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Vector Limited v Commerce Commission HC Wellington CIV-2011-485-536 [2011] NZHC 976 (26 September 2011)

Last Updated: 27 September 2011


IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY

CIV-2011-485-536

BETWEEN VECTOR LIMITED Applicant

AND COMMERCE COMMISSION Respondent

Hearing: 15-16 August 2011

Counsel: A Galbraith QC, A Butler, C Marks and R Versteeg for the applicant M Scholtens QC, R Schmidt-McCleave and D Lemmon for the respondent

Judgment: 26 September 2011

JUDGMENT OF CLIFFORD J

Solicitors:

Russell McVeagh, P O Box 10214, Wellington for the applicant andrew.butler@russellmcveagh.com; catherine.marks@russellmcveagh.com; ricky.versteeg@russellmcveagh.com

Counsel: Alan Galbraith QC (argalbraith@shortlandchambers.co.nz) Crown Law Office, Wellington for the respondent

rachael.schmidt@crownlaw.govt.nz david.lemmon@crownlaw.govt.nz

Counsel: M Scholtens QC (mary.scholtens@stoutstreet.co.nz)

VECTOR LIMITED V COMMERCE COMMISSION HC WN CIV-2011-485-536 [26 September 2011]

Contents

Introduction ............................................................................................................. [1]

Context ..................................................................................................................... [2]

Vector’s case and the Commission’s response

2011_97600.jpg My approach ................................................................................................. [16] 2011_97600.jpg Vector’s case .................................................................................................. [17] 2011_97600.jpg The Commission’s response ......................................................................... [25]

Analysis

2011_97600.jpg Legislative history ....................................................................................... [31]

2011_97600.jpg The scheme of Part 4

Overview .......................................................................................... [54]

Section 52P determinations and input methodologies generally ... [68]

DPP and Electricity DPP regulation specifically ........................... [79]

General observations....................................................................... [84]

2011_97600.jpg Input methodologies and regulatory certainty .......................................... [85]

2011_97600.jpg DPP regulation within Part 4 – the significance of starting price

adjustments ................................................................................................. [94]

2011_97600.jpg Should the Commission have determined more s 52T(1) IMs

for DPP regulation? ................................................................................... [97]

2011_97600.jpg Should the Commission have determined a SPA IM for

Electricity DPP regulation? ..................................................................... [106]

2011_97600.jpg Reset under s 54K ..................................................................................... [142] Result .................................................................................................................... [152] Costs ..................................................................................................................... [156]

Introduction

[1] In these judicial review proceedings Vector Limited challenges decisions1 made by the Commerce Commission (―the Commission‖) applying default price- quality regulation under Part 4 of the Commerce Act 19862 to suppliers of electricity lines services, including Vector.3 Vector says those decisions do not comply with the requirements of Part 4, particularly as to the way in which the determination and application of what are known as ―input methodologies‖ (or ―IMs‖)4 are intended to promote certainty for regulated suppliers of those services.

Context

[2] Part 4 of the Commerce Act, which in its current form came into effect on 1

April 2009, provides generally for the ―regulation of the price and quality of goods or services in markets where there is little or no competition and little or no likelihood of a substantial increase in competition‖.5 Part 4 provides four types of such regulation: information disclosure, negotiate/arbitrate, default/customised price- quality, and individual price-quality.6

[3] Part 4 regulation is generally imposed on particular goods and services by Order in Council on the recommendation of the responsible Minister following an inquiry by the Commission.7 Any such Order in Council must state which type or

types of Part 4 regulation will apply.8 Electricity lines services,9 gas pipeline


  1. In particular Commerce Act (Electricity Distribution Services Input Methodologies) Determination 2010, Decision No. 710, 22 December 2010.
  2. All references in this judgment to sections are to sections in Part 4 of the Commerce Act unless otherwise stated.
  3. Vector also supplies gas pipeline services, and will be subject to Part 4 regulation in that capacity. In these proceedings Vector directly challenges the Commission‘s approach to the

regulation of electricity lines services. To the extent that the Commission has or would apply the

same approach to the regulation of gas pipeline services, similar issues would arise.

  1. As explained in more detail later in this judgment, input methodologies are descriptions of methodologies, processes and rules relating to such matters as cost of capital and valuation of assets which are required to be applied by the Commission in determining how Part 4 regulation

is to apply to particular regulated goods and services.

5 Section 52.

6 Section 52B(2).

7 Section 52E(1).

8 Section 52N(2)(b).

services10 and specified airport services,11 are – however – made subject to Part 4 regulation, without the need for any such inquiry or Order in Council, by Subparts 9 to 11 of Part 4 as follows:

(a) all electricity lines services (including Transpower) – information disclosure regulation;

(b) non consumer-owned (―non-exempt‖) electricity line services,

including Vector – default/customised price-quality regulation; (c) Transpower –individual price-quality regulation;12

(d) all gas pipeline services – information disclosure and

default/customised price-quality regulation; and

(e) specified airport services – information disclosure regulation.

[4] The two forms of Part 4 regulation of particular relevance to non-exempt electricity lines businesses such as Vector are, therefore, information disclosure regulation and default/customised price-quality path regulation.

[5] Information disclosure regulation requires suppliers of regulated goods or services to disclose specified information related to the prices and quality of those goods and services in stipulated formats. The purpose of information disclosure regulation is to ensure that sufficient information is readily available to interested

persons to assess whether the purpose of Part 4 is being met.13

9 Electricity line services means the conveyance of electricity by line in New Zealand, including by Transpower and in the case of Transpower includes services performed as system operator – s 54C(1).

  1. Gas pipeline services means the conveyance of natural gas by pipeline, including the assumption of responsibility for losses of natural gas – s 55A(1).
  2. Specified airport services comprise aircraft and freight activities, airfield activities and certain passenger terminal activities – s 56A.

12 Transpower was made subject to individual price-quality regulation in 2010 by the Commerce

(Part 4 Regulation – Transpower) Order 2010.

13 Section 53A.

[6] Default/customised price-quality regulation provides default and customised price-quality paths for a regulatory period that set maximum prices and revenues, and minimum quality standards, that must be observed by regulated suppliers during that period. The purpose of default/customised price-quality regulation is to provide a relatively low-cost way of setting price-quality paths for suppliers of regulated goods and services, ie default price paths, while allowing the opportunity for individual regulated suppliers to have alternative price-quality paths that better meet

their particular circumstances, ie customised price paths.14

[7] In this judgment I refer to:

(a) information disclosure regulation imposed under Subpart 4 as ―ID

regulation‖;

(b) default/customised price-quality regulation imposed under Subpart 6 generally as ―DPP regulation‖ and default and customised price- quality paths as ―DPPs‖ and ―CPPs‖ respectively;

(c) ID regulation and DPP regulation as applied by Subpart 9 specifically

to electricity lines services as ―Electricity ID regulation‖ and

―Electricity DPP regulation‖ respectively.

[8] Once a relevant Order in Council is made, s 52P generally requires the Commission to make determinations (―s 52P determinations‖) setting out, for each type of regulation to be imposed under Part 4, how that regulation will apply, including stipulating relevant IMs and, pursuant to s 53O, DPPs. IMs are, also generally, determined as part of the inquiry pursuant to which the Commission recommends that Part 4 regulation be imposed.15 As, however, Electricity ID and DPP regulation is imposed directly by Subpart 9, specific provision needed to be made to establish how and when the Commission was to determine relevant IMs and

make its s 52P determinations as regards that regulation.

14 Section 53K.

15 Sections 52I(2)(a) and 52K(2)(c).

[9] For that purpose, s 52U(1) in Subpart 3 addresses the timing of the determination of IMs for Electricity ID and DPP regulation , whilst ss 54J and 54K in Subpart 9 set out when the Commission is to make s 52P determinations for Electricity DPP regulation.

[10] Taken together

(a) Section 54J(2) provides that the ―thresholds‖ for large electricity lines businesses, that were imposed under the previous regime and expired on 31 March 2009, were deemed to be s 52P determinations stipulating DPPs that applied until 31 March 2010. Those

―thresholds‖ had required regulated businesses to provide annually a written statement that they had complied, or otherwise, with stipulated price-quality paths.16

(b) Pursuant to s 52U(1) the Commission had until 31 December 2010 to determine the relevant IMs for Electricity ID and DPP regulation.17

(c) Under s 54K(1) the Commission was required, before 1 April 2010 and therefore before IMs were required to be determined, to reset the initial s 54J(2) deemed DPPs for electricity line services. Section

54K(2) provides a specific acknowledgement that under s 54K(1) the Commission may reset the initial s 54J(2) DPPs even if all or any of the relevant IMs had not yet been determined.

(d) Pursuant to s 54K(3) if an IM is, in fact, published after 1 April 2010 the Commission may reset a s 54K(1) DPP if that IM would have


  1. The concept of a price-quality path is central to Electricity DPP regulation. As is explained in more detail later in this judgment, and as it applies to prices, a ―price path‖ is the result of the specification of starting prices and revenues, as those may increase at CPI – X. Under Electricity DPP regulation, regulated suppliers must report their compliance, or otherwise, with the price path. A breach of the price path can result in a pecuniary penalty of up to $500,000 for an individual or $5,000,000 in the case of a body corporate (see s 87).
  2. Section 52U(1) originally required that IMs be set by 30 June 2010. On 10 December 2009, however, the Minister of Commerce announced his decision to grant the Commission under

s 52U(2) an extension of six months, to 31 December 2010.

resulted in a materially different path being set had it applied at the time that s 54K(1) DPP was set.

[11] On 30 November 2009, under s 54K(1), the Commission in effect rolled over for the regulatory period 1 April 2010 / 31 March 2015 the initial ―thresholds‖ which had been deemed DPPs.18

[12] On 22 December 2010, in a series of decisions, the Commission published IMs as required by s 52U(1).19 In the case of Electricity ID regulation, the Commission determined IMs for cost allocation, asset valuation, treatment of taxation and cost of capital. In the case of Electricity DPP regulation the Commission determined IMs for specification of price, amalgamations, incremental rolling incentive scheme, cost of capital and reconsideration of the default price- quality paths.20

[13] The Commission is currently consulting on the reset of the s 54K(1) DPPs under s 54(K)(3). It contends it may do this as a result of the 22 December 2010 publication of IMs. On 19 July this year the Commission published its 2010-2015

Default Price-Quality Path for Electricity Distribution: Draft Decisions Paper (―the Draft Electricity DPP Reset Paper‖). The Draft Electricity DPP Reset Paper describes the methodologies, processes and rules the Commission proposes to apply in resetting the s 54K(1) DPPs pursuant to s 54K(3) and, in particular, the calculation

of starting prices, (―the Commission‘s DPP Reset SPA methodology‖21).


  1. Commerce Act (Electricity Distribution Default Price-Quality Path) Determination 2010, Decision No. 685, 30 November 2009.

19 Commerce Act (Specified Airport Services Input Methodologies) Determination 2010, Decision

No. 709, 22 December 2010;

Commerce Act (Electricity Distribution Services Input Methodologies) Determination 2010, Decision No. 710, 22 December 2010;

Commerce Act (Gas Distribution Services Input Methodologies) Determination 2010, Decision

No. 711, 22 December 2010;

Commerce Act (Gas Transmission Services Input Methodologies) Determination 2010, Decision

No. 712, 22 December 2010.

Commerce Act (Transpower Input Methodologies) Determination 2010, Decision No. 713, 22

December 2010.

  1. The IM for reconsideration of the default price-quality paths provides that a DPP set for electricity lines services may be reconsidered by the Commission if it is satisfied there has been

an unintended error in it or where false or misleading information relating to the making or amending of the DPP has been relied on.

21 SPA is an acronym for ―starting price adjustment‖, a key element of the reset of DPPs.

[14] Taken overall, in these proceedings Vector is in effect saying that decisions indicated by the Commission in the Draft Electricity DPP Reset Paper reflect the use of methodologies that should have been, but were not, promulgated as IMs applying to Electricity DPP regulation.

[15] To the extent that the Commission has yet to make the decisions foreshadowed in the Draft Electricity DPP Reset Paper, it might (but was not by the Commission) be argued that these proceedings are premature. That is clearly not the case. Section 4(1) of the Judicature Amendment Act 1972 refers to the ―proposed‖ exercise of a statutory power. There is well-established authority, referred to in Zaoui v Attorney-General, that preliminary decisions in decision-making processes

can be reviewed.22

Vector’s case and the Commission’s response

My approach

[16] In this section I set out, very much in summary terms, Vector‘s case and the

Commission‘s response.

