DISCUSSION DOCUMENT ON UNREASONABLE OR EXCESSIVE PIPED- GAS PRICES OR TARIFFS

Transcription

1 DISCUSSION DOCUMENT ON UNREASONABLE OR EXCESSIVE PIPED- GAS PRICES OR TARIFFS

2 Table of Contents 1. PURPOSE SCOPE LEGAL CONTEXT PROBLEM STATEMENT HOW NERSA MEASURED EXCESSIVE PRICNG IN THE PREVIOUS REGIME HOW NERSA DETERMINE MAXIMUM GAS PRICE INTERPRETATION OF UNREASONABLE OR EXCESSIVE PRICE AND ECONOMIC VALUE BY THE SOUTH AFRICAN AUTHORITIES AND THE COURTS INTERNATIONAL APPROACHES TO EXCESSIVE PRICING CRITERIA FOR DETERMINING UNREASONABLE OR EXCESSIVE PRICE OR TARIFF GENERAL SUGGESTED APPROACHES IN DETERMINING EXCESSIVE PRICING CIRCUMSTANCES WHERE PRICES OR TARIFFS CAN BE VIEWED AS UNREASONABLE OR EXCESSIVE CONCLUSION

3 1. PURPOSE 1.1. The document is developed as a discussion document through which the National Energy Regulator (NERSA) can obtain guidance on the methodology to determine if prices or tariffs are unreasonable or excessive within the piped-gas industry, as contemplated in section 31(1)(b) of the Gas Act, 2001 (Act No. 48 of 2001) This document proposes the criteria to be considered or followed by the Energy Regulator when assessing whether prices or tariffs are excessive or unreasonable, within the context of the Gas Act, It does not intend to reproduce any prevailing legislation regarding the regulation of unreasonable or excessive prices or tariffs It is intended to discuss circumstances within which unreasonable or excessive prices or tariffs are charged based on cases considered by the Energy Regulator. Such proposed criteria and set of circumstances are largely underpinned by the legal framework governing gas prices, including: the Methodology to approve maximum prices of gas as approved in October 2011; Guidelines for transmission and storage tariffs as approved in May 2009; the Piped-Gas Regulations Regulation 4; and the Gas Act and Annexure A to the Regulations The criteria to test for excessive price, circumstances when prices or tariffs can be unreasonable or excessive and the measurement for unreasonable or excessive prices or tariffs discussed here will assist in determining whether prices or tariffs are unreasonable or excessive. 3

4 Question 1: Can a regulated price or tariff be excessive or unreasonable? 2. SCOPE 2.1. The document discusses the circumstances when prices or tariffs can be viewed as unreasonable or excessive. Furthermore, it looks at the criteria that must be met before such a determination can be made. This criteria enumerates aspects that need to be clarified, such as the definition and interpretation of unreasonable or excessive and economic value It will also look at the determination made by the courts and South African authorities on excessive prices for guidance on the interpretation of excessive price and economic value The document identifies circumstances where prices or tariffs can be determined as unreasonable or excessive based on cases investigated by the Energy Regulator in the gas sector. Question 2: Under what circumstances could a regulated price or tariff become excessive? 3. LEGAL CONTEXT 3.1. The Energy Regulator is mandated to regulate the gas prices in terms of section 4(g) read with section 21(1)(p) and the tariffs in terms of section 4(h) of the Gas Act, 2001 (Act No. 48 of 2001) In terms of section 21(1)(p), maximum prices for distributors, reticulators and all classes of consumers must be approved by the Gas Regulator 4

5 where there is inadequate competition as contemplated in Chapters 2 and 3 of the Competition Act, 1998 (Act No. 89 of 1998) Furthermore, section 4(h) of the Gas Act requires the Energy Regulator to monitor and approve, and if necessary regulate Transmission and storage tariffs and take appropriate action when necessary to ensure that they are applied in a non-discriminatory manner as contemplated in section A price is a charge for gas to a distributor, reticulator or final customer whereas a tariff is a charge for gas services to any customer. The total gas price in terms of our legal framework should consist of the gas price component, transmission tariff, distribution tariff, storage tariff (if available), the trading margin and the levies The prices regulated by the Energy Regulator should mimic competition as per the objectives of the Gas Act. This is strengthened by section 21(1)(p), which states that the Energy Regulator may only intervene by regulation of the gas prices when there is inadequate competition. Therefore the maximum price methodology provides a mechanism for determining maximum gas prices at which customers are willing to buy and at which gas traders are willing to sell, while also encouraging investment in the gas market. The ultimate goal is to encourage gas-on-gas competition The Energy Regulator has a duty in terms of the Gas Act 2001, section 31(1)(b) to conduct investigations into complaints by customers relating to unreasonable or excessive prices or tariffs imposed by a licensee. However, section 31(1)(b) does not define what an excessive or unreasonable price or tariff is. 5

