Envestra Limited v Essential Services Commission of South Australia (NO. 2) - [2007] SADC 90

DISTRICT COURT OF SOUTH AUSTRALIA
(District Court Administrative and Disciplinary Division: Application for Review)
ENVESTRA LIMITED v ESSENTIAL SERVICES COMMISSION OF SOUTH AUSTRALIA (NO. 2)
[2007] SADC 90
Judgment of His Honour Judge Tilmouth, Assessor Dr M Messenger and Assessor Mr D Round
27 August 2007
ADMINISTRATIVE LAW - ADMINISTRATIVE TRIBUNALS - STATUTORY APPEALS FROM ADMINISTRATIVE AUTHORITIES TO COURTS
Section 39(1)(c) of Schedule 1 to the Gas Pipeline Access Act (1997) (SA) provides for an appeal from the decision of a regulator - the respondent in this case - on grounds of error of fact, incorrect or unreasonable exercise of discretion , or when the occasion for exercising the discretion did not arise.
Held: The applicant has demonstrated reviewable error in relation to one issue, as to which the decision of the Commission is varied in accordance with s38(9) of Schedule 1.
Gas Pipeline Access Act 1997 (SA) s38, s39 of Schedule 1; Gas Pipeline Access Act 1997 (SA) s42, s43 of Part 6; District Court Act 1991 (SA) s20(4) and s42E; Gas Pipeline National Third Party Access Code s2.24, 2.28. 2.31-2.24, 2.35, 2.37, 2.27A, 2.38, 2.39, 2.40, 2.41, 3.3, 3.4, 3.5, 8.1-8.6, 8.8, 8.9, 8.30, 8.31, 8.32, 8.36, 8.37, referred to.
Re Epic Energy South Australia Pty Ltd (2003) ATPR 41-932; Australian Competition and Consumer commission (ACCC) v Australian Competition Tribunal (2006) 152 FCR 33; (2006) 232 ALR 153; ATPR 42-124; Re Michael: Ex parte Epic Energy (SA) Nominees Pty Ltd (2002) 25 WAR 511; (2002) ATPR 41-886; Re Application by GasNet Australia (Operations) Pty Ltd (2004) ATPR 41-978; House v The King (1936) 55 CLR 499, applied.
Envestra Ltd v Essential Services Commission of SA [2007] SADC 28; Telstra Corp Ltd (No 3) [2007] ACompT 3 at [462-468], considered.

ENVESTRA LIMITED v ESSENTIAL SERVICES COMMISSION OF SOUTH AUSTRALIA (NO. 2)
[2007] SADC 90
Index
Preliminary  [para 1]
Pre-trial procedural issues  [para 4]
An Overview  [para 10
The statutory grounds of review  [para 14]
The access arrangement procedures  [para 23]
The application for review  [para 30]
Error in Regulator’s findings of fact  [para34]
Incorrect exercise of Regulator’s discretion   [para 35]
Unreasonable exercise of Regulator’s discretion   [para 37]
The occasion for exercising the discretion did not arise  [para 38]
Rate of Return  [para 42]
         Equity Beta            [para 56]
Equity Beta analysis  [para 65]
Gamma            [para 70]
Gamma analysis  [para 86]
Debt Margin  [para 113]
Debt Margin analysis  [para 118]
Monte Carlo Simulation    [para 130]

Initial Capital Base  [para 136]
Initial Capital Base analysis  [para 147]
Network Management Fee  [para 152]
Network Management Fee analysis  [para 195]
Payment Terms  [para 219]
Environmental Management Costs   [para 220]
Orders  [para 221]
Preliminary

