FEDERAL COURT OF AUSTRALIA
SA Power Networks v Australian Competition Tribunal (No 2) [2018] FCAFC 3
ORDERS
SA POWER NETWORKS (ABN 13 332 330 749) Applicant | ||
AND: | AUSTRALIAN COMPETITION TRIBUNAL First Respondent AUSTRALIAN ENERGY REGULATOR Second Respondent |
DATE OF ORDER: |
THE COURT ORDERS THAT:
1. The applicant’s Amended Originating Application filed on 3 April 2017 be dismissed.
2. The applicant pay the second respondent’s costs of the application to be taxed in default of agreement.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
the court:
1 This is an application for judicial review under the Administrative Decisions (Judicial Review) Act 1977 (Cth) (“ADJR Act”) by SA Power Networks (“SAPN”) of a decision of the Australian Competition Tribunal (“the Tribunal”) made on 26 October 2016. The Tribunal decided to affirm a decision of the Australian Energy Regulator (“AER”) under s 71P(2)(a) of the National Electricity Law (“NEL”) (Application by SA Power Networks [2016] ACompT 11). The AER made its decision on 29 October 2015.
2 The Court is asked to find that the Tribunal made judicially reviewable errors in the course of reviewing, on (limited) merits review grounds, the AER’s decision.
3 These judicial review proceedings are in the original jurisdiction of the Court, although that jurisdiction has been directed by the Chief Justice to be exercised by a Full Court: s 20(1A) of the Federal Court of Australia Act 1976 (Cth).
4 The parties to the application for judicial review are SAPN as applicant, and the Tribunal and the AER as respondents. SAPN is the operator of an electricity distribution network located in South Australia. It is registered as a distribution network service provider (“DNSP”) within r 2.5.1 of the National Electricity Rules (“NER”) and it provides distribution network services by means of the South Australian distribution network. The AER made the decision which was challenged in the Tribunal. The Tribunal filed a submitting notice. The South Australian Minister for Mineral Resources and Energy (“State Minister”) was granted leave to intervene in relation to one of the matters considered by the Tribunal, namely, the forecast labour cost escalation (SA Power Networks v Australian Competition Tribunal [2017] FCA 415).
5 The background to the application is as follows. On 31 October 2014, SAPN submitted its regulatory proposal 2015-2020 to the AER pursuant to NER r 6.8.2(b)(1) as amended by r 11.60.4(a) and its revised regulatory proposal pursuant to r 11.60.4(b) on 3 July 2015. On 29 October 2015 pursuant to r 11.60.4(c) of the NER (made under s 90 of the NEL), the AER made a final decision and determination entitled “Final Decision: SA Power Networks Distribution Determination 2015-16 to 2019-20” (“Final Decision”).
6 On 19 November 2015, SAPN applied pursuant to s 71B of the NEL for review of the Final Decision.
7 On 4 May 2016, the Tribunal granted SAPN leave to apply for review of the Final Decision with respect to the designated grounds of review referred to in an Amended Application for Review filed with the Tribunal on 3 May 2016 (“Amended Application”).
8 The challenges before the Tribunal to the AER’s Final Decision related to the following components:
(1) the cost of corporate income tax (gamma);
(2) return on debt;
(3) forecast bushfire safety capex;
(4) forecast labour cost escalation; and
(5) forecast inflation.
9 The Tribunal’s decision formed part of the review that the Tribunal was required to undertake under Part 6 Division 3A subdivision 2 of the NEL. Section 71B of the NEL provides that an affected or interested person or body with the leave of the Tribunal may apply to the Tribunal for a review of a reviewable regulatory decision. The available grounds of review are specified in s 71C of the NEL. It is well established that the term “review” is used in various senses in public law and that it takes its content from the particular statutory or constitutional settings in which it appears (East Australian Pipeline Pty Limited v Australian Competition and Consumer Commission [2007] HCA 44; 233 CLR 229 at [62] per Gummow and Hayne JJ; at [13] Gleeson CJ, Heydon and Crennan JJ agreeing).
10 The review contemplated by subdivision 2 does not involve a de novo hearing. Rather, the nature of the review is a limited merits review regime. The grounds of review are that the AER made a material error of fact or exercised its discretion incorrectly, having regard to all the circumstances, or its decision was unreasonable, having regard to all the circumstances. The matters that an applicant for review may raise in a review are specified in s 71O(2). The matters which the Tribunal may consider when making its determination in respect of an application for review are specified in s 71R.
11 SAPN submitted that, subject to those limitations, the proper role of the Tribunal is to engage in a merits review of the AER’s determination in order to determine whether a ground of review listed in s 71C is established.
12 In its application for judicial review in this Court, SAPN contends that the Tribunal made errors in relation to the cost of corporate income tax (gamma), return on debt and forecast labour cost escalation. A variety of grounds in s 5 of the ADJR Act are relied on by SAPN and we will identify each of the grounds in relation to each of the three matters.
13 Before the Court heard SAPN’s application, the parties in this matter were advised that the Court would soon be handing down its decision in judicial review applications brought in relation to decisions made by the Tribunal in five related matters. The lead matter was the Tribunal’s decision in Re Application by Public Interest Advocacy Centre Ltd and Ausgrid [2016] ACompT 1 (“Ausgrid”) (ACT 1 of 2015, ACT 4 of 2015). For convenience, we will refer to these matters as the Ausgrid matters before the Tribunal. The parties in this matter were advised that when the Court had handed down its judgment, the parties would be invited to make further written submissions if they wished in relation to matters arising from the judgment. We handed down our decision in Ausgrid (Australian Energy Regulator v Australian Competition Tribunal (No 2) [2017] FCAFC 79; 345 ALR 1 (“AER v Australian Competition Tribunal”)) on 24 May 2017. SAPN and the AER made further written submissions. SAPN’s submissions addressed the matters of gamma and return on debt. The AER’s submissions addressed these matters and forecast labour cost escalation. We should say at this point that the AER submitted that there was nothing in this Court’s decision which affected the proper approach to the challenge in relation to the forecast labour cost escalation.
14 In AER v Australian Competition Tribunal, the Court considered at some length, at [133]-[159], the Tribunal’s authority and the function of the Court on judicial review of a decision of the Tribunal. We do not repeat that analysis here, except to repeat the observations made by an earlier Full Court in Pilbara Infrastructure Pty Ltd v Australian Competition Tribunal [2011] FCAFC 58; 193 FCR 57 at [16], as follows:
It is not this court’s function to resolve the difficult and complex matters of judgment raised by the evidence and resolved by the Tribunal. This court’s role in reviewing the decision of the Tribunal is to ensure that the decision of the Tribunal accords with the law. In Re Minister for Immigration & Multicultural Affairs; Ex parte Applicant S20/2002 (2003) 198 ALR 59; 77 ALJR 1165 at [114] it was said that it is no part of the supervisory jurisdiction of this court to
… enter upon a consideration of the factual merits of the individual decision. The grounds of judicial review ought not be used as a basis for a complete re-evaluation of the findings of fact, a reconsideration of the merits of the case or a re-litigation of the arguments that have been ventilated, and that failed, before the person designated as the repository of the decision-making power.
GAMMA (GROUNDS 1 – 6 INCLUSIVE)
15 The Tribunal introduced this topic by saying, at [106], that gamma is one of the required parameter inputs into the post-tax revenue model (“PTRM”) used under the NER for the determination of allowable revenues for a DNSP. It represents the “value” of imputation (tax) credits arising from company tax payments which are distributed with dividends to shareholders. The Tribunal said, at [108], that because gamma is unobservable, and also because of conflicting interpretations of the word “value” in its definition, there has been ongoing debate over the appropriate numerical value to use in the PTRM. SAPN argued before the Tribunal that the AER made errors in determining to use a value of 0.4 for gamma, and contended that it should have accepted the value of 0.25 for which SAPN argued.
16 At [117], the Tribunal said that the two issues at the heart of the dispute between SAPN and the AER were, first, whether the nature of the approach in Professor Officer’s 1994 paper, The Cost of Capital under an Imputation Tax System, has explicit implications for the interpretation of the term “value of imputation credits” used in the PTRM and the NER and, second, how a “value” of imputation credits should be estimated given the interpretation which is (or should be) adopted.
17 At [138], the Tribunal noted that in relation to the concept of the “value of imputation credits”, different theoretical models, all of which are simplifications of reality, with different strengths and weaknesses, and with different degrees of support among experts, may suggest differing approaches. Judgement about the weight to be given to alternative approaches would then be required, with resulting consequences for judgements about the subsequent issues.
18 The Tribunal, at [139]-[159], addressed the contention that the AER erred in misconstruing the correct interpretation of “value of imputation credits” through focusing on utilisation rather than implied market value. It concluded that the AER did not err, nor was unreasonable, in giving most weight to the “utilisation” approach. The AER considered the range of alternative approaches, recognised the diversity of views of experts on their merits (both theoretical and empirical), and made a judgement call. In doing so, it demonstrated responsiveness to the empirical evidence in lowering its estimate of gamma from 0.5 as proposed in its ROR Guidelines to a value of 0.4. We reproduce [159] in its entirety since some of SAPN’s grounds of review were founded on it:
Consequently, the Tribunal is of the view that the AER did not err, nor was unreasonable, in giving most weight to the “utilisation” approach. It considered the range of alternative approaches, recognised the diversity of views of experts on their merits (both theoretical and empirical), and made a judgement call. In doing so, it demonstrated responsiveness to the empirical evidence in lowering its estimate of gamma from 0.5 as proposed in its ROR Guidelines to a value of 0.4. The Tribunal recognises that this decision is the converse of that made by a differently constituted Tribunal in the Ausgrid case. The reason for this difference is twofold. First, submissions in this hearing gave greater attention to the theoretical underpinnings of the PTRM and “vanilla WACC” framework. Secondly, and as discussed immediately below, this Tribunal is of the view that the dividend drop-off evidence should be viewed in the context of the theoretical model underpinning it, and that there are significant uncertainties associated with extracting reliable evidence about tax-related parameters (such as gamma) from such studies.
We note that in AER v Australian Competition Tribunal the Full Court held, at [751]-[757], that the Tribunal in Ausgrid, as referred to but not followed by the present Tribunal in this paragraph, erred in law in this respect.
19 The Tribunal then, at [160]-[171], considered SAPN’s claim that the AER should have given more (or complete) weight to evidence from dividend drop-off studies. It concluded that the uncertainty associated with drawing conclusions about the value of imputation credits from any existing drop-off study (no matter how well specified and conducted) was sufficient for the AER to make a judgement to accord limited weight to this type of evidence. Consequently, the Tribunal did not agree that the AER erred or was unreasonable in placing less weight on dividend drop-off studies in the estimation of the value of gamma.
20 At [172]-[178], the Tribunal considered the role of personal costs. It concluded that while some investors do experience investor level (personal) costs in dealing in equities, these can vary substantially across investor groups. It was thus not clear what effect such costs will have on equity market prices or on the need to adjust estimates for implied values of franking credits drawn from shareholder distribution or tax statistics.
21 From [179], the Tribunal considered SAPN’s contention that the AER erred in three ways in data choices in estimating gamma. The Tribunal observed that the AER only gave a range of figures for each of the inputs to the gamma calculation and not explicit figures used in reaching its final estimate of gamma. The issue before the Tribunal, it said, was whether the net result of the AER’s decision based on these ranges for inputs was unreasonable or in error. To assess that, the Tribunal said, it was necessary to determine whether the ranges adopted were reasonable. It looked first at the value for the distribution rate. It then considered equity ownership data, the AER placing most reliance on estimates of the domestic ownership rate for estimating theta. The Tribunal then considered the AER’s use of taxation statistics, noting that the AER gave less weight to the taxation statistics than to equity ownership information (and more weight than to market value dividend drop-off studies).
22 At [196], the Tribunal stated its conclusion. We reproduce this paragraph in its entirety since some of SAPN’s grounds of review were also founded on it:
In the face of significant uncertainty, the approach by the AER of considering a range of approaches to estimating gamma and applying different weights to those approaches is, the Tribunal believes, appropriate. It is clear that some experts would apply different weights to the alternative types of evidence, and that some support the AER’s relative ranking while others disagree. In particular, some would accord much higher weight to results of dividend drop-off studies. The Tribunal has noted the arguments about the problems of deriving reliable tax-related parameters such as investor valuation of imputation credits from drop-off parameters, and is of the view that the AER did not err in forming the judgement it did regarding weight to give to different forms of evidence.
23 The grounds for judicial review in relation to gamma in SAPN’s Amended Application were, omitting particulars:
1 The Tribunal, especially at [159] and [196], failed to determine whether the AER’s exercise of discretion was incorrect by reason of the AER having acted on an incorrect construction of the words “the value of imputation credits” in cl 6.5.3 of the NER, and thereby misunderstood its function under s 71P of the NEL or otherwise erred in law.
2 The Tribunal, especially at [159] and [196], proceeded on the basis that the correct meaning of the words “the value of imputation credits” in cl 6.5.3 of the NER, or further or alternatively the methodology or evidence that could be used to calculate “the value of imputation credits”, was a matter for a “judgement call” by the AER in light of “the diversity of views of experts” and thereby misunderstood its function under s 71P of the NEL or otherwise erred in law.
3 The Tribunal, especially at [159] and [196], erred in concluding that the “utilisation rate” or “utilisation approach”, or further or alternatively the equity ownership approach or evidence from tax statistics, could be used to calculate “the value of imputation credits” under cl 6.5.3 of the NER.
4 Further or alternatively to Grounds 1 and 2, the Tribunal, by not finding error in the AER's construction of the words “the value of imputation credits” in cl 6.5.3 of the NER, itself acted on a wrong construction of those words, namely:
(a) that the “value” of imputation credits does not mean the amount that the investor values the imputation credit, which would be affected by reasons why investors do not value imputation credits at the face amount, including the costs of redeeming credits, the time value of money, and portfolio effects;
(b) that the utilisation rate or face amount of imputation credits could reflect the “value” of distributed imputation credits (known as “theta”).
5 Contrary to s 71R(1)(a) of the NEL, the Tribunal considered matter other than review related matter (within the meaning of s 71R(6) of the NEL), namely:
(a) that while some investors do experience investor level (personal) costs in dealing in equities, these can vary substantially across investor groups. It is thus not clear what effect such costs will have on equity market prices or on the need to adjust estimates for implied values of franking credits drawn from shareholder distribution or tax statistics; [178]
(b) that the composition of investors in the market could comprise those to whom personal costs are of minor significance; [174]
(c) that discounting of tax costs due to time delay could offset or outweigh discounting of imputation credits due to time delay; [175]
(d) that portfolio effects or the loss of diversification benefits could be offset or outweighed by “home bias” in investor portfolios; [177]
none of which formed part of the basis for the AER’s Gamma Decision or the AER’s Final Decision, or of the review related matter, and could only have been identified from matter other than review related matter, with the consequence that: the procedures that were required by law to be observed were not observed; or the Determination was an improper exercise of the power conferred by s 71P of the NEL; or the Determination involved an error of law; or the Determination was otherwise contrary to law.
6 The Tribunal considered, and reached its conclusions on the basis of, matters in its decision that were not advanced by the AER before the Tribunal or otherwise discussed in submissions before the Tribunal. In so doing, the Tribunal deprived SA Power Networks of any opportunity to address these matters, including but not limited to making a submission as to whether they were review related matter, such that a breach of the rules of natural justice occurred in connection with the making to the Determination. The matters were:
(a) the matters identified in paragraph 5(a)-(d) above;
(b) the distinction drawn by the Tribunal between the “marginal investor” and the “average investor”; [146], [148], [149]-[159], [168], [193]
(c) that investors could be different during the period of the dividend drop off study from those at other times, or different cum and ex dividend, such that the dividend drop off study does not measure the value of imputation credits to relevant investors; [154], [155], [168]
(d) that there would need to be a strong case to identify some general investor costs and attribute to them some systematic effect on asset prices and valuation of imputation credits before “personal costs” could be said to affect the valuation of imputation credits, and that no such case had been substantiated; [174]
(e) the Tribunal rejected use of a dividend drop off study as an estimate of theta on the basis that the study did not measure the value to the average investor but rather the value to a marginal investor at [168]-[169], where:
(i) the Tribunal had previously endorsed the use of reliable dividend drop off studies;
(ii) no objection had been taken to use of reliable dividend drop off studies;
(iii) the rejection of the use of the study was not supported matter; and
(iv) the Tribunal did not raise this matter with the parties.
24 SAPN submitted, in summary, as follows.
25 The methodologies to estimate gamma considered in the Final Decision were not different measures of the same thing but measured different things. The AER’s selection and approach, and primary reliance on “equity ownership”, was driven by its construction of “the value of imputation credits”: namely, the face amount of utilised credits: SAPN referred to its written submissions at [16]-[18], [22].
26 SAPN raised as a ground for review before the Tribunal that the AER’s approach involved a legal error in the construction of r 6.5.3 of the NER. The Tribunal was required by s 71P to determine that ground but did not do so. It did not consider the meaning of the text or its construction and context. Instead, it determined that because there were debates as to the best way of measuring gamma the AER was entitled to make a “judgement call”. That was an error of law: breach of s 71P and misconception of its function under s 71P (ADJR Act s 5(1)(f)); it also did not have jurisdiction not to determine the ground (s 5(1)(c)) and it was not authorised not to determine the ground (s 5(1)(d)): Ground 1. Also, the Tribunal misunderstood its function by concluding that the methodology was a matter for a judgement call, confusing a legal question with a discretionary weighing of evidence. This was an error of law as to its function under s 71P, as to the meaning of r 6.5.3, and as to the application of legal principles of statutory construction: Ground 2.
27 If the Tribunal did determine the alleged error of law, then it determined that the AER’s construction was correct. This involved an error of law or was contrary to law. The plain meaning of the text and its regulatory history support SAPN’s construction as the “value [to investors] of imputation credits”: it referred to its written submissions at [26]-[34]. The AER now, in submissions to this Court, concedes that matters affecting value (such as personal costs or portfolio effects) should be taken into account, but asserts that they are already taken into account in calculating the return on equity. The concession is correct but the assertion is wrong. The return on equity relies upon excess returns primarily from the period pre-imputation credits. The equity calculation relies upon excluding imputation credits (including costs and other matters influencing the value) to calculate an average long-term market risk premium, and then deducting the value of imputation credits separately. Separating face amounts and costs or other value-affecting matters at either stage is inconsistent with logic, principle and the scheme: Grounds 3 and 4. SAPN referred to its written reply submissions at [8]-[20].
28 The Tribunal’s reliance on the distinction between a marginal and average investor perspective, and its observations that the value of imputation credits (and personal costs) of the marginal investor might not be the same as the average investor, such that utilisation rates might not be an upper bound for such value, was a significant matter that was not raised by the AER in its Final Decision, or by any party (or the Tribunal) at the hearing before the Tribunal. If the matter had been raised, SAPN would have pointed out the conceptual confusion involved in the propositions and was thus denied procedural fairness (s 5(1)(a)): Ground 6(b), (d) and (e). That confusion includes: (1) confusion between average utilisation rates per dollar of credits and the average investor valuation model; (2) that a dividend drop off study is not a marginal investor model; and (3) that a marginal investor model cannot be used to measure something which is not traded, and it is meaningless to speak of the value of imputation credits to a marginal investor or the personal costs of a marginal investor. SAPN referred to its written submissions at [35]-[40]; and to its written reply submissions at [21]-[26].
29 Contrary to s 71R(1)(a) of the NEL, the Tribunal considered matter other than review related matter, being (1) that while some investors do experience investor level (personal) costs in dealing with equities, these can vary substantially across investor groups, and (2) the portfolio effects of the loss of diversification benefits could be offset or outweighed by “home bias” in investor portfolios: (s 5(1)(b), (b), (f) and (j)): Ground 5 (a) and (d). This was also a denial of procedural fairness: Ground 6(a): SAPN referred to its written submissions at [41]-[42]; and to its written reply submissions at [27]-[28].
30 In its supplementary written submissions filed, by leave, after the hearing and directed to the decision of the Full Court in AER v Australian Competition Tribunal, SAPN submitted as follows.
31 First, it maintained its primary submissions on construction and formally submitted that the earlier Full Court decision was wrongly decided on this point. SAPN submitted:
a. The construction for which it contends in this court does not depend upon any “error” of “limit[ing] attention to the word ‘value’ and giv[ing] it a meaning in isolation” ([751]), but rather flows from the text (SAPN submissions, [27]-[28]), construed as a whole, in its context and having regard to the subject matter of the exercise (SAPN submissions, [29]-[31]).
b. In AER v Australian Competition Tribunal, the Court held that “the Tribunal assumed that other parameters in the WACC calculations were market values that already incorporated investors’ tax positions and transaction costs” ([755]). The Tribunal did not merely “assume” that, but rather found it as a fact based on the expert evidence before it: Applications by Public Interest Advocacy Centre Ltd and Ausgrid [2016] ACompT 1 at [1073]. The contrary view, advanced by the AER in AER v Australian Competition Tribunal and accepted by the Court at [755], is incorrect as a matter of fact, finds no basis in the NER or the NEL, and is disavowed by the AER in the present matter.
32 Secondly, and in the alternative, the present Full Court should decide the present matter on the submissions and material before it, which differ from the submissions in AER v Australian Competition Tribunal.
33 Thirdly, the construction adopted in AER v Australian Competition Tribunal does not spell failure for Grounds 3 and 4 of SAPN’s application.
34 The effect of AER v Australian Competition Tribunal is that the words “value of imputation credits” has a fixed legal meaning with variable content, which content will depend upon the way in which the AER implements the statutory model for the determination of a regulated return, namely the PTRM based on a nominal vanilla WACC. Thus, the Court in AER v Australian Competition Tribunal “accept[ed] the AER’s submission that the Rules require consistency in the way the relevant building blocks interact, that is, a post-company tax and pre-personal tax and personal costs basis” ([752]), and held that the rules “required gamma to be determined consistently with return on equity” ([755]). The Court found error in what it saw to be the assumption of the Tribunal in that case that “other parameters in the WACC calculations were market values that already incorporated investors’ tax positions and transaction costs” ([755]).
35 Even if the approach of the Court in AER v Australian Competition Tribunal is applied (to treat imputation credits as a function of a model, rather than as something that is “real”), that directs attention to the content of the model and as to the material relating to that model in the individual case. If, as the Court decided in AER v Australian Competition Tribunal, the proper legal content of gamma in a given case depends upon the implementation of the PTRM by the AER, then there is permissible scope for different outcomes in different cases. In particular, outcomes may properly differ if there is different information about the nature of the PTRM before the court.
36 In the present case, although the AER has (rightly) acknowledged that the model is based on market observations and takes into account value-affecting matters such as transaction costs, the AER’s explanation as to how that is taken into account is incomplete and inaccurate. The AER has contended in this Court that the return on equity calculation reflects personal costs associated with imputation credits, and that the estimation of gamma therefore need not take such costs into account (AER, [32](f) and (g)).