Vector’s case

[17] By my assessment, there are three principal components to Vector‘s case.

[18] First, Vector argues that Parliament‘s intention when amending Part 4 of the Commerce Act in 2008 was to replace an undesirably uncertain regulatory environment with one that would provide more certainty for regulated suppliers. In particular, it was Parliament‘s intention that, to reinforce the Government‘s objective

on investment and infrastructure,23 regulated firms should be given greater certainty

22 Zaoui v Attorney-General [2004] 2 NZLR 339 (HC) at [69].

23 In August 2006, the Government issued an economic policy statement under s 26 of the

Commerce Act setting out the policy objectives that:

(a) regulated businesses should have incentives to invest in replacement, upgraded and new infrastructure and in related businesses for the long-term benefit of consumers; and

(b) the provision of efficient infrastructure requires that businesses have the confidence and incentives to make investments in replacement, upgraded, and new facilities and services.

as to the likely impact on them of Part 4 regulation in order to help improve the climate for investment in infrastructure.24 IMs were a principal way in which that certainty would be achieved. The Commission‘s failure to specify a more comprehensive range of IMs for Electricity DPP regulation was therefore inconsistent with Parliament‘s clear intention when amending Part 4.

[19] Secondly, the specific provisions of Part 4, in particular: (a) s 52R, which stipulates the purpose of IMs;

(b) s 52T, which requires IMs relating to particular goods and services to include, to the extent applicable to the type of regulation under consideration, IMs for cost of capital, valuation of assets, allocation of common costs and treatment of taxation (amongst other things); and

(c) s 52S, which requires that every relevant IM must be applied by the Commission in determining how Part 4 regulation is to apply or the prices or quality standards applying to the regulated goods and services,

taken together required the Commission:

(d) to specify, as relevant to Electricity DPP regulation, IMs for valuation of assets, allocation of common costs and treatment of taxation as had

been specified for Electricity ID regulation; and


  1. In recommending that IMs be set with the aim of improving certainty and predictability for businesses, the Regulatory Impact Statement for the Commerce Amendment Bill (201-2) noted that:

Investors are less likely to make long-term investments spanning multiple regulatory periods under a regime where the rules are unclear or applied inconsistently (at 18).

...

The proposal will provide an effective regime that over time provides more timeliness, certainty, and incentives for investment (at 24).

...

Setting input methods in advance will reduce the flexibility that is inherent in the current regime. It is considered that this risk is outweighed by the significant increase in business certainty, (at 25).

(e) to determine and publish under s 52U(1), as an IM applying to Electricity DPP regulation, the Commission‘s Electricity DPP Reset SPA methodology, or the key elements thereof (an ―Electricity SPA IM‖).25

[20] Thirdly, the conclusion that the Commission‘s failure to specify such IMs was in breach of Part 4 could be seen in the effect that decision had on Vector‘s rights of appeal. Under s 91 of the Commerce Act,26 rights of appeal against s 52P determinations that set out the DPPs applying to regulated suppliers are limited to rights of appeal on a question of law. By contrast, s 52Z provides for merits appeals against IM determinations. On the Commission‘s current interpretation of Part 4, Vector would only have a right of appeal on a point of law against the Commission‘s proposed s 54K(3) DPP reset. As a result the constraint on the Commission‘s

decision making which was intended by Parliament to be provided by merits appeals against IMs would not apply as it should.

[21] In effect, Vector argued that whilst the Commission had, when consulting on the s 54K(3) DPP reset, considered and arrived at relevant methodologies, it had not done so in the manner required by Part 4. Because those methodologies had not been determined as IMs applying to Electricity DPP regulation, the Commission would be able to change its mind in the future without regard both to the constraints on changing IMs provided by Part 4 and the certainty those constraints gave to regulated suppliers.

[22] In terms of the Commission‘s proposal to reset the current s 54K(3) DPPs by adjusting starting prices, Vector says:

(a) First, the now published IMs applicable to Electricity DPP regulation would not, as required by s 54K(3), have caused a material change to

25 Vector‘s affidavit evidence was that the following were those key elements:

(a) The sources of data or estimates (if any) to be used to determine each supplier‘s current and

projected profitability;

(b) The method that will be used to calculate current and projected profitability using the data specified in (a);

(c) The method for the derivation of the starting price adjustments for each supplier using the current and projected profitability assessments specified in (b).

26 In Part 6 of the Commerce Act 1986.

the starting prices in the s 54K(1) DPPs if they had been applicable when those price paths were set. Therefore, the Commission cannot reset those price paths under s 54K(3) by reference to those IMs.

(b) Secondly, because the Commission has not stipulated as being applicable to Electricity DPP regulation the Electricity ID regulation IMs which it has indicated will be used to determine a reset, it cannot reset under s 54K(3) by reference to those IMs.

(c) Thirdly, the Commission cannot rely on the Commission‘s DPP Reset SPA methodology to justify a reset under s 54K(3), as that is not an IM at all.

[23] Vector filed a number of affidavits in support of its application. In general terms, those affidavits (and Lynne Maree Taylor‘s and Allan Carvell‘s in particular), supported Vector‘s assertion as to the need for a SPA IM, promulgated under Subpart

3, to fulfil the certainty requirements of Part 4. They also confirmed the uncertainties that would result for Vector in the absence of the specification of a SPA IM and the IMs applicable to Electricity ID regulation that Vector says should also apply to Electricity DPP regulation. They further explained the potential impact those uncertainties would have on Vector‘s business.

[24] Vector also filed an affidavit in reply provided by the Regulatory and Business Manager at Powerco, Paul Goodeve. Mr Goodeve confirmed that the Commission‘s approach to the proposed s 54K(3) DPP reset, and the various approaches consulted on, had significantly varying effects on Powerco. The failure to specify the IMs that Vector complained of would create uncertainties for Powerco and its investors which were potentially costly and therefore undesirable.

The Commission’s response

[25] The Commission‘s response was very much based on what it considers to be the correct statutory interpretation of Part 4, and within that the relative roles of IM determinations made pursuant to Subpart 3 (ss 52R to 53) and s 52P determinations

made for the purposes of Subpart 6 pursuant to ss 53O and 53P and, specifically as regards Electricity DPP regulation, ss 54J and 54K.

[26] First, within that framework the two-step process the Commission had taken, namely setting IMs first and then making its s 52P determinations for DPPs for electricity line services, was clearly mandated by Part 4. That is, the statutory scheme clearly envisages pre-existing IMs being applied at the point in the process when it is determined how a starting price reset will be effected. The emphasis on certainty, however, as promoted by IMs that applied under Subpart 3 did not apply to the same extent under Subpart 6. Vector was, in effect, trying to rewrite Part 4 to achieve greater certainty than the statute contemplated. Put simply, the level of certainty that Vector sought was inconsistent with the scheme of Part 4 taken as a whole.

[27] Secondly, s 54K(3) expressly authorised the Commission‘s actions in proposing to reset starting prices for non-exempt electricity lines companies, including Vector, for the balance of the current 2010/2015 regulatory period. That was the second stage of the process that Part 4 had put in place. When that second stage exercise was completed, regulated suppliers such as Vector would be provided with the certainty that was intended by Part 4. Moreover, Electricity DPP regulation was intended to be a relatively low-cost exercise. It produced DPPs which, if an individual regulated firm did not think suited it, could be replaced by a CPP. A CPP was the way in which the certainty Vector sought could be obtained.

[28] The Commission‘s position on Vector‘s contention that a SPA IM was required for Electricity DPP regulation was well summarised in a letter from Commission Chair, Dr Mark Berry, to the Chief Executive of the Electricity Networks Association on 30 June 2010 in which Dr Berry stated:27

The Commission has carefully considered the relevant provisions of Part 4 when reaching views on all aspects of the new regulatory regime. It is clear that Parliament never intended that starting price adjustments would be specified as an input methodology. Rather, starting price adjustments form part of the default price-quality path (DPP) determination ... There is nothing


  1. Letter from Dr Mark Berry to Mr Alan Jenkins Re Starting Price Adjustments, 30 July 2010, pp 1-2.

in the statutory language to suggest that the approach for adjusting starting prices must be removed from the DPP determination and specified in an input methodology.

[29] The Commission filed affidavits by John McLaren, a senior economist closely involved in the determination by the Commission of IMs (and in the process of considering whether, and the way in which, DPPs should be reset) and Karen Murray, who was the project manager for the IMs project. Mr McLaren provided a general explanation of price-quality regulation under Part 4, and the processes for setting and resetting starting prices for DPPs. He also provided an explanation of the overall regulatory framework created by Part 4, and the history of the Commission‘s consultation process relating to the determination of IMs and the publication of the Draft Electricity DPP Reset Paper. Ms Murray‘s affidavit was largely directed at describing in more detail the documents released by the Commission in its consultation process and introducing certain correspondence into evidence.

[30] I also record, for the sake of completeness, that Vector filed an affidavit from Simon Mackenzie, the Group Chief Executive for Vector, which commented on some of the impact of the uncertainties that Vector was asserting had been created by the Commission‘s approach. The Commission responded by filing a very detailed affidavit from Gregory Houston, commenting on that issue. As matters transpired, little attention was paid during the hearing to the detail of those two affidavits.

Analysis

Legislative History

[31] As is well accepted, legislative history is an important contributor to statutory interpretation particularly as regards ascertaining the purpose of an enactment.28

Section 5(1) of the Interpretation Act 1999 provides that ―the meaning of an

enactment must be ascertained from its text and in the light of its purpose‖. As

Tipping J observed in Commerce Commission v Fonterra Co-operative Group Ltd:29

28 ―Enactment‖ means ―the whole or a portion of an Act or regulation‖: see s 29 of the

Interpretation Act 1999,

29 Commerce Commission v Fonterra Co-operative Group Ltd [2007] 3 NZLR 767 (SC), at [22].

It is necessary to bear in mind that s 5 of the Interpretation Act 1999 makes text and purpose the key drivers of statutory interpretation ... [T]he meaning [of the text] ... should always be cross-checked against purpose in order to observe the dual requirements of s 5. In determining purpose the court must obviously have regard to both the immediate and the general legislative context. Of relevance too may be the social, commercial or other objective of the enactment.

[32] Both Vector and the Commerce Commission provided the Court with a significant amount of material relating to the legislative history of Part 4. This included early departmental and Cabinet papers, detailed records of the Select Committee process (including officials‘ reports) and more traditional materials such as extracts from Hansard and from the Explanatory Statement to the Bill. Notwithstanding the comments of the Court of Appeal in Skycity Auckland Ltd &

Anor v Gambling Commission,30 no exception was taken by either Vector or the

Commerce Commission to this extensive range of material.

[33] Based on the parties‘ submissions and that material, I now consider the

legislative history of Part 4 as an aid to interpreting its provisions.

[34] The general purpose of the Commerce Act is ―to promote competition in

markets for the long-term benefit of consumers within New Zealand‖.31 Parts 2 and

3 of the Act are designed to protect the market process from contractual or market structures which hinder or undermine the incentives for firms to invest and innovate, lower their costs and prices, and improve quality so as to gain custom and general profits. Part 4 recognises, however, that there are sectors of the economy, that is markets, in which competition cannot and/or does not readily occur and where market-based incentives cannot be relied upon to secure those economic outcomes. As regards such markets, Part 4 – traditionally through the imposition of price controls – provided a remedial mechanism designed to restrict the ability of firms, not facing the workability of potential competition, from acting in a manner that was inconsistent with competitive outcomes, and therefore the long-term benefit of

consumers.32

30 Skycity Auckland Ltd & Anor v Gambling Commission [2008] 2 NZLR 182 (CA) at [39]-[42].

31 Section 1A.

32 Thomas Gault (ed) Gault on Commercial Law (online looseleaf ed. Brookers).

[35] The Privy Council recognised this distinction in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd when it contrasted the role and purpose of s 36 in Part 2 with the price control provisions provided in, until its amendment in

2008, Part 4:33

This problem [monopoly pricing] can be tackled in one or other or both of two ways viz by a regulatory body artificially restricting the price chargeable or by introducing efficient competition. The introduction of efficient competition (by such anti-trust legislation as s 36) does not in itself instantly remove the evils of the monopolist‘s overcharging: it produces the conditions which, by market forces, eventually force the monopolist to operate efficiently (and therefore more cheaply) and to abandon policies of excessive charging. Such legislation is neither effective nor apt to take the place of a regulatory proceeding which, after detailed investigation of the efficiency of the monopoly system, can set a maximum price for goods or services to be supplied having regard to economies that could be affected and a reasonable rate of return. The Commerce Act, inter alia, directed itself to both these processes: s 36 is designed to produce the competition which will, it is hoped, in due course compete out monopoly rents: Part IV of the Act enables immediate price restriction to be imposed by regulation.