In this matter the court sits in its Administrative Appeals Division, exercising the jurisdiction vested in it as the designated local appeals body within the meaning of s9 of the Gas Pipelines Access (South Australia) Act (SA) 1997 (“the Act”). By application filed on 10 November 2005 (as amended by leave of the Court granted by consent on 18 July 2007) the applicant (“Envestra”) seeks the review of a decision of the respondent published on 27 October 2006.
Envestra was incorporated on 16 May 1997 and listed as a public company on the Australian Stock Exchange on 21 August that year. It is for relevant purposes the “service provider” within the meaning of s2 of Schedule 1 to the Act. The respondent (the “Commission”) is the relevant or local “Regulator” within the meaning of s9 of the Act and is the successor to the South Australian Independent Pricing and Access Regulator (“SAIPAR”). Its responsibilities and statutory powers derive essentially from Schedule 1 of the Act entitled Third Party Access to Natural Gas Pipelines and Schedule 2 National Third Party Access Code for Natural Gas Pipeline System. Both schedules are together defined as the Gas Pipelines Access Law,[1] but in order to distinguish between them, as we often must, we refer to Schedule 1 as The Access Law and Schedule 2 as The Code.
[1] Section 3(1) of the Act
In reviews of this kind, questions of law and procedure are determined by the presiding Judge, whereas other questions fall for determination by majority opinion.[2]
[2] Sections 7(d) and 20(4) of the District Court Act 1991 (SA)
Pre-trial procedural issues
In February 2007 the court convened for the purpose of making consent orders, including fixing timetables for discovery and the production of documents. At this time the court also sat in order to extend the time in which to determine the review, pursuant to s38(3) of the Access Law. Section 38(3) requires the court to “make its determination on the review within 90 days after receiving the application for review”. The original application for review was received on 10 November 2006, so the original 90-day period was due to expire on 7 February 2007. Section 38(4) enables the court to make successive orders of 30 days each, extending the time in which to determine the review. An order was made at this time by consent in terms ‘this application is extended by five consecutive 30 day periods until 30 June 2007’.
As s38(4) supplies the power to extend “by a period of 30 days if it considers that the matter cannot be dealt with properly without the extension”, the court also made successive 30 day extension orders each month thereafter, once again by consent of the parties. When those orders were entered it was accepted on both sides of the record, that for various reasons the review was unable to be dealt with properly, as neither party was ready to proceed at those times.
A review application within the terms of s38 of the Access Law is determined by an “appeals body” constituted under s42(1) of the Act. It comprises a judge of this court and two expert assessors, selected from a panel established by the State Minister for Energy, having “knowledge of, or experience in, the gas supply industry or in the fields of commerce or economics” selected in accordance with s42(4).
It was at first anticipated that it would be necessary for the Court to be constituted by a judge and two assessors to enable the extension orders to be duly made. However, s20(5) of the District Court Act 1991 (SA) authorises the court sitting in its Administrative Division to “be separately constituted in accordance with this section for the hearing and determination of any number of separate matters”. Furthermore a judge sitting alone is empowered by s20(4)(ab) thereof, to make orders dealing with “preliminary, interlocutory or procedural matters” or when entering “consent” orders. These powers, by necessary implication, continue to apply to proceedings for review under the Act and the Access Law, as s43 of the Act precludes the operation of certain specified provisions of the District Court Act, but not s20.
Accordingly the court constituted by the presiding judge made the consent orders referred to. The subsequent hearing commenced on 18 July 2007. Assessors Dr Messenger and Professor Round sat with him during the hearing at these substantive stages of the proceedings.
The same powers were exercised on the further interlocutory application of the Commission seeking orders that Envestra was not entitled to rely on any report or statement not relied upon by the Commission in making the decision under review, or to examine or cross-examine any witness. The history and the issues raised in those proceedings can be found in Envestra Ltd v Essential Services Commission of SA.[3] The court concluded that s39(5) of the Access Law precluded any party to a review under s38(1) from examining or cross-examining any witness. An application for the judicial review of that decision was dismissed by the Supreme Court.[4]
[3] (2007) 247 LSJS 415; [2007] SADC 28, 16 March 2007
[4] Envestra Ltd vDistrict Court of South Australia [2007] SASC 177; BC200703626 White J, 18 May 2007
An overview
Envestra is the owner of the natural gas distribution network to the marketplace in South Australia. Since 1997 it has been maintained and operated on its behalf by Origin Energy Asset Management Pty Limited (“OEAM”), previously Boral Energy Asset Management Ltd, a wholly-owned subsidiary of Boral Ltd. At relevant times Envestra’s shareholding was made up of 17.1% held by a Malaysian syndicate and another 17.1% by Origin Energy Ltd. The balance was held by other shareholders. Each of those large minority shareholders had two Directors. There were nine Directors in all on the Envestra board.
Gas distribution is regulated by a “local Regulator” under the Access Law and the Code. Gas transmission lines are regulated by the Australian Competition and Consumer Commission (“ACCC”). Envestra’s distribution system in South Australia encompasses a number of networks located in Adelaide, the Barossa, Berri, Peterborough, Port Pirie, Mount Gambier, Whyalla and Murray Bridge. These receive gas or 'interconnect' with two main transmission lines transporting natural gas from production fields in the Cooper/Eromanga Basin in the north of the State and in the Otway Basin in Victoria. At issue are certain remuneration terms of the current Access Arrangement as between Envestra and the Commission.
The procedures established under the Code for negotiating and concluding access arrangements are complex. Reduced to essentials for the purposes of these reasons, the process commences with submissions by the Service Provider of proposed “revisions” to the prevailing access arrangements then due to expire (Code s2.28), followed by a period of public consultation (Code ss2.31-2.34). The Regulator then issues a Draft Decision in which it must either approve the revisions or propose not to approve them, in which case it must state the amendments required in order for the service provider to gain approval (Code s2.35). It must then request and consider submissions on the Draft (Code ss2.37, 2.37A). Thereafter it must issue a so-called “Final Decision” (Code s2.38) that once again enables approval of the proposed revisions of the service provider. When the proposed revisions are not approved it must state the amendments (or nature of the amendments) to be made in order for the Regulator to approve them (Code ss2.38(a)(i) and (ii)).
The Regulator may approve such revisions only if satisfied they substantially incorporate the amendments specified by the Regulator or alternatively if satisfied the amended revision addresses the matters identified “as being the reasons for requiring the amendments specified”: (s2.38A(a)(b)). The Service Provider then, in effect, resubmits amended revisions by the date specified: (Code s2.40). The process concludes when the Regulator issues a “Further Final Decision”, either approving or not approving the amended revisions and in the case of non-approval by drafting and approving its own amended revisions (Code s2.41). The Draft Decision was issued by the Commission in March 2006, the Final Decision on 30 June 2006 and the Further Final Decision on 27 October 2006. It is only the Further Final Decision which is subject to review in this case.
Statutory grounds of review
Section 39(1)(c) of the Access Law provides the primary means of redress.[5] Only those matters and materials before the Regulator can be raised or considered in this review process. Section 39 of the Access Law provides, so far as presently relevant:
[5] See also s2.48 of the Code
39—Limited review of certain decisions of Regulator
(1)If the relevant Regulator makes a decision under the Code to approve the Regulator's own access arrangement or the Regulator's own revisions of an access arrangement—
…
the following persons may apply to the relevant appeals body for a review of the decision:
(c)       the service provider;
…
(2)         An application under this section—
(a)    may be made only on the grounds, to be established by the applicant—
(i)      of an error in the relevant Regulator's finding of facts; or
(ii)that the exercise of the relevant Regulator's discretion was incorrect or    was unreasonable having regard to all the circumstances; or
(iii)    that the occasion for exercising the discretion did not arise; and
(b)in the case of an application under subsection (1), may not raise any matter that was not raised in submissions to the relevant Regulator before the decision was made.
Even though s42E(3) of the District Court Act[6] states the court must not depart from a decision forming the subject of administrative review “except for cogent reasons”, the applicant did not rely on any other basis of intervention other than those provided for under s39(2) of the Access Law. It is difficult to appreciate just how s42E(3) can possibly apply to the process of review, although somewhat surprisingly perhaps, it is not excluded by s43 of the Act. The available grounds of review, if made out, must inherently amount to “cogent reasons”. As it happens, nothing turns on this.
[6] Above
The administrative appeals jurisdiction of this Court is a creature of the District Court Act[7] and many other statutes vesting it with supervisory jurisdiction over various Boards and Tribunals. The Administrative Appeals Division of the Court is created by Part 6 Division 2 of the District Court Act.[8] When exercising that jurisdiction the Court is not bound by the rules of evidence and must act in accordance with equity, good conscience and the substantial merits of the matter (s42E(2)). Generally, it has the power to affirm, rescind or remit a matter or to “substitute a decision that the court considers appropriate”: (s42F). Noticeably the power of remission is excluded by s38(9) of the Access Law, as it limits the available powers of disposition to “affirming or setting aside, or varying”. No doubt the intention is to bring such proceedings to a timely end – hence the 90-day decision-making limitation, discussed above.
[7] Above
[8] Above
These provisions were examined in some detail in the earlier decisions of this and the Supreme Court. It is appropriate to summarise some of those matters again in this context. The supervisory jurisdiction to review vested by s38(1) of the Access Law is triggered once one or more of the limited grounds specified by s39(2)(a) are satisfied. Should that occur, the court must conduct a “merits review” confined to the particular identifiable error. Section 38(9) - as noted - limits the options of disposition and confines the power of variation to take effect “immediately or as from a specified date”. It follows from those words that the court retains no residual power to back-date any variation it might otherwise be inclined to make, for example to the date of the decision under review. Neither party in this matter contended otherwise. Any such variation does, however, take effect as if made by the Regulator: s38(12).
Once error within s39(2)(a) is demonstrated, the review process is by way of rehearing, so the court can then substitute its own decision, based on the facts and the law as they then stood: Da Costa v Cockburn Salvage Trading Pty Ltd,[9] Allesch v Maunz.[10] Then and only then is the court permitted to consider on the basis of the materials properly before it, what the correct or preferable decision of the Regulator should have been: Drake v Minister for Immigration and Ethnic Affairs[11] and Fletcher v Federal Commissioner of Taxation.[12] The Federal Court in Australian Competition and Consumer Commission (ACCC) v Australian Competition Tribunal[13] points out that an appeals body cannot go outside the issues raised by the parties and that it plays no inquisitorial role in the review process. Moreover there is no room in the scheme of this legislation for review on the grounds of procedural unfairness or denial of natural justice: Re Epic Energy South Australia Pty Ltd.[14]
[9] (1970) 124 CLR 192 at 208-209
[10] (2000) 203 CLR 172 at [23]
[11] (1979) 24 ALR 577 at 589
[12] (1988) 84 ALR 295 at 306
[13] (2006) 152 FCR 33; (2006) 232 ALR 153; (2006) ATPR 42-124 (French, Goldberg and Finkelstein JJ) at [73].
[14] [2002] ACompT 4; (2003) ATPR 41-932 at [28-29]
When discharging the jurisdiction to review decisions made pursuant to this scheme, the respective roles of the Regulator and the court must be borne in mind. Once the basic issues of interpretation are clarified, it remains for the Regulator to consider and weigh the factors and objectives contained in the Code and to assess the relevance and weight of each, before exercising the various discretions committed to it: Re Michael; Ex parte Epic Energy (WA) Nominees Pty Ltd,[15] and Re an Application by Epic Energy South Australia Pty Ltd.[16]
[15] (2002) 25 WAR 511; (2002) ATPR 41-886; [2002] WASCA 231 at [187]
[16] (2004) ATPR 41-977, [2003] ACompT 5 at [29-30]
Equally it must be remembered that when assessing any Access Arrangement proposals and deciding whether or not to approve them, the Regulator is not free to substitute its own preferred arrangements. Only once the threshold of non-approval is properly crossed is the Regulator at liberty to set the content of its own access arrangements within the framework of the Code: Re GasNet Australia (Operations) Pty Ltd.[17] The applicable principles were summarised in GasNet as being these:[18]
29.It is clear in the reasoning in Michael that there is no single correct figure involved in determining the values of the parameters to be applied in developing an applicable Reference Tariff. The application of the Reference Tariff Principles involves issues of judgment and degree. Different minds acting reasonably, can be expected to make different choices within a range of possible choices which nonetheless remain consistent with the Reference Tariff Principles. Where the Reference Tariff Principles produce tension, the Relevant Regulator has an overriding discretion to resolve the tensions in a way which best reflects the statutory objectives of the Law. However, where there are no conflicts or tensions in the application of the Reference Tariff Principles, and where the AA proposed by the Service Provider fails within the range of choice reasonably open and consistent with Reference Tariff Principles, it is beyond the power of the Relevant Regulator not to approve the proposed AA simply because it prefers a different AA which it believes would better achieve the Relevant Regulator’s understanding of the statutory objectives of the Law.
30.This follows because the power of the Relevant Regulator to require amendments, or to itself draft and approve its own AA, does not arise until it is of the opinion that the AA proposed by the Service Provider does not comply with the Code, and in determining the question of compliance, it must act in accordance with s2.24 of the Code.
[17] (2004) ATPR 41-978 – hereafter at times referred to as “GasNet”.
[18] At [29]
That decision was approved and applied in Australian Competition and Consumer Commission (ACCC) v Australian Competition Tribunal.[19] The court stated the following two “general propositions about the nature of the Regulator’s functions” under the Code consistent with the principles in GasNet:
4.The Relevant Regulator may not substitute its own Access Arrangement for a proposed Access Arrangement or a revised version thereof unless of the opinion that the proposed Access Arrangement does not comply with the Code.
5.If of the opinion that a proposed Access Arrangement or revised version does not comply with the Code, the Relevant Regulator is empowered to formulate and approve its own Access Arrangement and is, subject to the Code, at large with respect to the terms of that Access Arrangement.[20]
[19] Above at [165] & [170]
[20] At [168]

