Standard cubic metres per hour (at 15 o C and bara) Total Life Un-Depreciated Value Unaccounted-For Gas Weighted Average Cost of Capital

20 20 Draft ODRC Requirements Methodology APPENDIX A: ASSET TYPES, GROUPS AND SUBGROUPS FOR GAS PIPELINE CONTROLLED BUSINESSES Asset registers should include, as a minimum, the classification of assets such as set out in this appendix. DISTRIBUTION SYSTEMS (a) Distribution Pipelines This class of asset comprises: (i) (ii) Mains, being pipelines that usually run along streets and supply more than one customer, Services, being pipelines between a main and a customer meter station, include the connection to the main as well as the valve upstream of the metering station. Distribution pipelines should be divided into three main categories: High pressure pipelines with operating pressures above 20 barg used for distribution, Intermediate pressure (IP) pipelines with operating pressures between 7 and 20 barg, Medium pressure (MP) pipelines with operating pressures between 7 kpa and 7 barg, Low pressure (LP) pipelines with operating pressures up to 7 kpa. This distinction is based on the current New Zealand industry practice that limits the use of polyethylene (PE) to pressures up to 4 barg. This effectively splits the pressure regimes into two: a) PE and a few other lower tensile strength materials for low and medium pressure systems and b) steel for intermediate pressure systems. Where PE pipelines are operated at pressures higher than 4 barg they should be classed as medium pressure pipelines. This distinction by pressure rating may change in the future with the introduction of new materials and suitable fittings. IP, MP and LP pipelines should be grouped by the following diameters: 20, 32, 50, 80, 100, 150, 200, 250, 300 mm nominal bore (nb). Note that pipe sizes falling inbetween these sizes should be placed in the higher diameter category. For standard valuation purposes the unit is (1). (b) Stations Distribution system stations include gate stations and pressure reducing stations. Gate stations should be classified by the maximum hourly throughput in std. m 3 per hour.

21 21 Draft ODRC Requirements Methodology The pressure reducing stations control the gas flow from a higher pressure to a lower pressure system as, for example, between intermediate and medium pressure systems. The stations include safety devices to protect the downstream system from malfunctions of the active regulator. The pressure reducing stations should be appropriately grouped by their capacity in std. m 3 per hour. For each station, assets should be divided into the following categories: (c) Valves Land Site Development and Buildings Regulators Valves, Pipework and Fittings Instrumentation and RTUs Electrical Fittings These are underground valves other than those installed at stations. These valves can also include ancillary equipment such as additional venting valves, pits and covers and should be classified by diameter. The unit for valuation purposes is one (1) valve. (d) SCADA / Control Systems (i) SCADA Master Stations A Master Station consists of hardware and software. Note that individual Remote Terminal Units (RTU) installed at individual stations, including sensing devices such as meters and pressure sensors, power supply and instrument related transducers should be valued with their associated station. The unit for valuation purposes is one (1) Master Station. (ii) Telecommunication Systems Telecommunication systems include cables, wireless transmission systems and terminals. (e) Stores and Spares The stock of stores and spares should be recorded.

22 22 Draft ODRC Requirements Methodology (f) Easements The valuation of easements is not covered by this ODRC methodology Easements should be on the basis of the costs that would be faced by an averagely efficient new entrant to the market place in competition with the existing business to supply the same standard of service.

23 APPENDIX B: 23 Draft ODRC Requirements Methodology VALUING ASSETS AND ASSET COSTS AND LIVES B.1 This purpose of this appendix is to give the methodology to be applied in using replacement costs to value the system fixed assets of Powerco. The appendix, will contain a Table B for Distribution assets, which will specify the standard unit replacement costs and asset Total Lives to be used for the purpose of assessing the depreciated replacement costs of controlled business system fixed assets. In this draft methodology, no unit replacement costs are included as the Commission is determining these under a separate process. UNIT REPLACEMENT COSTS B.2 Unit replacement costs are shown in Table B for Distribution assets. B.3 The values in the tables are replacement costs of Modern Equivalent Assets (MEA). They are based on industry best practice and competitive pricing and include the following elements: (i) (ii) materials delivered to store; labour including indirect costs (ACC, holiday pay, sick leave, training, supervision, etc); (iii) transport and plant costs for delivery and erection; (iv) on-cost incorporating business administration, design, construction supervision, and project management costs; (v) reinstatement of the surface to its original and approved standard; (vi) traffic management (temporary, as normally required for roads with low traffic volumes); (vii) any fees associated with the construction works such as for approvals by authorities or compensation for damages incurred during construction; (viii) an allowance for finance during the construction of the assets, based on an efficient cost of capital and an assumed construction period and payment profile. Costs of land use consents, easements and GST are excluded, but other taxes and duties incurred in construction of the assets are included. B.4 For equipment used or installed in adverse conditions, multipliers and/or traffic management allowances can be applied to the values specified in the tables, but only subject to conditions specified in clause B.10. To ensure appropriate application of the cost multipliers and/or traffic management allowances, a record of their application shall be retained by the Gas business. The record should include: (i) (ii) (iii) Multipliers and/or allowances used; Quantity of the item to which each multiplier and/or allowance is applied; and The specific conditions justifying the use of the multipliers and/or allowances.

24 24 Draft ODRC Requirements Methodology B.5 Where more than one multiplier is applicable to a particular asset the effect of the multipliers is to be summated, not multiplied. For example, if multipliers of both 1.25 and 1.3 apply to an asset to adjust for specific construction conditions, then the combined multiplier to be applied is B.6 Where the nature of an asset in service differs from any listed in the tables, an engineering assessment of the replacement cost can be made, subject to the approval of the Valuer. Before such an assessment is made, the Valuer must be satisfied that there is justification for not selecting an MEA listed in the tables. This assessment must be recorded in the valuation report. B.7 In assessing costs for assets not listed in the tables, or where the Valuer s assessed value is less than the standard listed cost, the cost elements set out in B.3 should be recorded. Any costs so determined should be based on competitive pricing estimates, and should be commensurate with a significant scale of construction (within the limits of available resources) and not piecemeal additions. ASSET TYPES B.6 In the following sections additional information is given in relation to the valuation of certain types of asset used by GPBs. Distribution Pipelines: B.7 The pipeline costs in Table B will be based on PE-coated steel and PE construction based on suburban areas with standard ground conditions. Suburban areas are defined as those areas that include typical inner or outer suburbs comprising residential and general commercial and industrial areas; this classification applies to all suburban and rural districts; costs assume that the ground surface above the pipelines is partly grass, partly asphalt and that pipelines regularly cross under driveways. Standard ground conditions are defined as those that can consist of material suitable for directional drilling or thrust boring; this includes soil conditions that require occasional excavation work with diggers, such as occasional alluvial river stones. Replacement Cost Multipliers B.8 Pipelines laid in business districts, rocky ground or remote areas require special consideration by the application of multipliers on the following basis: (a) Business districts, a multiplier of 1.15 to 2.0 may be applied to the replacement costs in Table B. This multiplier takes into account restricted access times,

25 25 Draft ODRC Requirements Methodology special reticulation requirements and areas requiring substantial reinstatement and/or special backfilling. Business districts can include main arterial roads radiating from them where the roading authority sets requirements similar to those in CBD areas. The actual multiplier used should take account of the density of development and other relevant factors. (b) For pipe laid in rocky ground a multiplier of 1.0 to 2.0 can be applied to the replacement costs in Table B: (c) For pipes laid in remote areas (situated more than 75 from the nearest gas business or contractors works depot) a multiplier of 1.0 to 1.25 can be applied to the replacement costs in Table B. B.9 The replacement costs for pipelines apply for both mains and services. B.10 Where additional distribution pipelines are installed in the same trench together with another gas pipeline, the additional pipelines should be valued at the marginal cost of the additional pipelines. Traffic Management B.11 The replacement costs for gas pipelines include the cost of temporary traffic management as normally required for roads with low traffic volumes however where extensive traffic management provisions (e.g. the provision of dedicated staff to direct/control traffic) are required by road control authorities, a traffic management allowance may be added to the standard replacement cost, after any other multipliers have been applied, for every kilometre of pipe route length. The allowances are: (a) Level 1 temporary traffic management requirements $ per (b) Level 2 temporary traffic management requirements $ per (c) Level 2 temporary traffic management requirements with excavation in the carriageway $ per. (d) Level 3 temporary traffic management requirements $ per Distribution Stations B.12 Distribution gas stations include Pressure Reducing Stations and those sections of Gate Stations that are owned by the distribution business (as distinct from those sections that belong to the Transmission network).

26 26 Draft ODRC Requirements Methodology B.13 Pressure Reducing Stations and Gate Station replacement costs should be based on cost effective configurations and compiled by the Valuer in accordance with clause B.5 and should be presented in the categories set out in table B.2. SCADA Master Station B.14 All facilities associated with a system control centre should be valued together as a master station. The value of remote units should be incorporated in the value of the appropriate station. Telecommunication Systems B.15 Terminal facilities at both ends of the communication system and associated cables should be valued together. The value of remote units directly linked with the instruments or sensing devices should be incorporated in the value of the appropriate station. Station Land and Buildings B.16 The replacement cost of station buildings and all associated assets should be included in the station valuation, but the land value should be treated separately. MAXIMUM LIVES B.19 Proposed standard asset total lives are given in Table B for the Distribution controlled business. B.20 Where an asset is made up of a number of items that have differing lives, a weighted average life is to be determined. This assessment should be recorded in the valuation report. B.21 Lives of assets not listed in Table B for Distribution assets should be established on a comparable basis with those in the tables. Such lives should not exceed the lives for comparable assets, should be subject to the approval of the Valuer, and should be verified and documented. Assessment of the TL of such assets must include: (i) examination of asset service records; (ii) discussion with maintenance personnel; and (iii) physical inspection. B.22 TLs less than the values in Table B should be assigned when the Valuer considers this appropriate. Circumstances when this could be appropriate include: (i) assets subject to adverse environmental conditions;

27 (ii) 27 Draft ODRC Requirements Methodology assets subject to particularly high use or showing systematic premature retirement due to failure; (iii) assets which were poorly installed or have been poorly maintained. Assessing Remaining Lives B.23 The life of each asset commences when the equipment was first commissioned. B.24 Refurbishment is classed as work done on the asset (or set of assets) that results in a material extension of its service life beyond its normal TL. This is in distinction to maintenance work which is done to ensure that an asset is able to perform its designated function for its normal TL. Accumulated maintenance should not be considered as refurbishment. Usually, refurbishment requires the replacement of parts of an existing asset. The existing asset could be broken into one part that keeps its original asset life and another part that will have a new TL. B.25 When a part of an existing asset has been refurbished, the Valuer could also assign a RL for the entire asset, effective from the time of refurbishment, but this RL should not be greater than the maximum TL as specified in Table B. B.26 When an asset has not been refurbished but is still in service at the end of its TL, the Valuer should ascribe a Remaining Life of 3 years to that asset. Lives of Distribution Pipelines B.27 A uniform maximum life of 70 years is given for all IP pipelines. A uniform life of 60 years is given for all MP and LP pipelines. A 50 year life should be used for MP mains of PE construction installed prior to This is notwithstanding the fact that a single set of values has been given reflecting the MEA asset replacement type. B.28 The following tables give replacement costs and lives that should be applied in valuing controlled business system fixed assets.

28 28 Draft ODRC Requirements Methodology DISTRIBUTION STANDARD COSTS AND LIVES B.29 The following table gives standard replacement costs and lives that should be applied in valuing Distribution system fixed assets. TABLE B: DISTRIBUTION STANDARD ASSET VALUES AND LIVES Asset Description Unit Notes Unit Replacement Cost ($000) Total Life (Years) IP PIPELINES 20 mm 32 mm 50 mm 80 mm 100 mm 150 mm 200 mm 250 mm 300 mm a a a a a a a a a

29 29 Draft ODRC Requirements Methodology MP PIPELINES 20 mm 32 mm 50 mm 80 mm 100 mm 150 mm a, f a, f a, f a, f a, f a, f 200 mm a, f 60 LP PIPELINES 20 mm 32 mm 50 mm 80 mm 100 mm 150 mm 200 mm STATIONS Land - e - - Site Development and Buildings. e ** 50 Regulators No. ** 35 Valves, Pipework and Fittings No. ** 35 Instrumentation and RTUs No. ** 35 Electrical Fittings No. ** 35 a, f a, f a, f a, f a, f a, f d 60 VALVES IP Valves (includes Pits and Covers) No. ** 70 MP & LP Valves (includes Pits and Covers) No ** 60 SERVICE CONNECTIONS Residential Customer Service Connection No. g 60 Commercial Customer Service Connection No. g 60 SCADA / CONTROL SYSTEMS SCADA Master Station No. ** 7 Telecommunication Systems No. ** 7 STORES and SPARES - ** 40