[36] From 1986 to 2008, generic provisions in Part 4 of the Commerce Act provided for the Commission to undertake inquiries into whether particular goods or services should be subject to ―price control‖ (comprising control of prices, revenues and/or quality standards). Inquiries could result in recommendations to the responsible Minister to impose price control under Part 5 of the Act, on the grounds that:

(a) those goods or services were or would be supplied in markets in which competition was limited or likely to be lessened; and

(b) it was necessary or desirable for those goods or services to be controlled in the interests of persons acquiring those goods or services.

[37] In addition to the generic control provisions in Part 4 (and ss 70 to 74 of

Part 5), Part 4A of the Commerce Act allowed for individual electricity lines services businesses to be placed under regulatory control if they breached thresholds set by


  1. Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385 (PC) at 407-408.

the Commission. That regime was introduced in August 2001 and covered 29 lines businesses, including Transpower. Thresholds were reset in 2004 and again in 2009. The purpose of that threshold regime, as set out in (the then) s 57E of the Commerce Act, was to promote the efficient operation of markets directly related to electricity distribution and transmission services through targeted control for the long-term benefit of consumers by ensuring that suppliers:

(a) are limited in their ability to extract excessive profits;

(b) face strong incentives to improve efficiency and provide services at a quality that reflects consumer demands; and

(c) share the benefits of efficiency gains with consumers, including through lower prices.

[38] In May 2006, the Government announced a review of Part 4, including eventually Parts 4A and 5 of the Commerce Act.

[39] In August 2006 the Government issued an economic policy statement under s 26 of the Commerce Act setting out the policy objectives that:34

(a) regulated businesses should have incentives to invest in replacement, upgraded and new infrastructure and in related businesses for the long-term benefit of consumers; and

(b) the provision of efficient infrastructure requires that businesses have the confidence and incentives to make investments in replacement,

upgraded, and new facilities and services.35

34 Minister of Commerce ―Statement to the Commerce Commission of Economic Policy of the

Government: Incentives of regulated businesses to invest in infrastructure‖, 7 August 2006.

  1. The 2006 Government Policy Statement (―GPS‖) was revoked on 1 November 2010 on the basis that it is now reflected in Part 4 of the Commerce Act, see http://www.med.govt.nz/templates/MultipageDocumentTOC 21483.aspx.

[40] A September 2006 Cabinet Paper noted that objectives of the review included ensuring that ―any regulatory uncertainty is minimised‖, and that ―provisions are consistent with the Government‘s objectives around infrastructure investment‖. 36

[41] In April 2007, the Ministry of Economic Development (―MED‖) released a discussion document reviewing the regulatory control provisions under the Commerce Act.37 The Executive Summary contains the following observations:38

The primary objective of reviewing the regulatory control provisions of the Act is to ensure that economic regulation in New Zealand is consistent with providing for the long-term benefit of consumers within New Zealand. Economic regulation involves setting or influencing the prices that a firm charges and the quality of goods and services it supplies. Consistent with the broad objective, the Review will consider whether any amendments to the Act are desirable to reinforce the Government‘s policy objectives on investment in infrastructure.

[42] That proposed new purpose statement for Part 4 was also included:39

The purpose of this Part is, in markets where there is little or no competition or prospect of competition, to provide for economic regulation for the long term benefit of consumers in New Zealand. Any regulation under this Part should seek to ensure that suppliers:

(a) are limited in their ability to earn excessive profits;

(b) have incentives to improve efficiency and provide services at a quality that reflects consumer demands;

(c) share the benefits of efficiency gains with consumers, including through lower prices; and

(d) have incentives to innovate and to invest including in replacement, upgraded and new assets and in related businesses.

[43] Elsewhere in the Paper MED noted that:

The Commerce Act currently does not require that key technical decisions relating to how regulation will be imposed (e.g. type of control, how to determine rates of return and asset valuation) be set in advance ... This may create uncertainty for businesses (because it is difficult to predict regulatory outcomes) and lead to concerns that the Commerce Commission has the ability to settle on and change methodologies ‗as it goes‘.40

36 Cabinet Economic Development Committee, Review of Parts 4 and 5 of the Commerce Act

1986, 13 September 2006, paragraph 18 (―Cabinet Paper, September 2006‖).

37 Ministry of Economic Development, Review of Regulatory Control Provisions under the

Commerce Act 1986: Discussion Document, April 2007.

38 Ibid, at para 2.

39 Ibid, at para 6.

40 Ibid, at para 43.

...

The Ministry considers it is likely that certainty, transparency, predictability and quality of regulatory outcomes will improve if input methodologies are set in advance of the inquiry and following a transparent consultation process.41

[44] In January 2008, major reform of the Part 4 provisions was recommended by Cabinet in the form of the Commerce Amendment Bill. The Explanatory Note to that Bill confirms that those early expressions of policy were reflected in the draft legislation. Amongst other things, that Explanatory Note commented:42

Reasons why the Act requires amendment

The reviews found general (though not unanimous) agreement that the main problems with the existing legislation are as follows:

2011_97601.jpg absence of a specific purpose statement for Part 4. This has led to dispute and uncertainty, since the general purpose statement of the Commerce Act (section 1A), which seeks to ―promote competition‖, does not work for sectors where competition is not possible:

2011_97601.jpg there is no specific requirement for any regulation to incentivise investment and innovation:

2011_97601.jpg separate inquiries are required on ―whether to regulate‖ and ―how to regulate‖‖

2011_97601.jpg there is uncertainty about the rules governing regulatory decisions (such as the cost of capital):

...

2011_97601.jpg Part 4A thresholds regime is generally regarded as creating too much uncertainty for businesses and does not provide adequate incentives for investment in infrastructure:

2011_97601.jpg The accountability regime for the Commission is limited (primarily judicial review):

...

Objectives of the Bill

The objectives of the Bill are to address these issues, and in particular to─

2011_97601.jpg provide an efficient and credible regime to address the potential to exercise market power in markets where competition is not possible:

2011_97601.jpg improve clarity, certainty, timeliness, and predictability for businesses:

2011_97601.jpg tailor the regime to New Zealand‘s small size (with small firms and

limited resources):

2011_97601.jpg provide specifically for incentives to invest in infrastructure. Certainty is considered a pre-requisite for this.

41 Ibid, at para 138.

42 Commerce Amendment Bill 2008 (201-2) (Explanatory Note) at 3.

[45] In the Regulatory Impact Statement accompanying the Bill the following

description appears under the heading ―Status quo and problem‖:43

Electricity lines businesses (ELBs) have argued that the Part 4A regime has increased uncertainty in the sector. This uncertainty can affect their cost of capital, thereby deterring investment. While industry complaint is not by itself proof of a problem, analysis of the current regulatory mechanisms indicate that the current regulatory model in Parts 4 and 4A has not kept pace with changes in the regulatory environment and international best practice. For instance, Part 4A devolves a significant amount of discretion and flexibility to the regulator, but that has come at the cost of increased uncertainty for business.

[46] That it was intended by Parliament that the new Part 4 would increase certainty around regulatory outcomes, and therefore provide a better environment for decision-making by natural monopoly infrastructure businesses, is reflected in comments made by the Minister of Commerce on the passing of new legislation in September 2008. At that time, the Minister noted:44

The passing of this Bill is excellent news for the growth and improvement of New Zealand infrastructure businesses that are natural monopolies. It will create greater certainty for regulated businesses and incentives for investing in infrastructure while giving consumers protection from excessive prices and poor quality.

[47] Those public comments reflect statements the Minister had earlier made on the second reading of the Bill where she stated that:45

The absence of such a purpose statement (under the previous regime) has led to considerable uncertainty, which has affected the ability of infrastructure companies to make timely investment decisions.

[48] The legislative history also emphasises the significance of IMs as a key contributor to the greater certainty that the new Part 4 was intended to bring.

[49] The Explanatory Note to the Bill states:46

43 Ibid, at 16.

44 New Zealand Government, ―Infrastructure investment gets boost from law changes‖ (Media

Statement, 5 September 2008).

45 (2 September 2008) 649 NZPD 18313.

46 Explanatory Note, at 5.

Input methodologies

The term input methodologies refers to the rules, processes, and requirements relating to regulation, such as how to calculate the cost of capital, value assets, allocate common costs, comply with regulatory specifications and so forth.

The Bill requires the Commission to set input methodologies by 30 June

2010. The purpose of setting input methodologies is to give greater certainty, transparency, and predictability to businesses (including businesses

not subject to regulation) and their customers. This certainty is expected to

help improve the climate for investment in infrastructure.

[50] Other comments in the Explanatory Note and Regulatory Impact Statement confirm the significance of IMs:

(a) they are referred to as the ―detailed decision rules‖;47

(b) the requirement for IMs to be set as soon as possible had the aim of improving certainty and predictability for businesses,48 and

(c) IMs, as the key technical decisions relating to how regulation would be imposed, were to be set in advance of any major decision-making, as a stand-alone process, with provisions for their merits review.49

[51] The Bill, as reported back, largely conformed with its original form. The Commerce Committee noted that most submitters had supported the general intent of the Bill and considered that the proposed amendments would be likely to promote regulatory certainty and accountability. By my assessment, therefore, the policy views expressed prior to, and at the time of, the introduction of the Bill can be seen as continuing to inform the Bill as reported back and passed by Parliament.

[52] Based on that analysis, there can be no doubt that the legislative history establishes that an important purpose of Part 4 was to improve certainty as regards regulatory decision-making ahead of key decisions being made so that, in turn, regulated suppliers would have improved incentives to invest in infrastructure assets.

IMs are a central regulatory mechanism to achieve that outcome, by the way in

47 Ibid, at 7.

48 Ibid, at 15.

49 Ibid, at 17 and 19.

which they provide greater certainty. At the same time, as the Commission emphasised, it is to be observed that the overall purpose of Part 4 is to promote the long-term benefit of consumers.

[53] The question becomes, therefore, whether the proper interpretation of the relevant specific provisions of Part 4, given that clear legislative history, results in the interpretation argued for by Vector or that argued for by the Commission being correct.

The scheme of Part 450

Overview

[54] As already noted, the purpose of Part 4 regulation is, in general terms, to promote the long-term benefit of consumers of goods or services in markets where there is little or no competition and little or no likelihood of a substantial increase in competition. Section 52A provides for that purpose to be achieved by promoting outcomes that are consistent with outcomes produced in competitive markets such

that suppliers of those goods and services:51

(a) have incentives to innovate and to invest, including in replacement, upgraded, and new assets; and

(b) have incentives to improve efficiency and provide services at a quality that reflects consumer demands; and

(c) share with consumers the benefits of efficiency gains in the supply of the regulated goods or services, including through lower prices; and

(d) are limited in their ability to extract excessive profits.


  1. There is some duplication in this section of material that is included in the Context section of this judgment. The scheme of Part 4 is, however, complex and some duplication is, perhaps, inevitable.

51 Section 52A(1)(a) – (d).

[55] Two matters may be noted. The first is, relative to the Part 4A statement of purpose that had applied to the regulation of large electricity lines businesses, the reference to incentives to innovate and to invest has been added. The second is the close similarity of this statutory statement of purpose to the proposed purpose statement referred to in the Executive Summary of the April 2007 MED Discussion document, noting however that the reference to incentives to innovate and invest has been shifted from fourth to first place in the list of desired ―outcomes‖.

[56] Part 4 is divided into 11 Subparts.52 Taken overall:

(a) Subparts 1 to 3 contain generic provisions that relate to all Part 4 regulation;

(b) Subparts 4 to 8 contain provisions that apply respectively to the four general types of regulation provided by Part 4, with Subpart 6 dealing with DPP regulation; and

(c) Subparts 9 to 11 contain provisions specific to the regulation, without the need for an inquiry, of electricity line services, gas pipeline services and airport services respectively.