Where error is shown and the merits fall to be determined by the court, it must weigh the merits within the confines of the powers and limitations applicable to the Regulator, consistent with the above principles.
The access arrangement procedures
The previous access arrangement period commenced on 2 May 2003. The current period commenced on 13 November 2006 and expires on 30 June 2011. When it comes to negotiating new access arrangements in lieu of those covering the previous access period, elaborate provision is made with respect to the mode and manner applicable.
Of central importance in that framework are the requirements of s2.24 of the Code:
The Relevant Regulator may approve a proposed Access Arrangement only if it is satisfied the proposed Access Arrangement contains the elements and satisfies the principles set out in sections 3.1 to 3.20. The Relevant Regulator must not refuse to approve a proposed Access Arrangement solely for the reason that the proposed Access Arrangement does not address a matter that sections 3.1 to 3.20 do not require an Access Arrangement to address. In assessing a proposed Access Arrangement, the Relevant Regulator must take the following into account:
(a)the Service Provider’s legitimate business interests and investments in the Covered Pipeline;
(b)firm and binding contractual obligations of the Service Provider or other persons (or both) already using the Covered Pipeline;
(c)the operational and technical requirements necessary for the safe and reliable operation of the covered Pipeline.
(d)     the economically efficient operation of the Covered Pipeline;
(e)the public interest, including the public interest in having competition in markets (whether or not in Australia);
(f)    the interests of Users and Prospective Users;
(g)     any other matters that the Relevant Regulator considers are relevant.
Once satisfied of these requirements the Regulator may approve any proposed revisions to those arrangements in compliance with s2.46:
2.46   The Relevant Regulator may approve proposed revisions to an Access Arrangement only if it is satisfied the Access Arrangement as revised would contain the elements and satisfy the principles set out in sections 3.1 to 3.20. The Relevant Regulator must not refuse to approve proposed revisions to the Access Arrangement solely for the reason that the Access Arrangement as revised would not address a matter that sections 3.1 to 3.20 do not require an Access Arrangement to address. In assessing proposed revisions to the Access Arrangement, the Relevant Regulator:
(a)     must take into account the factors described in section 2.24; and
(b)     must take into account the provisions of the Access Arrangement.
It follows from the nature and the terms of these powers and functions that the discretion to decline approval does not arise until the Regulator forms the antecedent opinion that a proposed or amended Access Arrangement does not comply with the Code, having regard to all the circumstances: Re an Application by Epic Energy South Australia Pty Ltd.[21]
[21] (2004) ATPR 41-977, [2003] AcompT 5 at [29-30]
In addition, access arrangements must contain certain terms defined by subject matter specified in ss3.1 – 3.36 inclusive. Of particular relevance to this case is s3.3, the material portions providing:-
Reference Tariffs and Reference Tariff Policy
3.3 An Access Arrangement must include a Reference Tariff for:
(a)at least one Service that is likely to be sought by a significant part of the market; and
(b)each Service that is likely to be sought by a significant part of the market and for which the Relevant Regulator considers a Reference Tariff should be included.
….
3.4 An Access Arrangement must also include a policy describing the principles that are to be used to determine a Reference Tariff (a Reference Tariff Policy). A Reference Tariff Policy must, in the Relevant Regulator’s opinion, comply with the Reference Tariff Principles described in section 8.
Section 8 of the Code is devoted to what the preamble describes as “the principles with which Reference Tariffs and a Reference Tariff Policy (the principles underlying the calculation of Reference Tariffs) included in an Access Arrangement must comply.”
Many of the other provisions are quite lengthy. For that reason it is not possible to reproduce them in full. Of significance to the applicant’s case, as a prelude to its principal argument relating to the “rate of return” pressed first during the course of oral submissions, were the following features requiring the Regulator to:
·provide the Service Provider with the opportunity to earn a stream of revenue that recovers the efficient costs of delivering the Reference Service over the expected life of the assets used in delivering that service and by “replicating the outcome of a competitive market”: s8.1(a) &(b);
·calculate Total Revenue by the Cost of Service method, being equal to the cost of providing all Services (some of which may be the forecast costs), to be calculated on the basis of “a return (Rate of Return) on the value of the capital assets that form the Covered Pipeline (Capital Base)”; s8.4(a).
·have regard to an appropriate value within the range of values, that may be attributable to total revenue indicators it considers relevant in order to determine the level of costs within the range of feasible outcomes under section 8.4 that is most consistent with the objectives contained in sections 8.1 to 8.6;
·establish the Capital Base over time at the commencement of each Access Arrangement Period after the first, determined (amongst other things) as the Capital Base at the start of the immediately preceding Access Arrangement Period: s8.9(a).
The application for review
Five heads of review were agitated as to different aspects or items under the rubric of the rate of return or ‘total revenue allowance’ set by the Regulator. The overall complaint of Envestra was that rather than approving its amended revisions to the proposed Access Arrangements, the Commission instead erroneously drafted and approved its own revisions, effected in the Further Final Decision.
The five particular matters and the approximate consequential increase in the revenue over the course of the arrangement should the applicant succeed (based on the respondent’s estimates) are as follows:-
1.the Rate of Return applied by the Commission under ss8.4(a) and 8.37 of the Code - $49m;
2. the Initial Capital Base adopted by the Commission under s8.9(a) of the Code - $8.5 m;
3. the Network Management Fee disallowed by reference to s8.4(c) of the Code - $19 m;
4. the payment terms and conditions imposed - $5 m;
5.the removal of environmental management costs from the Access Arrangement - $3 m.
The applicant seeks orders varying the Further Final Decision of 27 October 2006 in the following respects:
(a) to provide for the Initial capital Base of $810.21 million as at 1 July 2003;
(b)to include as a Non-Capital Cost the costs paid to the contractor OEAM for the Network Management Fee;
(c)to provide for a real pre-tax WACC of 7.3 per cent based upon the component values for equity beta, imputation credits and debt margin set out in its written and oral submissions, after applying a Monte Carlo simulation;
(d)crediting a working capital adjustment to reflect by its payment terms that the applicant receives a benefit from receipt of revenue in advance, for 27 rather than 60 days; and
(e)allowing Non-Capital Costs of $2.2 million to the applicant for environmental monitoring of the Brompton and Port Pirie Sites.
First it is desirable to elaborate upon the available options of review contained in s39(2)(a)(i) – (iii) inclusive of the Access Law (as set out above), before turning to consider each principal head of review in the order they were agitated during the course of oral submissions.
Error in Regulator's finding of fact: s39(2)(a)(i)
In Australian Competition and Consumer Commission (ACCC) v Australian Competition Tribunal[22] it was held “findings of fact” referred to in s39 of the Access Law encompass opinions formed by the relevant Regulator based upon the assessment of facts or methodologies it chose to apply. However it also held the choice as to which of several permitted methodologies should ultimately be applied was not a finding of fact, nor was a decision as to the relative weight to be given to the factors set out in s8.10 of the Code. The court pointed out in that case:
[22] (Above)
[172]The first ground is error in the Relevant Regulator's finding of facts. Given the limitations imposed by s 39(5) this is a ground which can only be made out by reference to the materials which were before the ACCC. Findings of facts may include findings of the following kind:
1.    The existence of an historical fact being an event or circumstance.
2.    The existence of a present fact being an event or circumstance.
3.    An opinion about the existence of a future fact or circumstance.
The ACCC's function under the Code involves assessment not only of historical and present facts but also of expert opinion on various matters relevant to the fixing of a Reference Tariff. The term 'findings of fact' should be interpreted broadly enough to be meaningful in relation to the function of the ACCC under review. It should encompass opinions formed by the ACCC based upon approaches to the assessment of facts or methodologies which it has chosen to apply. The question of what constitutes a finding of 'facts' varies according to the statutory context in which that word or like words are used. In the judgment of McInerney J in Morley v National Insurance Co [1967] VR 566 at 567, a question arose about what constituted a 'fact' for the purposes of s 55 of the Evidence Act 1958 (Vic) which makes admissible certain documents containing statements by deceased persons tending to establish any fact. McInerney J said:
“It may be that the phrase "a fact" must be given an expanded meaning equivalent to some matter in issue to be established in the proceedings. Indeed, Wigmore, in his work on Evidence, 3rd ed., vol 1, p1, para 1, points out that, in one sense, "everything in the cosmos is a fact or a phenomenon."
In my view, it would be contrary to the policy of the legislation to give a restricted meaning to the word "fact" so as to exclude a statement of opinion by an expert.”
[172] In reaching findings of fact in this broad sense the ACCC will necessarily make choices of a discretionary character as was pointed out in Re Michael. An example is the choice between permitted methodologies for the calculation of total revenue mentioned in s 8.4 of the Code. Such a choice is not a finding of fact. Nor is a finding of fact in error because it is based upon the use of one methodology rather than another. The relative weight to be given to the factors set out in s 8.10 is also a matter of discretion rather than a finding of fact which can be impugned as such.
Incorrect exercise of the Regulator's discretion: s39(2)(a)(ii).
There are well known limitations on the scope of review of discretionary judgments governed by long-standing principle established in House v The King[23] and Cransen v The King,[24] as summarised in an oft-quoted passage from the former:[25]
The manner in which an appeal against an exercise of discretion should be determined is governed by established principles. It is not enough that the judges composing the appellate court consider that, if they had been in the position of the primary judge, they would have taken a different course. It must appear that some error has been made in exercising the discretion. If the judge acts upon a wrong principle, if he allows extraneous or irrelevant matters to guide or affect him, if he mistakes the facts, if he does not take into account some material consideration, then his determination should be reviewed and the appellate court may exercise its own discretion in substitution for his if it has the materials for doing so. It may not appear how the primary judge has reached the result embodied in his order, but, if upon the facts it is unreasonable or plainly unjust, the appellate court may infer that in some way there has been a failure properly to exercise the discretion which the law reposes in the court of first instance. In such a case, although the nature of the error may not be discoverable, the exercise of the discretion is reviewed on the ground that a substantial wrong has in fact occurred.
[23] (1936) 55 CLR499
[24] (1936) 55 CLR509
[25] (1936) 55 CLR499 at 504-505
At first sight s39(2)(a)(ii) appears to do no more and no less than incorporate these very principles. Indeed in In Re Epic Energy South Australia Pty Ltd[26] it was said of this avenue of redress:
[30]   Section 39(2)(a)(ii) is concerned with the correctness or unreasonableness of an exercise of discretion having regard to the circumstances relevant to the proper exercise of that discretion. Those circumstances are ones which are demonstrable from the matters to which the Tribunal may refer under s 39(5). For the purposes of the subsection, error is made out if it is demonstrated that the exercise of the discretion was so unreasonable on the basis of the matters available to the decision maker that no reasonable decision maker could ever come to it: Associated Provincial Picture Houses Ltd v Wednesbury Corporation [1948] 1 KB 223 at 223-234. It also deals with the situation where the decision is so far outside the range of decisions open to a reasonable decision maker that it bespeaks of error even though the particular error cannot be identified: House v R (1936) 55 CLR 499 at 505. For the purposes of s 39(2)(a)(ii) of GPA Law, correctness and reasonableness are to be determined by reference to applicable criteria contained in the Code applied to the matters which were before the relevant Regulator before the decision under review was made.
A similar approach appears to have been taken in Australian Competition and Consumer Commission (ACCC) v Australian Competition Tribunal:[27]
The discretion of the [Regulator] may be incorrectly exercised in the following ways:
(i)    Where its exercise is based upon a misconstruction or misapplication of the relevant principles (s8.1), methodologies (s8.4) or factors to be considered (s8.10) in the Code.
(ii)     Where its exercise is affected by a failure to have regard to a mandatory relevant factor including any one or more of the requisite principles, methodologies or factors.
(iii)    When its exercise is affected by the pursuit of some purpose extraneous to the purposes for which Access Arrangements are provided under the Code.
[26] (2003) ATPR 41-932 (Cooper J presiding).
[27] (2006) 152 FCR 33; (2006) 232 ALR 153; (2006) ATPR 42-124 at [174]
Unreasonable exercise of the Regulator's discretion: s39(2)(a)(ii)
To a large extent this ground of review has been covered in the previous section of these reasons. To those principles it may be added that the court is not entitled to set aside any decision simply because it thinks another decision is preferable. An exercise of a discretion is not unreasonable simply because another decision-maker would have come to a different view: Australian Competition & Consumer Commission (ACCC) v Australian Competition Tribunal.[28]As stated in Application by Epic Energy South Australia Pty Ltd,[29] the jurisdiction to review depends in the first place, on demonstrable error.
[28] (No 2) (2006) 152 FCR 33 at [7]
[29] (2003) ATPR 41-932 at [20]
The occasion for exercising the discretion did not arise: s39(2)(a)(iii)
This last available ground of review appears to contemplate the situation where an essential or prerequisite step to the forming of a necessary opinion or exercising a discretion under the Code is not taken or miscarries. Another way of expressing this might be when a regulator forms an opinion or makes a discretionary decision before the point at which that should be done or was one carried out in breach of the conditions which circumscribe its power and authority to do so: Public Service Association (SA) v Federated Clerks' Union.[30]
[30] (1991) 173 CLR 132 at 161 and 164.
One would expect these situations are most likely to occur at critical stages in the course of the access arrangements negotiations, particularly when reaching the degree of satisfaction as to the elements and principles in ss3.3-3.20 as specified in ss2.24, 2.38 and 2.46 of the Code. When it comes to the particular content of access arrangements relevant to this case, it might also arise in forming the necessary opinion relating to compliance with the Reference Tariff Principles, in respect of Total Revenue, as to Capital Base, as to Rate of Return and finally with respect to Non-Capital costs.
This ground of review received brief mention in Australian Competition and Consumer Commission (ACCC) v Australian Competition Tribunal[31] in the following terms:
[179] The third ground, namely ‘that the occasion for exercising the discretion did not arise’ seems to suggest that a condition for the exercise of the ACCC’s discretion had not arisen. It would be more broadly construed to encompass the proposition that, having regard to the nature of the Access Arrangement and Access Arrangement Information submitted by the Service Provider and their compliance with the provisions of the Code including its principles, methodologies and relevant factors, there was no justification for the ACCC to embark upon the exercise of substituting its own Access Arrangement for that proposed.
[31] (2006) 152 FCR 33 at [179]
In truth there are really four grounds of review contained in the three sub-sections, as incorrectness and unreasonableness under ss39(2)(a)(ii) are not usually necessarily co-extensive.
Rate of return
Counsel for the applicant paid great attention in oral submissions to the rate of return. It must be acknowledged this subject is at times both complex and difficult to absorb, involving as it does sophisticated economic and finance concepts. In simplified terms the applicant argues the thresholds the respondent must overcome before becoming entitled to substitute its own judgment or discretion when determining the rate of return applicable, were not met. Envestra says the material submitted by it was within reasonable ranges and was supported by the weight of expert opinion, so the Commission ought to have based its decisions on that material.
Section 3 of the Code provides that an access arrangement must have a Services Policy and s3.3(a) requires the policy to include “a Reference Tariff for… at least one Service that is likely to be sought by a significant part of the market.” Sections 3.4 and 3.5 combine to require the Regulator to form an opinion that the tariff complies with the Reference Tariff Principles described in section 8.
Sections 8.1 and 8.2 contain the elements of those principles:
General Principles