37 However, the model, properly understood on the material before the Court in the present case, requires two adjustments for the value of imputation credits: to gross up post-1987 return on equity calculations to exclude the value of imputation credits (so as to produce an overall average market risk premium, and thus an overall return on equity, unaffected by imputation credits), and then deduct the value of imputation credits. At each stage, matters affecting the value of imputation credits must be taken into account under the model.
38 Notwithstanding the decision of the Full Court, SAPN submitted this Court should set aside the Tribunal’s decision on gamma on Grounds 3 and 4 because:
(a) in light of the information that is before the Court about the AER’s approach to the PTRM in this case (which differs from the information that was before the earlier Full Court), the proper legal content for gamma in this case is a market value; or
(b) alternatively, the proper legal content for gamma remains to be determined in light of factual findings about the AER’s approach to the PTRM in this case, which findings have not been made by the Tribunal. On this point, the Tribunal concluded that “adoption of the ‘vanilla WACC’ approach in the PTRM does not imply anything about the precise value of [gamma] nor how it is determined”: [147].
39 Fourthly, even if Grounds 3 and 4 were dismissed, SAPN submitted it can succeed on its other grounds and nothing in AER v Australian Competition Tribunal bears substantially on that. In particular, success by SAPN on its procedural fairness grounds (Grounds 5 and 6) would require the matter be returned to the Tribunal because an opportunity to be heard on those issues could make a difference to the outcome on non-construction grounds.
40 The AER submitted, in summary, as follows.
41 The AER first identified the controversy. The AER interprets the expression “value of imputation credits” as the proportion of company tax returned to investors through the utilisation of imputation credits. SAPN interprets the expression as the “market value” to investors, reducing the value by various asserted personal costs associated with receiving credits such as the time value of money, transaction costs in redeeming credits and portfolio effects.
42 The AER next identified the regulatory framework. It submitted that the NER prescribes that a DNSP’s annual revenue requirement is to be determined using a PTRM with a nominal vanilla WACC, where the building blocks of the revenue requirement are allowances for return on capital, return of capital (depreciation), company tax and forecast opex. Under the NER, two of the building blocks are affected by the value of imputation credits: the return on equity component of the WACC and the allowance for company tax.
43 Thirdly, the AER referred to underlying economic principles. The building block framework within the NER is based on Professor Officer’s 1994 paper, The Cost of Capital under an Imputation Tax System. The paper explained two adjustments required to the calculation of cash flows within a post tax valuation model to account for imputation credits: an adjustment to the allowance for company tax and an adjustment to the allowed return on equity. The AER received expert economic advice from, inter alia, Associate Professor Handley that, within the post tax model described by Professor Officer and used in the NER, imputation credits should not be valued after the deduction of personal costs.
44 Fourthly, the AER summarised its submissions in relation to Grounds 1 and 4 of SAPN’s Amended Application. It submitted that the Tribunal correctly identified the AER’s interpretation of the value of imputation credits and decided that the AER’s interpretation was not erroneous having regard to the current economic learning about the required adjustments for imputation credits within a PTRM as prescribed by the NER. The interpretation advanced by SAPN based on the dictionary meaning of the word “value” should be rejected because it is inconsistent with the economic and financial context within which the expression is used in the NER. The expression “value of imputation credits” takes its meaning from its context. The context is the determination of a regulated return using a PTRM based on a nominal vanilla WACC. The expression therefore has an economic meaning and describes the adjustments required to the allowance for company tax and the return on equity for the purposes of the NER. It is necessary and appropriate to have regard to economic learning about the correct or preferred approach to the adjustment, notwithstanding that the correct or preferred approach is debated among economists.
45 Fifthly, the AER summarised its submissions in relation to Grounds 5 and 6. SAPN was not denied procedural fairness by the Tribunal. The matters about which SAPN complains were raised in issues considered in the Final Decision or in submissions to the Tribunal. SAPN had an appropriate opportunity to address them. Further, in performing its review task, the Tribunal, which is a specialised body, was required to consider the Final Decision, the submissions made to it and express its reasons for its conclusions. In expressing its reasons, it was not constrained by how the parties put arguments to it.
46 In its supplementary written submissions filed, by leave, after the hearing and in reply to SAPN’s submissions directed to AER v Australian Competition Tribunal, the AER submitted the decision of the earlier Full Court is both relevant to the gamma topic in the present proceeding and dispositive of the six grounds of review raised by SAPN’s Amended Application.
47 In AER v Australian Competition Tribunal, the Full Court made the following findings relevant to the grounds of review in the present proceeding:
(a) The appropriate method to determine “the value of imputation credits” within NER r 6.5.3, and the sources of information and/or weight to be attributed to each data source, was a derivative of the interpretation of that term: at [742].
(b) The expression “the value of imputation credits” is be construed as a whole, in its statutory context and having regard to the subject matter of the exercise. It would be an error to limit attention to the word “value” and give it a meaning in isolation. The relevant context is the function of imputation credits under the NER in relation to the return on capital and the tax building block and, in particular, the determination of a regulated return using a post-tax revenue model based on a nominal vanilla WACC. The NER requires consistency in the way the relevant building blocks interact: at [744], [751] and [752].
(c) It is a misconstruction of the expression “the value of imputation credits” to interpret “value” as a “market value” derived from market studies rather than a value within a PTRM in which the integers are determined on a consistent basis: at [753] and [755].
(d) It was not an error of construction for the AER to prefer one theoretical approach to considering the determination of gamma over another. Specifically, the AER did not err by focusing on the utilisation of imputation credits rather than on an implied market value: at [756].
48 The submissions of the AER in this proceeding, at [8]-[15] and [21]-[32], are consistent with and supported by the findings of the Full Court summarised above.
49 The decision of the Full Court disposes of Grounds 1 to 4 of SAPN’s Amended Application in this proceeding. All four grounds raise the same central issue: whether the Tribunal erred in relation to the interpretation of the phrase “the value of imputation credits” in r 6.5.3, either by failing to interpret it (Grounds 1 and 2) or misinterpreting it (Grounds 3 and 4). The grounds must be dismissed because the decision of the Full Court in AER v Australian Competition Tribunal is that the interpretation of that phrase adopted by the AER in its Final Decision was correct: Final Decision (Value of Imputation Credits) at pp 4–51 to 4–52. SAPN’s argument before the Tribunal below was the same as its argument before the earlier Full Court, which was rejected by the Full Court. The Tribunal’s rejection of SAPN’s arguments is consistent with and supported by the Full Court’s conclusions, summarised above.
50 On the assumption that this Court in this proceeding will follow the decision in AER v Australian Competition Tribunal, it is unnecessary for this Court to determine Grounds 5 and 6 of SAPN’s Amended Application. Even if (contrary to the submissions of the AER) the Tribunal erred in the manner alleged in Grounds 5 and 6, a new hearing before the Tribunal would inevitably result in the Tribunal finding no error in the AER’s decision below. In those circumstances, an order remitting the matter to the Tribunal for redetermination would be a futility: Stead v State Government Insurance Commission (1986] HCA 54; 161 CLR 141 at 145.
51 SAPN’s supplementary submission that the earlier Full Court had before it different information to that which is before this Court as to the nature of the model (the PTRM) used by the AER should be rejected. There is no relevant difference in the model, nor any relevant difference in the information before the Court about the model. As SAPN (correctly) submitted to the Tribunal below: “For all practical purposes, the Final Decision in the present case on the value of imputation credits is the same decision as the decision considered by the Tribunal in the NSW/ACT Tribunal Decision” [SAPN’s outline of submissions at [27]]. SAPN’s further supplementary submissions, at [14]-[27] concerning the PTRM used by the AER revisit matters addressed before the Court. The submissions fail to address the economic evidence relied upon by the AER (particularly Associate Professor Handley) as to why it is correct to focus upon utilisation rather than implied market value. The AER otherwise relied upon its submissions previously made.
52 We note SAPN’s formal submission that the earlier Full Court decision, AER v Australian Competition Tribunal, was wrongly decided on this point. We do not accept that submission and we are not persuaded that the earlier decision was either wrong or, more relevantly, manifestly wrong: Telstra Corp Ltd v Treloar [2000] FCA 1170; 102 FCR 595 at [26].
53 Next, it is to be kept in mind that this Court is determining an application for judicial review of the present Tribunal’s decision. In AER v Australian Competition Tribunal, the Full Court held that the Tribunal in that case erred in law in construing r 6.5.3 of the NER as invalidating the AER’s approach to estimating the cost of corporate income tax of the DNSPs where gamma is the value of imputation credits. It was not the function of that Court to decide whether the AER’s decision was “correct” and neither is it the function of this Court to decide whether the AER’s decision in this case is “correct”. This Court’s function is to determine whether or not there is judicially reviewable error on the part of the Tribunal in its limited merits review of the AER’s Final Decision.
54 Rule 6.5.3 provides:
6.5.3 Estimated cost of corporate income tax
The estimated cost of corporate income tax of a Distribution Network Service Provider for each regulatory year (ETCt) must be estimated in accordance with the following formula:
ETCt = (ETIt × rt) (1 – γ)
where:
ETIt is an estimate of the taxable income for that regulatory year that would be earned by a benchmark efficient entity as a result of the provision of standard control services if such an entity, rather than the Distribution Network Service Provider, operated the business of the Distribution Network Service Provider, such estimate being determined in accordance with the post-tax revenue model;
rt is the expected statutory income tax rate for that regulatory year as determined by the AER; and
γ is the value of imputation credits.
55 Grounds 1 and 2 of SAPN’s judicial review application must fail. In our opinion, contrary to SAPN’s submissions, the Tribunal did determine that the AER’s approach did not involve a legal error in the construction of r 6.5.3 of the NER. The Tribunal did consider the meaning of the text and its construction and context. It did determine that the AER was entitled to use its judgement, but that was not an error of law. Similarly, the Tribunal did not misunderstand its function by concluding that the methodology was a matter for judgement by the AER and it did not err in law in this respect.
56 As the Full Court said in AER v Australian Competition Tribunal at [756], it was not a reviewable error for the AER to prefer one theoretical approach to considering the determination of gamma over another. This means that it is not an error of construction for the AER to focus on utilisation rather than on implied market value.
57 Grounds 3 and 4 of SAPN’s judicial review application must also fail. We reject SAPN’s submission that we should set aside the Tribunal’s decision on gamma because in light of the information that is before this Court the proper legal content for gamma in this case is a market value. This is to ignore the limited merits review function of the Tribunal and the field of choice available to the AER as determined in AER v Australian Competition Tribunal. We also reject SAPN’s alternative submission in support of these grounds that the proper legal content for gamma remains to be determined in light of factual findings about the AER’s approach to the PTRM in this case, which findings have not been made by the Tribunal. Again, in our opinion, this is to ignore the limited merits review function of the Tribunal.
58 Grounds 5 and 6 claim a denial of procedural fairness on the part of the Tribunal.
59 Section 71R of the NEL provides that the Tribunal must not consider any matter other than review related matter. By s 71R(6):
In this section—
review related matter means—
(a) the application for review; and
(b) a notice raising new grounds for review filed by an intervener; and
(c) the submissions made to the Tribunal by the parties to the review; and
(d) decision related matter under section 28ZJ; and
(e) any other matter properly before the Tribunal in connection with the relevant proceedings.
60 Section 28ZJ provides that the AER must, in making a reviewable regulatory decision, keep a written record of decision related matter, which is defined as follows:
(2) In this section—
decision related matter, in relation to a reviewable regulatory decision, means—
(a) the decision and the written record of it and any written reasons for it; and
(b) any document, proposal or information required or allowed under the Rules to be submitted as part of the process for the making of the decision; and
(c) any written submissions made to the AER after the proposal to which the decision relates was lodged by a network service provider and before the decision was made; and
(d) any reports and materials (including (but not limited to) consultant reports, data sets, models or other documents) considered by the AER in making the decision; and
(e) any draft of the decision that has been released for consultation purposes; and
(f) any submissions on the draft of the decision or the decision itself considered by the AER; and
(g) the transcript of any hearing (if any) conducted by the AER for the purpose of making the decision.
61 In our opinion, the content of the paragraphs of the Tribunal’s reasons identified in Ground 5, being [174], [175], [177] and [178], do not fall outside s 71R(6) or otherwise establish a denial of procedural fairness. Each of these paragraphs concerns the Tribunals consideration of the role of personal costs. SAPN had contended, as one of its grounds of review before the Tribunal, that the AER erred in not recognising that investors would incur personal costs in extracting value from receipt of imputation credits which would reduce the value ascribed to them.
62 It was in the course of dealing with that contention that the Tribunal’s reasoning included the matters complained of in Ground 5. The conclusion reached was that while some investors do experience investor level (personal) costs in dealing in equities, these can vary substantially across investor groups. It is thus not clear, the Tribunal said, what effect such costs will have on equity market prices or on the need to adjust estimates for implied values of franking credits drawn from shareholder distribution or tax statistics.
63 In our opinion, the subject-matter was identified at an appropriate level of particularity and procedural fairness did not require SAPN to be further apprised of the Tribunal’s thought processes: Minister for Immigration and Citizenship v SZGUR [2011] HCA 1; 241 CLR 594 at [9], Commissioner for Australian Capital Territory Revenue v Alphaone Pty Ltd [1994] FCA 1074; 49 FCR 576 at 591–592. We do not see the reference to “review related matter” as taking the issue any further. The relevant “matter” was before the Tribunal in the application and in the submissions.
64 Turning to Ground 6, the paragraphs of the Tribunal’s reasons referred to in this ground are [146], [148], [149]-[159], [168]-[169], [174] and [193]. In these paragraphs the Tribunal was considering, first, SAPN’s challenge that the AER erred in misconstruing “value of imputation credits” through focusing on utilisation rather than implied market value. In the next set of paragraphs referred to in this ground, the Tribunal turned to consider SAPN’s assertion that the AER should have given more (or complete) weight to evidence from dividend drop-off studies. The next paragraph, [174], concerns the role of personal costs. The final paragraph to which attention is directed, [193], concerns the use of taxation statistics in respect of which SAPN contended that the AER erred by failing to recognise that the credit redemption rate of 0.45 from such statistics did not indicate the value of imputation credits to investors and was an upper bound on the value of theta.
65 As with Ground 5, in our opinion the subject-matters were identified at an appropriate level of particularity and procedural fairness did not require SAPN to be further apprised of the Tribunal’s thought processes. Again, the reference to “review related matter” does not take the issue further.
66 We reject SAPN’s application for judicial review in relation to gamma.
RETURN ON DEBT (GROUNDS 7 – 16 INCLUSIVE)
Introduction
67 Return on debt is an aspect of the return on capital building block. It is designed to provide a service provider with an allowance to cover its borrowing costs associated with funding investments in its network.
68 Rule 6.5.2(h) of the NER provides:
The return on debt for a regulatory year must be estimated such that it contributes to the achievement of the allowed rate of return objective.
69 The allowed rate of return objective is expressed in r 6.5.2(c):
The allowed rate of return objective is that the rate of return for a Distribution Network Service Provider is to be commensurate with the efficient financing costs of a benchmark efficient entity with a similar degree of risk as that which applies to the Distribution Network Service Provider in respect of the provision of standard control services (the allowed rate of return objective).
70 The return on debt has two components: a risk-free (or base) rate and a debt risk premium (“DRP”). In its Final Decision, the AER explained the DRP component as follows:
Unlike equity instruments, debt instruments typically provide investors [with] a specified and certain return for [a] particular period of time—for example, 5 percent each year—or a specific and certain method of calculating that return. However, there is a risk that the issuer of the debt will default and not be able to pay the investor that return. Accordingly, the DRP principally compensates the investor for that default risk. It also provides compensation for the systematic risk of debt and liquidity risk.
71 It is an accepted fact that service providers can hedge the risk-free component of debt, but not the DRP.
72 Prior to rule changes introduced in 2012, the NER required that the return on debt reflect the return that would be required by debt investors in a benchmark efficient entity should the entity raise debt at the time of, or shortly before, the making of a determination for the regulatory control period in question. This is referred to as the “on-the-day” approach.
73 The AER considered that an efficient financing practice under this approach would have been to borrow long-term (10 years) and stagger the borrowing so that only a proportion of the debt matures each year. The AER considered that a benchmark efficient entity would have combined this practice with interest rate swap contracts to broadly match the base rate component of its actual return on debt to its return on debt allowance. This would involve borrowing floating rate debt, or fixed rate debt converted to floating rate debt using fixed-to-floating interest rate swaps at the time of the debt issue, and then entering into floating-to-fixed interest rate swaps at, or around, the time of the service provider’s averaging period.
74 The AER reasoned that this strategy would effectively manage refinancing risk (the risk that a benchmark efficient entity would not be able to refinance its debt when it matures) and interest rate risk (the risk associated with a mismatch between the allowed return on debt and a benchmark efficient entity’s actual return on debt). Also, the AER found that most privately-owned service providers operating under the on-the-day approach generally adopted this strategy.
75 The rule changes introduced in 2012 permitted other methodologies for estimating the return on debt to be employed, including the “trailing average” approach. Under the trailing average approach, the return on debt reflects the average return that would have been required by debt investors in a benchmark efficient entity if it had raised debt over an historical period, taken as 10 years. As will be appreciated, the trailing average approach reflects how, according to the AER, a benchmark efficient entity would have managed its refinancing risk.
76 In estimating the return on debt, r 6.5.2(k) of the NER (as amended by the 2012 rule changes) requires the AER to have regard to certain factors:
In estimating the return on debt under paragraph (h), regard must be had to the following factors:
(1) the desirability of minimising any difference between the return on debt and the return on debt of a benchmark efficient entity referred to in the allowed rate of return objective;
(2) the interrelationship between the return on equity and the return on debt;
(3) the incentives that the return on debt may provide in relation to capital expenditure over the regulatory control period, including as to the timing of any capital expenditure; and
(4) any impacts (including in relation to the costs of servicing debt across regulatory control periods) on a benchmark efficient entity referred to in the allowed rate of return objective that could arise as a result of changing the methodology that is used to estimate the return on debt from one regulatory control period to the next.
77 Rule 6.5.2(k)(4) is of particular significance. It foreshadows the possible need for transitioning arrangements should the methodology for estimating the return on debt change in relation to a new regulatory control period. For example, in relation to the debt management strategy for the on-the-day approach discussed above, an immediate change from the on-the-day approach to a trailing average approach would require an entity to unwind hedging contracts, which might be costly (if possible at all).
78 SAPN provided its initial access proposal to the AER in October 2014. At that time, it proposed that its return on debt be estimated on the trailing average approach with a gradual forward-looking transition arrangement. This option, referred to as “Option 2”, starts with an on-the-day rate for the first regulatory control period. It then commences to transition in the next (second) year of the regulatory control period by applying the previously determined on-the-day rate to 90% of the service provider’s debt portfolio, with the remaining 10% updated to reflect prevailing interest rates for the averaging period applicable to the new year. For the next year (the third year of the regulatory control period), the initially determined on-the-day rate is applied to 80% of the debt portfolio, the on-the-day rate for the second year of the regulatory control period is applied to 10% of the debt portfolio, and 10% is updated to reflect interest rates during the averaging period applicable to the new (third) year. This process continues for subsequent years in the regulatory control period, with 10% of the return on debt being updated to reflect then prevailing interest rates.
79 The following matters should be noted.
80 First, this updating occurs over a 10 year transition period. On completion of the transition period, one is left with a simple average of interest rates prevailing over the previous 10 years. However, the regulatory control period in question is only for five years.
81 Secondly, this transitioning applies to both components of debt – the base rate and the DRP. This is of particular significance in the present matter.
82 After providing its initial access proposal, SAPN changed its position on the appropriate transitioning arrangement. It provided a draft submission to the AER in which it recommended a different, hybrid approach to transitioning to the trailing average approach. This hybrid approach—referred to as “Option 3”—was that there should be a gradual transition to the trailing average approach for the base rate component of debt as per Option 2, but not for the DRP component. With respect to the DRP component, SAPN sought an immediate implementation of the trailing average approach without transitioning.
83 In its preliminary decision in April 2015, the AER determined that Option 2 should be adopted.
84 In its revised proposal submitted in July 2015, SAPN explained its changed position by pointing to a significant fall in the DRP since its initial proposal, and the “high weight” given to the on-the-day approach in Option 2, which had the effect of depressing its allowed rate of return.
85 SAPN also argued that the hybrid approach of Option 3 was more consistent with the efficient financing processes of a benchmark firm.
86 In the present proceeding, SAPN explained its position as follows:
SAPN contended for Option 3 on the basis that it most accurately reflected the efficient debt costs of the regulated business: since the business could only hedge the base rate component of debt, only the base rate component had debt costs that differed from the debt costs calculated under the trailing average approach and only the base rate component should therefore be transitioned. The DRP component of debt was simply long-term debt at fixed interest rates entered into at different times over the previous 10 years, and thus produced debt costs that could be calculated using the trailing average approach.
87 In its Final Decision, the AER reaffirmed its decision to use Option 2 as the transition method. In the course of its deliberation, the AER had engaged Chairmont—described as an expert market practitioner—to advise on, amongst other things, the correct transition approach. Chairmont advised the AER to adopt Option 3. However, the AER did not accept that advice, stating:
We agree with Chairmont that the hybrid approach will provide a good match over the 10 year transition period to the costs of a benchmark efficient entity entering the transition from the ‘on-the-day’ regime. However, having regard to wider policy issues, we have maintained the Guideline approach. In particular we consider that proposal and adoption of the hybrid approach on the basis of changes in prevailing rates would introduce bias into regulatory decision making and violate the NPV=0 principle.
88 By “regulatory bias”, the AER meant a “potential to create a bias” by “choosing an approach that uses historical data after the results of that historical data [are] already known”.
89 As to violation of the NPV=0 principle, the AER said:
Transitioning from the on-the-day approach using the hybrid transition can create a mismatch between the allowed return on debt and the efficient financing costs of a benchmark efficient entity over the life of its assets. The change in the regulatory regime can therefore create windfall gains or losses to service providers or consumers. Windfall gains or losses do not result from a service provider’s efficient or inefficient decisions. In effect, they are a side effect of changing the methodology for estimating the return on debt at a particular point in time. They should be avoided, so that economic regulatory decisions deliver outcomes based on efficiency considerations, rather than timing or chance.
The Tribunal’s Reasons
90 The Tribunal recorded its understanding that SAPN’s case was that the AER’s Final Decision on return on debt involved an error or errors of fact, and an incorrect exercise of discretion. The alleged errors related to the AER’s choice of transition method, based on the following criteria:
the impact on promoting efficient financing practices consistent with the principles of incentive based regulation;
the impact on a benchmark efficient entity’s opportunity to recover at least its efficient financing costs over the life of its assets;
matching the allowed rate of return with efficient financing cash flows over a single regulatory period, and the potential conflict between this consideration and providing a benchmark efficient entity with a reasonable opportunity to recover efficient financing costs over the life of its assets;
avoiding potential bias in regulatory decision-making that can arise from choosing an approach that uses historical data after the results of that data are known; and
avoiding the practical difficulties in the use of historical data to calculate the allowed return on debt, particularly during the global financial crisis.