[57] The Subparts of particular relevance to these proceedings are, therefore, Subparts 1 (ss 52-52D), 2 (ss 52E-52Q), 3 (ss 52R-53), 6 (ss 53K-53ZB) and 9 (ss

54-54X).

[58] It is, I think, helpful to put my analysis of those provisions into the context of this case by providing, at this point, a general overview of ID regulation and DPP

regulation.


  1. Subpart 1 – Preliminary provisions: ss 52 – 52D; Subpart 2 – Regulating particular goods and services: ss 52E – 52Q; Subpart 3 – Input methodologies: ss 52R – 53; Subpart 4 – Information disclosure regulation: ss 53A – 53F; Subpart 5 – Negotiate/arbitrate regulation: ss 53G – 53J; Subpart 6 – Default/customised price-quality regulation: s 53K – 53ZB; Subpart 7 – Individual price-quality regulation: s 53ZC; Subpart 8 – Miscellaneous provisions: ss 53ZD – 53ZG; Subpart 9 – Electricity line services: ss 54 – 54X; Subpart 10 – Gas pipeline services: ss 55 –

55K; and Subpart 11 – Airport services: ss 56 – 56G.

[59] In very general terms, ID regulation requires regulated suppliers to provide information about the prices and quality of regulated goods and services in stipulated and, no doubt hopefully, relatively understandable formats. That information enables the Commission and consumers to assess those matters, in order to better promote the desired Part 4 outcomes.

[60] DPP regulation may be understood, in similarly general terms, as stipulating:

(a) by reference to prices and quantities – maximum revenues that regulated suppliers may derive from the provision of regulated goods and services; and

(b) by reference to maximum periods (assessed by reference to both duration and frequency) during which the supply of regulated goods and services may be interrupted – minimum quality standards that must be complied with.

[61] Common or similar methodologies are used for those disclosure and control purposes. Methodologies are used which relate to the way in which assets used by a supplier to supply regulated goods and services are valued and also to identify an acceptable return, in a regulated market, on those assets by reference to which actual returns can be assessed and controlled in terms of the identification of ―excessive profits‖.53

[62] ID regulation requires regulated suppliers to provide information to the Commission as to the prices and quality of their regulated goods and services in accordance with those methodologies on an ―ex-post‖ or ―after the event‖ basis.

[63] Under DPP regulation, however, the Commission sets a price path and quality standards on an ―ex ante” or ―before the event‖ basis. In terms of setting the price path, the Commission uses a methodology which, based on a current regulatory value for a supplier‘s asset base and projected capital expenditure and operating

revenues, determines – by reference to an acceptable rate of return – starting prices

53 Section 52A(1)(d).

and therefore approved revenues. The Commission then determines a maximum rate of change at which those prices and therefore revenues may increase. That rate of change is generally expressed by the formula CPI – X, where:

(a) CPI is a reference to the Consumer Price Index; and

(b) X is a stipulated percentage calculated by the Commission based on long-run average productivity improvements rates achieved by suppliers in New Zealand or comparable countries of relevant goods or services, using measures of productivity assessed by the Commission.54

[64] As Mr McLaren explained:

To meet the purpose of Part 4 of the Act (as provided for in s 52A), price- quality regulation must mimic some of the pressures that rivalry exerts in workably competitive markets, in order to promote outcomes consistent with outcomes in such markets. Whereas competitive rivalry would usually be relied upon to provide suppliers with continuous incentives to innovate, invest and improve their efficiency, the objective of price-quality regulation is to act as a partial surrogate for these pressures in markets where competition is limited.

Price-quality regulation achieves this aim by setting out the maximum prices that a supplier can charge, and the minimum service quality it can provide, over the duration of a regulatory period. The most common form of price

‗path‘ is CPI-X. Under this type of ‗path‘, prices or revenues are restricted

from increasing each year by more than the CPI less a certain number of percentage points (termed an ‗X factor‘). Suppliers are then able to boost their profitability over the regulatory period by reducing their costs relative to the assumptions used in setting the price path. Minimum service quality requirements ensure that costs are not reduced by cutting the level of service quality that consumers receive.

The prices that are allowed at the start of the price path – i.e. the ‗starting prices‘ – are only one of a number of elements of a price-quality path determination (the content and timing of which are provided for in s 53M). The other key elements are the allowable rate of change in prices over the regulatory period (i.e. CPI-X), the quality standard and the length of the regulatory period.

54 Section 53P(6).

[65] The Supreme Court commented on the previous, Part 4A, thresholds regime in Unison Networks Ltd v Commerce Commission to similar effect:55

In March 2002 the Commission published an initial discussion document. This summarised the statutory requirements for setting thresholds and outlined options involving various combinations of the elements of efficiency, profit, sharing of profit and quality of service. The discussion paper also referred to international practice in regulatory approaches to ensuring that profits were not excessive. These approaches tended to be based on setting initial prices, and then limiting price changes over a period to the rate of inflation, determined by an appropriate index such as the Consumer Price Index (CPI), less a percentage factor characterised as X. The approach is known as CPI-X regulation. Both the initial prices and the X efficiency factors would be fixed to reflect anticipated efficiency gains over the period, which would typically be five years.

[66] Faced with a DPP an individual supplier may submit to the Commission an individual price-quality path (ie a CPP) more suited to its needs than the DPP. A CPP is akin to a cost-based building-blocks approach, and involves a more detailed specification of the elements of the price-quality path than is involved in the preparation by the Commission of a DPP. It is for that reason that DPP regulation is seen as providing a relatively low cost form of regulation, as opposed to what would be the position if the Commission approached the task of setting price-quality paths for all regulated suppliers on the more detailed basis provided for in CPP regulation.

[67] In either form, the ―price path‖ is the result of the specification of starting prices and revenues, as those may increase at CPI – X. Regulated suppliers must report their compliance, or otherwise, with the price path. Suppliers who breach their price path are liable to pay a pecuniary penalty of up to $500,000 in the case of an individual or $5,000,000 in the case of a body corporate.56

Section 52P determinations and input methodologies generally

[68] Part 4 regulation generally has its origins in inquiries by the Commission following which they recommend such regulation be imposed on particular goods and services. The Commission‘s recommendation to the Minister must specify,

amongst other things, the goods and services to be regulated, the type or types of

55 Unison Networks Ltd v Commerce Commission [2008] 1 NZLR 42, at [16].

56 Section 87, in Part 6.

regulation to be used and the IMs that are to apply.57 Those IMs are first determined as part of the inquiry.58

[69] Once an Order in Council declaring goods or services to be regulated under Part 4 has been made, the Commission must make determinations ―as soon as practicable‖ under s 52P specifying how the relevant forms of regulation apply to suppliers of regulated goods or services. Section 52P goes on to provide:

(3) Determinations must─

(a) set out, for each type of regulation to which the goods or services are subject, the requirements that apply to each regulated supplier, and

(b) set out any time frames (including the regulatory periods) that must be met or that apply; and

(c) specify the input methodologies that apply; and

(d) be consistent with this Part.

...

(5) If a determination under this section is made following an inquiry and a recommendation under section 52K, the requirements referred to in subsection (3)(a) must not differ in any material respect from the recommendation, or (if applicable) from any advice given to the Minister under section 52L(3).

(6) A determination under this section may require a supplier to comply with the requirements set out in any other determination that has been made under this section in respect of regulated goods or services of the same type.

[70] Section 52Q provides for the Commission to amend s 52P determinations. Any material amendment requires consultation, but not a further inquiry.

[71] The term ―input methodology‖ is defined by s 52C as follows:

input methodology means a description of any methodology, process, rule, or matter that includes any of the matters listed in section 52T and that is published by the Commission under section 52W; and, in relation to particular goods or services, means any input methodology, or all input methodologies, that relate to the supply, or to suppliers, of those goods or services.

57 Section 52K(2).

58 Section 52I(2)(a).

[72] The words ―methodology, process, rule or matter‖ are not further defined. They must, however, mean – at least in general terms – such things as they apply or are related to Part 4 regulation. By reference, therefore, to the words ―any‖ and ―that includes‖ a methodology, process, rule or matter applying or relating to Part 4 regulation will be an IM if it includes a matter listed in s 52T. Section 52W requires the Commission to publish all IMs.

[73] Section 52T(1) provides:

The input methodologies relating to particular goods or services must include, to the extent applicable to the type of regulation under consideration,─

(a) methodologies for evaluating or determining the following matters in respect of the supply of the goods or services:

(i) cost of capital:

(ii) valuation of assets, including depreciation, and treatment of revaluations:

(iii) allocation of common costs, including between activities, business, consumer classes, and geographic areas:

(iv) treatment of taxation; and

(b) pricing methodologies, except where another industry regulator (such as the Electricity Authority) has the power to set pricing methodologies in relation to particular goods or services; and

(c) regulatory processes and rules, such as─

(i) the specification and definition of prices, including identifying any costs that can be passed through to prices (which may not include the legal costs of any appeals against input methodology determinations under this Part or of any appeals under section 91 or section 97); and

(ii) identifying circumstances in which price-quality paths may be reconsidered within a regulatory period; and

(d) matters relating to proposals by a regulated supplier for a customised price-quality path, including─

(i) requirements that must be met by the regulated supplier, including the scope and specificity of information required, the extent of independent verification and audit, and the extent of consultation and agreement with consumers; and

(ii) the criteria that the Commission will use to evaluate any proposal.

[74] Thus, and with reference back to the definition of IM, if a ―methodology, process, rule or matter‖ – undefined – relating to a type of Part 4 regulation includes, for example, ―cost of capital‖ or ―regulatory processes and rules, such as the specification and definition of prices‖, that methodology, process, rule or matter is an IM and must be determined and published as such by the Commission.

[75] The word ―includes‖ is, therefore, of some significance, and needs to be construed substantively so as not to over-extend the range of methodologies, processes, rules or matters that will come within the definition of an IM.

[76] Section 52T(2) goes on to provide:

Every input methodology must, as far as is reasonably practicable─

(a) set out the matters listed in subsection (1) in sufficient detail so that each affected supplier is reasonably able to estimate the material effects of the methodology on the supplier; and

(b) set out how the Commission intends to apply the input methodology to particular types of goods or services; and

(c) be consistent with the other input methodologies that relate to the same type of goods or services.

[77] Section 52R provides that the purpose of IMs is to promote ―certainty for suppliers and consumers in relation to the rules, requirements and processes‖ applying to Part 4 regulation.

[78] Section 52S requires relevant published IMs relating to the supply of particular goods and services to be applied:

(a) by regulated suppliers in accordance with the relevant s 52P

determination; and

(b) by persons entitled or required under the Act to recommend, decide or determine whether or how Part 4 regulation should be applied to regulated goods or services or the prices or quality standards applying to regulated goods or services.

DPP and Electricity DPP regulation specifically

[79] Those general provisions relating to s 52P determinations and IM

determinations are, again as already noted, supplemented by:

(a) provisions in Subpart 6 (ss 53M to 53P) specific to s 52P

determinations relating to DPP regulation generally; and

(b) provisions in Subpart 9 (but, in particular, ss 54J and 54I) specific to s 52P determinations relating to Electricity DPP regulation specifically.

[80] In particular:

(a) Section 53O provides that a s 52P determination applying Electricity DPP regulation must set out a DPP that includes, amongst other things, the starting prices that apply to the supply of the goods and services during the first regulatory period, the rate or rates of change in prices, relative to the CPI, allowed during the first regulatory period and the quality standards that apply during that regulatory period.

(b) Section 53M(1) provides that every price-quality path, whether a DPP, a CPP or an individual price-quality path, must specify in relation to prices, either or both of the maximum price or prices that may be charged by a regulated supplier and the maximum revenues that may be recovered by a regulated supplier, together with the quality standards that must be met in the regulatory period. In terms of s 53M(4), a regulatory period must be five years although the Commission may specify a period of not less than four years if that

―would better meet the purposes of‖ Part 4.59

(c) Section 53P provides that before the end of the first and every subsequent regulatory period the Commission must amend the s 52P determination by setting out starting prices, rates of change and quality standards that apply for the following regulatory period.

(d) In terms of s 53P(3) the starting prices must be either:

59 Section 53M(5).

(i) the prices that applied at the end of the preceding regulatory period; or

(ii) prices, determined by the Commission, that are based on the current and projected profitability of each supplier.

[81] Section 53P also contains a number of normative provisions relating to DPPs:

(4) Starting prices set in accordance with subsection (3)(b) must not seek to recover any excessive profits made during any earlier period.