8.1A Reference Tariff and Reference Tariff Policy should be designed with a view to achieving the following objectives:

(a)providing the Service Provider with the opportunity to earn a stream of revenue that recovers the efficient costs of delivering the Reference Service over the expected life of the assets used in delivering that Service;

(b)replicating the outcome of a competitive market;

(c)ensuring the safe and reliable operation of the Pipeline;

(d)not distorting investment decisions in Pipeline transportation systems or in upstream and downstream industries;

(e)efficiency in the level and structure of the Reference Tariff; and

(f)providing an incentive to the Service Provider to reduce costs and to develop the market for Reference and other Services.

To the extent that any of these objectives conflict in their application to a particular Reference Tariff determination, the Relevant Regulator may determine the manner in which they can best be reconciled or which of them should prevail.

8.2The factors about which the Relevant Regulator must be satisfied in determining to approve a Reference Tariff and Reference Tariff Policy are that:

(a)the revenue to be generated from the sales (or forecast sales) of all Services over the Access Arrangement Period (the Total Revenue) should be established consistently with the principles and according to one of the methodologies contained in this section 8;

(b)to the extent that the Covered Pipeline is used to provide a number of Services, that portion of Total Revenue that a Reference Tariff is designed to recover (which may be based upon forecasts) is calculated consistently with the principles contained in this section 8;

(c)a Reference Tariff (which may be based upon forecasts) is designed so that the portion of Total Revenue to be recovered from a Reference Service (referred to in paragraph (b)) is recovered from the Users of that Reference Service consistently with the principles contained in this section 8;

(d)Incentive Mechanisms are incorporated into the Reference Tariff Policy wherever the Relevant Regulator considers appropriate and such Incentive Mechanisms are consistent with the principles contained in this section 8; and

(e)any forecasts required in setting the Reference Tariff represent best estimates arrived at on a reasonable basis.