91 SAPN also contended that the AER’s Final Decision was unreasonable.
92 The Tribunal reasoned that, whether the AER committed errors, or whether its decision was unreasonable, turned on whether the AER had correctly interpreted r 6.5.2(k): see [76] above.
93 In this connection, the Tribunal pointed out that r 6.5.2(k)(1) and (4) are not specific as to the time periods in question. The Tribunal observed that r 6.5.2(k)(1) could refer to the minimisation of differences within a regulatory controlled period or over the life of assets financed partially by debt. In a similar way, r 6.5.2(k)(4) could refer to the result of changing estimation methodologies between two regulatory control periods spanning the change, or to a longer period, such as the life of the service provider’s assets.
94 The Tribunal noted that the AER had interpreted the NER as referring to impacts over the life of the benchmark efficient entity’s regulated assets. The Tribunal said that this consideration “permeated the AER discussion in the Final Decision”.
95 In its reasons, the Tribunal reflected on efficient investment and the regulatory approach to debt costs: see at [239]-[244]. It observed (at [239]) that while the (historical) trailing average approach to determining the return on debt is more compatible with actual debt management practices, it might be thought to be “less consistent” with determining the cost of capital, and the allowable revenue and prices, required for efficient, forward-looking investment decisions.
96 In this connection, it observed (at [240]) that, by using the on-the-day approach for determining the costs of capital, and thus allowable revenues, a service provider can expect a revenue stream consistent with what a competitive market would generate. Capital investment decisions made at that time, and which would meet a positive net present value (“NPV”) condition, would be efficient, based on current conditions in the market for funds.
97 By way of contrast, the Tribunal (at [241]) noted that capital investment decisions made by reference to an historical rate of return could result in inefficient investment decisions:
For example, suppose allowable revenues for a very short-term project were based on historical funding costs, and those were above current market funding costs. By undertaking that project abnormal profits could be made, because allowable revenue implies a positive NPV when evaluated at current market funding costs. However, it is by no means clear that a sophisticated DNSP would make investment decisions for the very long-lived assets required for its operations based on past financing costs rather than current and expected future financing costs. It is the latter which determine, through the building block model, future expected cash flows over the long horizon involved. Nor should it be expected that regulatory approval for capex plans would be based on an appraisal using historical funding costs rather than current market conditions.
98 The Tribunal also noted (at [242]) that the building block model using the on-the-day approach implies a NPV=0 condition at that date. In other words, expected cash value streams from current assets or new capex are just sufficient to match the required returns for investors. It observed that financial market conditions can change substantially over the five-year horizon of a regulatory control period—such that using the allowed cost of capital to assess potential investments during that period could, again, lead to inefficient decisions. The Tribunal noted, however, that it was not obvious that a sophisticated service provider would act in that manner in relation to investments that are very long-term.
99 At [243], the Tribunal said that while the approach to debt costs affects the risk facing the service provider from investment decisions, there is no evidence that these risks would be systematic and, thus, affect the cost of capital. The Tribunal reasoned that the choice between the on-the-day and the trailing average approaches to the cost of debt should not affect long-term investment decisions.
100 Further, the Tribunal noted (at [244]) that, while the transition approach used could have consequences for the service provider’s profitability over that period, this is not relevant to forward-looking investment decisions. The Tribunal concluded, therefore, that the form of transition should have no material implications for the efficiency of future investment decisions.
101 The Tribunal then turned to examine each of the bases on which the AER justified its decision to adopt Option 2. The Tribunal dealt with the first, fourth and fifth matters noted at [90] above, before turning to deal with the second and third matters together.
Efficient financing practices and incentive-based regulation
102 In its Final Decision, the AER concluded that both Option 2 and Option 3 were consistent with the promotion of efficient financing practices and the principles of incentive-based regulation. The AER reasoned that, in the context of an ex ante regulatory framework, the effectiveness of incentives relies on service providers understanding and accepting the financial consequences of their decisions at the time they make those decisions. The AER reasoned that, by gradually transitioning from the on-the-day approach to the trailing average approach (Option 2), service providers face the financial outcomes of their past financing decisions, whether positive or negative—as they would if the on-the-day approach were to be maintained for the whole of the regulatory control period. The AER accepted that the same outcome is also achieved by transitioning only that component of debt over which a benchmark efficient entity has most control (the risk-free component). This is Option 3.
103 The Tribunal accepted that the consequences of past efficient financing practices are affected by the choice of transition arrangement. It reasoned, however, that this has no consequences for choices regarding future practices. At [246], the Tribunal said:
… SAPN provides no explanation as to how future financing arrangements would be affected in a manner inconsistent with this consideration by the choice of transition approach. Indeed, the arguments advanced by SAPN about inability to hedge the DRP component of existing debt costs suggests that these are akin to “sunk costs” and, while relevant to profitability impacts from the choice of transition, [these costs] are not relevant to future debt financing decisions…
104 The Tribunal concluded that the AER had committed no error of fact, and had not exercised its discretion incorrectly. It also concluded that the AER was not unreasonable in reaching its conclusion.
Bias in regulatory decision-making
105 In its Final Decision, the AER noted that it is an important feature of building block incentive regulation that the approach used to determine the rate of return is set on a forward-looking basis. The AER noted that using an historical averaging period, where the results of the data are known, can introduce a bias in regulatory decision-making.
106 The AER concluded:
We are satisfied that an unbiased approach will contribute to estimating a rate of return that is commensurate with the efficient financing costs of a benchmark efficient entity. Setting the rate of return with fore-knowledge of the outcome does not reward efficient decision making or allow a comparison to benchmark performance. It does not provide the appropriate incentive for efficient investment, as contemplated in both the NEO/NGO and the revenue and pricing principles. This is because the use of backwards looking data in selecting a regulatory approach is likely to increase the risk of biased regulatory decision making.
107 At [248], the Tribunal said that it is hardly surprising that in proposing a one-off transition arrangement, a DNSP would prefer and recommend the option which, on available information, is to its advantage. The Tribunal noted that Option 3, from SAPN’s perspective, was clearly preferable because the immediate adoption of a trailing average for the DRP component would reflect the higher past values of that component.
108 The Tribunal noted that AER’s approach involves starting with an on-the-day rate and gradually transitioning to the trailing average approach using averaging periods for each year that are nominated in advance. At [250] the Tribunal concluded:
The Tribunal is of the view that this approach is a valid one, involving the AER considering alternative transition approaches to the one proposed by SAPN, in order to avoid a bias in regulatory decision-making. In determining which among the alternative transition options should be chosen, the AER was endeavouring to reach a decision that contributes to the [allowed rate of return objective]. This approach by the AER was correct.
109 The AER reasoned that Option 2 would avoid practical problems with the use of historical data, particularly in estimating the return on debt using data relating to the period of the global financial crisis. Use of Option 3 would involve such data, whereas transitioning from the on-the-day approach to the trailing average approach under Option 2 would not require data before 2015.
110 The Tribunal said that observable DRP figures during the period of the global financial crisis might be “noisy estimates of the DRP” of a benchmark efficient entity. The Tribunal remarked, however, that this is no different in principle to potentially similar problems in accuracy of DRP estimation which may occur in future years. The Tribunal also noted that such data was used in previous determinations of the cost of debt, suggesting that concerns about the validity of the historical data should not be paramount. The Tribunal considered that estimating appropriate DRP figures that might be problematic and contentious was not an argument for not incorporating such data, particularly given that it is eventually phased out of the trailing historical average: see at [254].
111 The Tribunal also noted and discussed the robustness of the interest rate data available from the providers of such data for the use required here: see at [255].
112 At [256]-[257], the Tribunal concluded that, although there were problems with obtaining accurate estimates of the DRP for a benchmark efficient entity for the decade prior to the commencement of the relevant regulatory control period, these problems were not a sufficient reason to reject Option 3. However, the Tribunal did not consider that the AER had erred in considering the reliability of historical information or that its decision was, by reason of that consideration, unreasonable.
Impact of change on BEE and recovery of efficient financing costs
113 It is to be recalled that, in considering the impact on a benchmark efficient entity of changing the method for estimating the return on debt, the AER had regard to:
the impact on the benchmark efficient entity’s opportunity to recover at least its efficient financing costs over the life of its assets; and
matching the allowed return on debt with efficient financing cash flows over a single regulatory period, and the potential conflict between this consideration and providing the benchmark efficient entity with a reasonable opportunity to recover efficient financing costs over the life of its assets.
114 As we have noted at [101] above, the Tribunal dealt with these matters together. The Tribunal considered them to be inter-related because they concern whether the AER correctly applied r 6.5.2(k)(4) by considering not just impacts over the regulatory control periods spanning the change in methodology to estimate the return on debt, but impacts over a longer time period or, as the Tribunal put it, “a longer horizon”— the life of a benchmark efficient entity’s assets.
115 To explain, in its Final Decision the AER said:
We consider the efficient debt financing costs of a benchmark efficient entity as those which are expected to minimise its debt financing costs over the life of its assets, while managing refinancing risk and interest risk rate.
116 As understood by the Tribunal, the AER’s reasoning was that, in taking a longer perspective, differences in the allowed and actual costs of debt in individual years and over regulatory control periods under the on-the-day approach, and under the trailing average approach, can be expected to balance out over time.
117 The AER saw a strong connection between the NPV principle, the allowed rate of return objective, and the NEL revenue and pricing principle of providing service providers with a reasonable opportunity to recover at least efficient costs.
118 The AER described the NPV principle as follows:
The NPV principle is a fundamental principle of economic regulation. The NPV principle is that the expected present value of a benchmark efficient entity’s regulated revenue should reflect the expected present value of its expenditure, plus or minus any efficiency incentive rewards or penalties. In other words, departures from cost recovery are acceptable and desirable, so long as they are the result of management induced efficiencies or inefficiencies, rather than windfall gains or losses. Windfall gains or losses would result in a service provider being over-or under-compensated for its efficient costs. The building block model which the [NER] require us to use is based on this principle.
119 The AER said:
A contentious issue in current and recent determinations is the timeframe over which it is appropriate to consider the impact of this change. In particular, in relation to providing a benchmark efficient entity a reasonable opportunity to recover its efficient financing costs, whether it is appropriate to consider the impact on the benchmark efficient entity over the life of its assets. Some service providers submit that the approach to debt should not be determined by reference to the activities and investments of a benchmark efficient entity beyond the access arrangement or regulatory control period in question. We disagree.
The rules referred to ‘any’ impacts on a benchmark efficient entity as a result of changing the return on debt methodology. The rules then give an example of one impact—the cost of servicing debt across access arrangement periods. That is, the rules specifically give an example where it is appropriate to take a perspective across more than one access arrangement.
We consider another impact that is encompassed in the rules is the impact on whether a benchmark efficient entity remains able to recover its efficient financing costs over the life of its assets, in light of the regime change. In other words, we are satisfied that the rules require us to consider whether the regime change results in a benchmark efficient entity being over or under compensated over the life of its assets. That is, we consider another relevant impact is on whether the NPV principle is satisfied or not, in light of the regime change.
120 The AER reasoned that gradually transitioning from the on-the-day approach to the trailing average approach (Option 2) would avoid the undesirable outcomes of changing the return on debt method. It allowed the regulatory regime to account for accumulated differences between the return on debt estimate and the actual return on debt of a benchmark efficient entity, despite any change in method. It also meant that a benchmark efficient entity would receive a return on debt commensurate with its efficient financing costs over the life of its assets, rather than commensurate with windfall gains or losses. It reasoned, therefore, that Option 2 would result in a return on debt that contributes to the achievement of the allowed rate of return objective. On the other hand, immediately applying a backwards-looking trailing average, such as in Option 3 in respect of the DRP component, could lead to windfall gains or losses which would violate the NPV principle.
121 Before the Tribunal, SAPN argued that the AER’s approach appeared to be that the NER only requires compensation for financing costs over “the life of its assets”, whereas the NER requires that the return on debt be commensurate with the efficient financing costs that a benchmark efficient entity would incur each year over the relevant regulatory control period.
122 At [269], the Tribunal concluded that the AER had not erred in applying r 6.5.2(k)(4) of the NER by referring to a longer time period, such as that involved in recovering efficient financing costs over the life of assets. The Tribunal explained (at [269]-[270]):
… The theoretical basis of the PTRM and the NER are premised on such an approach which involves determining allowable cash flows such that an NPV=0 condition is met ex ante. It is true that this NPV=0 condition is implemented via the PTRM so as to apply as at the start of each regulatory period ... However, the inclusion of the end of period regulatory asset base in that calculation (such that the opening regulatory asset base equals the present values of cash flows plus end-of-period regulatory asset base) implies that this is only one stage in a sequence of such decisions aimed at achieving NPV=0 over the life of the assets.
A BEE may adopt a different financing structure to that implied in the PTRM calculation, such as using a staggered-debt portfolio rather than an on-the-day rollover approach. This could lead to it facing a non-zero NPV situation for any regulatory period. But it can be assumed that it would only do so if it anticipated that over the longer term (life of the assets) such non-zero NPV situations would tend to balance out.
123 The Tribunal noted that r 6.5.2(k)(4) does not provide guidance on how to assess the impacts to which it refers. Similarly, s 7A of the NEL—which states the revenue and pricing principles to be applied—does not provide explicit guidance.
124 In this connection, s 7A(2) provides:
A regulated network service provider should be provided with a reasonable opportunity to recover at least the efficient costs the operator incurs in–
(a) providing direct control network services; and
(b) complying with a regulatory obligation or requirement or making a regulatory payment.
125 Section 7A(3) provides:
A regulated network service provider should be provided with effective incentives in order to promote economic efficiency with respect to direct control network services the operator provides. The economic efficiency that should be promoted includes—
(a) efficient investment in a distribution system or transmission system with which the operator provides direct control network services; and
(b) the efficient provision of electricity network services; and
(c) the efficient use of the distribution system or transmission system with which the operator provides direct control network services.
126 At [273], the Tribunal noted that s 7A(2) does not imply the recovery of costs within a particular regulatory control period. Further, the Tribunal suggested that s 7A(3)(c) indicates that, in determining allowable revenue and prices, the AER should take account of the impact of its decisions on the demand for electricity network services. Thus, the Tribunal reasoned, it would be appropriate for the AER to consider impacts on both service providers and consumers in arriving at a decision on the choice of transition approach.
127 In the Tribunal, SAPN had argued that the AER’s approach—which countenanced departures from cost recovery as a result of management induced efficiencies and inefficiencies, but not through windfall losses and gains—involved a “squaring up”. The Tribunal remarked (at [276]) that SAPN’s argument implied that an allowed DRP less than the actual in a staggered-debt portfolio in the current regulatory period under Option 2 is offsetting the reverse situation in previous periods. In this connection, SAPN had argued that r 6.5.2 of the NER must be interpreted as requiring a return that is sufficient to recover efficient financing costs in each year of the regulatory control period. This return cannot be reduced to “claw back” or “square up” differences between the allowed return on debt and the return on debt faced by a benchmark efficient entity in a previous regulatory year.
128 Although noting some “lack of clarity” in the AER’s decision on this issue, the Tribunal also noted (at [279]) the AER’s statement in its Final Decision that it had not sought to determine whether Option 2 would erode past windfall gains or losses. The Tribunal observed, in this regard, that the AER’s approach examined whether a particular transition would itself create “windfall gains or losses” over the current and subsequent transition period.
129 In this connection, the Tribunal observed that the AER had based its analysis on the NPV=0 principle underlying the PTRM, which implies that for each component of cost a corresponding component of the revenue stream with zero anticipated NPV is allowed. The Tribunal then noted that the AER considered the total debt portfolio of a benchmark efficient entity as a set of annual tranches of debt issued in each of the past 10 years, and examined the consequences of a transition approach for each tranche: see at [280].
130 The Tribunal further noted that a benchmark efficient entity which adopted a staggered-debt portfolio (and hedged the risk-free component) would accept risks of future deviations of actual embedded debt costs from allowed debt costs. But, over the long-term, such as the life of assets, these deviations might average out as debt raised in a particular year matures and is refinanced at prevailing rates. Once a shift to the trailing average approach is completed, there is no annual divergence between allowed and actual debt costs for each annual tranche of debt issued by the entity.
131 At [283]-[284], the Tribunal noted the following argument:
The AER argues that, under the on-the-day approach, such a BEE would have anticipated that each annual tranche of debt could have experienced future differences between the allowed and its actual debt cost. For example, a BEE which issued 10-year debt seven years prior to the start of the current regulatory control period would have expected that the allowed DRP for the remaining three years to maturity of that debt would be set under the on-the-day approach and could differ from its actual DRP.
Thus if the allowed DRP on that tranche of debt is set according to a different rule during the transition period, a different outcome to that based on the anticipated application of the existing rule when the debt was issued would occur as a result of the regulatory decision. In this sense, there would be “windfall gains or losses” on that tranche of debt occurring during the transition period. Option 2 avoids this outcome for previously issued debt. It also means that debt which is issued (either new debt to fund capex or rolling over of maturing debt) in the transition period would have no difference between allowed and actual debt costs over the term of that debt.
132 After considering various passages in the AER’s Final Decision, the Tribunal (at [289]) concluded as follows:
The Tribunal is of the view that the AER has committed no error of fact or been unreasonable in reaching the conclusion that Option 2 is preferable on grounds of the “impact of change on benchmark efficient entity and recovery of efficient financing costs”. Its interpretation of “across regulatory periods” as involving more than just the periods immediately surrounding the change in regulatory approach, and leading to consideration of effects over the life of the asset, is consistent with the NER. That justifies the attention paid by the AER to the NPV=0 criterion, which in turn leads it to consider whether one particular transition approach is more consistent with that criterion than the other. In that regard, it does not undertake a comparison based on offsetting historical excesses or deficiencies in the allowed DRP relative to actual. Rather, it assesses which approach is more consistent with meeting expectations held of how future DRP values would be determined when particular annual tranches of debt were issued. It concludes, correctly in the view of the Tribunal, that Option 2 is preferable in that regard because it does not create windfall gains or losses in the current regulatory period from the regulatory change.
Conclusion
133 In the result, the Tribunal concluded that each of the grounds of review on the return on debt should be rejected.
SAPN’s Grounds of Judicial Review
134 SAPN relies on 9 grounds of judicial review in relation to the Tribunal’s decision concerning the return on debt. These grounds rely on various provisions of the ADJR Act.
135 In Grounds 7 to 9, SAPN alleges that the Tribunal misconstrued r 6.5.2(h) of the NER by considering:
at [246] that the question posed for determination by r 6.5.2(h) is dealing with the impact on financing arrangements or practices in future periods, and by treating the recovery of financing costs in the current regulatory year as the recovery of “sunk costs” and relevant only to profitability: Ground 7;
at [248]-[250] that an allowance for the return on debt that does not best contribute to the achievement of the allowed rate of return objective might be preferred on the basis that it avoids regulatory bias: Ground 8; and
at [284] that anticipation by the service provider at the time the debt is issued of the continued application of a previous version of r 6.5.2 of the NER is relevant to the satisfaction of the allowed rate of return objective: Ground 9.
136 In Ground 10, SAPN alleges that the Tribunal misconstrued s 7A(2) of the NEL when it said at [273] that s 7A(2) does not imply recovery of costs within a particular regulatory control period. SAPN alleges that, properly construed (having regard to ss 16(2), 71P(2b)(b) and 88B of the NEL) s 7A(2) does refer to the opportunity to recover at least efficient costs, including efficient financing costs, in each regulatory year of the regulatory control period.
137 In Ground 11, SAPN alleges that the Tribunal, especially at [269] and [289], misconstrued the words “across regulatory control periods” in r 6.5.2(k)(4) as referring to the cost of servicing debt over a longer period of time, including over the life of assets. SAPN alleges that the words “across regulatory control periods” in r 6.5.2(k)(4) refer to recovery of the cost of servicing debt in each regulatory year in the regulatory control period.
138 In Ground 12, SAPN alleges that the Tribunal misconstrued r 6.5.2(h) and/or r 6.5.2(k) by considering whether the transition approach adopted by the AER would reduce the potential for “windfall gains or losses” based on an NPV=0 analysis over the “life of the asset”.
139 In Ground 13, SAPN alleges that the AER took irrelevant considerations into account, such that its determination:
was an improper exercise of the power conferred on it;
involved an error of law; or
was otherwise contrary to law.
140 SAPN alleges that the irrelevant considerations are:
potential bias in regulatory decision-making that can arise from choosing an approach that uses historical data after the results of that historical data are known;
if the allowed return on debt is set according to a different rule to that applying when the relevant debt was issued, there may be a different outcome to that based on the anticipated application of the existing rule;
whether the transition approach adopted by the AER would provide for recovery of efficient financing costs “over the life of the asset”; and
whether the transition approach adopted by the AER would reduce the potential for “windfall gains or losses” based on an NPV=0 analysis over the “life of the asset”.
141 It can be seen that Ground 13 is an iteration of some of the earlier grounds of review on this topic.
142 In Ground 14, SAPN alleges that the Tribunal considered matters that formed no part of the AER’s reasoning on return on debt, in particular the matters discussed at [239]-[241] of the Tribunal’s reasons concerning efficient investment and the regulatory approach to debt costs. SAPN alleges that this has the consequence that:
the procedures that were required by law to be observed were not observed by the Tribunal in making its decision;
the Tribunal misunderstood its function under s 71P(2)(a) of the NEL;
the Tribunal’s determination was an improper exercise of the power conferred by s 71P of the NEL;
the Tribunal’s determination involved an error of law; or
the Tribunal’s determination was otherwise contrary to law.
143 In Ground 15, SAPN alleges that, contrary to s 71R(1)(a) of the NEL, the Tribunal considered matter other than review related matter (see [59] above), namely that:
by using the on-the-day approach to determine the cost of capital and thus allowable revenues, the outcome—in theory at least—is that the DNSP can expect a revenue stream consistent with what a competitive market would generate (see at [240]); and
the building block model using the on-the-day approach implies a NPV=0 condition at that date, in the sense that expected cash flow streams from current assets or new capex are just sufficient to match required returns of investors (see at [242]).
144 SAPN alleges that these matters did not form part of the AER’s decision on return on debt and could only have been identified from matter other than review related matter. SAPN alleges that, as a consequence:
the procedures that were required by law to be observed were not observed by the Tribunal in making its decision;
the Tribunal’s determination was an improper exercise of the power conferred by s 71P of the NEL;
the Tribunal’s determination involved an error of law; or
the Tribunal’s determination was otherwise contrary to law.
145 In Ground 16, SAPN alleges that the Tribunal did not afford SAPN the opportunity to make submissions in relation to the non-review related matters identified in Ground 15 and that, as a consequence, a breach of the rules of natural justice occurred in connection with the making of the Tribunal’s determination.