(5) Subject to subsection (8), the Commission must set only one rate of change per type of regulated goods or services (for example, if the rate of change (x) is 1% in a CPI-x path, 1% must be the rate for all goods or services of that type).

(6) The rate of change must be based on the long-run average productivity improvement rate achieved by either or both of suppliers in New Zealand, and suppliers in other comparable countries, of the relevant goods or services, using whatever measures of productivity the Commission considers appropriate.

(7) When setting the rate of change, the Commission may take into account the effects of inflation on the inputs of suppliers of the relevant goods or services.

(8) The Commission may set alternative rates of change for a particular supplier—

(a) as an alternative, in whole or in part, to the starting prices set under subsection (3)(b) if, in the Commission's opinion, this is necessary or desirable to minimise any undue financial hardship to the supplier or to minimise price shock to consumers; or

(b) as an incentive (under section 53M(2)) for the supplier to improve its quality of supply.

(9) Any alternative rates of change set under subsection (8) may include step changes.

(10) The Commission may not, for the purposes of this section, use comparative benchmarking on efficiency in order to set starting prices, rates of change, quality standards, or incentives to improve quality of supply.

[82] Section 53ZB governs what happens to DPPs and CPPs if IMs change. It provides:

(1) Default or customised price-quality paths may not be reopened within a regulatory period on the grounds of a change in an input methodology, except as provided in subsection (2).

(2) Every default and customised price-quality path must be reset by the

Commission in accordance with section 53P if—

(a) an input methodology changes as a result of an appeal under section 52Z; and

(b) had the changed methodology applied at the time the price- quality path was set, it would have resulted in a materially different path being set.

(3) When resetting a default or customised price-quality path under subsection (2), the Commission must apply claw-back.60

[83] In terms of Electricity DPP regulation specifically, I have summarised at [10] the most significant – for this judgment – provisions of Subpart 9. As can now be seen, those essentially transitional provisions provide, by reference to the pre- existing thresholds regime, the initial DPPs for the Electricity DPP regulation which were to apply until 31 March 2010. The Commission was required, before 1 April

2010, to reset those DPPs explicitly on the basis – as set out in s 54K(2) – that not all of the relevant IMs would have yet been determined. Finally, and very importantly, s 54K(3) provides:

If an input methodology is published after 1 April 2010 and if, had that methodology applied at the time the default price-quality paths were reset as required by subsection (1), it would have resulted in a materially different path being set, then the Commission may reset the default price-quality paths in accordance with section 53P and may apply claw-back, despite section 53ZB(1).

General observations

[84] By reference to that analysis, the following points may be made:

(a) Section 52P(3)(c) envisages all s 52P determinations specifying, where relevant, the IMs that apply to each relevant form of regulation

applying to suppliers of regulated goods and services.

60 ―Claw back‖ is a mechanism whereby:

(a) The Commission may require a supplier to lower its prices on a temporary basis in order to compensate consumers for some or all of any over-recovery that occurred under the prices previously charged by the supplier; or

(b) Whereby the Commission may allow a supplier to recover some or all of any shortfall in its revenues that occurred prices under the prices previously charged by the supplier (see

s 52D).

(b) Section 53O, relating to s 52P determinations for DPP regulation generally, does not specifically refer to IMs (as for example do sections 53C(1)(g) and 53I(1)(d) in the case of ID regulation and negotiate/arbitrate regulation respectively). There can be no doubt, however, that the scheme of Part 4 anticipates DPP regulation involving stipulated IMs: most specifically, s 53ZB provides what happens to DPPs and CPPs if IMs change.

(c) Section 52T specifies certain matters that IMs must, to the extent applicable to the type of regulation under consideration, include. The Commission has approached s 52T on the basis that it may also determine and publish additional IMs to those specified in s 52T. For example, and as regards Electricity DPP regulation, it has published an incremental rolling incentive scheme IM and an amalgamations IM. Vector did not question that that was the correct interpretation of s 52T. Section 52T does not, in my view, limit the matters that may be covered by IMs.

(d) In addition to the determination of IMs themselves, s 52T(2) requires not only that the matters covered by IMs be set out in sufficient detail so that each affected supplier is reasonably able to estimate the material effects of the methodology on the supplier, but that the IM must also set out how the Commission intends to apply that IM to the goods or services in question.

(e) Sections 54J and 54K provide necessary transitional provisions. They envisage the first DPPs for electricity lines services being set by the Commission before relevant IMs have been determined. Thus, s

54K(2) reflects the anticipated application of IMs to Electricity DPP regulation. Section 54K(3) provides for a further reset of the first DPPs set by the Commission if an IM is published after 1 April 2010 and if, had that IM applied to Electricity DPP regulation at the time that DPP was reset, it would have resulted in a materially different path being set.

Input methodologies and regulatory certainty

[85] Central to Vector‘s case is its contention that the Commission‘s failure to

specify:

(a) various IMs that apply to Electricity ID regulation as also being applicable to Electricity DPP regulation; and

(b) the Commission‘s Electricity DPP Reset SPA methodology as an IM,

deprives Vector and other regulated suppliers of the degree of certainty Part 4 was intended to provide them with. For its part, the Commission says that Vector is arguing for more certainty than Part 4 as enacted was intended to provide. It is therefore important to understand the way in which the provisions of Part 4, particularly as they relate to the role of IMs, can be seen as providing regulatory certainty.

[86] Section 52V provides a specific process for the Commission‘s determination of IMs, including – in s 52V(2) – express provision for consultation (similar to those found in s 52J for inquiries).

[87] Once determined, s 52S requires IMs to be applied by the Commission when determining whether or how Part 4 regulation should apply to relevant goods and services or when determining the prices or quality standards applying to regulated goods or services. Once stipulated, therefore, an IM determines the way in which the Commission must approach important decisions under Part 4 regulation.

[88] The Commission must review IMs no later than seven years after their publication and, after that, at intervals of no more than seven years.61 It would appear, however, that the Commission may review IMs within that seven year period. Where it does so, it must once again undertake the s 52V consultation

process, as if the review were a new IM.

61 Section 52Y.

[89] IMs, when initially determined and reviewed, are subject to s 52Z merits appeals.

[90] Importantly, for DPP regulation, a DPP, determined in accordance with relevant IMs, applies for a period of, generally, five years.62 Section 53ZB provides that DPPs may not be reopened within a regulatory period on the grounds of a change in an IM, except where an IM is successfully appealed. The reset provisions provided by s 54K are, as noted, transitional provisions so that once the first reset, currently the subject of the Commission‘s Draft Electricity DPP Reset Paper, occurs

further resets will only occur between one regulatory period and another, or as the result of a successful IM merits appeal.63

[91] The regulatory certainty IMs contribute to is therefore the result of a combination of:

(a) the subject matters of IMs and the types of Part 4 regulation they apply to;

(b) the process for the determination of IMs, including s 52V consultation and s 52Z merits appeals; and

(c) the requirement that IMs, whilst they remain in force, must be used by the Commission for Part 4 decisions relating to the relevant type of regulation.

[92] Part 4 does not, however, anticipate that IMs will provide absolute certainty as to how Part 4 regulation will be applied by the Commission. The purpose of IMs is to ―promote‖ certainty:64 to that end, IMs as far as is reasonably practical, set out

relevant matters in sufficient detail so that each affected supplier is reasonably able

62 Section 53M(4).

  1. Pursuant to s 52T(1)(c)(ii) the Commission has published an IM for Electricity DPP regulation specifying when an Electricity DPP may be reconsidered within a regulatory period. That IM

provides for such reconsideration where a DPP has been determined based on a material error in

information provided by a regulated firm to the Commissioner or disclosed by such a firm pursuant to Part 4 regulation.

64 Section 52R.

to estimate the material effects of the methodology on the supplier.65 Thus, and as Vector acknowledged, notwithstanding the application of IMs, there will necessarily be uncertainty for regulated suppliers as to the impact on them of IMs and Part 4 regulation more generally. Such uncertainty is inevitable.

[93] At one point in its submissions Vector suggested that the mandatory seven year review period anticipated that IMs would apply across at least two regulatory periods. It is not clear to me, based on the foregoing analysis, that that is what was intended. Having said that, there is no question that Parliament‘s intention was that IMs would be significant contributors to greater regulatory certainty and, in that way, contribute to what was seen as an important new outcome of Part 4, namely giving regulated suppliers incentives to innovate and to invest, including in replacement, upgraded and new assets. At the same time, and as the Commission emphasised, the purpose of IMs sits within the overall Part 4 purpose of promoting long-term benefits of consumers, and the outcome of regulated suppliers having incentives to innovate and invest alongside those of regulated suppliers having incentives to improve efficiency, sharing the benefit of those improvements with consumers and being

limited in their ability to extract excessive profits.66 I also, therefore, accept the

Commission‘s argument that, notwithstanding what Vector might regard as the benefit of additional certainty being provided by a SPA IM and how, as a matter of policy, such an outcome might by Vector be seen as being consistent with the

―promote certainty‖ purpose of IMs, if such an IM is not required by Part 4 then that is not additional certainty Vector can ask for. The question here is very much one of statutory interpretation, and in particular whether a SPA IM is required to be determined by the Commission as a matter that must be included in the IMs relating to Electricity DPP regulation.

DPP regulation within Part 4 – the significance of starting price adjustments

[94] The price-quality path is the central ingredient of DPP regulation, both generally and for electricity lines services in particular. The revenue a supplier may

derive in each year is stipulated by a combination of specified prices and quantities

65 Sections 52R and 52T(2).

66 Section 52A.

set at the start of the regulatory period. These fix year-one regulatory income, and by reference to the CPI – X formula,67 limit the extent to which the regulated supplier may increase prices during the regulatory period – adjustments being made to allow for changes in quantities supplied. The price-quality path is, fairly obviously, a key mechanism whereby the Commission controls on a forward-looking basis the ability of regulated suppliers to earn excessive profits.

[95] Section 53P(3) provides that the starting prices must be either:

(a) the prices that applied at the end of the preceding regulatory period; or

(b) prices, determined by the Commission, that are based on the current and projected profitability of each supplier.

[96] In general terms, therefore, the significance of the reset of prices at the start of a regulatory period in DPP regulation is that it reflects the Commission‘s assessment, based on the current and projected profitability of a supplier, of the prices that will generate a normal, or non-excessive, profit. The Commission has explained the role of starting prices in the following terms:68

The Commission‘s current views on the starting price adjustment process set out in this Discussion Paper have been reached after taking into account the DPP regulatory framework and the Part 4 Purpose. For example, a downward adjustment to prices may be appropriate – consistent with s 52A(1)(c) and (d) – in cases where suppliers are considered to be earning, or likely to earn, excessive profits and/or to promote the sharing of efficiency gains with consumers. Similarly, upward adjustments may be justified where current prices are likely to be too low to allow a supplier to earn a normal rate of return and facilitate efficient investment – consistent with s 52A(1)(a) and (b).

The price reset mechanism is, therefore, in many ways the ―sharp end‖ of DPP

regulation. By way of illustration, in the Draft Electricity DPP Reset Paper the

Commission proposes an estimated nine per cent reduction in allowable revenues for

67 See para [61].

68 Starting Price Adjustments for DPPs – Discussion Paper, August 2010, at 2.13.

Vector for the three year, transitional, regulatory period starting 1 April 2012 due to the starting price adjustment.69

Should the Commission have determined more s 52T(1) IMs for DPP regulation?

[97] The first part of Vector‘s challenge to the Commission‘s decision is that, when the Commission determined IMs for Electricity DPP regulation in December

2010, it should – in addition to those IMs it determined – also have had determined IMs for allocation of costs, asset valuation and treatment of taxation, as it had in the case of Electricity ID regulation.

[98] The question therefore becomes, in terms of s 52T(1), whether those IMs – or perhaps variants thereof – are ―applicable to Electricity DPP regulation‖.

[99] There would appear to be little doubt that they are, as has – in my view – been effectively accepted by the Commission in materials published throughout its consultation on the s 54K(3) reset.