The applicable methodology is the “Cost of Service”, set out in s8.4 of the Code. So far as relevant to this matter it provides:
Total Revenue
8.4 The Total Revenue (a portion of which will be recovered from sales of Reference Services) should be calculated according to one of the following methodologies:
Cost of Service: The Total Revenue is equal to the cost of providing all Services (some of which may be the forecast of such costs), and with this cost to be calculated on the basis of:
(a)a return (Rate of Return) on the value of the capital assets that form the Covered Pipeline or are otherwise used to provide Services (Capital Base);
(b) depreciation of the Capital Base (Depreciation); and
(c) the operating, maintenance and other non‑capital costs incurred in providing all Services (Non‑Capital Costs).
In commencing lengthy submissions relating to total revenue, the applicant made the point that it fell to be calculated according to s8.6 of the Code. Three of four considerations it mentions are relevant here, namely the rate of return, capital base, and non-capital costs:
8.6 In view of the manner in which the Rate of Return, Capital Base, Depreciation Schedule and Non Capital Costs may be determined (in each case involving various discretions), it is possible that a range of values may be attributed to the Total Revenue described in section 8.4. In order to determine an appropriate value within this range the Relevant Regulator may have regard to any financial and operational performance indicators it considers relevant in order to determine the level of costs within the range of feasible outcomes under section 8.4 that is most consistent with the objectives contained in section 8.1.
The principles for establishing the Capital Base set out by the Code are these:
8.8 Principles for establishing the Capital Base for the Covered Pipeline when a Reference Tariff is first proposed for a Reference Service (ie, for the first Access Arrangement Period) are set out in sections 8.10 to 8.14.
8.9 Sections 8.15 to 8.29 then describe the principles to be applied in adjusting the value of the Capital Base over time as a result of additions to the capital assets that are used to provide Services and as a result of capital assets ceasing to be used for the delivery of Services. Consistently with those principles, the Capital Base at the commencement of each Access Arrangement Period after the first, for the Cost of Service methodology, is determined as:
(a) the Capital Base at the start of the immediately preceding Access Arrangement Period; plus
……….
Those dealing specifically with the rate of return are subsequent:
Rate of Return
8.30The Rate of Return used in determining a Reference Tariff should provide a return which is commensurate with prevailing conditions in the market for funds and the risk involved in delivering the Reference Service (as reflected in the terms and conditions on which the Reference Service is offered and any other risk associated with delivering the Reference Service).
8.31By way of example, the Rate of Return may be set on the basis of a weighted average of the return applicable to each source of funds (equity, debt and any other relevant source of funds). Such returns may be determined on the basis of a well accepted financial model, such as the Capital Asset Pricing Model. In general, the weighted average of the return on funds should be calculated by reference to a financing structure that reflects standard industry structures for a going concern and best practice. However, other approaches may be adopted where the Relevant Regulator is satisfied that to do so would be consistent with the objectives contained in section 8.1.
The Capital Asset Pricing Model (“CAPM”) and the weighted average cost of capital (“WACC”) are expressions fundamental to this context and to which further reference will become necessary in due course. The essence of the points made by the applicant was that having proffered a range of choices reasonably open on the economic and finance literature consistent with all the other available materials and the requirements of the Code, it was simply not open in the proper exercise of its powers for the Commission to replace it with a range it thought to be more appropriate. In order to appreciate the position of both parties and the significant of their differences, it is necessary first to refer to some complex concepts and then the material relied on by both sides.
Section 8.30 requires the Reference Tariff may be established by using a cost of service methodology, that is to say the Rate of Return on investment in the Capital Base commensurate with prevailing conditions in the market for funds and the risk involved in delivering the Reference Service. Section 8.31 allows for the Rate of Return to be set on the basis of the CAPM. The CAPM model is used to estimate the return on an equity investment. Stated simply, it seeks to determine the rate of return required to compensate an investor for the non-diversifiable risk associated with a particular equity investment.
The CAPM formula is R_e = R_f+ ß_e (R_m – R_f) where R_e is the rate of return on equity; R_f is the “risk-free” rate of the return an investor could expect from investing in a riskless investment using the 10 year bond rate as a proxy; (R_m – R_f) is the “market risk premium” or return an investor could expect above the risk-free rate (R_f) from investing in a well-diversified portfolio of equities (R_m), (typically measured by reference to the historical average return to equity over a 10-50 year period); ß is the “equity beta”, the particular equity’s risk relative to that of the market for equities as a whole (measured by reference to the returns of listed companies in industries akin to that of the particular company under consideration).
Equity betas have a value of 1 where the return (and therefore the risk) is the average for the market as a whole, less than 1 where the return is less than average and greater than one where the return is greater than average. The outcome of the CAPM calculation is an estimate of the rate of return required to compensate an investor for investing in the equities of a particular type of company and is therefore a measure of the cost of equity for that type of company.
The WACC of a company is the average of the cost of equity to the company and the cost of debt to the company, weighted by the respective shares of equity and debt used by the company in financing its assets. In regulatory decision-making, the norm is to use a notional level of gearing of 60% debt and 40% equity. The real pre-tax WACC is commonly used in setting tariffs for regulated industries in Australia, one proposed by Envestra and accepted by the Commission in the present case.
The estimate of a real pre-tax WACC starts with the derivation of a nominal post-tax WACC and is then ‘grossed up’ for tax and adjusted for inflation. This complex mathematical formula is uncontroversial in this case. Envestra proposed a real pre-tax WACC formula of 7.3% based on parameters within the following ranges: Equity Beta (ß) 0.9 - 1.1, Gamma (γ) 0.00 – 0.35, Debt Margin 1.38% - 1.48%. These three ranges are very much in issue. The WACC of 7.3% was generated by applying a “Monte Carlo” simulation to what Envestra proposed as the reasonable range of values for each relevant WACC parameter.
Thus the rate of return is essentially determined by a methodology which calculates what a hypothetical firm or benchmark utility in the subject industry has to offer as the return on its equity on average, in order to attract investors. It is not determined on individual data pertaining to Envestra. As already mentioned, Envestra sought 7.3% over the period of the proposed access arrangement but the Commission rejected this figure and replaced it with a lower figure of 6.14%. This rate of return is generally of some significance in the marketplace; if set too low, investors may desert the firm, whereas if set too high, consumers will be paying too much.
As we shall see, the Commission rejected as unreasonable the ranges for Equity Beta, Gamma and the Debt Margin proposed by Envestra, and hence its real pre-tax WACC of 7.3%, concluding that the reasonable ranges were Equity Beta (β) 0.8 - 1.0, Gamma (λ) 0.35–0.6 and a debt margin of 1.245%.
With this brief examination of the broader technical concepts we can now direct attention to these three key variables. There were no differences between the parties as to either the use of the CAPM model or the WACC formula.
The divergent positions focussed on what Envestra’s counsel not altogether inaccurately described as a “spirited academic debate” between Professor Gray of Strategic Finance Group Consulting (at times “SFG”) on the one hand and Mr Balchin of Allen Consulting Group (at times “ACG” or “Allens”) on the other.[32] Envestra relied heavily on the research and opinions of Professor Gray as part of its ongoing submissions to the Commission on this, and as will emerge, other issues of contention. In turn the Commission sought advice based on the research and opinions of Mr Balchin of ACG.
Equity Beta
[32] Transcript 40 L18-21
One component in the assessment of the rate of return is the equity beta. There was a difference ranging between 0.8 and 1.0 set by the Commission and that claimed by Envestra of 0.9 to 1.1. In presenting its position Envestra relied on a number of empirical studies in the academic literature, referred to and discussed by Professor Gray in a report of 3 May 2006, prepared in response to the Draft Decision. He there reported:
1.The regulated rate of return should be selected from within an economically reasonable range that takes account of estimation uncertainty and considers the consequences of under-investment. An economically reasonable range (indeed a full probability distribution) can be established using standard Monte Carlo simulation. This technique has been endorsed by the Australian Competition and Consumer Commission (ACCC), Independent Pricing and Regulatory Tribunal (IPART) and the Queensland Competition Authority (QCA).
2.There is no evidence to support using an equity beta mid-point estimate of less than one. Mechanical estimates of the equity betas of listed Australian comparables are based on scant, unreliable, and contaminated data. Utilising a range of techniques to account for outliers, the technology bubble and other statistical issues supports an equity beta of at least one. These statistical techniques can improve the performance of beta estimates and should be included in a thorough analysis. Raw beta estimates based on short periods of data are unreliable and potentially misleading.
Moreover, differences in the form of regulations imply that gas distribution has higher systematic risk than electricity distribution in South Australia. This point has been acknowledged by Envestra, ACG, and the Commission itself in its Electricity Distribution decision. For these reasons, we believe that a range of beta that is symmetric around the (low) electricity distribution point estimate is unsupportable, and that the revised range proposed by Envestra is within the bounds of reasonableness.
In our view, all relevant considerations taken together support an equity beta point estimate of at least 1.0. Since empirical estimates and conceptual arguments in relation to equity betas inevitably involve some degree of imprecision, it is appropriate to consider an economically plausible range rather than a single point estimate. In our view, a range of 0.9 to 1.1 is an appropriate range for the equity beta estimate, having given proper consideration to a full analysis of the various data and conceptual arguments.[33]
[33] Volume 15 Tab 19 P4
The applicant contended there was ‘total support’ for this position coming from the regulator's own expert, Mr Balchin, who suggested a likely range of 0.8 to 1.1. His assessment was that an equity beta of 1.0 was the average accepted by regulators in Australia. His report of 6 January 2006 observed the direct Australian evidence “on equity betas of energy companies is deficient”, that at “face value” the market evidence “suggests a value of an equity beta for Envestra of substantially less than one and possible [sic] in the order of 0.5 …” and “regulatory precedent … for equity beta values”of “0.8 to 1.0”.[34]
[34] Volume 15 Tab 16, P72
The significant sections of that report were these:
The level of Australian data available on gas distribution betas is relatively poor, but is showing a rising trend. The Allen Consulting Group’s judgment is that a reasonable person could examine this same data and conclude that the beta was anywhere between 0.80 and 1.10. The Envestra value submitted by Envestra (a range of 1.0 to 1.10) falls within this range.[35]
…
The Allen Consulting Group considers that the empirical evidence, together with the desirability of maintaining stability in regulatory decisions over time and consistency in regulatory decisions across companies justifies the use of an equity beta of about 1.0 (for a gearing level of 60 per cent) for Envestra.
A conclusion about the systematic risk associated with Envestra has been arrived at by taking account of the fact that:
·Envestra exhibits a relatively low level of systematic risk (and potentially high gearing) compared with the average business.
·The Australian and US evidence relating to gas proxy companies has been affected by the dot-com ‘bubble’, but is supportive of the fact that the geared equity beta of the Envestra is likely to be above 0.60, and possibly above 0.80.
An equity beta of 1.0 for Envestra is equivalent to the average of recent regulatory decisions for gas businesses. The Allan Consulting Group considers that it is important in the context of regulation that there be a consistency of beta decisions across time, and that appropriate beta relativities are maintained.
Given the current estimation difficulties alluded to, the Allen Consulting Group considers that a reasonable person could adopt a range of between 0.80 and 1.1 for Envestra.[36]
[35] Volume 15 Tab 16 P40
[36] Volume 15 Tab 16, P73
In its Draft Decision of March 2006 the Commission considered Envestra’s proposed rate of return parameter of 1.0 to 1.1,[37] and tellingly observed “different minds, acting reasonably, may make a range of choices therefore consistent with the Reference Tariff Principle”.[38] It took into account that Envestra exhibits a relatively lower risk (and potentially high gearing) compared with the average business and that the Australian and US evidence was “supportive of the view that the general equity beta of Envestra is likely to be below 1.0.” Next, after quoting a section from the submission of the Energy Consumer’s Coalition of South Australia which asserted “Envestra is significantly overstating its risk profile,” it determined:
Accordingly, in the Commission’s view, considering the empirical evidence, together with the desirability of maintaining stability in regulatory decisions over time and consistency in regulatory decisions across companies, different minds, acting reasonably would derive an equity beta that lies between 0.8 and 1.0 at a gearing of 60 percent debt. The Commission is also of the view that an equity beta within this range would be consistent with the Reference Tariff Principles.
Therefore, in the Commission’s view, Envestra’s proposed range of 1.0 to 1.1 at a gearing of 60 percent debt is not a reasonable estimate of the equity beta and is not compliant with the Code.[39]
The Draft Decision also examined closely the regulatory precedents,[40] the bulk of them falling between 0.8 and 1.0, although two decisions had equity betas as high as 1.1 and 1.11 respectively. Nevertheless it formed the opinion that there was no “justification … for the upper bound of this range”.[41]
[37] Volume 3 Tab 1, P64
[38] Volume 3 Tab 1, P65 [paras 1955 and 1980]
[39] Volume 3 Tab 1 Pp69-70
[40] Table A1.23
[41] Volume 3 Tab 1, P68
Of more significance, it viewed the report of Mr Balchin (of ACG) in the following light:
With regard to the issue that the Commission’s own consultants (ACG) have advised the Commission that an equity beta of about 1 is appropriate for Envestra, the Commission notes that the consultant’s task is limited to providing technical and economic advice on the issue. The consultants do not make the decision of what value is consistent with the Code requirements; that is the Commission’s task, which it undertakes after taking into account all relevant and available information (including any advice it receives from its consultants). As such, simply because ACG is of the view that (based on its economic analysis) an equity beta of around 1 is reasonable for Envestra, it does not imply that the Commission is obliged to accept this.[42]
[42] Volume 3 Tab 1, P70
We were taken to a second report from Professor Gray dated 21 July 2006 in which he wrote:
In summary, our view is that the appropriate range for equity beta is 0.9 to 1.1 but that if a single point estimate is to be selected, the appropriate value (in light of the regulatory objectives and the consequences of mis-estimation) is at least 1.0. [43]
…
This is all precisely why we recommend the use of a range (in the context of a Monte Carlo analysis), rather than a single point estimate. After analysing the available evidence and exercising economic judgment, we concluded that the appropriate range for the equity beta in this case is 0.9 to 1.1. The mid-point of this range is 1.0, which is the equity beta of the average firm. It is also the view of ACG that this represents the best point estimate for the average Australian energy distribution firm. We have applied a symmetric range around this mid-point. The lower bound is the 0.9 estimate that ESCOSA has used for ETSA’s electricity distribution business. We use this as a lower bound for two reasons: (1) in our view this estimate is already lower than what could be considered to be a reasonable point estimate for ETSA; and (2) the systematic risk of Envestra’s gas distribution business is likely, on balance, to be higher than the electricity distribution business of ETSA. An upper bound of 1.1 completes a symmetric range and is consistent with the upper bound recommended by ACG and with the equity beta recently adopted for gas distribution by the QCA. In our view, this range is also consistent with a proper analysis of the available data.[44]
[43] Volume 15 Tab 23, P17 & 18
[44] Volume 15 Tab 23 Pp 18 & 19 – The reference to “ESCOSA” here and subsequent quoted passages is a reference to the Respondent, The Essential Services Commission of South Australia.