The Submissions of the Parties
146 In its written submissions, SAPN said:
SAPN’s position before the Tribunal was straightforward: cl 6.5.2 of the NER required the return on debt to be calculated consistently with the efficient financing costs of … a benchmark efficient entity; Option 3 reflected these costs and Option 2 did not; and since compliance with the allowed rate of return objective is mandatory, the AER was in error in departing from the most accurate calculation of costs, and had no discretion to depart, on the basis of “wider policy issues”.
147 SAPN submitted that the Tribunal did not adequately deal with this complaint. It submitted that, instead, the Tribunal proceeded as if it (SAPN) was complaining about the correctness or otherwise of the application of the “wider policy issues” that had been formulated by the AER. Put simply, SAPN said that its case was that “wider policy issues” could not override the primary requirement that its return on debt must be estimated so as to contribute to the achievement of the allowed rate of return objective.
148 SAPN submitted that the structure of the scheme established by the NEL and the NER is to regulate the revenue earned from monopoly infrastructure so that a service provider cannot earn monopoly profits but can recover its efficient costs and a reasonable return to shareholders so as to encourage investment for the benefit of end users.
149 To this end, SAPN pointed to the statement of the revenue and pricing principles in s 7A(2) of the NEL. These principles refer to a regulated network service provider being provided with a reasonable opportunity to recover “at least” the efficient costs it incurs in providing direct control network services and in complying with regulatory obligations or requirements or in making regulatory payments.
150 Likewise, r 6.5.2 of the NER requires that, in each year of the regulatory control period, the service provider is to be allowed the rate of return that is commensurate with the efficient financing costs of a benchmark efficient entity.
151 With respect to Ground 7, SAPN submitted that the Tribunal erred in two respects at [246] of its reasons.
152 First, the Tribunal appears to have suggested that the DRP component of SAPN’s debt costs are tantamount to sunk costs that do not require recovery. SAPN submitted that, whether or not its debt costs are regarded as “sunk”, r 6.5.2 mandates that the return on capital, and hence the return on debt, is to be set at a level that allows a regulated entity to recover its costs, provided they are efficient.
153 Secondly, r 6.5.2 is not concerned with “future financing arrangements” and “future debt financing decisions”. SAPN submitted that the Tribunal’s reasoning on this aspect of its analysis is difficult to follow in light of the Tribunal’s earlier conclusions concerning efficient investment and the regulatory approach to debt costs: see at [29]-[34] above.
154 In this connection, SAPN pointed out that, at [242] of its reasons, the Tribunal appears to have recognised that it is unlikely that a sophisticated network service provider would use its allowed return on debt to make decisions about long-term investments. The Tribunal explained that future market conditions could change substantially over the five-year horizon of a regulatory control period.
155 Further in this connection, SAPN pointed out that, at [244] of its reasons, the Tribunal appears to have also recognised that the choice between the on-the-day approach and the trailing average approach to estimating the return on debt should not affect the service provider’s long-term investment decisions. The Tribunal reasoned that, because of this, the form of transition should also have no material implications for the efficiency of future investment decisions.
156 Thus, SAPN submitted, even if “future financing arrangements” or “future debt financing decisions” were relevant to the allowed return under r 6.5.2, the Tribunal appears to have concluded, in these earlier passages of its reasons, that these considerations would not affect the choice of transition approach. SAPN submitted that these considerations were, therefore, irrelevant to the determination of the appropriate rate of return for the current regulatory control period.
157 Therefore, SAPN submitted, the Tribunal “did not identify any factor that would override the circumstance that Option 2 did not reflect the efficient debt costs that would be incurred by the benchmark efficient entity”.
158 With respect to Ground 8 and, relatedly, Ground 13, SAPN submitted that its contention before the Tribunal was that the use of Option 3 was not “biased” in any relevant sense and that there was no basis in the NER for the AER to depart from the most accurate assessment of the efficient costs of the benchmark efficient entity on the basis that another approach involved “less bias”.
159 SAPN argued that the Tribunal’s reasoning on this topic was “very short and undeveloped”. It submitted that the Tribunal’s conclusion on this topic at [250] (see [108] above) is unexplained and not linked to the text of r 6.5.2. Further, SAPN submitted that the Tribunal did not identify the nature of the relevant bias.
160 In this latter connection, SAPN submitted that Option 3 does not involve bias “in a recognised sense”. There is no bias simply because certain costs and rates are known. A benchmark efficient entity faces costs over the forthcoming regulatory period because it has facilities on foot on which interest has to be paid at rates which are known.
161 Further, and in any event, compliance with the allowed rate of return objective is mandatory. It is not simply one of a number of factors to which the AER may have regard and weigh with other factors it may choose to consider, such as the desirability of avoiding bias.
162 SAPN submitted that the Tribunal’s conclusion at [250] that the AER’s approach is “a valid one”, involves error in the construction and application of r 6.5.2.
163 As developed in submissions, Ground 9 and, relatedly, Ground 13 concern the Tribunal’s treatment of “windfall gains and losses” at [284] of its reasons (see [131] above). In relation to these grounds, SAPN attributed to the AER a rationale for adopting Option 2 which involved a “squaring up” for past gains or losses as at the date of switching from one regulatory approach for estimating the return on debt, to another. SAPN submitted that, in its Final Decision, the AER abandoned this basis for propounding Option 2 and developed a new rationale, which was whether Option 3 would itself create “windfall gains or losses”.
164 SAPN then criticised aspects of the Tribunal’s reasoning at [281]-[284].
165 With respect to [281], SAPN criticised the Tribunal’s statement that, under the previous on-the-day approach, a benchmark efficient entity which adopted a staggered debt portfolio and hedged the risk-free component would “accept” risks of future deviations of actual embedded debt costs from allowed debt costs. SAPN submitted that a benchmark efficient entity did not “accept” any such mismatch. It argued that, if it wished to avoid excessive refinancing risk, such an entity had “no choice”. Further, SAPN submitted that the Tribunal’s statement that such “deviations” (mismatches) might “average out” over the long-term, was both unclear and inaccurate.
166 With respect to [283]-[284], SAPN pointed to the Tribunal’s reasoning that Option 2 would avoid “windfall gains and losses” in relation to the DRP component of debt when switching from the on-the-day approach to the trailing average approach. SAPN submitted that “it makes little sense to speak of a windfall gain or loss” where:
the regulated business is merely aware that the on-the-day approach would produce a randomly wrong debt allowance for the DRP component of debt, without knowing whether that would be positive or negative; and
the NER has been amended to provide a more accurate assessment of the debt allowance.
167 SAPN submitted that the Tribunal’s approach gives no effect to the language of r 6.5.2 and fails to recognise that r 6.5.2 had been amended before the forthcoming regulatory control period. SAPN emphasised, once again, that r 6.5.2 is mandatory and must be applied according to its terms. SAPN submitted that r 6.5.2 does not provide a discretion for the AER to depart from the allowed rate of return objective on the basis that the regulated business should have expected some years ago (under a different regulatory regime) not to receive its efficient financing costs.
168 Grounds 10, 11 and 12, and relatedly Ground 13, concern the Tribunal’s treatment of debt costs “across the life of the assets”. SAPN argued that this approach appears to be based on a construction of r 6.5.2 that permits the recovery of efficient financing costs “across the life of the assets” rather than each regulatory year or control period, and an acceptance of the proposition that random mismatches of allowed and actual debt costs under the on-the-day approach can be expected to even out “across the life of the assets” so as to provide for appropriate cost recovery. SAPN argued that there are a number of “problems” with this approach.
169 The first problem identified by SAPN concerns the identity of the “assets”: are the “assets” the debt facilities or the underlying capital assets? SAPN submitted that treating the “assets” as the underlying capital assets is nonsensical because debt facilities are not linked to specific assets. It submitted that neither the on-the-day approach nor the trailing average approach calculates debt costs over the long life of many assets used in the distribution of electricity.
170 The second problem identified by SAPN is that there is no basis for assuming that random mismatches will even out and provide an accurate calculation of debt costs. SAPN pointed to the fact that a 10-year term of debt is equivalent to only two 5-year regulatory control periods. It submitted that there is no basis for concluding that the random mismatch would even out over two periods or that the same quality of debt would be held in both periods.
171 Further, SAPN submitted that, even if viewed over a longer period, it could not be assumed that the DRP mismatch would be offset over time. In this connection, SAPN relied on the following advice given to AER by Chairmont:
… the question that needs to be considered is whether overs and unders are expected to approximately offset over time. DRPs will experience cycles where they rise and fall; however no conclusive literature has been tabled that demonstrates how long it may take for mismatches to fully offset. As the allowance measurement is made only every five years it will require many regulatory periods to establish enough occurrences to determine whether an offset will occur.
Further complicating the concept of offsetting over time, financial markets have changed significantly in the past 30 years, so that quite different interest rate regimes have existed. The concept of simple regular interest rate cycles seems too theoretical to be applied in practical circumstances.
Finally, in the face of the higher near term weighting of dollar impact of the mismatch … the chance of the random component of mismatches offsetting over time is minimal.
172 The third problem identified by SAPN is that, because assets change each regulatory control period, there is no continuity of the kind that would underpin this approach. SAPN develop this submission by directing attention to the following matters.
173 First, r 6.5.1(a) describes the nature of the regulatory asset base as follows:
The regulatory asset base for a distribution system owned, controlled or operated by a Distribution Network Service Provider is the value of those assets that are used by the Distribution Network Service Provider to provide standard control services, but only to the extent that they are used to provide such services.
174 SAPN directed attention to the closing words of this description.
175 Secondly, SAPN argued that assets may be used to provide other services, namely alternative control services, negotiated distribution services, and unregulated services. The classification of a service as “a direct control service” (and, hence, as either a standard control service or alternative control service (r 2.2(a)) is a matter for determination by the AER. The AER’s classification forms part of a distribution determination and operates for the regulatory control period for which the distribution determination is made: r 6.2.3.
176 As the classification of services by the AER is specific to each distribution determination, SAPN submitted that the only sensible construction of s 7A(2)—which is concerned with providing a regulated network service provider with a reasonable opportunity to recover at least its efficient costs in providing direct control network services—is that it applies to the recovery of costs in the particular regulatory control period under consideration.
177 Thirdly, SAPN said that the AER can make determinations as to the size of the regulatory asset base from period to period.
178 In light of these matters, SAPN submitted that there is no sense in which the AER’s decisions can be said to be aimed at achieving NPV=0 for a period that is “over the life of the assets”, because the assets comprising the value of the regulatory asset base will not necessarily form part of the regulatory asset base over the course of their lives. The return on debt is applied to a different regulatory asset base from period to period.
179 The fourth problem identified by SAPN is that, in light of the foregoing, there is no basis for construing r 6.5.2 so as to permit a shortfall or excess of recovery in any regulatory year or period on the basis that there might be some offset over a longer time period.
180 Here, SAPN focused on the Tribunal’s understanding of the expression “across regulatory control periods” as used in r 6.5.2(k)(4). SAPN argued that, consistently with comments made by the Australian Energy Market Commission (“AEMC”) in its 2012 Rule Determination, r 6.5.2(k)(4) is a transitional provision directed to the possibility that a service provider may have taken steps or ordered its affairs on the basis of a previous regime.
181 In this connection, SAPN argued that, for businesses that had entered into hedging arrangements in respect of the risk-free component of debt, r 6.5.2(k)(4) was designed to deal with circumstances in which those arrangements could not be unwound immediately. Thus, SAPN accepted, the imposition of a transition for the risk-free component of debt is appropriate. It argued that the reference in r 6.5.2(k)(4) to impacts, including the costs of servicing debt “across regulatory control periods”, is a reference to the possibility that there may be hedge contracts taken out in one regulatory control period that affect the cost of debt in that period and also in a subsequent period. In these circumstances, r 6.5.2(k)(4) requires the AER to consider the impact of a change of methodology (for estimating the return on debt) on the cost of debt across those two periods.
182 SAPN submitted that r 6.5.2(k)(4) does not result in the allowed rate of return objective in r 6.5.2(c) being construed as one referring to costs “across the life of the assets”, and the Tribunal erred in construing the allowed rate of return objective as if it did.
183 As to Grounds 14 to 16, SAPN argued that the Tribunal’s treatment of the capital expenditure incentives created by the trailing average and on-the-day approaches to estimating the return on debt did not form part of the AER’s reasoning on this topic. It said that these matters were not raised by the Tribunal with the parties.
184 Although these grounds were raised by SAPN, its primary position was that the Tribunal’s findings on these matters did not form the basis of the Tribunal’s ultimate conclusion on the topic of return on debt.
185 In supplementary submissions made pursuant to leave granted on 19 June 2017, SAPN relied on certain observations and conclusions expressed in AER v Australian Competition Tribunal as supporting its construction of r 6.5.2(k)(4). We will discuss those submissions in later paragraphs of these reasons: see [279]-[295] below.
The AER’s Submissions
186 The AER commenced its submissions by surveying the background to the 2012 rule changes. One reason for doing this was to contradict a theme in SAPN’s presentation of its submissions that the previous on-the-day approach to estimating the return on debt was a flawed approach that leads to outcomes that are “randomly wrong” or cause a “random mismatch”.
187 Based on its survey, which included the AEMC’s 2012 Rule Determination, the AER submitted that the on-the-day approach ensures that the allowed cost of capital reflects prevailing market conditions and promotes efficient capital investment. It submitted, further, that the on-the-day approach is consistent with the principle underpinning the regulatory framework, which is to estimate a price which equates the present value of expected cash flows to the regulated asset base, thereby satisfying the NPV=0 condition. Indeed, as the AER correctly pointed out, r 6.5.2(j) expressly empowers the AER to use an on-the-day approach or a trailing average approach. The NER thus recognises that each approach would contribute to the allowed rate of return objective in r 6.5.2(c). The AER submitted that one purpose of the 2012 rule changes was to provide it with an additional discretion when determining the methodology for debt estimation that is to be adopted, with the on-the-day and trailing average approaches (or some combination of them) expressly recognised as methodologies applicable to the Australian regulatory framework.
188 With respect to the allowed rate of return objective, the AER directed particular attention to the AEMC’s statements in its 2012 Rule Determination concerning the concept of efficient financing costs. The AEMC said that the primary objective of the allowed rate of return is to provide service providers with a return on capital that reflects efficient financing costs. The AEMC said that a rate of return that reflects efficient financing costs will allow a service provider to attract the necessary investment capital to maintain a reliable energy supply while minimising the cost to consumers.
189 The AEMC also explained:
If the allowed rate of return is not determined with regard to the prevailing market conditions, it will either be above or below the return that is required by capital market investors at the time of the determination. The Commission [is] of the view that neither of these outcomes is efficient nor in the long term interests of energy consumers.
190 The AEMC also said:
As the return on debt is part of the overall allowed rate of return, the Commission considers that the best way to meet the NER, the NGO and the RPP for estimating the return on debt is the same as that discussed in the rate of return framework chapter. That is, the return on debt estimate should reflect the efficient financing costs of a benchmark efficient service provider. It should try to create an incentive for service providers to adopt efficient financing practices and minimise the risk of creating distortions in the service provider’s investment decisions. If a service provider is run inefficiently then it shareholders, and not its customers, should bear the financial consequences of inefficient financing practices.
191 In oral submissions, the AER described this as a forward-looking consideration, and not merely a cost recovery consideration.
192 The AER also directed particular attention to the four mandatory factors in r 6.5.2(k) regarding its estimation of the return on debt.
193 With respect to r 6.5.2(k)(1)—the desirability of minimising any difference between the return on debt and the return on debt of a benchmark efficient entity—the AER submitted:
… the rules were altered to give the AER a broader discretion in its approach to the estimation of the return on debt because minimising the ‘mismatch’ between the allowed return on debt and the conceptualised return on debt of a BEE could reduce the volatility of the entity’s cash flows.
194 With respect to r 6.5.2(k)(2)—the interrelationship between the return on debt and the return on equity—the AER submitted:
It is equity holders that principally bear the risk of any difference between a service provider’s actual cost of debt and the allowed return on debt. Debt holders do not bear that risk because they are paid the contractual cost of debt. Therefore, debt interest rate risk is a component of the cost of equity.
195 With respect to r 6.5.2(k)(3)—the incentives that the return on debt may provide in relation to capital expenditure—the AER submitted:
Incentives for capital investment will be distorted by the extent to which the allowance for the cost of debt differs from the prevailing market cost of debt. This was a problem that was specifically recognised by SFG Consulting in its advice to the AEMC, and by the AEMC.
196 With respect to r 6.5.2(k)(4)—any impacts on a benchmark efficient entity that could arise as a result of changing the methodology that is used to estimate the cost of debt—the AER submitted:
This factor has particular significance, because the AER decided to change the methodology of estimating the return on debt for SAPN from the on-the-day approach, which had been used in the prior regulatory period, to a trailing average approach. In respect of this factor, the AEMC said that consideration should be given to the potential for consumers and service providers to face a significant and unexpected change in costs or prices that may have negative effects on confidence in the predictability of the regulatory arrangements. The AER decided that it was appropriate to change the methodology prospectively (ie in a forward looking manner), not immediately, to avoid such risks to service providers and consumers. It was that part of the decision that was the subject of review before the Tribunal.
197 The AER referenced each of these observations to passages from the AEMC’s 2012 Rule Determination. In oral submissions, the AER pointed out that the four mandatory factors r 6.5.2(k) represent possibly competing considerations that might bear upon an appropriate exercise of the discretion that is conferred when estimating the return on debt.
198 The AER noted that SAPN’s primary contention is that the allowed rate of return objective expressed in r 6.5.2(c) requires the AER to immediately adopt a trailing average approach to the DRP component of debt. The AER submitted that this construction conflicts with the discretion conferred on the AER by r 6.5.2(i) (which provides that the return on debt can be estimated so that it is the same in each year of the control period or different for different years in the period) and r 6.5.2(j) (which provides for a choice of methodology reflecting the on-the-day approach or the trailing average approach, or a combination of the two). The AER submitted that SAPN’s construction of r 6.5.2(c) also conflicts with the mandatory factors in r 6.5.2(k) which the AER must take into account.
199 The AER rejected SAPN’s contention that the Tribunal did not adequately deal with its complaints: see [146]-[147] above. In this connection it submitted:
SAPN’s complaints before the Tribunal were based upon a narrow construction of the allowed rate of return objective in NER cl 6.5.2(c) (the effect of SAPN’s construction is the AER must always apply a trailing average approach to determine the return on debt, so that the return on debt is not “randomly wrong”). SAPN’s construction conflicts with the express discretion given to the AER in NER cls 6.5.2(i) and (j) and the mandatory considerations in NER cl 6.5.2(k) including particularly 6.5.2(k)(3) and (4). SAPN’s construction fails to read the NER in a coherent manner and is contradicted by the relevant extrinsic material. On SAPN’s approach, the AER could never decide to continue to use the on-the-day approach, because that approach would not match the BEE’s cost of debt (acquired over time), and yet the NER expressly contemplate such a decision.
200 The AER correctly pointed out that none of the grounds of review in this Court raise the contention that the Tribunal failed to address its complaints. Rather, each ground of review challenges particular aspects of the Tribunal’s reasoning.
201 Having dealt with these background matters, the AER turned to consider SAPN’s specific grounds of review in this Court. It dealt, firstly, with Grounds 14 to 16.
202 With respect to these grounds, the AER submitted that, contrary to SAPN’s primary position (see [184] above), the Tribunal’s reasons at [239]-[244] (see [95]-[100] above) provided important background to its consideration of SAPN’s specific complaints. The AER submitted that SAPN’s contention that these matters formed no part of the AER’s reasons in its Final Decision (Ground 14) and that the Tribunal did not afford SAPN the opportunity to make submissions on these matters (Ground 16) should be rejected. The AER also submitted that SAPN’s contention that these matters were not “review related matter” (see s 71R(6) of the NEL) (Ground 15) should also be rejected.
203 In this connection, the AER submitted that the matters addressed in [239]-[244] of the Tribunal’s reasons were the subject of express treatment by the AEMC in its 2012 Rule Determination and the related extrinsic material. This treatment included reference to the advice that had been given to the AEMC in formulating its determination. These matters were, in turn, considered and discussed by the AER in its Final Decision on return on debt. The AER provided a number of references to these matters in its Final Decision, including its reliance on the NPV=0 principle. The AER submitted, further, that these matters were the subject of oral and written submissions by it to the Tribunal, to which SAPN responded. Once again, the AER provided a number of references to the submissions that had been made.
204 With respect to Ground 7, the AER noted that the effect of SAPN’s submissions to the Tribunal was that, without an immediate change to the trailing average approach (we interpolate, with respect to the DRP component of debt), SAPN’s historically incurred cost of debt would be higher than the allowed cost of debt. The AER submitted that, at [246] of its reasons, the Tribunal was saying that this fact was not decisive, because it was an outcome that was anticipated at the time the debt was incurred (because at that time the NER prescribed that outcome). The AER submitted that it was in this sense that the Tribunal suggested that SAPN’s arguments treated the differential as “akin to sunk costs”. The AER submitted that it was significant that, at [246], the Tribunal noted that SAPN’s arguments failed to address whether alternative transition methods impacted upon the promotion of future efficient financing decisions.
205 With respect to Ground 8 and the question of “bias”, the AER said that it considered Option 2 was preferable because the assessment of other approaches that use historical data, such as Option 3, would inevitably be influenced by the time in the interest rate cycle at which the change in methodology is implemented. As the AER put it, and as the Tribunal recognised at [248], service providers would advocate for, say, Option 3 when current interest rates were at a low point in the cycle, but not when interest rates were at a high point. The AER submitted that Option 2 eliminated this form of bias and that the Tribunal was correct to consider that the AER had not erred in this regard.
206 With respect to Ground 9, the AER argued that SAPN’s submissions proceed from its erroneous construction of r 6.5.2(c) and its erroneous rejection of the on-the-day approach to determining the return on debt. It is to be recalled that this ground alleges that the Tribunal erred by taking into account the fact that, when historical debt was issued, the service provider would have expected the continued application of the on-the-day approach (as SAPN put it, “the continued application of a previous version of cl 6.5.2 of the NER”).
207 The AER submitted that the Tribunal correctly appreciated that, when the AER had determined that it would change methodology from the on-the-day approach to the trailing average approach, r 6.5.2(k)(4) came into play, which required the AER to take into account any impacts that could arise as a result of the change in methodology. The AER submitted that, at [280]-[289], the Tribunal correctly restated its reasoning. In this connection it submitted:
Option 2 was preferred by the AER because it avoids windfall gains or losses to the regulated entity resulting from a change in the method of determining the cost of debt. As the Tribunal observed, at the time of incurring historical debt, investors in the regulated entity would have invested assuming the continuation of the on-the-day approach and anticipating potential diversions between the actual historical cost of debt and the allowed cost of debt in a future regulatory period. The resulting risk would be reflected in the investment decision. Any change to the method of determining the cost of debt causes a change to that expectation. The change may be advantageous or disadvantageous to investors, depending on whether prevailing interest rates are higher or lower than historic rates. The advantage or disadvantage is a windfall gain or loss caused only by the change of method. Option 2 avoids such windfall gains or losses because a transition is to the new method on a forward-looking basis. By transitioning 10% of the regulated entity’s debt to the new method each year, the effect is to preserve the on-the-day methodology for all historic debt but apply the trailing average methodology to all new debt.