6 3.7. It does not mean that the price will only be excessive when it is above the approved maximum. There may be other instances where the gas price is lower than the approved maximum level, but is still at an unreasonable level. Those circumstances will be discussed later in this document The question is whether it will be an appropriate approach to adopt the definition of excessive price as provided in the Competition Act, This approach will be in line with the object of concurrent jurisdiction as set out in the Competition Act, Question 3: Should the definition of excessive price as provided in the Competition Act be adopted in determining excessive price in the Gas Industry? What is an unreasonable or excessive price? 3.9. Section 1(1)(ix) of the Competition Act defines excessive price as a price for goods or services that bears no reasonable relation to the economic value of those goods or services and is higher than such economic value However, the Competition Act does not define the term economic value. As a result, due regard has to be taken from relevant case law to fully explore the meaning attached by judicial authorities to various elements of excessive pricing The Energy Regulator s approach within the context of arriving at a maximum gas price has considered the economic value of gas as the weighted average of the value of energy indicators such as liquefied petroleum gas (LPG), high fuel oil (HFO), diesel, electricity and coal. 6

7 These are tracked at wholesale level at the point of entry of gas into the transmission or distribution pipeline The word unreasonable is also not defined. A Google search on definitions defines unreasonable as something that is excessive, immoderate, or exorbitant; unconscionable and not guided by reason or sound judgement. This supports that an unreasonable price is a price that is exorbitant or unconscionable. The question is at what level could the price be exorbitant? This can be described as prices that are unfairly high relative to the value of the product and service provided and when compared to prices in other markets with similar circumstances or other customers with similar circumstances. Question 4: How do you determine the economic value of the product in the gas industry? 4. PROBLEM STATEMENT 4.1. The Energy Regulator regulates maximum prices and tariffs by approving the maximum levels. There are instances where customers have approached the Energy Regulator alleging that gas prices or tariffs are unreasonable or excessive. Under such circumstances, the Energy Regulator is compelled in terms of section 31(1)(b) to investigate complaints from customers pertaining to unreasonable or excessive prices or tariffs There are instances where customers asserted that the tariffs charged are unreasonable because of a lack of differentiation based on cost associated with the transmission distance. In this case, customers argue that the cost of supply of gas if they are close to the connecting point should be lower than the tariff that is charged. Currently, the tariff charged 7

8 does not give due regard to the cost of supply/service incurred by that customer This occurs in circumstances where the Energy Regulator has approved zonal tariffs, taking into account the value of assets of the transmission pipeline within the specific zone. This results in all customers in that zone paying the same tariff irrespective of cost of supply or transmission distance. An example is a case where the customer s point of connection for gas supply is closer to the transmission pipeline than other customers on the same transmission pipeline Another instance relates to the notional or inflated pass-through tariff. In this instance, a customer could be overcharged as a result of the wrong implementation of tariffs by using a weighted average of two or more approved maximum tariffs that are applicable to different customers. This results in a customer being charged a tariff higher than that which is applicable to it In the case of price, the use of the declining pricing mechanism by the licensee, when influenced largely by volumes, determines the actual price to be charged to a customer. In this instance, the price the customer pays is determined by calculating the gas price using the weighted average prices of different customer class volumes instead of using only the volumes that are applicable to the class volumes that the customer belongs to Furthermore, there are instances where there is a duplication (double counting) of the costs when calculating the weights of the energy indicators. An example is when the cost of coal used in generating electricity is used in the electricity indicator calculation. This cost must be excluded from the weights of the energy indicators. 8