Although this report suggested a range of 0.9 to 1.1 Envestra’s proposal remained at 1.0 to 1.1.[45] In a report of 9 June 2006 the Allen Consulting Group of 9 June 2006 conceded “there are arguments in both directions”.[46]
[45] Volume 4 Tab 4, P69, Para 2035.
[46] Volume 15 Tab 21, P3
By the time of the Final Decision, although noting Envestra’s stance (paragraph 7.3.2), the Commission analysed the issue in this way:
Turning to the issues of substance that were raised in the SFG report, the Commission accepts ACG’s advice that it is difficult to make fine distinctions in the equity beta for matters like the form of price control that is applied to a particular regulated entity, noting ACG’s view that:
…
·it has not been the practice of Australian regulators to adopt different betas depending on the form of price control (the recent decision of the QCA that was noted by SFG being one where the decision to adopt a lower beta reflected the totality of the regulatory regime, such as the fact that the Government had a policy of absorbing changes in distribution prices rather than permitting these to be passed through to customers, and because of the extensive cost pass through arrangements that were foreshadowed).
Accordingly, to the extent that regulatory consistency furthers the objects of the Code, the Commission considers that its Draft Decision in respect of the equity beta for Envestra is not inconsistent with other decisions or the Code. The empirical evidence that SFG has asserted implies an equity beta of at least 1 for Envestra’s gas distribution activities is the empirical analysis that was undertaken by Stephen Gray (of SFG Consulting) along with Bob Officer for ETSA Utilities during the review of the Commission’s determination on that matter. The empirical evidence presented in that matter used a method the Commission had not previously considered, which was to exclude ‘outlier’ observations from the estimation of betas. The Commission analysed that evidence in some detail during that matter, and concluded that, if properly interpreted, the evidence that was presented was consistent with an equity beta of 0.90. In that matter, the Commission made two key findings, which were that:
·the ‘Blume adjustment’ is not appropriate and should be removed; and
·the definition of an outlier should be restricted to the minimal definition that was proposed by Gray and Officer.
SFG has not presented any new evidence that would lead the Commission to change its view on how that particular evidence should be presented. The Commission notes ACG’s advice that it would be undesirable to place sole weight on the outlier-adjusted estimates of beta that were provided by Gray and Officer. In particular, it noted that a number of different techniques exist for defining ‘outliers’, which can generate materially different results. It also noted that the process of removing outliers itself can induce bias in the beta estimates – which is why a leading Australian authority on beta estimation techniques advocates that, if outlier adjusted betas are to be used, account should also be taken of unadjusted beta estimates. Lastly, ACG also noted that the firms for which the Commission and Gray and Officer have estimated betas have substantial non-regulated businesses, which would be expected already to impart an upward bias in the beta estimates (although ACG also noted that it is impossible to estimate how large such a bias may be in practice),
7.3.3 Final Decision
For the reasons described above, including the analysis undertaken by ACG, the Commission determines that the equity beta range of 0.8 to 1.0 for a gearing level of 60 per cent is appropriate for Envestra and consistent with the Code for the purpose of determining the Rate of Return to be used to determine Reference Tariffs in accordance with section 8.30 and 8.31 of the Code.[47].
[47] Volume 4 Tab 4, Pp70-71 [2080-2120]
In the Further Final Decision the Commission noted the arguments put forward by Envestra “replicate those it submitted in response to the Commission’s Draft Decision;” hence it did not approve the amended revisions.[48]
Equity beta - analysis
[48] Volume 4 Tab 5, P48
In sum it was the position of Envestra that both experts were “really at one”, in as much as they both pointed to an equity beta of at least 1.0, or in the range of either 0.9 to 1.1 (Professor Gray) or 0.8 to 1.1 (Mr Balchin). The Commission determined in the Draft Decision that Envestra’s proposed range of 1.0 to 1.1 was not reasonable or was not “compliant with the Code”, because it took the range of 0.8 and 1.0 as being “consistent with the reference Tariff Principles”.
Rejection of Envestra’s range appears to have essentially been on the grounds of “the empirical evidence”, regulatory consistency and because it was thought to exhibit a relatively low level of systematic risk.
Although Mr Balchin did express an opinion that equity beta could be as high as 1.1, the empirical evidence and the regulatory precedents cited by him in the main do not bear this out. His report does not elucidate the process of reasoning or identify the precise evidence which led him to raise the higher end of the range to 1.1. It is true that there was some support for that view in two regulatory precedents, namely the 2005 Queensland Competition Authority (“QCA”) draft determination (range of 0.78 – 1.11) and the IPART determination (point value of 1.1).[49] In its Final Decision of May 2006 the QCA adopted an equity value of 1.1,[50] yet the situation in Queensland might be distinguishable.[51]
[49] Volume 3 Tab 1, P254
[50] Volume 10 Tab 22, P92
[51] Volume 10 Tab 2, P106, para 5.
The reasons of the Commission at first sight might appear to suggest it approached the exercise from the perspective that as reasonable minds might differ, it was entitled to make its own choice. The language employed tends to lend some support for that view. However on close analysis it did no such thing. It was entitled to be sceptical of the views of Professor Gray because he furnished no evidence to support an equity beta as high as 1.1, because of defects in his methodology identified in the Final Report[52] and because he expressed opinions which were the Commission to form in accordance with the Code and not his. Having considered this and the other evidence, especially the regulatory precedents, the Commission formed the necessary threshold opinion that a reasonable range for equity beta lay between 0.8 and 1.0, that Envestra’s range fell outside a reasonable range of values and was therefore non-compliant with the Code.
[52] Quoted above Volume 4 Tab 4, P70
It follows the Commission identified a proper “threshold of non-approval” and having done so it was then at liberty to set the content of its own range of values within the parameters of the Code. Accordingly no reviewable error is disclosed pursuant to s39(1)(2)(iii) or pursuant to s39(2)(a)(ii) of the Access Law.
Gamma
A second hotly disputed component in the rate of return formula was the variable gamma. This represents the value to a shareholder of franking or imputation credits. The higher the value of gamma (other things being equal) the lower the rate of return on equity needed to satisfy shareholders. Gamma is the product of two components - F, the proportion of franking credits distributed and theta, the value of these credits to shareholders. Gamma can take a value from zero to one. Its actual value is entirely dependent on empirical investigation into each component.
In this case Envestra suggested a range for gamma of 0 to 0.35, a range once again substituted by the Commission, to one of 0.35 to 0.6. Both parties agreed on the method of calculation and accepted the determination of gamma was essentially an empirical question of fact, one dependent upon the research and the accuracy of the available data.
We were referred once again in this context to the report of Mr Balchin to the Commission of 16 January 2006 in which he proffered the view:
The recent application of a range of gamma values below 0.50 in gas distribution and transmission cases reflects the GasNet decision and a number of recent studies, which suggest that the value of gamma may be significantly below 0.50, in particular the studies by Cannavan, Finn and Gray, and Hathaway and Officer (Capital Research Pty Ltd). These studies proposed that gamma for the average large Australian company is zero and 0.355 respectively.[53]
…
Allen Consulting Group (2005): 1997-2000 and 2000-2005 periods
A major problem with all the studies described above is that they pre-dated (or the vast majority of their data pre-dated) the current set of taxation arrangements, governing imputation credits and corporate taxation in general. Since 1 July 2000, Australian financial institutions (which are taxed at a rate of 15 per cent of income) have been able to claim a rebate from the Australian Taxation Office for tax paid at the corporate level and, since 1 July 2001, the corporate taxation rate has been 30 per cent. These are the taxation parameters relevant to the current valuation of Australian businesses, but there are no published studies estimating gamma for this period.[54]
…
For the period of 1997 to 2000 after the imposition of the 45-day rule and prior to the rebate allowance for low-taxed institutions, the value of franking credits (theta) is not statistically different from zero. This corroborates the findings of Cannavan, Finn and Gray for the same period using data on derivatives trading. Also, in the period July 2000 to June 2003, immediately following the allowance of a cash imputation rebate for Australian financial institutions, the value of theta is not statistically different from zero. However, in the last two years, July 2003 to June 2005, the value of theta is estimated at 74.3 percent for companies with a market capitalisation over $500 million, and this value is statistically different from zero at better than the 99 percent confidence level. For the whole of the period 2000 to 2005, the average theta observed is 29 per cent.
…
These results supports the proposition that the imposition of the 45-day rule in 1997 eliminated any value that franking credits previously had. However, the strongly statistically significant result for the past two years indicates that, presently at least, imputation credits are being valued in the Australian market at around three quarters of their face value. Such a result is consistent with the notion that, in the past two years, Australian institutional investors have been the marginal (price setting) investors in large Australian companies.
It is puzzling that the introduction of the cash rebate in July 2000 did not have an immediate on the value of franking credits. However, Brown and Clarke and Bruckner, Dews and White found the valuation impact of franking increased in the years following introduction in 1987. This observation could be seen as consistent with a clientele effect forming over time.[55]
…
[53] Volume 15 Tab 16, P58
[54] Volume 15 Tab 16, P60
[55] Volume 15 Tab 16, P61
Conclusion on the value of dividend imputation
The Allen Consulting Group’s own recent empirical analysis of the value of theta, is the most up-to-date available, and is reflective of current tax rates, laws and economic conditions. This evidence indicates current value of franking credits as a proportion of their face value (θ) is about 74 per cent. A benchmark utility would have an incentive to distribute all of its franking credits over time. Applying a distribution rate of between 100 per cent indicates a value of franking credits to shareholders (y) of around 75 per cent. However, there is some recent evidence that gamma may at times be zero. On this basis, a range of values for y of between 0.35 and 0.60 is recommended be considered in assessing the rate of return for Envestra. A gamma of 0.35 estimated by Hathaway and Officer is considered to define the lower boundary of a reasonable estimate for a benchmark utility, as such a utility would distribute a far higher percentage of its dividends (and franking credits) than the average business considered in the Hathaway and Officer study.[56]
[56] Volume 15 Tab 16, P62
The Hathaway and Officer study was also referred to in a report from the Allan Consulting Group to the Commission of 16 February 2006.
The March 2006 Draft Report of the Commission opted for the range 0.35 to 0.6 accordingly:
7.8           Value of imputation Credits
7.8.1        Proposed revised Access Arrangement
Envestra proposes a range of values of imputation credits (gamma values) of between 0 and 0.35, citing recent empirical analyses indicating a lack of support for a gamma value of 0.5 as previously applied by regulators under the Code.
7.8.2        Commission’s considerations
In the Commission’s view, the two key studies relied upon by Envestra to set the upper and lower bounds of its proposed gamma range of zero to 0.35 should not be applied to obtain a benchmark utility under current market and tax arrangements and do not represent a reasonable value that is consistent with the Reference Tariff Principles. The Commission accepts and adopts the ACG’s analysis of gamma referred to in item A1.4 of Appendix 1 and notes the following matters:
▲     Envestra’s lower bound gamma of zero – the Commission notes that the ACG found evidence supporting the conclusion of Cannavan et al that theta (and therefore gamma) for the period 1997 to 1999 was zero. The ACG also noted, and the Commission accepted, that applying a consistent dividend drop-off methodology for the period covered by Cannavan et all and for the most recent period, yields a significantly positive theta of around 75 percent for the last two years. Hence, Envestra’s lower bound gamma of zero is not supported by evidence applying to the current taxation arrangements.
▲     Envestra’s upper bound gamma of 0.35 – Envestra’s upper bound gamma of 0.35 was based on Hathaway and Officer’s (2004) result that for the average firm a theta of 0.50 and an F ratio of 71 percent are the appropriate assumptions. Hathaway and Officer clearly stated that their recommended gamma of 0.35 related to the ‘average’ company. Due to very low growth options, a benchmark utility company should have an F ratio of close to 100 percent, which would imply a gamma of close to 0.50. However, Hathaway and Officer’s research suffers from the fact that the theta estimate of 0.50 is made over a long period of changing tax arrangements, and their findings for the most recent years indicate a theta in excess of 0.60.
The Commission accepts that the estimate of gamma is a matter which different minds, acting reasonably, may make a range of choices that are consistent with the Reference Tariff Principles. However, for the reasons noted above, in the Commission’s view, the range selected by Envestra would not fall within such a range. Accordingly, the Commission’s view is that an appropriate range for the gamma value is between 0.35 and 0.60 for the purpose of determining the Rate of Return to be used to determine Reference Tariffs in accordance with sections 8.30 and 8.31 of the Code.[57]
It adhered to this position in the Final Decision of June 2006. [58]
[57] Volume 3 Tab 1, P82
[58] Volume 4 Tab 4 P79 paragraph 7.8.3
In a report prepared for the applicant of 3 May 2006, Professor Gray opined thus on the gamma issue:
In our view, it is impossible for a reasonable person to reach the conclusion the Commission has, that the evidence supports a range of 0.35 – 0.60 for gamma. The better interpretation of the evidence, and having regard to consistency with the model in which it is to be used, is that an appropriate value for gamma is zero. We are aware that Envestra’s revised proposal uses a range of 0 to 0.35 for gamma, with more weight given to values at the lower end of this range. In our view, the empirical evidence and conceptual considerations, taken together, indicate that an appropriate value for gamma is zero. We can see no basis whatsoever for serious consideration to be given to any value greater than 0.35.[59]
Next, in a memorandum to the Commission of 9 June 2006 Mr Balchin wrote:
ACG’s response: ACG’s previous report did not claim that its research had settled the issue of gamma measurement, and noted that its finding of recent periods in which no gamma valuation effect could be found indicates that caution should be exercised by regulators. At the same time the finding of a relatively high and statistically robust Theta in the most recent years leads us to conclude that a 0.50 gamma continues to be the best point estimate given current taxation arrangements, and its continued application is justified in the absence of conclusive evidence to the contrary.
…
In the attached Appendix to this note we show the results of further tests that we undertook to demonstrate the robustness of the finding that during the last two years (2004 and 2005) the estimated Theta is well above 0.50. The fact that ACG’s analysis arrived at the same Theta estimate that would be obtained by a simple regression does not invalidate the result. We have confirmed the result ACG found in its initial analysis of the data. We have found that the Theta estimate of 0.74 obtained in ACG’s original report is relatively robust, and that problems such as multicollinearity and hetroskedasticity are not present in a way that would invalidate the result. For different sub-samples of large cap firms, and for a different sample of smaller cap firms, the results confirm that for the period covering the financial years 2004-2005, there appears to have been a relatively strong valuation effect based on dividend imputation.[60]
[59] Volume 15 Tab 19 P32
[60] Volume 15 Tab 21 PP9-10
In writing a response to the Final Decision on 21 July 2006, Professor Gray remained adamant that the only gamma consistent with all the data was one set at zero.[61] He adhered to that view in another report of 27 September 2006.[62]
[61] Volume 15 Tab 23, P39
[62] Volume 15 Tab 30
The question of the effect of the July 2000 tax changes on the assessment of gamma then became an issue of some importance. It was taken up by Professor Gray in his report of 21 July 2006:
It seems that there are only two explanations to this “puzzle”. One is that the estimates that are produced by this empirical work are unreliable. We explore the statistical basis for this in the subsequent section. The second is that Australian financial markets have collectively mis-valued franking credits for long periods of time – three years after a franking credit rebate is made available to charities and welfare recipients, the whole market suddenly realises that franking credits have a substantial value.
If we prefer the former explanation, the ACG results are affected by statistical problems and are therefore unreliable. If we prefer the second explanation, market data is so unreliable that we should not rely on it. In particular, how do we know that the market was mis-valuing franking credits from 2000-03, but has correctly valued them from 2003-05? Surely it is just as likely that the reverse is true – that the current valuation is wrong and the former was correct. That is, if we do accept that the market systematically mis-values franking credits for substantial periods, how do we know which periods contain correct valuations and which contain mis-valuations? In our view, a substantial reason must underpin any decision to focus on data from a particular period. We accept that substantial tax law changes might affect the appropriate estimate of gamma. For example, a 1997 tax amendment effectively eliminated the ability of foreign investors to “sell” franking credits to residents and the empirical evidence suggests that this impacted on the value of gamma. However, the 2000 rebate provision applies only to non-taxed investors who are unlikely to have a measurable impact on broad financial markets. Moreover, the ACG results suggest that this amendment had no measurable impact on the value of franking credits for at least three years and this result is ignored when ESCOSA sets its range for gamma. That is, the ACG study is motivated by the 2000 rebate provision and an argument that data from pre-2000 is “redundant”. However, in setting the range for gamma, the majority of the post-2000 data is ignored. Only two of the five years of data is considered relevant.
Neither ACG nor ESCOSA explain the basis for concluding that in a small sample over 2004-05 the market has finally got it right when the same methodology implies that the market has systematically mis-valued franking credits in the past. An alternative explanation is that it is the empirical technique that is being used to estimate gamma, rather than the collective Australian financial market, that is not up to the task.[63]
[63] Volume 15 Tab 23, Pp27-28

The “regulatory accounts” referred to could only have been those of OEAM, as there was already an obligation on Envestra as a regulated entity to supply its own under the Access Law. Counsel for the applicant acknowledged it understood that to be the position.
Network management fee analysis
The applicant mounted a substantial attack on this whole process of reasoning. It argued that it had demonstrated Envestra was paying the management fee according to sound and accepted industry practice, so that this should be the end of the matter. The Commission, acting reasonably, could only properly exercise a discretion by approving the fee. Envestra had also conclusively demonstrated there was no “double dipping” involved.
It appears tolerably clear that what ultimately moved the Commission to its concluded view was the failure of Envestra to “provide any evidence” that the “indirect costs … met the requirement of s8.37 of the Code.” Although the reasons are somewhat discursive at times, in the end the operative consideration was the failure of Envestra to demonstrate compliance with the Code and especially that it had not produced enough material in order to demonstrate to the satisfaction of the Commission that a prudent service provider would incur such a fee or that it endeavoured to achieve “the lowest sustainable cost”, in accordance with s8.37 of the Code.
No doubt the Commission was entitled to examine all relevant aspects of the management fee, including its origins and the commercial and practical realities in which it arose. The applicant’s counsel accepted that. Nonetheless, when giving attention to the Reference Tariff Principles in general and allowable Non-Capital Costs in particular, the Commission was necessarily required to assess those costs for the prospective period of the access arrangements then under negotiation. Although in several places the Commission reverts back to the situation existing at the time when the fee was first agreed, in reality it was clearly seeking information about the existing arrangements and the current regulatory accounts, which could only have related to the merits of the present and therefore the proposed commercial arrangements.
Envestra strongly argued before us that the conclusion of the Commission was both speculative and based on mere supposition, especially since these arrangements had been in place for upwards of ten years and had passed unscathed, indeed unquestioned.
This discussion leads to a legal point taken by the Commission. It was contended that it was not obliged to consider any material (to adopt a neutral phrase as this point) supplied by Envestra between the Final Decision and the Further Final Decision, as these could not be “submissions” of the kind authorised by the Access Law. We briefly outlined the process of negotiations in and about the access arrangements earlier in these reasons. Further elaboration becomes necessary in the present context. That process contemplates three distinct stages: the Draft, the Final and the Further Final decision making processes. Before the Draft and Final decisions, the Commission is required to receive submissions (ss2.33, 2.37 and 2.38) and it may in its discretion receive at each of those two phases “submissions” arriving later than the date specified: (ss2.34 and 2.37).
Thereafter the regime is different. Between the Final and the Further Final phases, there is no longer any provision for making or being obliged to consider “submissions”. After delivering the Final Decision the task of the Regulator becomes that described by the Access Law:
2.39The Relevant Regulator must provide a copy of its final decision to the Service Provider, any person who made a submission on the matter and other any person who requests a copy.
2.40If the Relevant Regulator decides not to approve the revisions to the Access Arrangement under section 2.38(a)(ii) or (b)(ii) the Service Provider must, if the revisions it proposed were proposed as required by the Access Arrangement, submit amended revisions to the Relevant Regulator by the date specified by the Relevant Regulator under section 2.38(a)(ii) or (b)(ii).
2.41If the Service Provider submits amended revisions to the Access Arrangement by the date specified by the Relevant Regulator under section 2.38(a)(ii) or (b)(ii) then the Relevant Regulator must issue a further final decision that:
(a)if the Relevant Regulator is satisfied that the amended revisions to the Access Arrangement incorporate the amendments specified by the Relevant Regulator in its final decision under section 2.38(a)(ii) or (b)(ii), approves the amended revisions to the Access Arrangement; or
(b)if the Relevant Regulator is satisfied that the amended revisions to the Access Arrangement either substantially incorporate the amendments specified by the Relevant Regulator or otherwise address to the Relevant Regulator’s satisfaction the matters the Relevant Regulator identified in its final decision as being the reasons for requiring the amendments specified in its final decision under section 2.38(a)(ii) or (b)(ii), either approves or does not approve the amended revisions to the Access Arrangement (in the Relevant Regulator’s discretion); or
(b)in any other case, does not approve the amended revisions to the Access Arrangement.
It can be seen these provisions do not contemplate, nor do they permit submissions beyond the Final Decision stage. They allow only for amended revisions to the access arrangements – fine tuning as it were. From that point onwards the statutory task is more or less whether to approve the amended revisions or not.
The contention raised by the Commission was that it was not strictly entitled to consider the material presented after the Final Decision and that Envestra failed to submit amended revisions. To the contrary it persisted to make further representations it was not entitled to make. This accurately describes the situation, at least according to the strict letter of the legislative scheme.
But whatever the legal niceties may technically be, the Commission for all practical purposes treated the material received after the Final Decision as a submission and framed the amendments required to bring them into line with the requirements under the Code on that understanding. It also obtained the report from Mr Balchin after the Final Decision, so it proceeded to deal with the ongoing issues in much the same way as it had beforehand. Furthermore, it acted inconsistently by stating that it did not consider that material in reaching its Further Final Decision at one point, whilst at another that it did so only to the extent that it was relevant to its task in making the Further Final Decision. [197]
[197] Volume 4 Tab 5, P2
Given these considerations, this situation involved the provision of material comprising, if nothing else, “related … or proposed access arrangement … information” within the meaning of s39(5)(ab) of the Access Law and as such this court is entitled to consider it.
The case for the applicant was built substantially on the strength of the reports and other supporting material produced by Envestra, which its counsel described as going “… all one way: it was unchallenged and it was un-argued; it was simply rejected”.[198] He furthered the argument by submitting any question of an uncommercial incentive existing at the time it was entered into, was “supposition and speculation in the absence of any evidence whatsoever”.[199] There was said to be relevant factual error in finding an intention to inflate the fee, that it represented a profit margin, by failing to have regard to the evidence produced and by not addressing the actual question whether it was an allowable expense under s8.37.
[198] Transcript 232 L34-38
[199] Transcript 226 L1-5
The respondent’s position is succinctly captured in these submissions on its behalf:
What is not stated here but what appears elsewhere is that this 3% management fee is not separately accounted for or shown, in the report of WorleyParsons, rather the 3% management fee is somehow, in an unexplained way, embedded in the numbers for these operational categories.[200]
…
…the essential point that bothered the Commission, really the nub of its inability to be satisfied in relation to the network management fee was this: it says ‘…Envestra and OEAM are now at arm's length. We see that this contract is structured in a way that OEAM can, under clause 10.2, recover all of its overheads in its invoiced costs. You are now coming along and saying "As a matter of practice there are overheads that aren't invoiced"… and they add up miraculously to just the same dollar amount as you get if you take 3% of Envestra's revenue. Now … you are telling us in one high level assertion in the letter that we get a couple of days before we make our final decision.' We find it difficult to accept that OEAM rationally, in its own self-interest now in an arm's length relationship with Envestra, would not recover whatever it appears to be entitled to recover under clause 10.2. We cannot accept in the absence of some business records to back it up, that this high level assertion there are unrecovered overhead costs, not recovered under 10.2, as made out. That is really the essence of the reasoning of the commission in its final decision.[201]
[200] Transcript 435 L8-13
[201] Transcript 445 L14-L34
In our opinion there is no escaping the conclusion that the Commission rejected the fee because it was not satisfied on the material furnished to it, that the fee was one an efficient and prudent service provider would incur, or that it was aimed at delivering the service at the lowest sustainable cost. In our considered opinion Envestra was less than forthcoming about the components of the fee all along. It delayed in dealing with the merits, which were clearly flagged in the Draft Decision of March 2006. The benchmarking evidence presented by it was fairly broad and not at all definitive in a quantitative sense. It may well have been cheaper for Envestra to outsource the network management operations, objectively speaking. The outstanding question remained unanswered, whether the cost actually incurred was consistent with the lowest sustainable cost that would have been incurred by a prudent operator, whatever those costs were. The correspondence between OEAM and Envestra and the Commission is more revealing for what it fails to disclose than what it does.
It is difficult to appreciate exactly why OEAM was being so precious, putting aside issues of commercial confidence. It was contractually obligated to co-operate with Envestra in relation to the provision of information to the Regulator (clause 4.2(c)). As we have seen it was also obliged to furnish detailed invoices, including those claiming a bonus (clause 10.8(c)) and it was in addition obligated on the written notice of Envestra to benchmark its projected costs and implement a program to reduce them, if they were excessive (Clause 9.6).[202] The former was precisely the very kind of information the Commission was seeking to inspect.
[202] Volume 7 Tab 2, P30
In the final analysis, the Commission was of course required to take into account and weigh (amongst other things) various competing considerations, including that Envestra was entitled to earn a stream of revenue covering the efficient costs of delivery (Code s8.1(a)), its legitimate business interests and contractual obligations (including the contract under discussion), as well as the economic efficiency of its operations (Code s2.24), when deliberating on the relevant value of specified Non-Capital costs consistent with ss8.36 and 8.37.
The submissions for Envestra do not satisfactorily deal with the considerable room for profit making otherwise available under clause 10.5 of the operating and management agreement. Nor do they completely dispose of the compelling reasons to unveil the cloak erected over the substance of those arrangements. There were legitimate reasons for seeking further information. The remunerations clauses contained unusual features, including the pegging of the margin to revenue earned by Envestra rather than OEAM and that it is and was fixed at 3% in perpetuity. On the surface, neither appear to be in any way related to the actual costs incurred in the provision of the services. Furthermore, the contention that the Network Management Fee was not profit related fits awkwardly with the structure and content of the entire remuneration regime under the contract itself.
We feel it fair to say there was a measure of fault on both sides. On the one hand Envestra knew well in advance of the deadline for the final decision was to be 30 June 2006. The Draft Decision of March 2006 made it clear the Commission thought the Network Management Fee was a margin on OEAM’s costs and so by draft amendment 64 it required changes accordingly. [203] This issue was live from then on, one on which Envestra significantly changed tack. It remained tardy in responding and proved unwilling to provide the requested information. In that situation it is bound by the conduct of its case to the Commission: Port of Melbourne Authority v Anshun Pty Ltd.[204]
[203] Volume 3 Tab 1, Pp.153-154 & 164
[204] (1981) 147 CLR 589
On the other hand, the respondent seems to have directed its early enquiries in generalities. Only later did the precise material it was seeking become apparent. In such circumstances it should have been prepared to nominate with a higher degree of precision precisely what was required. It could also have given more time for that purpose and to discuss the matter with OEAM or even Origin.
The factual and other errors alleged by the applicant have not been made out, because the essence of the Commission’s decision centred upon the failure to secure for examination the primary or regulatory records or invoices of OEAM, in order for them to be duly considered against the Non-Capital Costs requirements of the Code. There was no relevant reviewable error in requesting that information and resolving the issue as it did, in light of Envestra’s intransigence.
The Commission was entitled to examine directly the costs incurred, rather than benchmark margins. Since OEAM was required to fully particularise its accounts to Envestra under the contract and was also required to assist with inquiries by the Commission, on the face of matters it should not have been a difficult or onerous task to produce that material for inspection. There were always ways and means of protecting OEAM’s commercially sensitive information, if needs be.
Even if there was error, we have insufficient material to judge the merits and therefore we are not in a position to make any variation that would do other than arbitrarily select one or other of the two competing views. The material relevant to this issue, such as it was, is largely based on general premises rather than on the specific invoicing arrangements. Like the Commission, we have insufficient material available to us to assess for ourselves whether the 3% network management fee conforms with ss8.1, 8.36 and 8.37 of the Code. [205]
[205] Compare Re Telstra Corp Ltd (No 3) [2007] ACompT 3 at [430-432] and Re Telstra Corp Ltd (2006) ATPR 42-121; [2006] ACompT 4 at [44-46]
In the wash we find ourselves, then, in much the same position as the Australian Competition Tribunal found itself in Re Telstra Corp Ltd:[206]
Having regard to the conclusions which we have reached it is not necessary to determine whether Telstra’s costs were established as efficient costs. However, we would point out that whenever an access provider seeks approval of an access undertaking from the Commission which involves a consideration of a price term by comparing it with costs, it would be necessary, in order to satisfy the statutory framework, that the access provider establish that its costs are efficient costs. An access provider should also recognise that if the Commission decides against accepting the access undertaking and rejects it and the provider wishes to seek review of the Commission’s decision before the Tribunal, it would be necessary to establish before the Tribunal that its costs are efficient. It is apparent from the statutory framework that the Tribunal is limited in respect of the material to which it may give consideration as it is limited to the material which was before the Commission and any material referred to in the Commission’s decision. Put shortly, if an access provider wishes to establish before the Commission, or needs to establish before the Tribunal, that its costs are efficient, it will need to have put material to that effect before the Commission.
[206] (2006) ATPR 42-121; [2006] AcompT 4 at [46]
We have not overlooked the fact that in July 2006 the Queensland Competition Authority considered this very issue and determined Envestra’s “Non Capital Costs (including the Network Management Fee)…were generally prudent and efficient”.[207] It was accepted by the respondent in these proceedings that those arrangements in respect of the Network Management Fee were precisely the same as they are here in South Australia. Even then, the QCA noted there were some doubts about the fee and merely “assumed” that over time they would lead to efficiencies in the delivery of these out-sourced operations.[208] In any case, closer examination of the decision reveals the QCA allowed forecast Non-Capital costs that were significantly lower than Envestra proposed.[209]
[207] Volume 11 Tab 37, P8
[208] Final Decision of QCA, Volume 10 Tab 22, P118
[209] Volume 10 Tab 22, Pp 125-126 Table 13.3
It must also follow that our decision with respect to the Network Management fee is based entirely on procedural grounds, which do not lend themselves to an examination of the merits. In that state of affairs we are neither able to endorse nor disapprove of the 3% fee in this particular matter, as there is no basis for us to do so in the proper discharge of our statutory remit. That being so, our decision is confined to the finding that as the course of events unfolded and in light of the stance taken by Envestra, the Commission acted within the limits of its statutory authority and discretions, in concluding that it was not satisfied the fee came within the Reference Tariff Principles in general or within the allowable Non-Capital costs in particular, on the material submitted or otherwise forwarded to it on that score.
Payment Terms
This head of review was abandoned during the course of submissions by the applicant, in conjunction with the next head of complaint pursuant to an agreement reached between the parties. That agreement embraces a consent order that there be no order as to costs of either.
Environmental Management Costs (site remediation)
As just indicated, this final ground of complaint was settled between the parties during the course of the hearing, effectively by the Commission making a concession of error of fact by it within the meaning of s39(2)(i) of the Access Law. This results in an allowance to Envestra of $2.2m for site remediation of two sites at Brompton and Port Pirie. The parties have leave to file short minutes of order giving effect to the settlement terms under this and the previous head accordingly.
Formal orders
The application for review against the Further Final Decision of the Essential Services Commission of South Australia dated 27 October 2006 is allowed in relation to the Rate of Return, to the extent that the range selected for gamma of 0.35 to 0.6 will be varied to 0.35 to 0.5, effective immediately. The application for review is also allowed to the extent necessary to give effect to the agreement between the parties in relation to payment terms and site remediation. On all other grounds it is otherwise dismissed.
We will hear the parties as to the precise terms of the formal orders to be entered consistent with these reasons and as to costs. Both parties have liberty to apply on short notice