208 The AER submitted that the Tribunal correctly decided that its (the AER’s) reasoning was consistent with r 6.5.2 and the economic principles underpinning it.
209 The AER noted that Grounds 10, 11 and 12 raise substantially the same issue, which concerns the proper construction of r 6.5.2(k)(4) of the NER and s 7A(2) of the NEL. The AER also noted that, once again, SAPN’s submissions proceed from the premise that the allowed rate of return objective in r 6.5.2(c) requires the use of the trailing average approach because it enables the service provider to recover its actual cost of debt historically incurred.
210 The AER submitted that the text of r 6.5.2(k)(4) is clear. It requires the AER to have regard to the impacts in relation to the costs of servicing debt across regulatory control periods. We understand the AER to mean (as the Tribunal accepted at [289]) that “across regulatory control periods” involves more than just the periods immediately surrounding the change in regulatory approach. The AER submitted that, at [269] (see [122] above), the Tribunal correctly observed that this meaning was consistent with the economic basis of the building block regulatory approach reflected in the NER and the PTRM.
211 The AER submitted that the text of s 7A(2) is likewise clear. It submitted that SAPN’s construction involves the unwarranted reading in of the words “in each regulatory control period” in relation to the recovery of costs to which the provision refers. The AER submitted that the Tribunal correctly concluded at [273] that s 7A(2) does not imply the recovery of costs within a particular regulatory control period.
212 The AER submitted that the Tribunal correctly concluded at [289] that Option 2 was preferable because it was more consistent with meeting expectations held of how future DRP values would be determined when particular annual tranches of debt were issued and avoids windfall gains or losses in the current regulatory control period.
213 With respect to Ground 13, the AER noted that this was really a recasting of Grounds 8, 9, 11 and 12 in the form of alleged irrelevant considerations. The AER simply submitted that this ground should be rejected having regard to its submissions on other grounds.
214 The AER responded to SAPN’s supplementary submissions. We will discuss that response in later paragraphs of these reasons: see below at [279]-[295].
SAPN’s Submissions in Response
215 In reply, SAPN argued that the AER’s submissions proceeded on two incorrect propositions. The first is that SAPN had construed “efficient financing costs” in the allowed rate of return objective in r 6.5.2(c) as costs incurred over time and that, accordingly, the trailing average approach must always be applied. The second is that the trailing average approach is an “historic” cost methodology.
216 As to the first proposition, SAPN argued that its construction recognises that efficient benchmark service providers may have different efficient debt management strategies and practices. In its case, it was common ground that the efficient financing practice of a benchmark efficient entity with a similar degree of risk as SAPN was to hold a staggered portfolio of fixed rate debt that was hedged to accommodate the interest rate risk associated with the application of the on-the-day approach to estimating the return on debt. SAPN submitted that it followed that the methodology to be used to estimate the return on debt for it is Option 3 in which a transition is applied to the risk-free component (which could be hedged) but not the DRP component (which could not be hedged). This did not mean, however, that the AER must always apply the trailing average approach to estimate the return on debt for all service providers. SAPN argued that there may be more than one benchmark efficient entity and that, for a given service provider, the on-the-day approach may, for example, properly measure debt costs in relation to the benchmark efficient entity for that service provider.
217 By way of contrast, SAPN submitted that a construction of the allowed rate of return objective that equates “efficient financing costs” to prevailing market costs imposed on the entity’s entire debt portfolio, is in conflict with r 6.5.2. SAPN attributed this construction to the AER and then argued that this construction meant that only the on-the-day approach can provide an estimate of the return on debt that contributes to the allowed rate of return objective. Indeed, SAPN went further to suggest that, by its submissions, the AER considers that the trailing average approach does not provide for efficient capital investment.
218 SAPN then argued that, if this construction were to be accepted, it would leave no operation for r 6.5.2(j)(2) and (3), which contemplate the adoption of a range of methodologies, including the trailing average methodology. It also leaves unexplained how it was open to the AER to adopt a 10-year transition that ultimately leads to a return on debt estimated by reference to a 10-year trailing average. SAPN submitted that as the trailing average approach is not simply a measure of the prevailing market cost of capital, it could never reflect “efficient financing costs”.
219 SAPN also submitted that the AER’s submissions do not accurately describe the basis upon which the AEMC concluded that the NER should be amended to permit the adoption of the trailing average approach. SAPN said that the AER’s submissions gave the impression that the only reason that the AEMC provided for the trailing average approach was to reduce the volatility of the entity’s cash flows, which was incorrect. SAPN submitted that, if the AEMC considered that “efficient financing costs” were simply reflected in prevailing market conditions, then consideration of efficient financing practices would be largely irrelevant and wholly inconsistent with a return estimated by reference to costs incurred pursuant to debt instruments entered into prior to the commencement of the regulatory year in which the return on debt is to be estimated.
220 Thus, according to SAPN, the AER’s construction of “efficient financing costs” does not give meaning to every word of r 6.5.2 and does not best achieve the purpose or object of the NEL. SAPN submitted that the Tribunal fell into the same error of construction.
221 As to the second proposition (that the trailing average approach is an “historic” cost methodology), SAPN submitted that the trailing average approach is a combination of historic costs and prevailing costs. The trailing average approach is only “historic” in the sense that the costs arise from debt instruments entered into prior to the regulatory year in which the return on debt is to be estimated. SAPN submitted that, in all other senses, the costs are “current” because they are costs actually faced by the benchmark efficient entity pursuant to the instruments in the regulatory year in which the return on debt is being estimated.
222 SAPN provided the following explanation:
The trailing average approach assumes that new facilities are taken out in each year of the regulatory control period at the prevailing rate for new debt, and calculates debt costs accordingly. Thus in year 1, the portion of debt that is taken out in that year is calculated in accordance with the prevailing rate. In year 2, 10% of the debt is calculated at the prevailing rate in year 2, and 10% at the rate that was the prevailing rate in year 1, and so on. By year 5, half of the debt is calculated at rates that were prevailing rates during the regulatory control period, including some debt at the prevailing rate in year 5.
223 SAPN submitted that the prevailing rate thus applies for new debt taken out each year, including debt for new investment.
224 By way of contrast, SAPN submitted that the on-the-day approach takes a single prevailing rate just prior to the commencement of the regulatory control period. It is not updated at any point during the regulatory control period and thus becomes out of date and ceases to be the prevailing rate after the first year.
225 SAPN argued that the trailing average approach is consonant with the common pattern of investment for businesses. It said that the use of a regulatory asset base under the NER reflects the reality that a distribution business operating in the National Electricity Market engages in capital expenditure and replaces and, in some cases, expands its assets year by year. On the other hand, the on-the-day approach provides a “prevailing cost” approach only for a new entrant who enters at the commencement of the regulatory control period and thus acquires an entirely new regulatory asset base at that time, supported by a large portfolio of debt entered into simultaneously with the commencement of the provision of services. The on-the-day approach is also a methodology that models debt costs of a business that refinances the entirety of its debt at the commencement of the regulatory control period.
226 SAPN pointed to the fact that r 6.5.2(j)(3) makes specific provision for the AER to adopt “some combination” of the on-the-day approach and the trailing average approach. SAPN said that such an approach was relevant to the present circumstances where, as a consequence of adopting a staggered/swap financing practice, the service provider faces the on-the-day rate for the risk-free component of debt, and a trailing average for the DRP component. Thus, for a benchmark efficient entity in the position of SAPN, the efficient financing costs were represented by Option 3. The on-the-day approach produces an output that is randomly wrong.
227 As to Grounds 14 to 16, SAPN submitted that the primary matters canvassed in the AER’s submissions did not find expression in its Final Decision. SAPN submitted that while the NPV=0 principle was discussed in the AER’s Final Decision, it was not in the context of construing the term “efficient financing costs” in the rate of return objective. It argued that it had cautioned the Tribunal that the matters discussed in AER’s oral submissions were not to be found in its Final Decision. SAPN argued that it was “practically constrained” from specifically addressing these matters.
Analysis
228 We have set out in some detail the submissions of the parties to show the wide-ranging scope and complexity of the arguments marshalled on this topic. Despite that scope and complexity, we think that the resolution of the grounds of judicial review raised in this proceeding on this topic falls within a relatively confined area. We do not think that it requires us to pursue every argument that was agitated before us.
229 We commence by noting a number of foundational principles.
230 The AER is required to perform and exercise its economic regulatory functions and powers in a manner that will, or will be likely to, contribute to the achievement of the national electricity objective: s 16(1)(a) NEL. The national electricity objective is to promote efficient investment in, and efficient operation and use of, electricity services for the long-term interests of consumers of electricity with respect to price, quality, safety, reliability and security of supply of electricity, and with respect to the reliability, safety and security of the national electricity system: s 7 NEL.
231 The AER must also take into account the revenue and pricing principles set out in s 7A of the NEL. These principles stipulate that a regulated network service provider should be provided with a reasonable opportunity to recover at least its efficient costs in providing direct control network services and complying with a regulatory obligation or requirement, or making a regulatory payment: s 7A(2). However, the revenue and pricing principles also stipulate that a regulated network service provider should be provided with effective incentives to promote economic efficiency with respect to the direct control network services that the service provider provides, including efficient investment in the distribution or transmission system with which the service provider provides direct control network services: s 7A(3).
232 The allowed rate of return objective concerns the return on capital that is to be allowed to each service provider under the building block approach to regulating revenues/prices using a PTRM. The return on capital has two components— a return on equity and a return on debt. The allowed rate of return objective addresses both components. It is the same objective.
233 The allowed rate of return objective is to ensure that a service provider receives returns that are commensurate with the efficient financing costs of a benchmark efficient entity. When the allowed rate of return objective refers to the “efficient financing costs” of a benchmark efficient entity, it is not referring merely to cost recovery. A broader notion is involved.
234 In the context of the return on debt, the “efficient financing costs” of a benchmark efficient entity also comprehend the economic efficiencies involved in the deployment of debt for capital expenditure. Indeed, r 6.5.2(k)(3) requires the AER to have regard to the incentives that the return on debt may provide in relation to capital expenditure over the regulatory control period, including as to the timing of that expenditure.
235 In this connection, in its 2012 Rule Determination the AEMC specifically noted that the return on debt should reflect the efficient financing costs of a benchmark efficiency service provider so as to provide an incentive to the service provider to adopt efficient financing practices, and to minimise the risks of creating distortions in the service provider’s investment decisions: see at [190] above.
236 The AEMC recorded the economic advice it received (and accepted) that an historical trailing average approach to estimating the return on debt can lead to significant differences between the regulatory allowance for return on debt and the cost of debt in the market for funds at any point in time. It noted that such differences could impact on the incentives for service providers to invest efficiently in capital expenditure. It exemplified the case of a service provider who may not invest as much as would be efficient when the market cost of debt is higher than the regulatory allowance given. It noted that a proposal—the QTC proposal, which is reflected in Option 2—was one way to address this risk. The AER stressed the importance of incentives for efficient capital expenditure and said that those incentives are stronger when the difference between the return on debt and the debt servicing costs of the service provider is minimised.
237 Relatedly, we observe that the NER accept that returns based on prevailing rates are consistent with the allowed rate of return objective. Rule 6.5.2(g) requires that, in estimating the return on equity, regard must be had to the prevailing conditions in the market for equity funds. Rule 6.5.2(j)(1) provides that the estimation for the return on debt can reflect the on-the-day approach which is, of course, concerned with prevailing rates at the time the estimate is made. Of course, r 6.5.2(j) also provides that the estimation of the return on debt can reflect the trailing average approach or some combination of the on-the-day approach and the trailing average approach. The important matter for present purposes is that the on-the-day approach is not presented in the NER as some flawed approach as SAPN’s submissions appear to suggest. In its 2012 Rule Determination, the AEMC consistently stressed the importance of prevailing rates—what the AER described as a forward-looking approach—to estimating both the return on equity and the return on debt. Rule 6.5.2(k)(2) requires that, in estimating the return on debt, the AER must have regard to the interrelationship between the return on equity and the return on debt.
238 It is also convenient to note at this point that the building block model which the AER is required to use is based on the NPV=0 principle. In Appendix G to Attachment 3 of its Final Decision, the AER discussed the connection between this principle and the development of the NER: see at 3-563 to 3-565. One adviser to the AER described the position as follows:
The legal requirement for the allowed cost of debt to be commensurate with the costs incurred by a [benchmark efficient entity] is not sufficiently precise to be readily implemented, and therefore requires formalizing. This is obtained through the NPV=0 principle: the allowed prices or revenues of the regulated business should be such that the present value of the resulting revenues net of opex and taxes must equal the initial investment. Lower revenues than those that satisfy this principle will fail to entice producers to invest and higher revenues constitute the very excess profit that regulation seeks to prevent…
239 In its Final Decision, the AER addressed the meaning of “efficient financing costs” in the context of the return on debt. It recorded the economic advice it had acted on, including the relevance of the NPV=0 principle to the estimation of the return on debt. It considered the promotion of efficient financing practices consistent with the principles of incentive-based regulation and also the question of what would be required to provide a benchmark efficient entity with a reasonable opportunity to recover its efficient financing costs. These topics are reflected in the five considerations noted at [90] above to which the AER directed specific attention.
240 Having made these opening observations, we now turn to the grounds of review in this proceeding. It is convenient to commence with Grounds 10 to 12.
241 As to Ground 10, we are not persuaded that the Tribunal erred in finding that s 7A(2) of the NEL does not imply the recovery of costs within a particular regulatory control period. It is to be noted that s 7A(2) expresses a broadly-stated principle for revenue and pricing which refers to costs generally. Its concern is not specific to debt costs, but all efficiently incurred costs of the operator in providing direct control services and in complying with its regulatory obligations and requirements, including the making of regulatory payments. It seems to us that reading into such a broadly-stated principle a limitation that the opportunity it affords is one for recovery within a given or particular regulatory control period is an unwarranted gloss on the legislation and an unnecessary confinement of the principle it expresses.
242 Further, the principle stated in s 7A(2) must be read with the other revenue and pricing principles. If that principle is read with an eye to the recovery of debt costs, it must also be read with an eye to the requirement of s 7A(3) that a regulated network service provider should be provided with effective incentives in order to promote economic efficiency, including in respect of investment in the system with which it provides direct control network services.
243 The passage at [273] of the Tribunal’s reasons to which Ground 10 is directed was made in the context of the Tribunal discussing the nature of incentive-based regulation under the NEL and NER, dealing more specifically with the interpretation of s 7A(2). We do not see that impugned statement as having any determinative significance in the Tribunal’s finding in relation to the interpretation of r 6.5.2(k)(4).
244 Accordingly, we are not persuaded that Ground 10 discloses any judicially reviewable error on the part of the Tribunal.
245 As to Ground 11, we are not persuaded that the Tribunal erred in its construction of the phrase “across regulatory control periods” when used in r 6.5.2(k)(4). It is to be recalled that the Tribunal considered that the AER did not err in applying r 6.5.2(k)(4) as referring to a longer time period, such as that involved in recovering efficient financing costs over the life of assets.
246 The following matters should be noted.
247 First, as a matter of ordinary language, “across regulatory control periods” is not specific to two conterminous periods. Secondly, as a matter of context, there is no reason to construe the phrase as if it were qualified in this way. Thirdly, and in any event, r 6.5.2(k)(4) requires the AER to have regard to any impacts. Even if the phrase “across regulatory control periods” has the construction for which SAPN contends, the inclusive reference to the costs of servicing debt across regulatory control periods does not preclude the AER’s consideration of impacts seen over a longer time period. In other words, in relation to the servicing of debt costs, r 6.5.2(k)(4) does not confine the AER’s attention to having regard only to impacts and recovery in each regulatory year of the regulatory control period, as SAPN contends.
248 Accordingly, we are not persuaded that Ground 11 discloses judicially reviewable error on the part of the Tribunal.
249 As to Ground 12, we are not persuaded that the Tribunal acted on a wrong construction of either r 6.5.2(h) or r 6.5.2(k)(4) by considering whether the transition approach adopted by the AER would reduce the potential for “windfall gains or losses”.
250 The topic of “windfall gains or losses” is bound up with the adoption of the NPV=0 principle in the regulatory framework. In this connection, it is important to bear in mind what the AER meant by “windfall gains or losses”. These are gains or losses which result from changing the methodology for estimating the return on debt at a particular point in time. In its Final Decision, the AER characterised such gains or losses as a “side-effect” of changing estimation methodology: see the passage quoted at [89] above. They are not gains or losses which result from a service provider’s decisions on efficient financing practices.
251 As we have noted at [207] above, before this Court the AER submitted that the Tribunal at [280]-[289] of its reasons correctly captured the AER’s reasoning on this topic.
252 It is clear that the allowed rate of return objective is concerned with providing a return which is commensurate with efficient financing costs. This permeates the requirement of r 6.5.2(h) to estimate a service provider’s return on debt such that it contributes to the achievement of the allowed rate of return objective. It is consistent with the allowed rate of return objective to ensure that returns are based on (what the AER described as) management induced efficiencies or inefficiencies rather than unexpected or “windfall” gains or losses that have nothing to do with management induced efficiencies or inefficiencies but are merely the happenstance of regulatory change.
253 Rule 6.5.2(k)(4) requires the AER, when estimating the return on debt, to have regard to impacts that could arise as a result of changing the methodology that is used to estimate the return on debt. When the AER came to consider the impacts of changing the methodology from the on-the-day approach to the trailing average approach, it took into account how “windfall” gains or losses, in the sense described above, could be avoided. We see no error in that approach. As events transpired, the AER concluded that Option 2 best achieved this outcome.
254 Similarly, we see no error in the Tribunal’s acceptance of this approach. As we have said, we are not persuaded that, in so doing, the Tribunal acted on a wrong construction of either r 6.5.2(h) or r 6.5.2(k)(4).
255 Accordingly, we are not persuaded that Ground 12 discloses judicially reviewable error on the part of the Tribunal.
256 In determining Grounds 10, 11 and 12, it is not necessary for us to determine whether the conceptual “problems” to which SAPN referred in its submissions (see [168]-[182] above) exist, let alone investigate such “problems” (assuming them to exist) with a view to determining whether they truly present, for example, any difficulties in estimating the return on debt in accordance with the regulatory framework under the NER. The point of present significance is that there are a number of facets involved in estimating the return on debt, which include the incentives provided for efficient investment decisions of a long term nature in relation to assets required to provide the system used for direct control network services. The allowed rate of return objective is not limited to consideration of the recovery in any particular regulatory control period of efficient financing costs.
257 We now turn to the earlier grounds of SAPN’s application for judicial review on the topic of return on debt.
258 As to Ground 7, we are not persuaded that the Tribunal acted on a wrong construction of r 6.5.2(h) in relation to its observation that the arguments advanced by SAPN suggested that the DRP component of its continuing debt costs are akin to “sunk” costs. Whether or not the Tribunal was correct to characterise SAPN’s submissions in this way, and whether or not “sunk” is an appropriate characterisation in any event, are not matters which we need to address. Of present importance is the fact that, in this part of its reasons, the Tribunal was not saying that SAPN was precluded from obtaining a return on debt that was commensurate with its efficient financing costs in relation to both components of debt. This is enough to dispose of this ground.
259 We note, however, that in Ground 7 SAPN also queries the Tribunal’s reference, in this part of its reasons, to “future financing arrangements” and “future practices”. Further in this regard, SAPN argues that, in making these references, the Tribunal appears to have acted inconsistently with other passages in its reasons.
260 We do not accept that this part of the Tribunal’s reasons has the difficulties to which SAPN refers. Contrary to SAPN’s submission, the point made by the Tribunal at [246] is that the choice of transition arrangements has no consequences for a service provider’s choice of future financing arrangements or practices. This is consistent with the earlier passages in the Tribunal’s reasons ([239]-[244]) to which SAPN refers. We do not accept that this part of the Tribunal’s reasons reflects error.
261 Accordingly, we are not persuaded that Ground 7 discloses judicially reviewable error on the part of the Tribunal.
262 As to Ground 8, we are not persuaded that the Tribunal acted on a wrong construction of r 6.5.2(h) by considering the avoidance of what the AER described as the potential for “regulatory bias”. Once again, it is important to understand what the AER meant by “regulatory bias”.
263 In its Final Decision, the AER noted that it is an important feature of building block incentive regulation that the rate of return (whether on equity or on debt) is forward-looking. We do not understand there to be any challenge to that statement as a general proposition. The AER reasoned that, whatever the virtues might be of choosing a trailing average approach to estimating the return on debt, the use of an historical averaging period can introduce a bias in regulatory decision-making simply because it might be said that the choice made by the regulator was one influenced by pre-knowledge of the historical data.
264 The AER explained its concerns in its Final Decision:
We are satisfied that an unbiased approach will contribute to estimating a rate of return that is commensurate with the efficient financing costs of a benchmark efficient entity. Setting the rate of return with foreknowledge of the outcome does not reward efficient decision making or allow a comparison to benchmark performance. It does not provide the appropriate incentive for efficient investment, as contemplated in both the NEO/NGO and the revenue and pricing principles. This is because the use of backwards looking data in selecting a regulatory approach is likely to increase the risk of biased regulatory decision-making.
265 In the context of applying r 6.5.2(k)(4) and considering what is an appropriate transitioning arrangement to take into account the impacts occasioned by the change in methodology for estimating the return on debt, we are not persuaded that the AER acted on an incorrect construction of r 6.5.2(h) by taking into account the potential for regulatory bias, as explained by it. Similarly, we are not persuaded that, in deciding that the AER’s approach in adopting Option 2 was a valid one in light of this consideration, the Tribunal was itself acting on an incorrect construction of r 6.5.2(h).
266 Accordingly, we are not persuaded that Ground 8 discloses judicially reviewable error on the part of the Tribunal.
267 As to Ground 9, we are not persuaded that the Tribunal acted on a wrong construction of r 6.5.2(h) when, at [284] of its reasons, it gave its example of setting the rate of return by a rule during the transition period that is different to the rule prevailing when the debt was issued. This ground is closely related to Ground 12 dealing with “windfall gains or losses”.
268 In this part of its reasons, the Tribunal was simply illustrating the meaning of “windfall”. Its point was that, if debt was taken out during the period when the on-the-day approach was required to be applied in estimating the return on debt, and that debt would mature in a future regulatory control period, the service provider would have had, at the time of taking out the debt, an expectation that, in the future regulatory control period, its return on debt would be estimated according to the on-the-day approach. However, if in the future regulatory control period the rule changed, and produced by reason of that change alone a gain or loss, that gain or loss would be a “windfall”. It would have nothing to do with the service provider’s own efficient (or perhaps inefficient) financing practices or decisions.
