Australia: 2010 in review - A watershed year for regulated WACCs

Competition & Market Regulation
Last Updated: 16 December 2010
Article by Fleur Gibbons, Geoff Taperell and Simon Uthmeyer

The 2010 calendar year has been a watershed year for the determination of regulated weighted average costs of capital (WACCs) for infrastructure service providers.

In late 2009, the Australian Competition Tribunal (Tribunal) made a decision that hinted at the prospect of a greater preparedness to take a proactive approach to the determination of questions of WACC estimation than at any time previously. In 2010, the Tribunal has realised this prospect, finding errors in fundamental elements of the Australian Energy Regulator's (AER's) approach to the estimation of service providers' weighted average cost of capital (WACC). These errors have been found in respect of both the assumed utilisation of imputation credits (or gamma) and the debt risk premium (DRP), and in respect of more than one aspect of the AER's approach to estimating those parameter values. In addition, a number of additional review proceedings before the Tribunal were commenced in 2010 that raise issues of WACC estimation which will be determined by the Tribunal in 2011.

The Tribunal's findings have implications for regulated infrastructure service providers and the users of their services both within and outside the energy industry.

Tribunal decisions on regulated WACC

The Tribunal's decision, in late 2009, on the review of the AER's various transmission and distribution determinations for New South Wales and Tasmania was a harbinger of the Tribunal's changed approach to the determination of questions on WACC estimation. It provided only an inkling of the more numerous and significant Tribunal decisions on WACC estimation that have followed in 2010.

The implications of those decisions for infrastructure service providers are set out in the table that follows.

Paramater Value DLA Phillips Fox comments on implications for infrastructure service providers
Energy Australia Decision
RISK-FREE RATE The Tribunal's decision that the AER unreasonably withheld agreement to the averaging periods for determining the risk-free rate proposed by Energy Australia and the other applicants:
  • has precedential effect for future transmission and distribution determinations under the National Electricity Rules (which provide for service providers to propose and the AER to agree the averaging period), in which the choice of averaging period can have a significant impact on the risk-free rate. (In the Energy Australia Decision, for example, Energy Australia's proposed, and the AER's choice of, averaging period generated a risk-free rate of 4.29% and 5.82% respectively);
  • is of more limited relevance to decision-making on WACC under other regulatory frameworks which do not provide for a service provider to propose an averaging period for agreement by the regulator. The decision does, however, outline the principles that should be applied in deciding the time of estimation of the risk-free rate more generally.
DRP The Tribunal's decision that the AER made no error in selecting the Bloomberg fair yield curve service for estimation of the DRP is of limited precedential effect, as demonstrated by the subsequent ActewAGL Decision. In particular, the Tribunal's conclusion that no reviewable error was established was not dependent on any conclusions reached on the AER's methodology for assessing competing fair yield curve services or the data used by that methodology, and the Tribunal expressly observed that the AER would need to again consider its data sources and methodology in future revenue determinations.
Telstra ULLS Decision
RISK-FREE RATE In deciding that Telstra's estimate of the risk-free rate was not reasonable, the Tribunal reiterates its views expressed in the Energy Australia Decision on the principles that should be applied in deciding the time of estimation of the risk-free rate. As noted above, these may have future relevance.
In addition, the Tribunal expressed views on the term to maturity of the Government bonds used in estimating the risk-free rate which views may also have future significance, for example in the AER's forthcoming WACC review to be completed in 2014.
EQUITY BETA Many of the Tribunal's findings in support of its decision that Telstra's estimate of equity beta was not reasonable are of limited relevance to the estimation of WACC in respect of infrastructure services other than those provided by Telstra's copper customer-access network (or CAN).
However, the Tribunal's rejection of the use of the Blume adjustment (a technique that assumes that a firm's systematic risk reverts towards the mean of the market or a value of 1) and its reasons for doing so would have applicability to any future application of the Blume adjustment in estimating equity beta for infrastructure services other than those provided by the CAN.
WACC ESTIMATION GENERALLY It is not the Tribunal's specific findings on the risk-free rate or equity beta that are of greatest significance. It is the observations made by the Tribunal in the course of reaching those findings regarding the object of WACC estimation and the principles that should guide choices made in estimating WACC that are of the greatest significance for future matters. These comments provide insight into the likely approach of the Tribunal to, and the principles that will inform its consideration of, WACC issues in future reviews. By way of example, these observations include its observations:

at [422] that 'the use of the WACC formula is only a means to an end, which is to estimate the required rate of return for an investment with certain characteristics of riskiness and debt. ... Moreover, the rate of return applies over the period of the undertaking. Both the access provider and the ACCC should keep these facts in mind to ensure that they do not, by lighting on parameter values that are unrepresentative, end up with a rate of return that is inappropriate to its purpose'; and