[100] In its first consultation paper, Reset of Default Price-Quality Path for Electricity Distribution Businesses – Discussion Paper released on 19 June 2009 – the Commission commented, in chapter 6, on starting prices as follows:70

Relevance of input methodologies

213 Starting price adjustments used by utility regulators are usually based on metrics relating to the firm‘s performance (e.g., capital expenditure) and the wider economy (e.g., tax rates). Further, likely inputs to the adjustment include WACC, RAB, operational expenditure, depreciation, and revenue. A number of these inputs will be calculated based on relevant input methodology determinations (e.g. cost allocation, asset valuation, cost of capital and tax). The potential incorporation of these inputs into starting price adjustments is discussed further in paragraphs 234 –

241 below. (emphasis added)


  1. Reset of Starting Prices, CPI Adjustment & Other Amendments Draft Decision Paper, July 2011 (Figure 2.2) at 17.

70 Reset of Default Price-Quality Path for Electricity Distribution Businesses – Discussion Paper,

19 June 2009, at 58. See the similar explanation at 2.18 of the Commission‘s 5 August 2010

Starting Price Adjustments of Default Price-Quality Paths – Discussion Paper.

[101] Most recently, in the Draft Electricity DPP Reset Paper (mentioned above at [13]) the Commission included the following discussion, as part of its justification for the reset it proposes pursuant to s 54K(3):71

Assessing current and future profitability using input methodologies

...

1.26 For the purposes of assessing the need to reset the 2010-15 DPP for a starting price reset, the current and projected profitability of an EDB depends on the extent to which the revenues under the DPP72 will cover its costs. The way that each EDB‘s costs are calculated for the assessment is constrained, either implicitly or explicitly, by the IMs that have been determined.73

...

2011_97601.jpg Firstly, suppliers require compensation for their past investments. The amount of compensation that they require is reflected in the information available immediately prior to the start of the regulatory period, which is determined explicitly by the IMs for information disclosure regulation. For example, the value of the regulatory asset base (RAB) at the start of the regulatory period is determined by the asset valuation IM for information disclosure regulation.74

2011_97601.jpg Secondly, suppliers require compensation for future efficient Capex and Opex, and tax costs. Suppliers, however, do not recover all of these costs in the year in which they are incurred. Therefore it is necessary to calculate the effect of this expenditure on the level of regulatory depreciation and tax costs. The way these regulatory costs are specified in the IMs relating to information disclosure regulation implicitly

71 2020-2015 Default Price-Quality Path for Electricity Distribution Draft Decisions Paper, July

2011 at 6.

72 DPP is the Commission‘s acronym for a default-quality price path.

  1. We have released our model for consultation alongside this paper, 2010-15 Default Price- Quality Path: 2012/13 Price Reset Model – Draft Decisions, July 2011. The model specifies the IMs that we have used for calculating supplier costs and projected profitability for 2012-15 (see spreadsheet tab ―Specification‖ for the relevant IM determination clause references). We have

applied IMs for both information disclosure and CPPs, as appropriate to the calculation. IMs for asset valuation, tax and cost allocation essentially apply the same methodology for both information disclosure and CPPs. However, when calculating a multi-year forecast, the approach set out in the IM for CPPs will be more relevant than the approach for information disclosure, which is designed to calculate a one-year historical value.

(emphasis added)

  1. Information disclosure requirements for EDBs are not yet consistent with IMs. (The Commission is currently in the process of consulting on its proposed approach to information disclosure under Part 4 of the Act.) Therefore for timing reasons, we issued notices under

s 53ZD (s 53ZD Notices) requiring this information. In future this information will be readily available through information disclosure. The s 53ZD Notice issued in March 2011 listed the

relevant clause references from the IM determination that were being applied. Refer to:

Commerce Commission, Notice to Supply Information to the Commerce Commission Section

53ZD to Commerce Act 1986, 16 March 2011, which is available at http://www.comcom.govt.nz/2010-2015-default-price-quality-path/.

constrains our assessment of current and projected profitability of each supplier under a DPP.

...

1.29 At the time we released the Update Paper, information disclosed consistent with IMs was yet to be supplied by EDBs. However, we had already issued information notices under s 53ZD of the Act (s 53ZD Notices).75 All EDBs have now provided us with the information needed to take into account the impact of the IMs on our assessment of current and projected profitability. It is clear from the information that EDBs have provided that IMs have a material impact on the level of costs used to assess profitability.

(emphasis added)

[102] Mr McLaren provided a very similar explanation of the process for the determination of starting prices in his affidavit.

[103] What I think these extracts, and Mr McLaren‘s evidence, make clear is that IMs for matters such as valuation of assets, allocation of common costs and treatment of taxation are applicable to Electricity DPP regulation and, more specifically, to the DPP price reset process. The Commission‘s acknowledgement that ―inputs will be calculated based on‖ those IMs, that it is ―constrained, either implicitly or explicitly, by the IMs that have been determined‖, and that it ―has applied IMs for both information disclosure and CPP‖ in assessing the need to reset

―the 2010 – 2015 DPP‖, confirm that. The other emphasised phrases support that same conclusion. The fact that those IMs might need to be in a slightly different form for Electricity DPP regulation than they are for Electricity ID regulation does not, in my view, argue against the conclusion that they are ―applicable‖ in terms of s 52T(1) and, therefore, must be stipulated for Electricity DPP regulation in addition to Electricity ID regulation.

[104] When I drew these extracts to Ms Scholtens‘ attention, she responsibly acknowledged that similar references appeared throughout the Draft Electricity DPP Reset Paper. Ms Scholtens also confirmed that the regulated asset base value, a key input used for specification of starting prices, was itself derived from information

disclosed pursuant to the IMs stipulated for Electricity ID regulation.

75 The deadline for responding to these s 53ZD Notices was 27 May 2011.

[105] I acknowledge that the Commission has, throughout its consultation process on the s 54K(3) reset, been fully transparent with regulated suppliers as to the relevance for that reset of information disclosed pursuant to the IMs for Electricity ID regulation. In my view, however, the error the Commission has made is in not stipulating those IMs, or a modified form thereof, as being relevant for Electricity DPP regulation. As Vector in my view rightly submitted, because the Commission has not done so, the Commission would be free, subject perhaps to a Wednesbury reasonableness standard of judicial review, to adopt different methodologies when it came to consider the DPP reset for the next regulatory period, without going through the IM review process, including the opportunity for merits appeals. I accept Vector‘s submission that that outcome is inconsistent with the scheme of Part 4 as it relates to IMs generally, and their contribution to regulatory certainty specifically.

Should the Commission have determined a SPA IM for Electricity DPP

regulation?

[106] In its Draft Electricity DPP Reset Paper the Commission sets out and explains its draft decision to reset the s 54K(1) price path, and therefore its Electricity DPP Reset SPA methodology. That paper is the latest stage in a consultation process which began in March 2009. The Commission summarised that very extensive process in a chronology it provided to the Court. In addition, and in response to questions from me, the Commission produced on the second day of the hearing a very helpful summary of its Electricity DPP Reset SPA methodology.

[107] That summary set out 17 separate steps. As I understand matters, the first step was to collect cost data by the issue of a notice under s 53ZD which, ahead of disclosure pursuant to Electricity ID regulation, obtained information that would – in terms of the relevant IMs – subsequently be disclosed in that manner. That information was then used, in terms of an assessment by the Commission of current and project profitability, to derive starting prices, and therefore revenues, by reference to the determination of regulatory investment value, Commission- determined Capex and Opex and the application of cost of capital considerations based on the cost of capital Electricity DPP IM.

[108] Vector acknowledged that the Commission had consulted extensively on, and had expressed carefully considered views in, the Draft Electricity DPP Reset Paper. It acknowledged further that, even if it succeeded in these proceedings, the Commission might well – albeit following a further process – confirm those views, including its Electricity DPP Reset SPA methodology. Nevertheless, Vector argued that the Commission‘s Electricity DPP Reset SPA methodology summarised for the Court, or at least the key elements thereof, should as a matter of principle in terms of the scheme and purpose of Part 4 be specified as an IM pursuant to s 52U(1).

[109] The point at issue is, therefore and as I have already noted, a relatively narrow one. That is, should the Commission have stipulated a SPA IM?

[110] In arguing that a SPA IM is not required, the Commission points to what it considers to be the correct relationship between s 52P, and IM, determinations, and the essentially two-stage process that is involved. In its written submissions it summarised its argument as follows:

1. The issue in this proceeding is whether the Commission, when setting relevant input methodologies, was obliged either to set an input methodology which covered the setting of starting prices (or, and specifically in this context, the resetting of starting prices that form part of the 2010-15 Default Price-Quality Path for Electricity Distribution Businesses under Subpart 6), or to incorporate in each input methodology in some way detailed rules and processes which set out how each input methodology would be utilised in any future starting price set or reset.

2. The Commission says that neither step was required. It says that it may lawfully follow a two-stage process of first, setting relevant input methodologies under subpart 3 of Part 4 of the Commerce Act, and second, setting (or resetting) starting prices that form part of a default price-quality path under subpart 6:76

2.1 Section 53O (in subpart 6) sets out the general requirements for DPP regulation: a s 52P determination must be made which includes the starting prices that apply, allowable rate(s) of change in prices and the relevant quality standards. Such a s 52P determination – in relation to these matters – must also specify the input methodologies which apply. The statutory scheme clearly envisages pre-existing input methodologies being applied at the

76 In circumstances where relevant input methodologies were not determined when the 2010-15

DPP for EDBs was published and, if they had been, a materially different path would have been set.

point in the process when it is determined how a starting price reset will be effected.

2.2 Where (as is the case with electricity lines services) there is an existing DPP determination in place before determination of the input methodologies has occurred, s 54K(3) provides for a reset of the starting price if the new input methodologies would have resulted in a materially different price-quality price, and as long as the Commission acts within 9 months. Again, this statutory scheme envisages a two-step process as the Commission has adopted – determination of input methodologies and (if, following the first determination of input methodologies, they would result in a materially different price-quality price) an amendment (under s 53P) of the existing determination under s 52P.

3. There is no basis for Vector‘s argument that, notwithstanding this express power, the Commission was obliged to include, in input methodologies under subpart 3, matters relating to settling of default price-quality paths for regulated suppliers. Indeed, by interpreting sections 52R and 52T in the way that it does, Vector is trying to rewrite the Act to achieve an outcome that Vector wants but which the statute does not contemplate.

[111] The Commission made the general proposition that Subpart 3, relating to IMs, and Subpart 6, relating to DPP/CPP regulation, were separate Subparts and each was self-contained. It spoke of a statutory divide between the approach to the reset of prices in DPPs and the determination of IMs.

[112] More specifically, the Commission:

(a) pointed to the fact that there is no reference in s 52T to a SPA IM, and contrasted this with s 52T(1)(d), which requires matters relating to proposals by a regulated supplier for a CPP to be set as an IM;

(b) said that it was notable that s 53P did not refer to Subpart 3, or IMs, at all and contrasted this to the position under s 53Q which in the context of CPP proposals did refer to IMs;

(c) argued that s 53P sets the baseline rules for the low-cost set and reset and that if all such matters were in fact intended to be subsumed under s 52T, then 53P would be rendered redundant, and the obligation to consult in s 53P(2) meaningless;

(d) placed considerable emphasis on the fact that the legislative history of Part 4 included the rejection of a proposal that there be a specific reference to a SPA IM in s 52T; and

(e) submitted that certainty for suppliers under Electricity DPP regulation was specifically catered for by such suppliers being able to propose a CPP if the DPP, the setting of which was intended to involve a relatively low-cost process, did not accommodate their requirements.

[113] In all of this, the Commission noted that the overall statement of the purpose of Part 4, found in s 52A, did not contain a specific reference to certainty, but that certainty was a purpose requirement of IMs themselves.

[114] There is no doubt that the Commission is right to identify a two-stage process under Part 4, particularly as regards Electricity DPP regulation and the transitional provisions of s 54K. It is absolutely clear that s 54K envisages the Commission resetting the initial ―deemed‖ price path, which involved the pre-existing thresholds being continued by s 54J(2), before relevant IMs had been determined. In my view, however, that does not in and of itself imply that the process for price reset is not to be developed as an IM. After all, if such an IM is by law required, then it may be the basis of an adjustment of that price path pursuant to s 54K(3). By the same token, the Commission could have, as it was entitled to, reset the deemed price path pursuant to s 54K(1). It need not have simply rolled that price path over. It could have adjusted it under s 54K(1) using – in fact – the Commission‘s Electricity DPP Reset SPA methodology as has now been described in the Draft Electricity DPP Reset Paper. If it had approached the matter on that basis, the issue would remain whether that methodology was required to be specified as an IM, and therefore become subject to merits review.