269 In our view, this ground falls with Ground 12. We are not persuaded that Ground 9 discloses judicially reviewable error on the part of the Tribunal.
270 The fate of Ground 13 is really dependent on our conclusions with respect to Grounds 8 to 12. We are not persuaded that the matters covered by those grounds, as discussed above, involve the errors attributed to them or stand as irrelevant considerations to the Tribunal’s decision. For this reason, we are not persuaded that Ground 13 discloses judicially reviewable error on the part of the Tribunal.
271 As to Ground 14, we do not accept that the matters discussed at [239]-[241] of the Tribunal’s reasons formed no part of its reasoning on its return on debt decision. We do not see this part of the Tribunal’s reasons as some free-standing meditation divorced from its consideration of the grounds of review brought before it.
272 In this part of its reasons, the Tribunal gave consideration to important background matters providing some of the context in which a return on debt decision is made. The Tribunal referred to the requirement of r 6.5.2(k)(3) that the AER must have regard to the incentives that the return on debt may provide in relation to capital expenditure over the regulatory control period, including the timing of that expenditure. It discussed the incidents of the on-the-day approach to estimating the return on debt and how, theoretically, this approach could impact on investment decisions. It discussed the building block model and the significance of the NPV=0 principle to that model. With respect to transitioning from the on-the-day approach to the trailing average approach, it noted that although the transition used will have implications for the service provider’s profitability, it should have no material implications for the efficiency of future investment decisions.
273 SAPN did not develop this ground in its submissions. In substance, it treated its “primary” position—that the Tribunal’s “findings” in this part of its reasons did not form the basis of its ultimate conclusion on the return on debt topic—as its only position. This ground was pleaded as covering numerous grounds under the ADJR Act. On the basis of the submissions presented, we are not persuaded that any of these grounds are made out.
274 Grounds 15 and 16 were treated similarly. Ground 15 is that the Tribunal considered matter other than review related matter within the meaning of s 71R(6) of the NEL. Ground 16 is that the Tribunal did not afford SAPN the opportunity to make submissions in relation to this material. These grounds were not developed in SAPN’s submissions in chief.
275 As we have noted, in response the AER provided a number of references in its submissions to the material that was before it in making its Final Decision. This included the AEMC’s 2012 Rule Determination and the extrinsic material referred to in the 2012 Rule Determination which were referenced or discussed by the AER in its Final Decision. It included discussion of the NPV=0 principle in the context of choosing the correct transition approach.
276 SAPN’s reply submissions did not really engage with what material was or was not before the Tribunal. It took issue with some matters in the AER’s submissions before us which, it said, were not in the AER’s Final Decision, but there was no precise identification of these matters. It referred to some matters (once again, not precisely identified) as not having been addressed in the AER’s oral submissions before the Tribunal. It said that it had cautioned the Tribunal that some matters in the AER’s submissions were not to be found in its Final Decision. It gave an oblique reference in the transcript of the hearing before the Tribunal to illustrate this point. That reference is not informative of any error sought to be captured by Ground 15.
277 Our own reading of the AER’s Final Decision indicates that significant elements of it were referred to in the Tribunal’s discussion at [239]-[244]. We cannot tell from SAPN’s submissions the precise matters in the Tribunal’s reasons which it says were not review related matter or whether, if there was such matter, it had any significance for the findings that SAPN has challenged.
278 It is for SAPN to make good its grounds of review. In the absence of precise articulation, and a properly developed argument, we are not persuaded that Ground 15 is established. Therefore, Ground 15 fails, and Ground 16 with it.
279 As we have noted, in supplementary submissions SAPN relied on certain conclusions expressed in AER v Australian Competition Tribunal as supporting its construction of r 6.5.2(k)(4). One question which arose for consideration in that case was the characteristics of the benchmark efficient entity referred to in the allowed rate of return objective in r 6.5.2(c)—in particular, whether the benchmark efficient entity was a regulated or unregulated entity. On that question, the Full Court expressed its conclusion, at [537], as follows:
Thus, in our view, it is not appropriate to characterise the benchmark efficient entity as either a regulated or an unregulated entity. The allowed rate of return objective does not do so, and there is no need to do so. The allowed rate of return objective confers on the benchmark its particular, necessary and defining characteristics: it must be efficient and it must face “a similar degree of risk” as that which applies to the particular service provider in question in relation to the provision of standard control services. But the attribution of the relevant “efficiency” (ie, in respect of financing costs) is to be gauged by the disciplines of a workably competitive market (ie, an unregulated market).
280 Another question was whether the Tribunal had correctly applied r 6.5.2(k)(4) by adopting a single definition of a benchmark efficient entity and a single transition approach based on that entity in estimating the return on debt for all service providers. This question arose in the context of whether the AER had erred in adopting, as the appropriate transition arrangement, Option 2 over another option—Option 4—which was the immediate adoption of a backwards looking trailing average approach to estimate the return on debt, with no transition of either the risk-free component or the DRP component of debt.
281 The questions identified at [279]-[280] above are not questions that were before the Tribunal in the present review.
282 One of the consequences of the AER’s approach discussed in AER v Australian Competition Tribunal was that, when deciding that Option 2 should be implemented over Option 4, the AER had attributed to the service providers in question the fiction that each of them had hedging contracts that needed to be unwound. In fact, the relevant service providers had no such contracts. It will be immediately apparent that no such fiction was attributed to SAPN in the present case.
283 At [571], the Full Court said:
The requirement of r 6.5.2(h) is to estimate the return on debt for a particular service provider in a way that achieves the allowed rate of return objective. In this connection, the undoubted function of r 6.5.2(c) is to provide, as the electricity network respondents said, an “efficiency yardstick” for the particular costs under consideration. This was plainly the AEMC’s intention in the 2012 Rule Determination. While, for this purpose, the benchmark efficient entity is a construct, there is nothing in r 6.5.2(c) which requires one to be oblivious to the actual circumstances, including the debt management practices, of the particular service provider whose debt costs are being benchmarked. It is the efficiency of that service provider’s costs that is to be benchmarked according to what would be required by the disciplines of a workably competitive market. Considered against the yardstick of the efficient financing costs of the benchmark, the service provider’s debt management practices will either be efficient or inefficient. Where inefficiency exists, that inefficiency should not be reflected in the allowed rate of return for that service provider. Only efficient financing costs are to be allowed. But none of this means that, in applying r 6.5.2(c) to estimate the return on debt under r 6.5.2(h), and in considering whether impacts of the kind referred to in r 6.5.2(k)(4) exist that should be taken into account for that purpose, fictions should be imposed when the service provider has, for example, already implemented a debt structure that satisfies a required aspect of the intended benchmark efficiency.
284 The Full Court remarked that, when the AER came to consider r 6.5.2(k)(4) in relation to those service providers, there were no impacts in the form of hedging contracts that needed to be unwound. The Full Court said (at [572]):
At the commencement of the new regulatory period, the NSW service providers already had in place a debt structure that was both their particular response to the previous on-the-day approach to estimating the return on debt and, as it happened, a debt structure that was amenable to the “changed” methodology of the trailing average approach which the AER had decided to adopt. Significantly, in each case, that debt structure was not one complicated by the overlay of hedging contracts that needed to be unwound. The consequence of this was that, when the AER came to consider r 6.5.2(k)(4) in relation to those service providers, there were no impacts (in the form of hedging contracts that needed to be unwound) apposite to the benchmark efficient entity (or each benchmark efficient entity) for each such service provider that could be said to have arisen from the AER’s change in methodology from the on-the-day approach to the trailing average approach. Given that there were no such impacts, there was no need for the AER to take a step which, in the circumstances, r 6.5.2(k)(4) did not require for those service providers, namely a transition to the trailing average approach of estimating the return on debt by adopting a mechanism to unwind hedging contracts, such as that reflected in Option 2.
285 At [573], the Full Court expressed a similar conclusion with respect to another service provider (ActewAGL) which had no debt.
286 In its supplementary submissions, SAPN sought to rely on AER v Australian Competition Tribunal as supporting its characterisation (in its submissions in chief) of r 6.5.2(k)(4) as a transitional provision. In its submissions in chief, SAPN had exemplified the word “impacts” in r 6.5.2(k)(4) by reference to the possibility that there may be hedging contracts taken out in one regulatory control period that affect the cost of debt in that period and in a subsequent period, such that the AER is required to consider the impact of a change of methodology on the cost of debt across the two periods. This submission was made in the context of arguing that the words “across regulatory control periods” means (and only means) two conterminous periods—a submission we have rejected.
287 In its supplementary submissions, SAPN argued that, for the purposes of r 6.5.2(k)(4), the only relevant “impact” on SAPN from the change in methodology to estimate the return on debt is the unwinding of “commitments” it had entered into in relation to the risk-free component of debt when the on-the-day approach had been applied to estimating its return on debt. It submitted that this is the only point of distinction between its position and the position of the particular service providers in AER v Australian Competition Tribunal.
288 We do not think that it is in question that r 6.5.2(k)(4) envisages the possible need for transitioning arrangements when there is a change in the methodology used for estimating the return on debt. Moreover, it can be accepted that, in part, the reasoning in AER v Australian Competition Tribunal might support an argument that Option 3 might be a preferable alternative to Option 2. In this connection, SAPN argued in its supplementary submissions:
…a hybrid transition, whereby a transition is applied to the base rate and no transition is applied to the DRP, for an entity in the position of SAPN, has the benefit of matching the costs that would be incurred by an efficient business in the position of SAPN, both under existing facilities and under new facilities as they are taken out over the regulatory control period. The on-the-day approach does not. As it happens, the hybrid transition also provides an appropriate signal for efficient investment for a business in the position of SAPN because it provides the current rate for new debt, whereas the on-the-day approach does not because it provides a single rate for all debt (both existing and new) across the whole 5 year period, and indeed for 10 years (in decreasing weighting) under the AER’s transition.
289 Whatever the merits of this argument might be, the question whether Option 3 is a preferable alternative to Option 2 is not the question before us. The question before us is whether the Tribunal made the judicially reviewable errors identified in SAPN’s grounds of review.
290 Further, the issues before the Tribunal under review in the present proceeding are quite different to, and distinct from, the issues before the Tribunal that were under review in AER v Australian Competition Tribunal.
291 SAPN acknowledged this at the outset of the present case. It accepted that s 71O of the NEL precluded it from raising matters before the Tribunal it might otherwise have wished to raise. It went so far as to state that, under the limited merits review regime provided by the NEL, the Tribunal in the present case “had to proceed on an artificial basis” or “on potentially an incorrect construction of the NER”.
292 For the reasons we have given, we do not accept that the Tribunal proceeded on an artificial basis or on an incorrect construction of the NER on the matters raised in SAPN’s grounds of review to this Court. Further, we do not think that there is any necessary inconsistency between the determination of the particular questions of construction of r 6.5.2(k)(4) raised in AER v Australian Competition Tribunal and the particular questions of construction determined in the present case.
293 In responding to SAPN’s supplementary submissions, the AER pointed out:
In the case of the AER, having received the adverse decision from the Tribunal in the NSW/ACT matters, the AER reconsidered the proper approach to the applicable rules, including the economic considerations relevant to the applicable rules and the AER’s decision on the return on debt topic. In light of the relevant extrinsic material relating to NER clause 6.5.2, and based on the evidence before it (including economic expert reports), the AER advanced arguments to the Tribunal below concerning:
(a) the economic principles underpinning the building block framework prescribed by the NER generally, and why the building block framework prescribed by the NER is premised on an NPV=0 condition;
(b) the proper construction of the expression “efficient financing costs” within the allowed rate of return objective in NER clause 6.5.2(c);
(c) the economic reasons for using an “on the day” methodology in determining a return on debt (and the cost of capital more generally);
(d) the economic reasons for changing to a trailing average methodology for determining the return on debt instead of the “on the day” methodology; and
(e) the impacts of such a change on the service provider and consumers and how such impacts could be mitigated by a forward looking transition process.
294 We accept the AER’s submission that while the Full Court in AER v Australian Competition Tribunal considered r 6.5.2(k)(4) in the course of addressing the AER’s judicial review grounds in that case, its consideration does not impact on the grounds of review raised by SAPN in the present case in relation to r 6.5.2(k)(4).
295 We would add that the present proceeding has raised a number of issues that were not advanced by the parties in AER v Australian Competition Tribunal. The Full Court’s observation at [572] of AER v Australian Competition Tribunal that there were no impacts in the form of hedging contracts that needed to be unwound was made in the context of the facts of that case and the submissions that were advanced by the parties at that time. No wider consideration of the possible “impacts” of a change in methodology to estimate the return on debt was advanced or addressed. We do not regard AER v Australian Competition Tribunal as in any way confining the “impacts” to which the AER might have regard when applying r 6.5.2(k)(4).
Conclusion
296 We reject SAPN’s application for judicial review in relation to the return on debt.
FORECAST LABOUR COST ESCALATION (GROUNDS 17 – 21 INCLUSIVE)
The Tribunal’s Reasons
297 The Tribunal noted that a component of the AER’s decision concerning forecast operating expenditure (“forecast opex”) under rr 6.5.6 and 6.12.1(4) of the NER was an annual escalator to take account of likely changes in prices (input costs, output and productivity) during the regulatory control period. A similar approach was applied to forecast capital expenditure (“forecast capex”) under rr 6.5.7 and 6.12.1(3) of the NER. The Tribunal noted that the AER used a weighted average of forecast labour price growth and forecast non-labour price growth. The weighting applied by the AER in the Final Decision was 62% for labour and 38% for non-labour. The escalator used for forecasting non-labour price growth was CPI and there was no dispute between the parties about this forecast. The dispute between the AER and SAPN related to the forecast labour price growth.
298 The Tribunal noted that SAPN’s proposal was that the AER should adopt real labour cost escalators of:
(1) +1.66% per annum for 2015-16 and 2016-17, based on the nominal wage increase outcomes negotiated by SAPN under its EA (Enterprise Agreement or Enterprise Bargaining Agreement) for 2014-16; and
(2) +1.77% per annum for 2017-18 through 2019-2020, being the forecast based on the Frontier Economics Wage Price Index (“WPI”) for Electricity, Gas, Water and Waste Services (“EGWWS”) in South Australia.
299 In its revised regulatory proposal, SAPN contended that compliance with the EA was mandatory and it was a “regulatory obligation or requirement” as described within s 2D(b)(v) of the NEL.
300 The Tribunal noted that the AER did not accept SAPN’s proposal. It substituted real labour cost escalators of:
(1) +0.50% and +0.45% for 2015-16 and 2016-17, respectively; and
(2) values increasing from +1.00% to +1.45% for the years 2017-18 through 2019-20 based on the average of the EGWWS WPI forecasts provided by Deloitte Access Economics and BIS Schrapnel.
301 The only dispute between the parties before the Tribunal related to the first two years of the regulatory control period.
302 The Tribunal then summarised the contentions SAPN put to the AER and the AER’s response. SAPN contended that the EA is a “regulatory requirement or obligation” because it is an instrument made or issued under or for the purposes of the Fair Work Act 2009 (Cth) (“FW Act”) which in turn is an Act of a participating jurisdiction (namely, the Commonwealth); s 50 of the FW Act requires SAPN to comply with its EA; and the EA materially affects the provision by SAPN of the electricity network services that are the subject of the Final Decision. SAPN contended that it followed from these propositions that the costs incurred by it in complying with its EA were costs that met the expenditure objectives in rr 6.5.6(a)(2) (forecast opex) and 6.5.7(a)(2) (forecast capex) of the NER; SAPN contended that its proposed labour cost escalators reasonably reflected the prudent and efficient cost of achieving the expenditure objectives; and the AER was required to take into account the principle that SAPN should be provided with a reasonable opportunity to recover at least the efficient cost of complying with the regulatory obligation created by or under the FW Act.
303 The AER did not accept that the EA was a regulatory obligation or requirement. It did not accept that an EA was “made or issued by or under” the FW Act. The AER also concluded that an EA was not an instrument that “materially affects the provision of electricity network services” within s 2D of the NEL.
304 The Tribunal then set out the rules which identify the operating expenditure objectives and operating expenditure criteria. Rule 6.5.6(a) of the NER contains the operating expenditure objectives:
A building block proposal must include the total forecast operating expenditure for the relevant regulatory control period which the Distribution Network Service Provider considers is required in order to achieve each of the following (the operating expenditure objectives):
(1) meet or manage the expected demand for standard control services over that period;
(2) comply with all applicable regulatory obligations or requirements associated with the provision of standard control services;
(3) to the extent that there is no applicable regulatory obligation or requirement in relation to:
(i) the quality, reliability or security of supply of standard control services; or
(ii) the reliability or security of the distribution system through the supply of standard control services,
to the relevant extent:
(iii) maintain the quality, reliability and security of supply of standard control services; and
(iv) maintain the reliability and security of the distribution system through the supply of standard control services; and
(4) maintain the safety of the distribution system through the supply of standard control services.
305 Rule 6.5.6(c) of the NER contains the operating expenditure criteria:
The AER must accept the forecast of required operating expenditure of a Distribution Network Service Provider that is included in a building block proposal if the AER is satisfied that the total of the forecast operating expenditure for the regulatory control period reasonably reflects each of the following (the operating expenditure criteria):
(1) the efficient costs of achieving the operating expenditure objectives; and
(2) the costs that a prudent operator would require to achieve the operating expenditure objectives; and
(3) a realistic expectation of the demand forecast and cost inputs required to achieve the operating expenditure objectives.
There are relevantly identical provisions in relation to capex (rr 6.5.7(a) and 6.5.7(c)).
306 Rule 6.5.6(d) of the NER provides that if the AER is not satisfied in the manner identified in r 6.5.6(c), then it must not accept the forecast of required operating expenditure of a DNSP that is included in a building block proposal (see r 6.5.7(d) as to capex).
307 The Tribunal then identified the two submissions advanced by SAPN. First, SAPN submitted that the AER had wrongly concluded that SAPN’s EA is not a regulatory obligation or requirement. Secondly, SAPN submitted that even if the EA is not a regulatory obligation or requirement, it is nevertheless required to achieve the opex and capex objectives of maintaining the safety of the distribution system through the supply of standard control services (r 6.5.6(a)(4) as to opex and r 6.5.7(a)(4) as to capex). Furthermore, compliance with the EA satisfies the operating expenditure criteria and the capex expenditure criteria in that it reflects a realistic expectation of the demand forecast and cost inputs required to achieve the objectives.
308 As to the first submission, it is convenient at this point to note that the term “regulatory obligation or requirement” used in the NER, for example, r 6.5.6(a)(2), is defined in s 2D of the NEL as follows, relevantly:
(1) A regulatory obligation or requirement is—
(a) in relation to the provision of an electricity network service by a regulated network service provider—
(i) a distribution system safety duty or transmission system safety duty; or
(ii) a distribution reliability standard or transmission reliability standard; or
(iii) a distribution service standard or transmission service standard; or
(b) an obligation or requirement under—
(i) this Law or Rules; or
(ia) the National Energy Retail Law or the National Energy Retail Rules; or
(ii) an Act of a participating jurisdiction, or any instrument made or issued under or for the purposes of that Act, that levies or imposes a tax or other levy that is payable by a regulated network service provider; or
(iii) an Act of a participating jurisdiction, or any instrument made or issued under or for the purposes of that Act, that regulates the use of land in a participating jurisdiction by a regulated network service provider; or
(iv) an Act of a participating jurisdiction or any instrument made or issued under or for the purposes of that Act that relates to the protection of the environment; or
(v) an Act of a participating jurisdiction, or any instrument made or issued under or for the purposes of that Act (other than national electricity legislation or an Act of a participating jurisdiction or an Act or instrument referred to in subparagraphs (ii) to (iv)), that materially affects the provision, by a regulated network service provider, of electricity network services that are the subject of a distribution determination or transmission determination.
The directly relevant part of this definition is s 2D(1)(b)(v).
309 There was no dispute before the Tribunal that the Commonwealth was a participating jurisdiction and the Tribunal held that the EA was an “instrument made or issued under or for the purposes of the FW Act”. In connection with that conclusion, the Tribunal referred to the decision of the Full Court of this Court in Toyota Motor Corporation Australia Limited v Marmara [2014] FCAFC 84; 222 FCR 152 (“Toyota Motor Corporation v Marmara”). We will return to that decision.
310 The issue before the Tribunal was whether the FW Act or the EA satisfied the requirement that it “materially affects” the provision of electricity network services within s 2D(1)(b)(v) of the NEL. The Tribunal held that neither the Act nor the EA materially affects the provision of electricity network services. Its reasons for reaching this conclusion were as follows.
311 First, the Tribunal said that there must be a direct connection between the Act and instrument and the provision of electricity network services. The Tribunal said that the direct connection in a case such as the present is the labour needed to provide the electricity network services, not the mechanism, in this case the EA, that is used to deliver the labour. The mechanism chosen to employ the labour did not impact on the provision of electricity network services. The Tribunal said that it would be an odd circumstance where the definition is attracted merely by the vehicle chosen to deliver that labour (at [522]).
312 Secondly, the Tribunal said that the FW Act applied to all Australian companies and the EA model was open to companies across many industries, not just DNSPs. The Tribunal said that in that sense “there is no unique connection between the EA and the provision of electricity network services, any more than there is to any other industry” (at [523]).
313 Thirdly, the Tribunal said that the other examples of regulatory obligations or requirements in s 2D shed “some light” on the type of matters contemplated. The Tribunal noted that the other provisions dealt with instruments which imposed levies or taxes or applied to the use of land or the protection of the environment. This may be contrasted (said the Tribunal) with an EA which is within the choice of SAPN management. The Tribunal said that the decision to pursue an EA was not “imposed” on SAPN by s 2D of the NEL in the same way that taxes and levies, for example, are imposed on it under s 2D (at [525]).
314 The Tribunal also referred to the national electricity objective in s 7 of the NEL. It is convenient at this point to set out that objective and one of the revenue and pricing principles in s 7A(2) of the NEL:
7 National electricity objective
The objective of this Law is to promote efficient investment in, and efficient operation and use of, electricity services for the long term interests of consumers of electricity with respect to—
(a) price, quality, safety, reliability and security of supply of electricity; and
(b) the reliability, safety and security of the national electricity system.
7A Revenue and pricing principles
…
(2) A regulated network service provider should be provided with a reasonable opportunity to recover at least the efficient costs the operator incurs in–
(a) providing direct control network services; and
(b) complying with a regulatory obligation or requirement or making a regulatory payment.
315 The Tribunal noted (at [527]) that the “overarching” objective was supported by the opex criteria (r 6.5.6(c)) which directed attention to whether opex costs were prudent and efficient. The Tribunal made the point that there is “capacity” for an EA to include terms and corresponding costs that were not conducive to meeting the national electricity objective. The Tribunal said that an EA is not necessarily benchmarked to provide the necessary comfort that costs under it are efficient.