at [477] to [482] that a variety of techniques should be used to estimate the ultimate WACC value and individual parameter values like the equity beta and that, while international benchmarking analysis is useful in estimating equity beta, it should employ a broad data set where there is uncertainty over suitable comparators and should not be relied on to the exclusion of other techniques.
ActewAGL Decision
DRP The cessation of publication of all CBASpectrum fair yield curves in early September 2010, leaving only the Bloomberg fair yield curve service, reduces the future applicability of the ActewAGL Decision, in which the Tribunal concluded that the AER's method for selecting between the CBASpectrum and Bloomberg services was erroneous. It is only in the event that CBASpectrum recommences publication of a fair yield curve after revising its methodology to determine that curve (which it has foreshadowed it may do) that the Tribunal's conclusions will be directly applicable.
WACC ESTIMATION GENERALLY However, the principles underpinning the Tribunal's approach in the ActewAGL Decision may nonetheless inform its own and other economic regulators' future consideration of the estimation of both the DRP and other WACC parameter values. For example:
  • the reservations expressed by the Tribunal regarding the use of statistical outlier tests are likely to inform its own and other economic regulators' future consideration of the exclusion of outliers, including in the estimation of other parameter values such as gamma. (For an example of this, see the subsequent Energex Decision on gamma estimation, in which the Tribunal echoed its sentiments on the exclusion of outliers and the use of statistical outlier tests in respect of the filtering of the data used in deriving an estimate of theta in the Beggs and Skeels study);
  • the ActewAGL Decision may inform other economic regulators' consideration of the future method for estimation of the DRP following the cessation of publication of all CBASpectrum fair yield curves in September 2010. (For an example of this, see the Western Australian Economic Regulation Authority's Discussion Paper Measuring the Debt Risk Premium: A Bond-Yield Approach dated 1 December 2010, in which the Authority sets out its proposed future method to estimation of the DRP for rail, electricity and gas pipeline service providers following cessation of the CBASpectrum service and, in so doing, has explicit regard to the ActewAGL Decision.); and
  • the ActewAGL Decision may inform any future Tribunal assessment of the AER's most recent approach, as seen in the AER's Final decision Victorian electricity distribution network service providers Distribution determination 2011-2015 of October 2010 (Victorian Distribution Determination Decision), of comparing the Bloomberg fair yield curve to a single data point provided by an individual corporate bond (in the Victorian Distribution Determination Decision, the bond issued by the Australian Pipeline Trust) to determine if any adjustment to the Bloomberg fair yield curve is required in estimating the DRP.
Energex Decision
GAMMA The Energex Decision has significant precedential effect. It will have significant implications for the Tribunal's determination of the pending reviews commenced by Jemena Gas networks (NSW) Ltd and the Victorian electricity distributors with respect to the AER's decision-making on gamma. It can also be expected to influence the decision-making of the AER and economic regulators on gamma estimation in other industries such gas, water and telecommunications.

Tribunal's changed approach to questions of WACC estimation

Under Justice Finkelstein's presidency, the Tribunal would appear to have adopted a markedly different approach to the review of WACC estimation. While the decisions summarised above are of differing precedential significance, they all demonstrate a greater preparedness by the current Tribunal to actively scrutinise and interfere with the original regulator's decision on WACC estimation.

Before Justice Finkelstein's appointment, the Tribunal's decisions, even though made in the context of a full rehearing rather than a review for error as in the case of reviews from AER decisions under the National Electricity Law or National Gas Law, disclose a reticence to depart from the decision made by the original regulator. The Tribunal's approach was one of weighing the competing submissions and expert evidentiary material before it.1

By contrast, under Justice Finkelstein, the Tribunal has disclosed a greater propensity to rely on and substitute its own expert opinion for that of the regulator at first instance in determining the questions of WACC estimation before it and (as illustrated by the Energex Decision in particular) to consider issues pertaining to WACC estimation not put in issue by the parties before it. It no longer confines itself to a weighing of the expert opinion put before it by the parties to resolve the questions put in issue by those parties.

The Tribunal's preparedness to proactively engage with and determine questions of WACC estimation using the Tribunal's specialist knowledge of WACC issues is consistent with the views expressed by the Tribunal on its role under Justice Finkelstein's presidency shortly after his appointment. The Tribunal concluded that, in contrast to a judge who must decide cases based on the facts that have been tendered in evidence, the Tribunal may have regard to its own expertise:

'Each of the ACCC and the Tribunal perform highly specialised tasks. In the absence of appropriately qualified members who can make use of their knowledge and experience in the areas which qualified them for appointment, neither the ACCC nor the Tribunal could carry out its functions effectively.
... It is for this reason that courts have held that a member of a specialised tribunal is entitled to use his or her experience in interpreting and weighing the material and in reaching conclusions on technical matters...
In this respect the function of a specialist tribunal is different from that of a judge. Judges must decide cases based on the facts that have been tendered in evidence. The judge is an expert in the law and will rely on that expertise in deciding a case...
The Tribunal, however, is better placed than a judge. It has no need to go to external material to inform itself of, for example, principles of industrial organisation, although those principles may go to the very heart of an issue before it. The reason the Tribunal has no need to look to extrinsic material is that some of its members were appointed because they possess knowledge of those principles.'

The Tribunal's view that it is a specialist body, more akin to economic regulators like the ACCC and the AER than to judges, is borne out by its preference, having found error in the AER's decision-making on WACC, to commission its own expert reports and definitively determine the matters before it rather than to remit them to the AER for redetermination.

Conclusion and the 'watching brief'

The Tribunal's findings to date are likely to shape not only the AER's decision-making on WACC estimation in future transmission and distribution determinations, its next WACC review under the National Electricity Rules and future access arrangement decisions under the National Gas Rules, but also that of other economic regulators including those responsible for regulating industries other than the energy industry. This is particularly so where review by the Tribunal is available for the decisions of those regulators.

In addition, the Tribunal's decisions mark a fundamental shift in the Tribunal's approach to the review of regulatory decisions on WACC estimation. It follows that the Tribunal's review decisions on the AER's estimation of WACC tell us something about its future appetite for engaging with, and finding error in, the original regulator's approach to estimating WACC, regardless of the industry that is the subject of regulation.

It follows that the Tribunal's findings have implications for regulated infrastructure service providers and the users of their services both within and outside the energy industry. The Tribunal's decisions in 2010 and its impending decisions in 2011 on WACC estimation should be on the radar of every regulated infrastructure service provider.

On the regulated service provider's 'watch list' should be the following decisions that are expected to be made by the Tribunal in 2011:

  • The further decision of the Tribunal foreshadowed in the Energex Decision, in which the Tribunal will make orders to address the errors found in the Energex Decisions in the AER's approach to the estimation of gamma and which are anticipated to include an order as to the value of gamma to be applied to Energex Limited (Energex), Ergon Energy Corporation Limited (Ergon) and ETSA Utilities (ETSA) in their current distribution determinations.
    • A decision on the review by Jemena Gas Networks (NSW) Ltd (JGN) of the AER's decision, Jemena Gas Networks (NSW) Ltd's NSW Gas Distribution Networks: Decision - Access Arrangement, heard by the Tribunal in December 2010. JGN alleges that the AER erred in estimating both the DRP and gamma. In particular, JGN contends that:
    • The AER erred in adopting its own methodology for testing the Bloomberg and CBASpectrum fair yield curve services with a view to determining which service to use in estimating the DRP and in its resultant decision to use the CBASpectrum service.
    • The AER erred in estimating gamma for substantively similar reasons to those considered by the Tribunal in the Energex Decision.
  • A decision on the review by the Victorian electricity distributors, CitiPower Pty, Powercor Australia Ltd, SPI Electricity Pty Limited, Jemena Electricity Networks (Vic) Ltd and United Energy Distribution Pty Limited, which is expected to be heard in mid-March to mid-April 2011. The issues raised by the Victorian distributors regarding WACC estimation include:
    • The AER's failure to annualise Bloomberg bond yield data and its decision to give the yield on an individual corporate bond, being the bond issued by Australian Pipeline Trust, a weighting of 25% (with the Bloomberg bond yield data being given a weighting of 75%) in estimating the DRP.
    • The AER's approach to the estimation of gamma in the Victorian Distribution Determination Decision, which approach differed to some extent from that considered by the Tribunal in the Energex Decision.

The Tribunal's decision on the JGN review may be of limited precedential significance given that:

  • CBASpectrum ceased publication of all of its fair yield curves in early September 2010 and, as a result, the AER has subsequently, in the Victorian Distribution Determination Decision, adopted a different methodology for estimation of the DRP; and
  • JGN advances substantively similar reasons for asserting the AER erred in estimating gamma to those advanced by Energex, Ergon and ETSA in their application for review, the Tribunal could reasonably be expected to follow the findings of the Tribunal in the Energex Decision in the JGN review.

The decision on the Victorian distribution determinations can, however, be expected to provide additional guidance on the Tribunal's approach to WACC estimation.

Summary of Recent Australian Competition Tribunal Review Decisions on WACC Estimation

DLA Phillips Fox has acted/acts in a number of the Tribunal proceedings discussed in this update including Re Telstra Corporation (No 3), the Telstra ULLS Decision and the current proceedings for review commenced by the Victorian electricity distributors. All views expressed in this update are DLA Phillips Fox's own.

1. Re Telstra Corporation (No 3) [2007] ACompT 3 at [414]-[473]; Re Vodafone Network Pty Ltd & Vodafone Australia Limited [2007] AComp T 1 at [258]-[261].

© DLA Phillips Fox

DLA Phillips Fox is one of the largest legal firms in Australasia and a member of DLA Piper Group, an alliance of independent legal practices. It is a separate and distinct legal entity. For more information visit

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances.

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