[115] Moreover, and in terms of the general scheme of Part 4, IMs are to be determined and applied by the Commission as part of the inquiry into particular goods or services that may be subject to Part 4 regulation, before a recommendation to that effect is made to the Minister. IMs determined in that way apply in all material respects once Part 4 regulation is in place. The specific two-stage

procedure, on which the Commission places considerable emphasis, involving a DPP reset being made before relevant IMs are determined, is, in my view, a transitional arrangement. That is, it was designed to deal with the imposition of Electricity DPP regulation by s 54G(1). Therefore it does not support a general conclusion that a SPA IM for price reset as part of DPP regulation is – by reference to the overall scheme of Part 4 – not required.

[116] Nor do I think it would be correct to conclude that Subparts 3 and 6 are

―separate Subparts and each is self-contained‖, or that there exists a ―statutory divide‖ between them. I think the interrelationship between those Subparts has already been made clear, particularly in that s 53ZB specifically acknowledges the interconnection between IMs and price-quality paths, providing what happens to price-quality paths if IMs change.

[117] I also acknowledge that there is no specific reference to certainty in s 52A, nor in Subpart 6. In my view, however, that does not reduce the significance of increased certainty as one of the overall objectives of the amendments that were made to Part 4. Whilst the reference to the promotion of certainty is said to be the purpose of IMs, that certainty is as regards the ―rules, requirements and process

applying to the regulation, or proposed regulation of goods or services‖77 under Part

4 generally. I am therefore not persuaded that the Commission can make much of the fact that the location, in Part 4, of the specific reference to the purpose of certainty is in Subpart 3.

[118] Having said that, I think the Commission‘s submissions as to the relationship between s 52P determinations, particularly as ss 53O and 53P require those determinations to be made for DPP regulation, and the Subpart 3 provisions relating to the purpose of, and matters covered by, IMs are more persuasive.

[119] The Commission, in effect, argues that ss 53O and 53P reflect substantive decision-making processes by the Commission, supplementing its IM decisions, particularly on the matters of starting prices, rates of change in prices and quality

standards. The Commission submits that none of those matters are referred to in

77 Section 52R.

s 52T and that, moreover, Vector is not arguing that there should be IMs for rates of change or quality standards. Therefore, neither should there be, nor need there be, a SPA IM for Electricity DPP regulation.

[120] I acknowledge that there are no express references in s 52T to IMs determining the rate of change in prices relative to the CPI, nor for determining quality standards. I have to say, however, that it is far less clear to me that there is not – if not an express, then at least an implicit – reference to a SPA IM in s 52T.

[121] Section 52T(1)(c)(i) provides that IMs must include, to the extent applicable to the type of regulation under consideration, regulatory processes and rules, such as

The specification and definition of prices, including identifying any costs that can be passed through to prices (which may not include the legal costs of any appeals against input methodology determinations under this Part or of any appeals under section 91 or section 97).

Price is defined in section 52C as follows:

Price─

(a) means any one or more of individual prices, aggregate prices, or revenues (whether in the form of specific numbers, or in the form of formulas by which specific numbers are derived); and

(b) includes any related terms of payment.

[122] As it applies to Electricity DPP regulation, s 52T(1) can be expressed as requiring that ―input methodologies relating to electricity line services must include, to the extent applicable to DPP regulation, regulatory processes and rules for the specification and definition of prices and revenues‖. Section 53O(a) requires a s 52P determination for DPP regulation to ―set‖ starting prices. Section 53P requires starting prices to be reset. It is difficult to see how, therefore, s 52T(1)(c)(i) does not specifically require a SPA IM. A SPA IM is, after all, by reference to s 52C, a description of the ―methodology, process, rule or matter‖ for a matter listed in s 52T applicable to DPP regulation, namely the specification/setting of starting prices for DPPs for Electricity DPP regulation. By my assessment, that is the fairly obvious interpretation, in this context, of the combination of the definition of IM in s 52C and the provisions of s 52T(1)(c)(i).

[123] Moreover, it was precisely that ―methodology‖ that the Commission

acknowledged was reflected in the Draft Electricity DPP Reset Paper.

[124] I do acknowledge, however, that the Commission has released an IM for

―specification of prices for Electricity DPP regulation‖. That IM provides definitions of price, allowable notional revenue, pass-through costs and recoverable costs. It does not make any reference to the methodology that would be used by the Commission in its decision as to whether the specification of previous starting prices, if carried forward, would or would not result in the derivation of normal or excessive profitability. The terms of that IM might be considered support for the Commission‘s decision that s 52T(1) does not require a SPA IM. On the other hand, in reality all it reflects is the conclusion the Commission reached on that point, which is now challenged by Vector. At the same time, and perhaps more significantly, I also note that Vector did not, at least as I understood its submissions, appear to contend that s 52T(1)(c)(i) was an explicit reference to the specification of prices inherent in the setting of starting prices for a DPP, although it did argue more generally that a SPA IM came within the description of matters provided by s 52T(1)(c)(i).

[125] To the extent that there is any ambiguity in the requirement of s 52T(1)(c)(i) as, in and of itself, requiring a SPA IM, I think that ambiguity is considerably resolved by the requirements of s 52T(2). In terms of that provision, not only must an IM set out the relevant methodologies for evaluating or determining the relevant matter (as per s 52T(1)), but it must also set out how the Commission intends to apply that IM to the particular types of goods or services in question (as per s 52T(2)(b)). As the Commission has I think acknowledged, s 52T(1) IMs are proposed to be used, albeit in conjunction with other inputs reflecting the forward- looking nature of a DPP, to set opening prices and, therefore, the s 54K(3) price path resets. Another way of understanding the Commission‘s methodology that is reflected in the Draft Electricity DPP Reset Paper, and that was helpfully summarised in the memorandum provided to the Court in response to my questions, is that the Commission has – through those materials – described ―how‖ various other IMs are to be used for the purposes of the price reset. It has, in that way, in

effect produced a SPA IM. Thus, in its written response to questions raised by the

Court, the Commission explained that:

(a) it had obtained cost data which formed the basis of various projections by references to ―IM determinations‖ that were being applied (at 3.1);

(b) the WACC (Weighted Average Cost of Capital) value for the DPP regulatory period was found from the DPP WACC IM (3.5) and that the regulatory investment value, or the ―initial RAB values‖ were also derived from information obtained by references to IMs.

[126] Reflecting material already referred to in my consideration of the question of whether cost allocation, asset valuation, treatment of taxation and cost of capital IMs should be stipulated for Electricity DPP regulation as they have been for Electricity ID regulation, Mr McLaren explained aspects of the Commission‘s Electricity DPP Reset SPA methodology in the following way:

As a simple matter of arithmetic, the current and projected profitability of a supplier depends on the extent to which the revenues under the DPP will cover its costs. Starting prices determined in accordance with s 53P(3)(b) therefore depend on the way in which each supplier‘s costs are calculated. These calculations are constrained, either implicitly or explicitly, by the IMs that apply to the supply of electricity lines and gas pipeline services:

2011_97601.jpg First, suppliers require compensation for investments undertaken in the past. The amount of compensation that they require is reflected in the information disclosed at the start of the regulatory period, which is determined explicitly by the IMs for information disclosure regulation. For example, the regulatory asset base (―RAB‖) value at the start of the default regulatory period is determined by the IM for the valuation of assets under information disclosure regulation. Assessments of current profitability are therefore constrained by the IMs for information disclosure.

2011_97601.jpg Second, suppliers require compensation for future efficient capital and operating expenditure, and tax costs. However, suppliers do not recover all of these costs in the year in which they are incurred; hence the effect of this expenditure on the level of regulatory depreciation, opex, and tax costs must be calculated. The way these regulatory costs are specified in the IMs relating to information disclosure regulation implicitly

constrains78 the Commission‘s assessment of current and projected

profitability of each supplier under a DPP.

2011_97601.jpg Thirdly, the return required by debt and equity holders must be calculated (i.e. the cost of capital). This is the risk-adjusted level of profitability that a supplier in a workably competitive market would expect to earn. The way in which an estimate of the cost of capital must be determined for a DPP is set out explicitly in the IMs for DPPs.

In summary, while the Commission is currently consulting on the approach to determine the actual starting prices that will apply for EDBs in the 2010-

2015 period, the Commission is heavily constrained by the combined effect

of section 53P and the IMs that have been determined.

[127] Whilst the forward-looking nature of the exercise involved in the setting and resetting of a DPP may involve additional considerations, what I think is clear is that the Commission is applying published IMs for that purpose. The Commission itself acknowledged this in its written submissions to the extent that it argued ―specific input methodologies are not necessary for the DPP determination as, once the DPP determination is in place, many of the inputs to DPP regulation will come from information disclosure, which itself is subject to input methodologies‖. In other words IMs are being applied to electricity lines services and Electricity DPP regulation. Therefore, in my view, s 52T(2) requires the description of that process of application to be specified in those IMs as they apply to Electricity DPP regulation.

[128] That outcome supports my view that the requirements of s 52T(2) also support the conclusion that a SPA IM is required.

[129] Coming back to ss 53O and 53P, I have then reconsidered the significance of the various references, particularly in s 53P, to resetting starting prices, rates of change and quality standards, and the Commission‘s pertinent observation that whilst Vector argues for a SPA IM, it does not argue for a rate of change or quality standard IM. I think the simple answer to that argument is that there is no express or implied reference to rates of change or quality standards in s 52T and that, moreover, I do not understand that methodologies for matters such as valuation of assets, allocation of

common costs and treatment of taxation (for example) are involved in determination

78 NB this explains and answers the Vector submissions and table at 5.18 to 5.19. These IMs,

while not explicitly tied in to DPP determinations, have to be applied in their terms in any DPP –

they implicitly constrain the Commission.

of matters such as the rate of change or quality standards. Nor do I think it is particularly significant that s 53O does not refer to IMs specifically. Section

52P(3)(c) has already required a reference to applicable IMs in s 52P determinations. There is no need for that requirement to be repeated in s 53O. Nor, in my view, does this approach to the requirement for a SPA IM render consultation pursuant to s 53P(2) meaningless. As acknowledged, IMs do not provide absolute certainty and their application will not be mechanical. The need for consultation will remain. The requirement in s 53Q(2) for CPP proposals to comply with IMs is, in my view, a mechanical provision. In the context of the proposal of a CPP, it supplements the provisions of s 52S. Section 52S provides generally how published IMs are to apply, but does not require a regulated firm proposing a CPP to conform with stipulated IMs. I am, therefore, not persuaded that the provisions of s 53O and 53P mean that a SPA IM is not required.

[130] I have also considered whether, as the Commission contended, the opportunity for firms subject to Electricity DPP regulation to specify a CPP, if the DPP does not accommodate their requirements, provides the additional certainty that Vector argues for. I acknowledge the significance, in terms of certainty for an individual firm, of the ability to propose a CPP. Having said that, I do not think that ability counts against the interpretation of s 52T set out above as, either explicitly or in effect, requiring a SPA IM. It is, I think, important to note that the desired ―low- cost‖ nature of DPP regulation must be an outcome intended to benefit not only the Commission, but also regulated firms. Moreover, and as Vector submitted, there are certain inflexibilities with the CPP regime – in particular that once proposed a CPP may not be withdrawn and that the Commission may replace a proposed CPP with one of its own determinations – that create some uncertainties about the CPP process itself. A CPP is an alternative to a DPP: that does not mean, however, that a SPA IM is not required.

[131] There is a further element of the overall scheme of Part 4 that, in my view, supports the conclusion I have thus far reached. This relates to the structure of appeal rights provided pursuant to ss 91 (Part 5) and 52Z.

[132] The starting point here is that, under the old Part 4, there was no right of appeal against s 57F declarations of the Commission imposing price controls. Those decisions were specifically excluded from the ambit of the general right of appeal provided by s 91(1). In amending Part 4, Parliament concluded that some form of appeal against Part 4 decisions was appropriate, and that such an appeal should, as did the then existing general right of appeal under s 91(1), allow the High Court to reconsider the correctness of a Commission decision. Parliament was concerned, however, that the High Court should not too readily interfere with Part 4 decisions made by the Commission. Thus, reflecting the centrality of IMs to Part 4, s 52Z provides for merits appeals against IM determinations, but sets a ―materially better‖ threshold before the High Court may, in effect, replace a Commission decision on an IM with its own. Further, and reflecting the very technical nature of decisions in this area, the High Court will generally sit with two specialist members when it hears

such appeals.79 At the same time, Parliament retained general rights of appeal

against s 52P determinations, other than to determinations which set out (i) how information disclosure or negotiate/arbitrate regulation applies to regulated suppliers, (ii) the DPP that applies to regulated suppliers, and (iii) IMs (in respect of which s 52Z provides a specific right of appeal).80

[133] Therefore, if the Commission‘s approach as regards the need for a SPA IM is correct, there will be no appeal against the relevant part of the s 52P determination, as that is clearly a part of a determination that sets out the DPP that applies to regulated suppliers. At the same time, and because the Commission has not specified a SPA IM pursuant to s 52U, the basic approach the Commission takes to the resetting of prices would not be subject to the possibility of merits appeals.