316 There is an issue between the parties as to the way in which the Tribunal relied on the national electricity objective and the opex criteria, which we will address later in these reasons. However, it is convenient to identify the issue at this point and to set out the relevant passage in the Tribunal’s reasons. The issue is whether the Tribunal was examining the EA against efficiency criteria, having accepted that the EA was a regulatory obligation or criteria, or was calling in aid the national electricity objective in its interpretation of the phrase, “regulatory obligation or requirement”. The relevant passage in the Tribunal’s reasons is as follows (at [527]):
The NEO indicates that the overarching objective is to ensure the efficient investment in and operation of electricity services for the long-term interests of end users. The NEO is supported, among other things, by the opex criteria which directs attention to whether opex costs are prudent and efficient. The contents of an EA (at least at the point of its establishment) is something which is negotiated by SAPN management and the employees covered by the EA. Despite the best efforts of a DNSP (like SAPN), there is the capacity for an EA to include terms (and corresponding costs) that are not conducive to meeting the NEO, for example because a DNSP needs to accede to employee demands. Ultimately an EA is the product of negotiation and there is considerable discretion on SAPN on the costs associated with complying with the terms of an EA. It is not necessarily benchmarked to provide the necessary comfort that EA costs are efficient. The Tribunal does not accept SAPN’s submission that the arms-length negotiation of its EA is a substitute for benchmarking or other appropriate means for testing its costs.
317 The Tribunal then turned to examine SAPN’s alternative argument. The argument relies on r 6.5.6(a)(4) (r 6.5.7(a)(4) for capex) and is that, although not a regulatory obligation or requirement, the EA is necessary or required to maintain the safety of the distribution system through the supply of standard control services.
318 SAPN relied on the Tribunal’s previous decision in Ausgrid to argue that the Tribunal in this matter should conclude that the labour cost arrived at in accordance with an EA reasonably reflected the opex and capex criteria previously mentioned. The Tribunal rejected that argument.
319 The Tribunal rejected SAPN’s argument that the EA was necessary to maintain the safety of the distribution system and fell within the opex and capex objectives for two reasons. First, it said that the NER required SAPN to demonstrate that the EA was necessary to “maintain the safety of the distribution system through the supply of standard control services”. The Tribunal said that as it had previously explained in the context of its consideration of regulatory obligation or requirement, “there must be a direct connection between the EA and the delivery of standard control services”. The Tribunal considered that the connection was the labour employed to deliver the services, not the mechanism chosen to provide that labour (at [545]). Secondly, the Tribunal noted that the capex and opex objectives applied to the total estimates for capex and opex. It noted that the labour cost escalator was one such factor. The Tribunal said that it could not be assumed that any error with respect to the labour cost escalator would completely undermine the capex and opex objectives applying to the safe delivery of standard control services (at [546]).
320 The Tribunal’s conclusions to this point were sufficient to dispose of SAPN’s challenge to the AER’s decision with respect to the forecast labour cost escalation. Nevertheless, the Tribunal went on to consider (briefly) whether the EA satisfied the opex criteria and the capex criteria. The Tribunal said that the mere negotiation of an EA, albeit in good faith and at arm’s length, is not itself an adequate foundation for discharging the opex and capex criteria. An EA may result from the exercise of discretion by management as to its terms even if they result from employee demands. The Tribunal noted that it would be important, for example, to demonstrate productivity and other improvements, consistent with wage conditions in the industry. The Tribunal’s conclusion was as follows (at [551]):
Finally SAPN has not mounted a compelling challenge in face of the considerable sectoral wage growth data and wage growth trends relied on by the AER.
321 The Tribunal concluded that the AER had not made an error of fact (or facts) that was material to the making of the decision and that the exercise of the AER’s discretion was not incorrect or the decision unreasonable, having regard to all the circumstances (at [552]).
SAPN’s Grounds of Judicial Review
322 SAPN relies on six grounds of judicial review in relation to the Tribunal’s decision concerning forecast labour cost escalation. All of the grounds relied on ss 5(1)(c) and 5(1)(f) of the ADJR Act. Those subsections provide a ground of review where the person who purported to make the decision did not have jurisdiction to make the decision (s 5(1)(c)) or where the decision involved an error of law, whether or not the error appears on the record of the decision (s 5(1)(f)). One of the grounds in SAPN’s application (Ground 19A), also relied on s 5(1)(j) to the effect that the decision was otherwise contrary to law.
323 In Ground 17, SAPN alleges that the Tribunal misconstrued s 2D(1)(b)(v) of the NEL and misdirected itself in law. The Tribunal referred to a “direct connection” and a “unique connection” when, in fact, the statutory test was whether the Act or instrument “materially affects” the provision of electricity network services.
324 In Ground 18, SAPN alleges that Tribunal misconstrued r 6.5.6(c) of the NER and ss 7 and 7A(2) of the NEL in that it considered the following matters to be relevant:
(1) there is capacity for an EA to include terms (and corresponding costs) that are not conducive to meeting the NEO; and
(2) an EA is not necessarily benchmarked to provide the necessary comfort that EA costs are efficient.
SAPN submitted that the Tribunal wrongly equated the reference in r 6.5.6(c) to the efficient costs of achieving the operating expenditure objectives with the costs of achieving efficient operating expenditure objectives. SAPN submitted that properly construed, the NEL and NER permit revenue in relation to costs of complying with regulatory obligations and requirements, even if those regulatory obligations and requirements are not themselves efficient. The other cases referred to in s 2D(1)(b) of the NEL, namely those involving taxes and levies, land use restrictions and environmental protection obligations, need not be efficient. Put another way, under r 6.5.6(c), it is the efficient costs of achieving the operating expenditure objectives which is relevant, not the costs of achieving the efficient operating expenditure objectives.
325 In Ground 19, SAPN alleges that in the context of its consideration of r 6.5.6(a)(4) of the NER, the Tribunal misunderstood the legal effect of its own decision in Ausgrid.
326 In Ground 19A, SAPN directs its attention to the Tribunal’s conclusion that it could not be assumed that any error with respect to the labour cost escalator would completely undermine the capex and opex objectives applying to the safe delivery of standard control services. SAPN submitted that the Tribunal asked itself the wrong question. It submitted that the theoretical possibility that an error with respect to the labour cost escalator may not completely undermine the capex and opex objectives applying to the safe delivery of standard control services did not imply that labour cost escalation based on the EA is not within the opex and capex objectives.
327 In Ground 20, SAPN alleges that the Tribunal erred in holding that in order to establish that the EA is necessary to “maintain the safety of the distribution system through the supply of standard control services, there must be a direct connection between the EA and the delivery of standard control services”.
328 Finally, in Ground 21, SAPN contends that the Tribunal made a similar error to that raised in Ground 18 in that SAPN alleged that r 6.5.6(c) of the NER (and, in the case of capex, r 6.5.7(c) of the NER) allowed the efficient, prudent and realistic costs “required to achieve the capital expenditure objectives” and did not require that the capital expenditure objectives themselves satisfy “prudency and efficiency tests”.
329 It will assist to organise the grounds around the matters SAPN was required to satisfy. It seems to us that Grounds 17 and 18 relate to the issue of whether the EA is a regulatory obligation or requirement. Ground 19 relates to the Tribunal’s interpretation and use of the Tribunal’s decision in Ausgrid. Grounds 19A and 20 relate to the issue of whether the EA is required to maintain the safety of the distribution system argument. Ground 21 relates to the efficiency, prudency and realism tests in rr 6.5.6(c) and 6.5.7(c) of the NER, that is to say, the opex criteria and the capex criteria.
The Submissions of the Parties
330 It is convenient to identify the key submissions of the parties.
SAPN’s Submissions
331 SAPN submitted that the dispute before the Tribunal turned on three issues. The first issue was whether the EA was a regulatory “obligation or requirement” within the meaning of s 2D(1)(b)(v) of the NEL so as to fall within the opex and capex objectives in rr 6.5.6(a)(2) and 6.5.7(a)(2) of the NER. The second issue (and put in the alternative) was whether the EA was “necessary to maintain the safety of the distribution system” so as to fall within the opex and capex objectives in rr 6.5.6(a)(4) and 6.5.7(a)(4) of the NER. The third issue was whether the escalators based on the EA met the opex and capex criteria in rr 6.5.6(c) and 6.5.7(c) of the NER.
332 SAPN submitted that the Tribunal’s first error was to require a “direct connection” or a “unique connection” between the EA or FW Act on the one hand, and the provision of electricity network services on the other. SAPN pointed out that these terms do not appear in the statutory text which refers to “materially affects” the provision of electricity network services. SAPN submitted that the Tribunal committed this error in relation to its construction of s 2D(1)(b)(v) of the NEL (Ground 17). This error flowed through or was repeated when the Tribunal considered the alternative ground (i.e., rr 6.5.6(a)(4) and 6.5.7(a)4)) that the EA was required to maintain the safety of the distribution system (Ground 20).
333 Secondly, SAPN submitted that the Tribunal misconstrued the references in rr 6.5.6(c) and 6.5.7(c) to the efficient costs of achieving the operating expenditure objectives as if they were references to the “costs of achieving the efficient … expenditure objectives”. SAPN submitted that properly construed, the NER permits recovery of the efficient costs of complying with the specified opex and capex objectives, even if those objectives include compliance with obligations or requirements that are not themselves efficient. SAPN submitted that the Tribunal committed a reviewable error in not allowing recovery of the costs of achieving the objectives associated with the EA on the basis that compliance with the EA was not efficient (Grounds 18 and 21).
334 Thirdly, SAPN submitted that the Tribunal committed a legal error by acting on a wrong understanding of its own previous decision in Ausgrid (Ground 19).
335 Finally, SAPN submitted that the Tribunal acted on a wrong construction of rr 6.5.6(a)(4), 6.5.6(c), 6.5.7(a)(4) and 6.5.7(c) of the NER in deciding that a labour cost escalator based on the EA was outside the opex and capex objectives because “it cannot be assumed” that an error with respect to the labour cost escalator would “completely undermine the capex and opex objectives” (Ground 19A).
336 With respect to the first alleged error, SAPN submitted that by having recourse to the concepts of a “direct” or “unique” connection, the Tribunal has allowed “paraphrases of the statutory language” to intrude upon the constructional task. SAPN submitted that the words “materially affects” in their natural and ordinary meaning have a wider connotation than “direct” or “unique” connection. SAPN submitted that what is “material” may vary according to context, but the range of the word’s ordinary meanings speak against attributing to it a meaning as narrow as “directly” or “uniquely”. SAPN submitted that when regard was had to the context, particularly s 7A(2) of the NEL, it is clear that a wide meaning was intended. Section 7A(2) provides that a regulated network service provider should be provided with a reasonable opportunity to recover at least the efficient costs it incurs in both providing direct control network services and complying with a regulatory obligation or requirement, or making a regulatory payment. SAPN submitted that if a regulatory obligation or requirement was restricted to a direct connection, then the distinction drawn in s 7A(2)(a) and (b) would be inutile.
337 SAPN submitted that the Tribunal erroneously applied the ejusdem generis maxim to its construction of s 2D(1)(b)(v) of the NEL. There is no genus established by s 2D(1)(b)(ii)-(iv) and s 2D(1)(b)(v) is not, in any event, expressed in general terms. Sections 2D(b)(ii)-(iv) inclusive identify an obligation or requirement by reference to its subject matter, whereas s 2D(b)(v) refers to the effect of the obligation or requirement. In other words, in the case of (v), subject matter is irrelevant. SAPN submitted that there is no plausible or convincing distinction between obligations or requirements that are imposed on a service provider and obligations or requirements that arise as a result of the decisions of management. SAPN submitted that the phrase “materially affects” is wide enough to encompass any Act or instrument which has a meaningful or non-trivial effect on the provision of electricity network services and that the EA answers this statutory description. The EA governs the terms and conditions of employment of 95% of SAPN’s employees and contractors subject to parity terms under cl 7.6. The EA places constraints upon the availability of flexibility within work under certain conditions, such as power outages or emergency response calls. Clause 7.15 of the EA sets out certain requirements arising from the need to meet customer service standards as set out by the regulator, and the need for employees to be available to restore power in a timely manner. The EA makes provision for the conditions under which workers can raise disputes under the EA. SAPN submitted that whether wide scale industrial action can occur is a function of the EA read with the FW Act. Such events are apt materially to affect the provision of network control services in a material way. SAPN submitted that the distinction drawn by the Tribunal between the provision of labour and the terms upon which the labour is provided is a false one which is exposed once the error of requiring a direct connection is exposed.
338 As to the second error, SAPN submitted that the Tribunal added an unnecessary requirement under rr 6.5.6(c) and 6.5.7(c) of the NER. There is no requirement that the opex or capex objective itself be efficient or prudent. As we understand the submission, it is that once it is determined that an EA is a regulatory obligation or requirement, there is no further requirement that the EA itself reflect efficient costs. The same point is made insofar as the Tribunal adopted a similar approach in relation to maintaining the safety of the distribution system. SAPN submitted as follows:
It was not open to the Tribunal to determine that the EA is not a regulatory obligation or requirement because it is or may be inefficient. It was also not open to the Tribunal to determine that the costs of compliance with the EA were not efficient (or prudent or realistic) because the terms of the EA were not efficient. If the EA is a regulatory obligation or requirement, then the correct and only question for the Tribunal was whether the forecast expenditure reflects the efficient, prudent and realistic costs of complying with the EA.
339 SAPN submitted that the Tribunal’s erroneous understanding of the decision in Ausgrid amounted to a reviewable error of law or manifested an erroneous construction of rr 6.5.6(a)(4) and 6.5.7(a)(4). SAPN submitted that the Ausgrid decision was clearly to the effect that the efficient costs of complying with an EA were recoverable costs of complying with an opex objective. Furthermore, the Tribunal erred in concluding that the decision in Ausgrid had something to say on whether an EA was a regulatory obligation or requirement. SAPN submitted that the Tribunal’s misunderstanding of the decision in Ausgrid affected its disposition of the review ground before it and amounted to a reviewable legal error or manifested a wrong construction of the NER.
340 Finally, SAPN submitted that the Tribunal erred in concluding that the possibility that an error in the labour cost escalation may not completely undermine the safety of the distribution system was sufficient to take the EA outside the terms of the objective.
The AER’s Submissions
341 The AER’s submissions were as follows. First, the AER submitted that the only obligation or requirement in the EA relied upon by SAPN in connection with the AER’s estimate of forecast opex and capex was the annual wage escalation clause in the EA. It would have been sufficient for the Tribunal to conclude that the annual wage increase obligation under the 2014-16 EA was not an obligation or requirement that “materially affected the provision of … electricity network services”. The AER submitted that that conclusion is “legally inevitable and consistent with the Tribunal’s reasons”.
342 The AER submitted that the definition of regulatory obligation or requirement in s 2D(1)(b)(v) directed attention to specific obligations or requirements. The words “material” and “affect” are ordinary English words and “material” means in a significant way or considerably, and “affect” means make a difference to.
343 The AER submitted that a wage increase under an EA has no material effect on the provision of electricity network services. It is not necessary for a DNSP to engage labour pursuant to an EA made under the FW Act, and, further, a wage increase in a particular year may be higher or lower without out any necessary effect, let alone a material effect, on the provision of electricity network services.
344 The AER pointed out that SAPN directed only one paragraph in its written submissions to the question of whether the EA had a material effect on the provision of electricity network services. We have summarised the thrust of that one paragraph above (at [337]). The AER submitted that SAPN’s contentions are revealing. It points to the fact that SAPN does not contend that the annual wage escalation provision within the EA materially effects the provision of network services. It submitted that even the provisions relied upon by SAPN are marginal and unlikely to have a material effect on the provision of network services and there is no evidence that those provisions had such an effect.
345 The AER submitted that the Tribunal’s reference to a direct connection between the Act and instrument and the provision of electricity network services was merely another way of conveying the need for a material effect. The AER submitted that the difficulty facing the Tribunal arose as a result of SAPN’s failure to articulate the manner in which the provisions of the EA affected the provision of network services. The AER submitted that SAPN failed to address the issue of how the provision of network services would differ if labour were to be engaged under different legal arrangements or on different terms. It is not necessary for a DNSP to engage labour pursuant to the FW Act or an EA and labour costs may be higher or lower and other employment terms may differ without any necessary effect, let alone a material effect, on the provision of electricity network services.
346 The AER made two further points. First, it submitted that the Tribunal’s reference to the other limbs of the definition in s 2D(1)(b) (i.e., (ii)-(iv) inclusive) did not involve error. Rather, the Tribunal properly considered subparagraph (v) in its statutory context. Secondly, the AER submitted that the Tribunal’s reference in [527] of its reasons to the national electricity objective was not an error. It was open to the Tribunal to construe the expression “regulatory obligation or requirement” by reference to whether a particular construction would or would not promote the national electricity objective.
347 The AER submitted that SAPN’s alternative argument to the effect that the annual wage increases in the 2014-16 EA were necessary to maintain the safety of the distribution system within the meaning of r 6.5.6(a)(4) of the NER should be rejected. SAPN had not established, as a matter of fact, that the annual wage increases in the 2014-16 EA were necessary to maintain the safety of the distribution system. Before the Tribunal, SAPN submitted that the Tribunal’s previous decision in Ausgrid had decided that wage increases in EAs would always be required to maintain the safety of the distribution system consistent with the opex criteria, but SAPN had offered no evidence in support of that contention. The AER pointed out that that argument is not advanced in this Court. Instead, SAPN’s submissions criticise two aspects of the Tribunal’s discussion of the Ausgrid decision. The AER submitted that such criticisms are irrelevant if SAPN no longer contends that Ausgrid mandated the conclusion that the AER was required to base its labour escalation on the wage increase rates in the 2014-16 EA in the first two years of the regulatory control period to ensure that opex objective (4) was satisfied.
348 AER submitted that at [547] and following, the Tribunal addressed a question which did not arise given the Tribunal’s earlier conclusions. That question was whether, assuming the EA was a regulatory obligation within r 6.5.6(a)(2) or was otherwise necessary to maintain the safety of the distribution system within r 6.5.6(a)(4), it was nevertheless necessary to consider whether the wage increases under the EA satisfied the opex criteria? The Tribunal answered that question in the affirmative. The AER submitted that if the Court dismisses the earlier grounds of review, then it is unnecessary to consider this aspect of the Tribunal’s reasons.
349 The AER makes the following submissions on the assumption that, contrary to its primary submissions, the Court finds that the 2014-16 EA was a regulatory obligation within r 6.5.6(a)(2) or was otherwise necessary to maintain the safety of the distribution system within r 6.5.6(a)(4).
350 The AER accepts that if the wage increase provisions in the 2014-16 EA were a “regulatory obligation” within r 6.5.6(a)(2), then there is little work for the opex criteria to perform in relation to that specific cost component. The AER accepts that this follows from, amongst other things, the fact that the opex criteria require an assessment of the efficient costs of achieving the opex objectives which include compliance with regulatory obligations. As the AER put it:
If the wage increase under the EA was a regulatory obligation, it must be complied with and the efficient costs of complying with it are simply the costs of complying with it. The costs cannot be avoided.
351 The AER submitted that, to the extent that the Tribunal held otherwise, it does not seek to support that aspect of the Tribunal’s reasoning.
352 However, the AER went on to submit that the application of the opex criteria in the SAPN decision involves many more considerations than a single consideration. It submitted that even if the 2014-16 EA was a regulatory obligation within r 6.5.6(a)(2), that would not have been a sufficient basis to set aside the AER’s decision with respect to forecast opex. The AER submitted that the relevant constituent decision of the AER was to estimate the total of the forecast opex required for the regulatory control period (see r 6.12.1(4)). The AER submitted that any relevant error must relate to the total forecast. In some circumstances, an error in one component of the forecast might result in error in the total. That will not always be the case and, the AER submitted, is not the case here. Criticism of the labour cost escalator in two of the five years of the control year does not demonstrate error in the total forecast. The AER identified the type of matters which are relevant to any forecast of total opex.
353 The AER also submitted that the 2014-16 EA did not prevent SAPN from choosing to reduce the proportion of its workforce employed under EA conditions. The AER submitted that the “contractor parity” clause to which SAPN referred relates only to supplementary labour engaged to cover employees on leave, temporary vacancies and peak workloads in certain areas. It expressly does not apply to contractors or subcontractors who are engaged on defined projects or contracts, or engaged on contracts for services. Furthermore, the 2014-16 EA did not prohibit SAPN from making redundancies. The AER submitted that there was no “regulatory obligation or requirement” that stood in the way of SAPN seeking to restructure its labour arrangements in ways that would promote cost-efficiency and productivity over time. The AER also submitted that its labour cost escalator in its forecast of total opex was applied to a broader category of costs than simply internal labour. The AER concluded its submissions by submitting that even if the wage increase clause in the EA was a regulatory obligation within r 6.5.6(a)(2) or was otherwise necessary to maintain the safety of the distribution system within r 6.5.6(a)(4), it did not follow that the AER’s constituent decision estimating the total of forecast opex for the regulatory control period involved error.
The State Minister’s Submissions
354 As we have said, the State Minister was granted leave to intervene and he made submissions in relation to Grounds 17, 18 and 21. Those were the matters in respect of which he intervened before the Tribunal.
355 The State Minister submitted that regulatory obligations or requirements may be of the following kinds:
(1) A primary obligation that imposes a specific direction such that there is only one means of compliance with relatively fixed and determined costs;
(2) A primary obligation that may be complied with in a range of different ways at the discretion of the providers; and
(3) A subsidiary obligation that a provider chooses to assume voluntarily in order to fulfil an obligation of the second kind referred to above.
356 The State Minister submitted that the selection of the method by which a provider complied with a primary obligation and the consequential assumption of subsidiary obligations may be more or less efficient. He submitted that where a choice exists, the selection of one method over another may have an impact, and potentially a significant one, on the costs incurred by a provider. The State Minister submitted that any obligation which was voluntarily assumed by a provider is not a regulatory obligation or requirement within s 2D of the NEL. The State Minister submitted that, properly construed within its statutory context, s 2D limits the concept of a regulatory obligation or requirement to those obligations and requirements that are imposed on providers. The State Minister submitted that the proper construction of the phrase “regulatory obligation or requirement” focused upon the source of the obligation.
357 The State Minister referred to the Minister’s second reading speech in support of the National Electricity (South Australia) (National Energy Law – Miscellaneous Amendments) Bill 2007 in which it the following appears:
The Bill also defines the meaning of a regulatory obligation or instrument and the meaning of a regulatory payment. A regulatory obligation or requirement is defined to cover obligations or a requirement imposed on network service providers through participating jurisdictional instruments and also recognises obligations and requirements imposed by the National Electricity Law and Rules.