9 5. HOW NERSA MEASURED EXCESSIVE PRICE UNDER THE PREVIOUS PRICING REGIME Prices (excessive or unreasonable) 5.1. The gas prices to customers were determined using the Market Value Pricing (MVP) mechanism in terms of clause 1.16 and clause 8 of the Regulations. In terms of MVP, prices are determined by comparison with: the cost of the alternative fuel delivered to the customer s premises or anticipated place of use; the difference between all the operating costs of the customer s use of the alternative fuel and all the operating costs of using natural gas; and the difference between the Net Present Value (NPV) of the capital costs of the customer s continued use of the alternative fuel and the NPV of the capital costs involved in switching to natural gas, as would be reflected in the customer s accounts The gas price was determined by considering the cost of the alternative fuel used by the customer before switching to gas. In this case operational costs and capital expenditure were taken into consideration. The price will then be a maximum as required by clause 8 of the Regulations. This is the maximum price applicable to an individual customer However, the MVP had several shortcomings because it required, inter alia, historical data, which was not available at times. A product proxy had to be used to track the value of the alternative energy source. If the 9

10 price was above the MVP level determined, then it was considered excessive or unreasonable. This regime expired on 25 March Tariff (excessive or unreasonable) 5.4. Section 4(h) of the Gas Act requires the Energy Regulator to monitor and approve, and if necessary regulate Transmission and storage tariffs and take appropriate action when necessary to ensure that they are applied in a non-discriminatory manner as contemplated in section During this regime it was not possible to determine whether a tariff is excessive or unreasonable because it was included in a bundled price. There was no separate calculation of the tariff. 6. HOW NERSA DETERMINES MAXIMUM GAS PRICES 6.1. The Energy Regulator determines the maximum gas price by tracking its value to energy indicators (i.e. LPG, HFO, electricity, diesel and coal). This is done by taking the weighted average of the energy indicators The cost of gas is not the determinant of the price of gas. The value of the energy indicators at wholesale levels are considered at the point of entry of gas into the transmission and distribution pipelines as benchmarks on a weighted average basis to arrive at the maximum gas price. That value for gas should be determined at the first point of entry into the transmission or distribution pipeline. The wholesale levels considered relate only to the gas price component and not the charge for the use of the infrastructure to transport gas (tariffs), as well as trading margin and levies. 10

11 6.3. The Energy Regulator approves the maximum prices, not the actual gas prices. Actual prices are subject to commercial negotiations between the gas traders and customers, guided by the principle of price discrimination as prescribed in section 22 of the Gas Act. This is where unreasonableness or excessiveness of gas prices or tariffs could arise as individual negotiations on actual prices present an opportunity for differentiation on prices or tariffs In terms of section 22(1) of the Gas Act, Licensees may not discriminate between customers or classes of customers regarding access, tariffs, prices, conditions or service except for objectively justifiable and identifiable differences regarding such matters as quantity, transmission distance, length of contract, load profile, interruptible supply or other distinguishing feature approved by the Gas Regulator Section 22 of the Gas Act allows differential prices or tariffs if it is objectively justified by quantity, transmission distance, length of contract and other factors in terms of this section. Differential price based on quantity (volume), if not properly implemented within the confines of allowed volumes, may result in excessive price. 7. INTERPRETATION OF EXCESSIVE OR UNREASONABLE PRICE AND ECONOMIC VALUE BY THE SOUTH AFRICAN AUTHORITIES AND THE COURTS 7.1. In regulating for competition, the Energy Regulator should take guidance from section 3(1A) (b) of the Competition Act, which provides a governing policy statement on regulation of competition matters in regulated sectors. This section provides guidance on concurrent jurisdiction management. A Memorandum of Understanding (MoU) was concluded with the former National Electricity Regulator (NER) in terms of sections 11

12 21(1)(h) and 82(1) of the Competition Act between the NER and the Competition Commission, however there is no such MoU between NERSA and the Competition Commission. The said concurrent jurisdictional management is realised through cooperation between the competition authorities and the Energy Regulator for their inputs before making any decisions relating to gas prices Further guidance may be taken from the relevant decisions of the Competition Tribunal and also the relevant decisions of the Competition Appeals Court, in their capacities as the competition authorities of record with jurisdiction throughout the Republic in terms of section 26(1) and section 36(1) of the Competition Act Lastly, the Energy Regulator will consider the approaches of other international jurisdictions in the interpretation of what constitutes unreasonable or excessive price. Competition Act 7.4. Section 8(a) prohibits a dominant firm from charging an excessive price to the detriment of consumers Section 1(1)(ix) of the Competition Act defines excessive price as a price for goods or services that bears no reasonable relation to the economic value of those goods or services and is higher than such economic value However, the Competition Act does not define the terms economic value. As a result, due regard has to be given to relevant decided case law to fully explore the meaning attached by judicial authorities to various elements of excessive pricing. 12

13 Excessive pricing in decided case laws 7.7. The cases that were heard in South Africa on excessive pricing are listed below: The Competition Tribunal case of Harmony Gold Mining Company Ltd and Another v Mittal Steel South Africa Limited and Another (13/CR/Feb04) [2007] ACT 21 (hereinafter Harmony Gold ), which was later taken on appeal to the Competition Appeal Court under the citation of Mittal Steel South Africa Limited and Others v Harmony Gold Mining Company Limited and Another (70/CAC/Apr07) [2009] ZACAC (hereinafter Mittal Steel ) The Competition Tribunal case in the matter between The Competition Commission v Telkom SA Ltd 11/CR/Feb The definition of excessive price in the Competition Act is based on the leading European excessive pricing case of United Brands v Commission 27/76 [1978] ECR 207, [1978] 1 CMLR 429, where the European Court of Justice confirmed that a firm abuses its dominance if it charges a price that is excessive because it has no reasonable relation to the economic value of the product supplied. The Tribunal s approach to excessive pricing in Harmony Gold 7.9. In the Harmony Gold case, the Tribunal completely rejected the methods by which excessive prices have been identified in European Communities case law on the basis that it is not itself in the business of price regulation, but is rather only focused on removing the structural and behavioural conditions that generate excessive prices and so inhibit competition. 13

14 7.10. The tribunal proceeded to set out the following two-step test for analysing whether the firm has indeed charged an excessive price The structural test The Tribunal held that the firm must be super-dominant and the market should be both uncontested and incontestable The conduct test The Tribunal held that for the price to be regarded as bearing no relation to the economic value of goods or services concerned, no explanation must exist for it other than the exercise of the monopoly power as evidenced by the market structure in line with guidance given under the structural test The Tribunal found in favour of the complainants and held that Mittal Steel s pricing method (i.e. import parity pricing or the pricing of its domestically manufactured products on the basis of notional cost that its customers will incur to import the same product) constituted a contravention of section 8(a) of the Competition Act. The Competition Appeal Court s approach to excessive pricing in Mittal Steel The Competition Appeal Court (CAC) held that the notion that the firm must be super dominant and that the market must be uncontested and incontestable find no support in the Competition Act. Instead, the prohibition of excessive pricing applies to all dominant firms, provided that the requirements of section 6 and 7 are met. The CAC did not define what economic value is and whether it must be assessed from cost of the product or service. 14

15 7.13. The CAC held that the Tribunal had erred in its approach when it found that Mittal had charged an excessive price without establishing the economic value of the goods or service. The CAC confirmed that the tribunal is not required to set or regulate prices The CAC did not interpret the economic value and whether it must be assessed from cost of the product or service thereof The CAC took guidance from some relevant European case law and set the following four-step test in analysing if the firm has charged an excessive price: Factual determination of the actual price of the good or service alleged to be excessive the CAC asserted that the actual price of the goods or service that is alleged to be excessive must be factually determined Factual determination of the economic value of the goods or service in question in monetary terms the CAC held that the term economic value means an estimated or imaginary price that would be charged in circumstances of long-run equilibrium, and that it must therefore refer to an amount of money. It further held that the economic value of goods or services should be determined in light of the relationship between the actual price charged for such goods or services and its monetary value, taking into account the value of the product both to the vendor and the purchaser as evidenced by a series of factors Exercise of the value judgement as to whether or not, if the actual price is found to be higher than the economic value of the goods or service in question, the difference between the two amounts is unreasonable where the price of goods or services appears to bear no reasonable relation to the economic value of such 15

16 goods or services, the onus shifts to the dominant firm to adduce evidence to the contrary Exercise of the value judgement as to whether the imposition of excessive price is to the detriment of consumers the term consumer ought to include both those who consume the goods or service productively or as final consumers. In other words, it is immaterial that the excessive price has only been charged to an intermediate buyer who is still going to on-sell it to the final consumer The matter was remitted to the Tribunal for determination by the CAC. However, the parties settled the matter out of court before it could return to the Tribunal. The Tribunal s approach to excessive pricing in Telkom SA Ltd The Tribunal found that the Commission s pleadings failed to allege what the economic value of the goods or services were as required by Mittal 1. It only alleged that Telkom was providing access to its customers at prices that were cheaper than those charged to private VANS providers and their customers The Commission argued that the prices that Telkom was charging to its customers could be deemed to constitute the economic value. The Tribunal concluded that the Commission did not lead any evidence that these charges were indeed the economic value of the access circuit as required by Mittal. 1 Mittal Steel South Africa Ltd and others v Harmony Gold Mining Company Ltd and other, CAC Case No:70/CAC/Apr07 16

17 7.19. The Tribunal concluded that they did not have enough information to conclude that these charges could serve as a proxy for economic value. The Tribunal made no finding of excessive pricing or price discrimination The issue of the interpretation of what excessive price is, has not been settled. It appears they do not use the price-cost comparison as a paramount measure for excessive prices. Question 5: What is the method of assessing whether a regulated price is excessive or unreasonable? 8. INTERNATIONAL APPROACHES TO EXCESSIVE PRICING The approach to the United Brands Company and United Brands Continental BV (United Brands) v The Commission of the European Communities (The Commission) The case was heard by the European Court of Justice (ECJ). The Commission alleged that United Brands infringed article 86 of the treaty establishing the European Economic Community by imposing unfair prices for the sale of Chiquita bananas on its customers in the Belgo- Luxembourg Economic Union, Denmark, the Netherlands and Germany (other than the SCIPIO Group), which under the circumstances it considered to be excessive in relation to the economic value of the product supplied In order to evaluate excessive price, the court used the following parameters: the banana prices of competing brand names; 2 United Brands v Commission 27/76 [1978] ECR 207, [1978] 1 CMLR 429; Attheraces Ltd 17

18 the prices of United Brands non-branded bananas; and the prices of United Brands bananas with brand names affixed according to country of destination The price differences showed that the highest prices were excessive compared to the lowest prices, especially as the latter yields a profit There are other cases that were based on the European excessive pricing case laws on the definition of excessive price From the consulted United States case law 4, however, it has become manifest that excessive pricing is not regulated in that particular jurisdiction. Therefore, these case laws are not further deliberated on for the purpose of this evaluation. 9. CRITERIA FOR DETERMINING UNREASONABLE OR EXCESSIVE PRICE OR TARIFF 9.1. Section 31(1)(b) of the Gas Act requires the Energy Regulator to conduct investigations into complaints by customers relating to unreasonable or excessive prices or tariffs imposed by a licensee. However, there is no mention in the Gas Act on how this should be done Furthermore, section 10(d) of the Gas Act state that any decision of the Energy Regulator must be taken within a procedurally fair process in which all affected persons have the opportunity to submit their views and 3 The British Horseracing Board Ltd [2007] EWCA Civ 38; and Napp Pharmaceutical Holdings v Director-General of Fair Trading UK Competition Appeal Tribunal 1001/1/1/01 15/01/ Trinko decision of the US Supreme Court; United States v Trans-Missouri Freight Ass, 166 U.S. 290 (1897); United States v Trenton Potteries Co,273 U.S 392 (1927); United States v Aluminium Co. of America, 148 F.2d 416 (2d Cir. 1945) 18

19 present relevant facts and evidence at their own expense to the Energy Regulator Before deciding on whether a price or tariff is excessive or not, certain criteria should be met. Criteria to be satisfied for an effective test of excessive price or tariff 9.4. The criteria to be met are stated below: Be well-defined there needs to be a clear definition regarding what constitutes unreasonable or excessive prices or tariffs and of any other circumstances that may result in unreasonable or excessive prices or tariffs Provide ex ante legal certainty requires that a test is known by firms before they make their pricing decisions, which informs them of which prices or tariffs will be an infringement of the Gas Act or which will not Be simple to implement collection of relevant information required on the variables of the test should be simple and the information should be able to determine that the price is excessive Improve welfare it should deter licensees from exploiting consumers in the long run with minimal adverse effects on investment and innovation Define economic value the definition of the economic value must be related to the Energy Regulator s adopted maximum price methodology of October Question 6: Are the criteria mentioned in the Discussion Document exhaustive? If not, what other criteria should be used? 19

20 10. GENERAL SUGGESTED APPROACHES IN DETERMINING EXCESSIVE PRICING There is no case law in South Africa on excessive pricing that has determined which methodology is the appropriate one to be used in determining excessive prices. Even in terms of the international cases, no methodology has been decided on as the appropriate one. Different methodologies have been proposed and applied in situations where they are best suited The Energy Regulator has prepared the discussion on the methodologies that were referred to in various literature. This does not mean that the ones listed in this discussion document are the only ones that can be used in determining excessive prices. Question 7: Is it the appropriate time for the Energy Regulator to be discussing methodologies to determine unreasonable or excessive price or tariff? If not, how should the Energy Regulator determine unreasonable or excessive prices or tariffs at the moment? Price-cost comparison approach The above test requires that there should be a threshold price which guarantees a sufficient margin with respect to costs, and that above such a threshold the price charged by a dominant firm will be excessive The difficulty with such an approach is that a competitive price is not only determined by supply-side factors, but also by demand-side factors. It is also not possible to apply the same threshold margins to licensees who have different business models even though they are all trading in gas. 20

21 10.5. The costs to be used in this test should also be only those that relate to the business. It is difficult to allocate the exact costs if the business is involved in producing multi-products. There are also questions that will need to be clarified. The Energy Regulator s approach to the methodology Profitability is used to measure the acceptable level in this methodology. The Energy Regulator uses the rate of return when approving the tariffs of a licensee. This is done by calculating the weighted average cost of capital (WACC) to see if it is at an acceptable level. This is done when the tariff or trading margin is being processed If the WACC calculation is not accurate or costs associated to its components such as the cost of debt and equity are overstated, this situation may be corrected when a clawback is done in the following year. If the projected gas volumes used to determine the revenue required for the applicant firm is high, a clawback will be done to rectify the matter Ex post assessment of a tariff involves checking whether there is overrecovery or under-recovery of the tariff. The Energy Regulator uses the Regulatory Reporting Manuals (RRM) to get the regulatory financial information. Regulated entities submit their half-year and full-year financial reports, which the Energy Regulator evaluates to determine if they conform to the RRM When calculating the gas price, the Energy Regulator uses the WACC to calculate the trading margin. The charge of gas is based on the value of other energy indicators. 21

22 Using the above to measure the value of gas might be unreasonable as the value derived here might be due to the inefficiency of the regulated entity. In this instance, it will not be easy to draw a comparison with other companies in South Africa because of the structure of the gas market. Another way would be to check profitability levels and do a comparison with other companies in similar markets The reason for this is that there is only one supplier of gas in South Africa who does not directly compete with suppliers of available energy sources such as electricity, diesel, etc. Comparison between prices charged by the dominant firm in different markets approach This approach is prevalent in a situation where a licensee set a price in one market that is well above the price it sets for the same product in another market, and it is then profitable in the latter market. The Energy Regulator s approach to the methodology This approach cannot be used in the South African gas market because the dominant firm charges its prices based on the maximum price that is approved by the Energy Regulator. Benchmarking approach This approach consists of a comparison between the prices charged by the dominant firm and those charged by other firms, either in the same market or other markets, which operate in competitive market conditions. 22

23 The Energy Regulator s approach to the methodology The prices of other energy indicators have been considered as substitutes (i.e. coal, electricity, diesel, LPG and HFO). The gas price is determined by reference to the values of these products. In determining the values of these products, the transport elements are deducted. The values are determined by using the wholesale values Using this approach is also impossible because gas is imported (even though there is insufficient gas produced in the domestic market) and there are transportation costs involved that must be considered The methodology for arriving at the maximum price of gas (the basket of alternatives) is appropriate under the prevailing circumstances characterised by the existence of a single gas supplier with the vast majority of the gas being sourced from a single imported gas supply However, where the licensee deems the price determined by this methodology to be materially lower or higher than its preferred and appropriate gas price in that it impacts the ability to compete and/or recover efficiently and prudently incurred costs and make a profit commensurate with risk, then the Energy Regulator will allow such a licensee to opt for the use of the pass-through approach to ensure that the licensee fully recovers all its efficiently and prudently incurred costs and makes a profit commensurate with its risk as provided for in the legislation. This will of course apply to instances when the preferred and appropriate price is either higher or lower than the one determined by using the approach of the basket of alternatives. 23

24 This approach will then become the systematic methodology to be consistently applied throughout the licence period for such a licensee electing to use this pass-through approach. Concentrating on the profits of the dominant firm and comparing such profits either with a normal competitive profit or the profits of other firms The methodology compares the licensee s return on capital with its WACC. If the licensee s return on capital is greater than its WACC, then the price is considered excessive Furthermore, the methodology compares the profit rates of the dominant firm to the profits obtained by similar companies in other geographic markets. The Energy Regulator s approach to the methodology The Energy Regulator calculates the WACC of the licensee when it approves the return that the licensee should earn during the approval of the maximum prices and tariffs. The Energy Regulator allows for a reasonable return based on the costs incurred by the licensee on its investments. A prudence check is done on the costs incurred by the licensee to avoid the inclusion of those that are not relevant to the business. Question 8: Which methodology should the Energy Regulator use when determining unreasonable or excessive pricing? 24

25 11. CIRCUMSTANCES WHERE A PRICE AND TARIFF CAN BE VIEWED AS UNREASONABLE OR EXCESSIVE Price Implementation of Declining Pricing Mechanism The Regulations provide for different customer classes based on volumes. In this case, prices can be excessive when determining the actual price. The declining block mechanism is used in such a way that the price is calculated across all the customer classes, instead of using only the customer class that the customer belongs to The actual price calculated will still be below the maximum price of the class, but at a higher price level than it would have been had only the licensee considered the volumes of the customer class to which the licensee belongs Calculating using weighted average of other energy indicators The weighted average calculation using the energy indicators may result in the overstatement of the cost when adjusting for the actual maximum price levels. This can be done by using wrong conversion factors for LPG or HFO Duplication (double counting) This can happen in a situation where coal or diesel costs used for electricity generation are included in the electricity component 25

26 when calculating the Gas Energy (GE) price. When calculated the weight for electricity, such cost must be excluded Inflated value of GE indicators The value of the maximum price approved may be inflated via the diesel price Prices charged by the licensee exceed the maximum GE level approved by the Energy Regulator Based on cases considered by the Energy Regulator, there are situations where the licensee implements prices that are higher than the approved maximum price. This may also happen in a situation where a component of the total maximum price is not approved by the Energy Regulator, but the licensee implements it regardless of this Unfair discrimination Unfair discrimination occurs when customers with the same objectively identifiable features in terms of section 22 are charged different prices or unreasonable prices. When using objectively identifiable features like volume, it can result in unreasonable prices. This occurs when customers in lower volumes are charged prices that are much higher than those in other classes. 26

27 Tariff Transmission distance There are instances where customers asserted that the tariffs charged are unreasonable because of a lack of differentiation based on cost associated with the transmission distance. In this case, customers argue that the cost of supply of gas if they are close to the connecting point should be lower than the tariff that is charged. Currently, the tariff charged does not give due regard to the cost of supply/service incurred by that customer. This occurs in circumstances where the Energy Regulator had approved zonal tariffs taking into account the value of assets of the transmission pipeline within the specific zone. This results in all customers in that zone paying the same tariff irrespective of cost of supply or transmission distance. An example is in the case where the point of connection for gas supply is closer to the transmission pipeline Pass-through tariff Overcharging as a result of wrong implementation by using weighted average of the two tariffs that should have been charged to different customers based on the pipeline they are using. This happens in a situation where the licensee combines tariffs that it charges to different customers and then implements a weighted average to all its customers, even though some of them do not have to incur costs of one on the tariffs. 27

28 11.9. Unregulated distribution tariff The Energy Regulator is not mandated to regulate distribution tariffs. A licensee may decide to charge a very high distribution tariff, which will result in a total gas charge higher than what it is supposed to be A regasification tariff, if not regulated, may also result in a total gas charge higher than what it is supposed to be. Question 9: At what level can a regulated price or tariff charged be regarded as excessive or unreasonable? 12. CONCLUSION This is not an exhaustive list of circumstances where the Energy Regulator found circumstances of unreasonable or excessive prices or tariffs. The identified circumstances were mainly influenced by the nature of cases reported and investigated by the Energy Regulator (an experienced-based approach) The legal approaches do not tell us what measures should be taken, in the absence of the legal guidance to measure what is excessive or unreasonable. The measures given above have not been tested in courts Regulated prices could be unreasonable or excessive under the circumstances or scenarios set out above. 28