[134] The interpretation that a SPA IM is required, given the centrality of DPPs for DPP regulation and, in that, the significance of the price setting and resetting process, would therefore appear to be consistent with the scheme and purpose of Part

4, and within that the certainty intended to be provided by IMs and the role of the

appeal process provided by s 52Z.

79 Section 52ZA(3).

80 Section 91(1).

[135] With respect therefore to the various arguments I have so far considered I would reach the conclusion that, as Vector argues, a SPA IM is required. There is, however, one important matter that I have not yet considered.

[136] During the Select Committee‘s consideration of the Commerce Amendment Bill, a number of proposals were made for additional matters to be covered by IMs in what became s 52T. One such additional matter was that there be a specific reference to an IM to be used when setting and resetting DPPs. That proposal was made by Vector and was also the subject, at one point, of a recommendation by MED, which MED subsequently withdrew. That proposal was not accepted by the Select Committee. At the same time, however, what became s 52T(2) was added, in response to concerns that IMs might be set at too high a level of generality to serve their purpose.

[137] In its commentary on the Commerce Amendment Bill as reported back, the

Select Committee stated:81

We recommend the addition of a new section 52S(1A)(clause 4) to ensure that input methodologies would be set out in sufficient detail to allow affected suppliers to reasonably estimate the impact on their business.

We did not agree with submitters who put forward a range of proposals for additional matters to be covered by input methodologies in new section 52S. Given that the Commission is already faced with a very large and demanding workload we consider that additional requirements would put pressure on the input-methodology process.

[138] In the very detailed legislative history materials that the Commission provided to me, some further light was thrown on that decision-making process. MED, in a note of 21 July 2008 responding to issues raised by the Commission, commented on its earlier recommendation that a methodology for setting DPPs be included, and that there also be an additional IM on how to compile financial statements. MED noted the Commission‘s concerns as to the additional work implicit in those proposals, considered there was substance in those concerns and went on to note that proposed amendments to s 52S (as it then was), including the addition of what became s 52T(2), meant that those additional IMs were

unnecessary. In addition to referring to what became s 52T(2) as regards IMs for

81 Commerce Amendment Bill 2008 (201-2) (Select Committee report) at 4.

setting DPPs, MED also referred to the prohibition on the use of comparative benchmarking and the availability of CPPs.

[139] It is clear, therefore, that the Select Committee did consider an additional specific reference in s 52T(1) to an IM for setting DPPs, and rejected that proposal. That is clearly a factor which counts against Vector‘s argument that the Commission must specify a SPA IM.

[140] Having said that, I am not persuaded that the very detailed material put before me, when seen in the context of the interpretation that I think the legislation as passed calls for, is – at the end of the day – conclusive on the point. First, there is at least a suggestion that the decision not to include a specific reference was made, not because a SPA IM was considered unnecessary, but that in the view of officials at least, s 52T(2) in effect met that need. Moreover, and as probably does not need to be said but as was also observed by the Court of Appeal in Skycity Auckland Ltd v Gambling Commission, it can be difficult and even inappropriate – particularly in an MMP environment – to draw firm conclusions from expressions of opinions in

legislative history as to what legislation, when enacted, may mean.82 Moreover, with

contentious and very technical legislation such as the Commerce Act, what may or may not have been in the minds of a Select Committee, or individual submitters, is not necessarily in my view a particularly helpful source of guidance to interpreting the legislation when passed.

[141] Trying to balance those considerations, I have reflected at length on the significance of this matter. In terms of my overall assessment of the arguments made by Vector and the Commerce Commission, this was at the end of the day the matter that I considered was capable of providing the strongest support for the Commission‘s position that a SPA IM is not required. On balance, when I take into account what I consider to be:

(a) the strength of the interpretation of s 52T(1) and (2) that I have arrived at;

82 Skycity Auckland Ltd v Gambling Commission [2008] NZLR 182 (CA).

(b) the fact, as I consider now is made very clear by the Commission‘s own material, of the relevance and use by the Commission in its Electricity DPP Reset SPA methodology of various IMs, and the significance of that use in fact in terms of s 52T(2) (a matter which, quite understandably, might well not have been appreciated by the Select Committee at the time); and

(c) the significance – in terms of the scheme of Part 4 generally, and in particular the importance of DPP set and resets for DPP regulation – of the relevant ―methodologies, process and rules‖ applied by the Commission when it undertakes those exercises – being stipulated as an IM,

I have concluded, notwithstanding this element of the legislative history, that Part 4 as properly construed does require an IM providing the key elements of the regulatory processes and rules for the specification of starting point prices (and therefore revenues) for DPP sets and resets. That is, taken overall, and although I acknowledge the complexity of the Part 4 regulatory scheme and the challenges it no doubt has provided to the Commission, I conclude that the Commission is required to determine, what was termed before and is referred to in this judgment as, a SPA IM for Electricity DPP regulation.

Reset under s 54K

[142] In this part of its case, Vector challenges the approach the Commission has, transparently and consistently, taken to the proposed reset of the current DPPs for electricity lines services under s 54K(3) and, in particular, to the adjustment of starting prices that the Commission has signalled it considers appropriate. The Commission‘s position is that once it is established that a materially different DPP would have been set had a subsequently published IM applied at that time, s 54K(3) allows the Commission to reset that DPP. Such a reset may not only take account of the effect of the subsequently published IM, but also can be undertaken more generally ―in accordance with s 53P‖. Further, s 52P, and in turn ss 53O and 53P, allow the Commission to determine starting prices by taking into account a

methodology not specified as an IM. The Commission pointed, in particular, to the words ―in accordance with s 53P‖ as supporting that interpretation. That is, once it is established that an IM causes a material difference to a price path, the price path may be reset afresh in accordance with s 53P.

[143] Vector has, equally consistently, argued that the Commission‘s approach is

incorrect in the three ways set out at [22].

[144] The decisions I have already made, namely that the Commission should have determined the Electricity ID regulation asset valuation, treatment of taxation and cost of capital IMs as applicable, in the same or some modified form, to DPP regulation, and should also determine and publish a SPA IM, mean that – subject of course to any appeals against this decision – the Commission will need to re-consult on the determination of those IMs. Following that process, and depending on this, the second and third limbs of Vector‘s challenge to the Commission‘s decision will fall away, as the Commission will determine its approach to the s 54K(3) reset by reference to IMs in the manner Vector says is required.

[145] There will remain, however, the first limb of Vector‘s challenge, that is whether in fact IMs already determined, and in particular the exclusion of GST effects now stipulated in IMs as pointed to by the Commission, would have resulted in materially different DPPs if those IMs had been in effect at the time of the s 54K(1) reset. There is also the more general question of whether it is only by reference to the specific effect of one or more IMs that DPPs may be reset under s 53ZB generally and s 54K(3) in particular.

[146] The evidence provided to me by each of Vector and the Commission as to whether or not in fact various IMs would have caused a material change to the s 54K(1) price paths determined in November 2009 if they had applied at the time was unclear. I have been unable myself to clarify it. Therefore, I do not intend to endeavour to reach a finding on that specific factual matter. What I will do, however, is set out my views as to the extent of the reset allowed by s 54K(3).

[147] In my view, this matter can be expressed relatively briefly. DPPs are set by the Commission for a regulatory period which must, generally, be five years.

Section 53ZB(1) provides that DPPs may not be opened within a regulatory period on the grounds of a change in an IM, except as provided in subsection (2) following a successful merits appeal against an IM. Therefore, and except to the limited extent provided by the IM for reconsideration of Electricity DPP regulation (see [12]), in effect DPPs may not be reopened except where there is a change in an IM. As already analysed at [84](e), however, and as a transitional measure, s 54K(3) allows a DPP set pursuant to s 54K(1) to be reopened if a subsequently published IM would have materially altered that price path had it applied at the time it was reset.

[148] I note first that I am unable to conclude that the general provisions of s 53ZB can be interpreted in the way the Commission contended. Section 53ZB provides, in my view, for the limited reopening of DPPs to take account of the extent to which those price paths would have changed if the successfully appealed IM had applied at the time they were set. Section 53ZB(2) provides:

Every default and customised price-quality path must be reset by the

Commission in accordance with section 53P if─

(a) an input methodology changes as a result of an appeal under section

52Z; and

(b) had the changed methodology applied at the time the price-quality path was set, it would have resulted in a materially different path being set.

[149] In my view, the reset is to identify the materially different path that would have been set if ―it‖, that is the changed IM, had originally applied. The section does not mandate reset on a broader basis. In my view, it would be inconsistent with the general statutory scheme if the words in s 53ZB(2) ―in accordance with s 53P‖ were read as a signal that the resetting of a price path, following a successful IM appeal, could have such a broader basis.

[150] I take the same approach with regard to the interpretation of s 54K(3). That a similar approach is required is, I think, confirmed by the cross-reference in that section to s 53ZB as otherwise preventing reset. Moreover, I think the words of s 54K(3) direct the focus of the reset being to the subsequently published IM, and the effect it would have had on the s 54K(1) price path, i.e. resulting in a materially different price path, if it had applied at the time that price path was set. In my view,

if Parliament had intended that the Commission could, in effect, reset the price paths by reference to more general considerations, the legislation would have said that.

[151] That conclusion supports the view I have reached of the requirement that the Commission promulgate a SPA IM. That is, as s 54K(3) only allows the s 54K(1) price path to be reopened by reference to subsequently published IMs, if the Commission did not promulgate a SPA IM, albeit reflecting its Electricity DPP Reset SPA methodology, it would not be entitled to reset in the manner anticipated by the Draft Electricity DPP Reset Paper.

Result

[152] In general terms, therefore, the result of these proceedings is that the Commission has misinterpreted Part 4 to the extent that it has not determined s 52T(1)(a) valuation of assets, allocation of common costs and treatment of taxation IMs for Electricity DPP regulation, and to the extent that it has not determined a SPA IM for Electricity DPP regulation.

[153] In terms of appropriate relief, the Commission filed useful submissions concerning the question of relief, were I to determine these proceedings in Vector‘s favour. Vector accepted that the approach set out by the Commission in those submissions was generally appropriate. I therefore consider that the appropriate relief is as follows:

(a) The Commission should specify valuation of assets, allocation of common costs and treatment of taxation IMs for Electricity DPP regulation. The Commission could do that by simply specifying the equivalent IMs for Electricity ID regulation as applicable to Electricity DPP regulation. As Vector suggested, any adjustment to the way those IMs are to be applied for Electricity DPP regulation could be indicated in the SPA IM. Alternatively, the Commission could specify separate such IMs for Electricity DPP regulation. That is a matter for the Commission.

(b) The Commission should, as it set out its submission on relief under the heading ―Third option – a stand-alone SPA IM‖, consult on, in terms of the consultation process provided by s 52V, and stipulate a stand-alone SPA IM for Electricity DPP regulation. For that purpose the period of time provided by s 52U needs to be extended: I reserve the question of the period of that extension, and invite further submissions from the Commission and Vector on that point. I record that I consider, as both the Commission and Vector submitted, that s 4(5B) of the Judicature Amendment Act 1972 provides me with appropriate powers.

(c) As the Commission further submitted on relief, merits review of that SPA IM would then be available and, on the making of the SPA IM, the time for a DPP reset/claw back under s 54K(4) for electricity lines services would begin to run again, if the new IM determinations had a material effect on the existing DPP.

[154] On that basis, none of the existing IMs determined by the Commission are rendered invalid.

[155] As noted at the outset, Vector is also a gas distribution business and the decisions in this proceeding will apply equally to the approach the Commission is required to take to the Subpart 10 DPP regulation of gas pipeline services.

Costs

[156] The question of costs is reserved.


“Clifford J”


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