358 The State Minister submitted that the construction he advances is supported by the context in which s 2D(1)(b)(v) appears and he referred to the other cases which are all cases where there is something imposed on the network service providers. He also referred to the national electricity objective and the first of the revenue and pricing principles in s 7(2)(a). The State Minister submitted that in the case of an obligation of the first kind, there will rarely be a gap between the actual and efficient costs of a provider arising from compliance with obligations of this kind. In the case of an obligation of the second and third kinds, it is consistent with the national electricity objective and the revenue and pricing principles that there be an assessment of what constitutes efficient costs and that will involve a consideration of whether the methods selected by the provider are efficient in all the circumstances. The State Minister submitted that if the voluntary assumption of subsidiary obligations amounted to a regulatory obligation or requirement, then a provider would be entitled to an opportunity to recover those efficient costs even in circumstances where the assumption of those subsidiary obligations may have been manifestly inefficient. The operation of the revenue and pricing principles in this manner would plainly be inconsistent with the efficiency obligation mandated by the national electricity objective. The State Minister made the point that to construe the phrase “regulatory obligation or requirement” in the manner he advanced, would not deprive a provider of the costs of compliance with subsidiary obligations. Rather, it would, consistently with the national electricity objective, subject the assumption of those obligations to an efficiency assessment.
359 The State Minister also made submissions as to the meaning of a “regulatory obligation or requirement” in the NER. He submitted that the phrase in the NER has the meaning set out in the NEL. He submitted that in the case of a primary obligation, which imposes a specific direction, the cost of compliance is relatively fixed and determined, then the AER will commonly be readily satisfied that the forecast expenditure reflects efficient, prudent and realistic costs. Where the primary obligation is of the second kind, then the AER will need to determine whether the option chosen by the provider reflects efficient, prudent and realistic costs. The State Minister submitted that where obligations of the third kind are confused with obligations of the first kind, “then fixed costs associated with the compliance with an inefficient, imprudent or unrealistic obligation assumed by a provider may be passed through with inadequate scrutiny in a manner that is inconsistent with the NEO”.
360 The State Minister submitted that in this case the EA was not a regulatory obligation or requirement. In those circumstances, the AER retained an important evaluative task in determining the path selected by SAPN, that is, whether entry into this particular enterprise agreement, was efficient, prudent and realistic in all the circumstances.
361 In the State Minister’s submission, the EA is not a regulatory obligation or requirement and at best, it falls within r 6.5.6(a)(1), that is to say, expenditure required to meet or manage the expected demand for standard control services, and is to be assessed under r 6.5.6(c).
362 As we understand it, the State Minister also submits that if a voluntarily assumed obligation can be a regulatory obligation or requirement, then it is subject to the opex criteria.
SAPN’s Submissions in Response to the AER’s Submissions
363 In response to the AER’s submissions, SAPN submitted that the Tribunal’s use of notions of direct and unique connections placed a distorting gloss on the statutory text and led the Tribunal into error. SAPN submitted that the AER’s submissions appear to accept this because it proposes a different construction of the words “materially affects”. The AER’s submission that the different constructions are merely matters of expression not substance is not correct.
364 SAPN submitted that the AER effectively asks this Court to examine the merits and the Court should not do so. This Court should only decline to remit the matter to the Tribunal if it is satisfied that the error has not denied SAPN of even “the possibility of a successful outcome” (House v Defence Force Retirement and Death Benefits Authority [2011] FCAFC 72; 193 FCR 112 at [31] per Greenwood J with whom Logan J relevantly agreed). That was not established in this case.
365 SAPN submitted that the AER accepts in its submissions that the Tribunal erred in concluding that the EA must satisfy the prudency and efficiency tests under the opex criteria. SAPN submitted that the AER’s reference to the need to look at the total forecast opex does not appear to be an argument that the erroneous failure to account for the EA wage increases would be offset by variation in some other component of the total forecast. Rather, the AER’s submission appears to be that SAPN could have conducted its affairs otherwise than in accordance with the wage increases stipulated in the EA, either by engaging labour otherwise than under the EA, or by resort to forced redundancies. SAPN submitted that if the EA is a regulatory obligation or requirement within the meaning of the NEL, then the AER was obliged to include in its building block proposal, a total forecast of opex “required in order to achieve” compliance with r 6.5.6(a) and it is no answer to say that SAPN need not have complied with it.
366 SAPN submitted that the Tribunal made the same error (i.e., efficiency not established) in [527] (set out above at [316]) as it did in [550] (summarised above at [320]) and that the AER concedes as much. SAPN submitted that there is no evidence in the present case that the negotiated wage increases were uncompetitive.
367 Finally, SAPN submitted that while the NEL ought to be construed purposively, it ought not to be construed as though it pursues the national electricity objective “at all costs”. In this context, it referred to the well-known statement by Gleeson CJ in Carr v Western Australia [2007] HCA 47; 232 CLR 138 at [5] that legislation rarely pursues a single purpose “at all costs”. SAPN pointed to the fact that some regulatory obligations and requirements may involve inefficient costs which are borne ultimately by consumers.
SAPN’s Submissions in Response to the State Minister’s Submissions
368 SAPN submitted that the State Minister’s submissions differ from those made by the AER and from the reasons of the Tribunal. SAPN submitted that both the AER and the Tribunal accept that the EA is a regulatory obligation or requirement.
369 SAPN submitted that the State Minister’s distinction between obligations or requirements imposed on providers, and obligations or requirements voluntarily assumed is unsatisfactory because the distinction is conceptually unstable. It misconceives the notion of legal obligation and oversimplifies the notion of voluntariness. SAPN submitted that an enforceable legal duty, that is to say an obligation, may be voluntarily assumed (Australian Woollen Mills Pty Ltd v Commonwealth [1954] HCA 20; 92 CLR 424 at 457). Furthermore, SAPN submitted that volition is not a binary notion, but rather it is a scalar concept that involves matters of degree. SAPN gave an example in the case of income tax: income tax is imposed only because of an anterior voluntary choice by the taxpayer to earn income.
370 SAPN submitted that the State Minister’s distinction finds no support in the text or context of the NEL. First, SAPN submitted that it is wrong to suggest that the proper construction of the phrase “regulatory obligation or requirement” focuses upon the source of the obligation. Secondly, the use of the word “imposed” in the Minister’s second reading speech is of no consequence because the speech did not use the word in contradistinction to voluntarily assumed obligations as the State Minister now seeks to use it. Furthermore, the State Minister seeks to rely on the speech for an impermissible purpose. A second reading speech may be used for identifying purpose or mischief, but it is virtually never useful for a statement of intention as to the meaning of words. Thirdly, the regulatory obligations referred to in the other paragraphs of s 2D do not assist. Fourthly, SAPN’s construction coheres with the national electricity objective. Finally, SAPN repeated the point that although the NEL ought to be construed purposively, it ought not to be construed as though it pursues the national electricity objective “at all costs”.
371 SAPN submitted that if the State Minister’s construction is accepted, then the decision would need to be set aside and the matter referred back to the Tribunal for consideration according to law. SAPN submitted that it could not be said that the Tribunal would inevitably have reached the same conclusion applying the construction advanced by the State Minister. SAPN submitted that it could not be said that the Tribunal might not have found error in the AER’s determination, had it proceeded on the basis that the AER was required to ask itself whether the EA, in all the circumstances, reflected efficient, prudent and realistic costs.
Analysis
372 Before examining the grounds in the application for judicial review, it is important to recall some general matters about the Tribunal and the proper approach to its reasons. The Court dealt with these matters in AER v Australian Competition Tribunal where the Court said (at [274]-[277]):
The Tribunal must keep its determinations and the statement of the reasons for the determination in the register established under regulation 9C of the Competition and Consumer Regulations 2010 (Cth). Under the NEL where it decides to vary a reviewable regulatory decision or to set it aside and remit it back to the AER, the Tribunal must “specify” in its determination certain matters. In the case of an order of the latter type, it must specify the manner in which it has taken into account the inter-relationship between the constituent components of the reviewable regulatory decision and how they relate to the matters raised as a ground of review which is a matter it is required to consider (s 71P(2b) and (2c)). There are no other sections which direct the Tribunal to include matters in its determination or reasons.
The procedure of the Tribunal is within its own discretion. It is not bound by the rules of evidence and the proceedings before the Tribunal shall be conducted with as little formality and technicality, and with as much expedition, as the requirements of the Act and a proper consideration of the matter before the Tribunal permit (Competition and Consumer Act, s 103(1)).
In addition to that requirement for expedition, s 71Q of the NEL provides tight target times (with a power to extend) for the Tribunal to make a determination. This is in a context where from time to time the Tribunal deals with complex matters. …
The Tribunal is an administrative body and it is well-settled that the reasons of such a body “are not to be construed minutely and finely with an eye keenly attuned to the perception of error”: Collector of Customs v Pozzolanic Enterprises Pty Ltd [1993] FCA 456; 43 FCR 280 at 287; Minister for Immigration and Ethnic Affairs v Wu Shan Liang [1996] HCA 6; 185 CLR 259 at 272.
We recognise, of course, that that case involved many more issues than this case.
373 It is convenient to deal with Grounds 17 and 18 together because we think both grounds relate to the Tribunal’s consideration of whether the EA was a regulatory obligation or requirement. That is not SAPN’s contention as we understand it, but we reject that contention for reasons we will give.
374 By way of background, it is worth recalling that there was no dispute that the Commonwealth is a participating jurisdiction, that the FW Act is an Act of the Commonwealth and that the EA is an instrument made or issued under the FW Act. The last proposition follows from the observations of the Full Court of this Court in Toyota Motor Corporation v Marmara at [89]:
… However, although the FW Act provides that an enterprise agreement is “made” otherwise than by the Commission, the Act does more than merely impose conditions upon, and give additional legal effect to, an agreement made between private parties. The effect of the legislation is to empower the employer and the relevant majority of its employees to specify terms which will apply to the employment of all employees in the area of work concerned. The legal efficacy of those terms will arise under statute, not contract, and, as mentioned above, will be felt also by those who did not agree to them. Someone, such as an employee subsequently taken on, who had nothing to do with the choice of the terms or the making of the agreement, will be exposed to penal consequences under s 50 if he or she should happen to contravene one of the terms. When viewed in this way, it is not difficult to share in the perception that an enterprise agreement approved under the FW Act has a legislative character.
375 The statutory test is whether the Act or instrument “materially affects” the provision of electricity network services.
376 “Materially” is relevantly defined in the Macquarie Dictionary (6th ed, MacMillan, 2013) as meaning:
1. to an important degree, considerably.
…
“Affect” is relevantly defined in the same dictionary as meaning:
1. to act on; produce an effect or a change in: ….
377 SAPN’s submission (supported in this respect by the State Minister) was not that a direct connection was not sufficient. It was that an indirect connection may also be sufficient for the purposes of concluding that an Act or instrument materially affects the provision of electricity network services. The Tribunal’s error was in concluding that the two phrases were exactly synonymous or alternatively, it is submitted that in searching for an appropriate synonym, the Tribunal lost sight of the statutory words.
378 We do not think that the Tribunal made the legal error which SAPN attributes to it.
379 It is important to note that the Tribunal’s discussion in this case appeared under the heading, “Regulatory obligation or requirement” and that what the Tribunal said was that the third limb (the limb that was to be decisive) was “whether the Act or instrument materially affects the provision of electricity network services” (at [520]). That was the precise statutory question.
380 The Tribunal then said that for several reasons neither the FW Act nor the instrument satisfied that statutory test. It then proceeded to state those reasons. We think that a couple of matters are crucial in a proper understanding of the approach taken by the Tribunal. First, the phrase itself, “materially affects”, is broad and elastic and is not one that is readily capable of precise definition. It denotes a causal link of some substance. Secondly, the Tribunal then discussed four or possibly three reasons for concluding that the necessary causal link was not made out. As to the first reason, despite the imperative language used by the Tribunal in connection with its reference to a direct connection, we do not think the Tribunal was reformulating the test, or if it was, it was not doing that with any more precision than the statutory words, “materially affects”. What is important, in our view, is that there were a number of reasons and the matter which lay beneath the direct connection analysis – the connection was the labour and it would be odd if the definition was attracted merely by the vehicle chosen to deliver that labour – was a sound and rational reason for concluding that the provisions of the EA did not materially affect the provision of electricity network services.
381 SAPN also attacked the other reasons relied on by the Tribunal. None of the matters SAPN identified constitute an error within s 5 of the ADJR Act. The Tribunal’s reference to the absence of a unique connection between the EA and the provision of electricity network services any more than there is to any other industry is not a reformulation of the test from “materially affects” to “direct connection” to “unique connection”. It is really just making the point, perhaps with emphasis, that the “EA model”, as the Tribunal called it, is available to all industries.
382 The Tribunal’s reference to the other paragraphs in s 2D(1)(b)(iv) and, in particular, paragraphs (ii)-(iv), did not involve legal error. The Tribunal said that the other examples “also sheds (sic) some light on the type of matters contemplated”. With respect, that is a legitimate approach to statutory construction and does not involve an impermissible or inappropriate application of the ejusdem generis maxim. In interpreting and applying a broad and elastic phrase (materially affects), the Tribunal was entitled to take into account, as a guide, the fact that a feature of other examples was not present in the situation before the Court. That is all the Tribunal did.
383 Finally, SAPN submitted that the Tribunal’s reference to the national electricity objective and the opex criteria involved error. This is the matter raised in Ground 18. In order to understand the challenge, it is necessary to consider carefully what the Tribunal said in [527] of its reasons. This paragraph is set out above (at [316]).
384 As we understood the submission, it was that the Tribunal, by reference to the national electricity objective and the opex criteria, held that only efficient regulatory obligations or requirements were within the scope of the definition of a regulatory obligation or requirement. That was an error (so the submission went) because there were undoubtedly regulatory obligations or requirements which were not efficient.
385 We do not think that this is the correct characterisation of the Tribunal’s approach. The matter appears in the Tribunal’s analysis of whether the EA is a regulatory obligation or requirement and is one of the several reasons for the Tribunal’s conclusion that neither the FW Act nor the EA satisfied the “materially affects” test. Without making any observation about the EA in this case, it was open to the Tribunal to conclude that the costs associated with an EA were not necessarily efficient costs. A characterisation of an EA which is the product of negotiation by SAPN management and the employees at the time it is made as satisfying the materially affects test and, therefore, a regulatory obligation or requirement, insulates it from an efficiency examination. That runs counter to the emphasis on efficiency in the national electricity objective and the opex criteria. The consideration is not decisive because, as SAPN submitted, there are likely to be externally imposed regulatory obligations and requirements which would not be considered efficient, but it is a factor to be considered in applying the broad and elastic “materially affects” test to a particular fact situation. That is all the Tribunal did and we do not think it erred.
386 In our opinion, the Tribunal did not make the errors alleged in Grounds 17 and 18.
387 We would add this about the State Minister’s carefully articulated argument about imposed obligations of a clear and definite nature on the one hand, and obligations which are assumed voluntarily on the other. We would not embrace such a test. It represents an obvious departure from the statutory words. It is not just an exposition of the statutory test; it is a different test. That is sufficient to reject it, but we note that, in addition, it is likely to give rise to its own problems and difficulties.
388 It is convenient to deal with that part of Ground 21 which relates to the issue of regulatory obligations or requirements. It is not altogether clear whether the Tribunal applied efficiency and prudency tests to the EA only on the assumption that the EA was necessary to maintain the safety of the distribution system limb or also to the regulatory obligation or requirement limb. In other words, it is not entirely clear on what assumptions (contrary to its primary conclusions) the Tribunal proceeded to consider something it was not required to consider. If the Tribunal did apply efficiency and prudency tests to the EA assuming it was a regulatory obligation or requirement, then it probably erred in law, but the error is immaterial. There does not seem to be any room for efficiency and prudency tests where an obligation or requirement gives rise to a clear and fixed cost and the obligation or requirement falls within s 2D. However, any error on the part of the Tribunal is irrelevant because the Tribunal held that the EA was not a regulatory obligation or requirement and we have dismissed a challenge to that conclusion.
389 We turn now to Grounds 19, 19A and 20 which are directed at the second limb advanced by SAPN namely, that the EA was required to maintain the safety of the distribution system.
390 Ground 19 contained a challenge to how the Tribunal applied its own previous decision in Ausgrid. In Ausgrid, the Tribunal made the following remarks (at [418]):
Noting that in its Final Decisions the AER maintained the view that the Commonwealth is not a “participating jurisdiction”, Networks NSW draws on the Minister’s intervention in these proceedings to submit that the AER now acknowledges that status. It is, however, unnecessary to delve further into whether the Minister’s intervention amounts to a concession on the part of the AER. That is because the EBAs may be reasonably regarded as:
(a) otherwise required to achieve an opex objective, namely, the r 6.5.6(a)(4) objective to: “maintain the safety of the distribution system through the supply of standard control services”; and
(b) reasonably reflecting the opex criteria in r 6.5.6(c)(3): “a realistic expectation of the demand forecast and cost inputs required to achieve the operating expenditure objectives.”
391 The present Tribunal identified matters that qualified this passage (at [534]-[535]):
The Tribunal’s conclusion that the EA may reasonably be regarded as satisfying the capex objective and capex criterion, was presumably drawn from the following statement in the above passage:
This is because the terms of an EBA could plausibly materially affect a service provider’s provision of standard control services.
However that passage emerged only in the context of the AER attempting to find a category of regulatory obligation or requirement under s 2D to which an EA could logically “fit”. It considered the most logical fit was with the category dealing with an Act or instrument that materially affects the provision of electricity network services. The AER was not suggesting from the above passage that it had in fact concluded that an EA materially affects a service provider’s provision of standard control services. Rather that was the only working category that could possibly fit within the requirements of s 2D. Hence the AER’s use of the expression “plausibly”.
392 In Ausgrid, the Tribunal also said the following (at [436]):
It may be said that, in the view of the Tribunal, it is the policy of the legislative arm of government that, to the extent that the EBA’s are (if they are) an inefficient imposition on the DNSPs, nevertheless they are a cost to be borne by the consumers of electricity. … [H]aving regard to the regulatory prescriptions, the Tribunal does not accept that [the AER] may, by the use of the EI model [proposed by the AER], simply select the measurement of efficiency which it did in this respect without regard to the obligations under the EBAs as they presently exist. Over time, and probably during the new current regulatory period, any such inefficiencies as the AER considers to exist may progressively be reduced … and any allowances under the EBAs (as they expire) which the AER considers to be inefficient may also by the same elapse of time be reduced to an efficient level.
393 The present Tribunal referred to other passages in the Tribunal’s decision in Ausgrid and then said (at [541]):
The Tribunal is there suggesting that an EA does not attract the regulatory obligation of s 2D or indeed the safety and reliability standard of cl 6.5.6(a)(3). This of course also lends further support to our view that SAPN’s EA is not a regulatory obligation. It is then said “Networks NSW DNSPs are bound by their EBAs as a matter of law”. Having already rejected the application of s 2D and cl 6.5.6(a)(3), the Tribunal must be referring to the fact that a DNSP is bound by an EA only in the sense that a failure to comply would constitute a breach and attract penalties under the FW Act. That interpretation is supported by the remainder of the passage where the Tribunal discusses the limited rights to terminate an EA – reinforcing the point that an EA is binding on a DNSP as a matter of law.
394 The way in which the present Tribunal dealt with the Tribunal’s decision in Ausgrid closely aligns with the way in which this Court dealt with the Tribunal’s decision on the applications for judicial review. The Court said (AER v Australian Competition Tribunal at [371]):
We have reached the conclusion that as to the two interrelated matters which we have identified (i.e., the AER’s reliance on the EI Model and the AER’s conclusion that the EBAs were an endogenous managerial choice), it was open to the Tribunal to conclude that the AER committed material errors of fact or (our preferred characterisation) incorrectly exercised its discretion. We would add that it may be considered that standing alone, the Tribunal’s statement that it is the policy of the legislative arm of government that, to the extent that the EBAs are (if they are) an inefficient imposition on the electricity network respondents, nevertheless they are a cost to be borne by consumers of electricity (at [436]) is incorrect However, the statement is not to be construed as standing alone and the Tribunal went on to explain, not contradict as the AER submitted, what it meant by this statement. Even if it is an overstatement, it does not affect the Tribunal’s earlier conclusions with respect to the labour costs.
395 We can detect no legal error in the way in which the present Tribunal approached the Tribunal’s decision in Ausgrid. In our opinion, the Tribunal did not make the error alleged in Ground 19.
396 Grounds 19A and 20 challenge the Tribunal’s two reasons for rejecting SAPN’s case that the EA fell within the category of an item which is required to achieve the maintenance of the safety of the distribution system through the supply of standard control services.
397 SAPN challenged the Tribunal’s reliance on the test of a direct connection between the EA and the delivery of standard control services. The Tribunal, relying on its earlier reasoning in relation to s 2D(1)(b)(v), said that the connection between the cost and the maintenance of a safe distribution system is the labour and not the means or mechanism chosen to provide that labour. We do not think that there is any legal error in this approach. The question is what expenditure is required to achieve specified objectives. There can be no doubt that an expenditure on labour is required. However, it was open to the Tribunal to conclude that an EA was not required to achieve the specified objectives. In any particular case, another DNSP may achieve the opex objectives without such additional expenditure as may be associated with an EA.
398 Furthermore, acceptance of SAPN’s submission could lead to what, on the face of it, would be an odd result. If expenditure associated with an EA was required to maintain the safety of the distribution system, then arguably that expenditure is the efficient cost of achieving the objective such that the opex criteria of efficiency, prudency and realism have little, if any, work to do.
399 It seems to us that it was open to the Tribunal to conclude that what was required to achieve the safety of the distribution system was labour, not labour employed under particular EAs. That did not mean that the costs associated with the EAs could never be allowed, but only that they would need to satisfy the opex criteria.
400 The meaning of the Tribunal’s second reason is not altogether clear. It is true that the opex objectives apply to the total estimates for opex and that the labour cost escalator is one such factor. It is also true that it cannot be assumed that any error with respect to the labour cost escalator would completely undermine the opex objectives applying to the safe delivery of standard control services. The difficulty is that whilst each of those propositions is true, we would not be disposed to accept that the last of the propositions is an appropriate test. We would not have thought a “complete undermining” was necessary. An error may be significant if it partially undermines an objective. We do not need to pursue this further because we think the Tribunal’s first reason was sufficient to justify its conclusion and we think that, properly construed, that was the view of the Tribunal.
401 In our opinion, the Tribunal did not make the errors alleged in Grounds 19, 19A and 20.
402 In view of the way the case was presented, the above conclusions are sufficient to dispose of SAPN’s challenge to the Tribunal’s reasons with respect to the forecast labour cost escalation. We would only add that insofar as the EA fell to be considered by reference to the opex criteria and otherwise than on the assumption that it was a regulatory obligation or requirement, we can detect no legal error in the Tribunal’s conclusions that it did not satisfy the opex criteria.
403 Ground 21 may be partly made out (i.e., as to the regulatory obligation or requirement limb) but, as we have said, it is of no consequence (at [388]). Otherwise, it is not made out.
Conclusion
404 We reject SAPN’s application for judicial review in relation to the forecast labour cost escalation.
CONCLUSION AND ORDERS
405 The application is dismissed, with costs.
I certify that the preceding four hundred and five (405) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justices Besanko, Yates and Robertson. |
Associate: