Metro Trains Melbourne Pty Limited
Access Arrangement Information
31 March 2011
Access Arrangement Information March 2011
Contents
INTRODUCTION...... 3 1.1 Purpose of this Document ...... 3 1.2 About ConnexMetro...... 3 1.3 Description of the Network...... 3 1.4 Relationship between Connex Metro and the State of Victoria ...... 4 1.5 Victorian Rail Access Regime and this Access Arrangement...... 4 1.6 The Requirement for an Access Arrangement and Access Arrangement Information...... 5 1.7 Approval of ConnexMetro’s Access Arrangement ...... 6 1.8 Interpretation...... 8 1.9 Contact Details...... 8
2 Key Features of the Access Arrangement ...... 9 2.1 Background ...... 9 2.2 Scope of this Access Arrangement...... 9 2.3 Train Path Request Process and Protocol...... 9 2.4 Pricing Principles ...... 10 2.5 Variation of the Access Arrangement ...... 11
3 SERVICES ...... 12 3.1 Freight Reference Services ...... 12
4 FORECAST REVENUE REQUIREMENT ...... 13
5 CAPITAL BASE...... 14 5.1 Opening Asset Values as at 1 July 2006 ...... 14
6 FORECAST CAPITAL EXPENDITURE ...... 15
7 FORECAST DEPRECIATION ...... 16
8 COST OF CAPITAL...... 17 8.1 Connex Metro Approach...... 17 8.2 Real Risk Free Rate ...... 17 8.3 Capital Structure...... 17 8.4 Equity Beta...... 17 8.5 Market Risk Premium ...... 18 8.6 Value of Imputation Credits...... 18 8.7 Debt Margin ...... 18 8.8 Real Pre-Tax Weighted Average Cost of Capital...... 18
9 FORECAST OPERATIONS AND MAINTENANCE COSTS ...... 20 9.1 Summary of Operations and Maintenance Costs ...... 20 9.2 Operational Costs...... 20 9.3 Maintenance Costs ...... 21
10 FORECAST REVENUE REQUIREMENT ...... 27 10.1 Derivation of Forecast Revenue Requirement ...... 27 10.2 Smoothing of the Revenue Requirement for Reference Services ...... 27
Metro AAI_V1 1
Access Arrangement Information March 2011
11 REFERENCE TARIFFS ...... 29 11.1 Derivation of Reference Tariffs ...... 29 11.2 Tariff Structure...... 29
12 Rail Movement Forecasts...... 30
Metro AAI_V1 2
Access Arrangement Information March 2011
INTRODUCTION
1.1 Purpose of this Document
This document is the Access Arrangement Information in relation to the Metro Trains Melbourne Pty Limited (ABN 43 136 429 948) rail network and is submitted by Metro Trains Melbourne Pty Limited (“Metro”) to the Essential Services Commission of Victoria (the “Commission”) in accordance with sections 38W and 38X of the Rail Management Act 1996.
The purpose of this document is to set out such information as is necessary to enable Operators to understand the derivation of the elements of the Access Arrangement and to form an opinion as to the compliance of the Access Arrangement with applicable legislation and Guidelines released by the Commission.
1.2 About Metro
Metro is the company that bid and won the franchise to operate and maintain the Melbourne metropolitan train network. Metro commenced the franchise operation on 30 November 2009.
Metro shareholders are:
MTR Corporation Limited (Hong Kong) – 60% John Holland Melbourne Rail Franchise Pty Ltd - 20% UGL Rail Services Ltd – 20%
Metro operates a vertically integrated above and below rail operation. It is the operator and track manager of the Melbourne metropolitan rail network and the associated passenger services.
1.3 Description of the Network
The network covers fifteen (15) electrified main lines from Sandringham, Frankston, Cranbourne and Pakenham in the south east of Melbourne and travels in an arc that covers Glen Waverley, Alamein, Belgrave and Lilydale in the east, Hurstbridge and Epping in the north-east, Upfield and Broadmeadows in the north, Sydenham in the north-west and Werribee and Williamstown to the west.
There is also a branch line between Newmarket and the Flemington Racecourse which operates for special events traffic, including the Royal Melbourne Show and the Spring Racing Carnival at Flemington.
In addition to the electrified area, Metro also operates passenger services on the non electrified Frankston to Stony Point line.
However, Metro is not responsible for certain track work on and around Southern Cross Station used by other operators such as V/Line Pty Ltd.
Metro operates around 13,365 revenue services per week as well as around 1,539 planned empty train movements per week. There are 398 route kilometres and 802 main line track kilometres.
Due to the radial design of the rail infrastructure emanating from Melbourne, it is necessary for freight services travelling from Eastern Victoria to Western or Northern Victoria, and visa versa, to pass through the network. All country freight services must operate over the network in order to reach the freight terminals in Melbourne. All country and interstate passenger services travelling to and from Melbourne must also utilise the Network. Metro has Access Agreements with all third parties that utilise its network.
Metro AAI_V1 3
Access Arrangement Information March 2011
Metro has responsibility for the Master Timetable approved by the State Government, which schedules all metropolitan passenger services, and also has responsibility for approving train paths for all freight, country and interstate passenger services that require access to the network. This ensures that the network use is maximised to meet the priority of providing metropolitan and country passenger services and also freight services.
The Master Timetable:
• incorporates scheduled V/Line pathways set out in the existing Access Agreement with V/Line and these pathways cannot be changed without agreement with V/Line or the consent of the State; and
• includes scheduled freight pathways set out under Access Agreements which cannot be changed without the agreement of freight operators. In addition to the various Access Agreements there are established protocols and operating procedures to effect these Access Agreements.
1.4 Relationship between Metro and the State of Victoria
Metro has the franchise from the Director of Public Transport on behalf of the State Government to operate the metropolitan passenger train network.
Metro also has a contract with the State Government to maintain and upgrade the Network and is responsible, in conjunction with the State, for delivering a number of major infrastructure projects such as the Sunbury electrification project, South Morang extension and the Regional Rail Link.
1.5 Victorian Rail Access Regime and this Access Arrangement
Section 38E of the Rail Management Act 1996 provides that railways and tram infrastructure are a regulated industry for the purposes of the Essential Services Commission Act 2001.
The Essential Services Commission Act 2001 establishes clear objectives that the Commission is required to pursue in performing its functions. Its primary objective is to protect the long-term interests of Victorian consumers with regard to the price, quality and reliability of essential services. The Commission's objectives also include a requirement to promote a more certain and stable regulatory framework which is conducive to longer-term infrastructure investment and to maintain the financial viability of regulated utility industries.
Other key objectives and obligations of the Commission include requirements to:
• have regard to relevant health, safety, environmental and social legislation in its decision-making;
• be consultative and transparent in its processes and to publish a Charter of Consultation and Regulatory Practice; and
• co-ordinate formally with other regulators to avoid duplication and to achieve more integrated decisions and outcomes.
The Rail Management Act 1996 provides the Commission with two further objectives – being:
• To ensure access seekers, and any other person the Commission considers may want to be provided declared rail transport services, have a fair and reasonable opportunity to be provided declared rail transport services; and
Metro AAI_V1 4
Access Arrangement Information March 2011
• To promote competition in rail transport services to achieve an increase in the use of, and efficient investment in, rail infrastructure or tram infrastructure (as the case requires).
1.6 The Requirement for an Access Arrangement and Access Arrangement Information Metro is required to submit to the Commission for approval a proposed Access Arrangement in relation to declared rail transport services.
The proposed Access Arrangement must include information that an Operator would reasonably require to understand the derivation of the elements of the Access Arrangement so as to form an opinion as to whether the Access Arrangement complies with the access regime. In particular, the Access Arrangement1 must at a minimum:
a) in relation to every reference service to which the arrangement relates, include— i. a description of the service. This is set out by Metro in section 2 of the Access Arrangement; ii. information as to whether that service is being provided by the access provider to itself or a related body corporate of the access provider. This is set out by Metro in Section 1.1 of the Access Arrangement; iii. the terms and conditions for the provision of that service. This is set out by Metro in Attachment A to the Access Arrangement, and summarised in Section 5 of the Access Arrangement; and iv. the price, or methodology for the calculation of the price, to be charged in respect of the provision of that service. This is set out by Metro in Section 3 of the Access Arrangement (Reference Tariffs) and sections 4-12 of this Access Arrangement Information (the methodology for the calculation of the price); b) include information in relation to the availability and the indicative terms and conditions, for the provision of declared rail transport services that are not reference services. This is set out by Metro in section 2.3 of the Access Arrangement; c) include a description of the information that the access provider will make available to an access seeker. This is set out by Metro in section 2.3 of this Access Arrangement Information and in the Train Path Request Process and Protocol set out in Attachment B to the Access Arrangement; d) set out the procedure for the making of an application by an access seeker for the provision to them of a declared rail transport service. This is set out by Metro in the Train Path Request Process and Protocol set out in Attachment B to the Access Arrangement. This Protocol also references the Additional Capacity Works Protocol which is provided as Attachment C of the Access Arrangement; e) describe the procedure and method how the access provider will assess and determine an application for the provision by them of a declared rail transport service. This is set out by Metro in the Train Path Request Process and Protocol set out in Attachment B to the Access Arrangement; and f) specify a date for the expiry of the access arrangement, being a date that is not less than 3 years, and not more than 5 years, after the date on which the access arrangement may be approved by the Commission under this Part in a final decision. This is set out by Metro in section 1.2 of the Access Arrangement. The Commission also requires that Metro provides: • a ‘cost allocation policy’ and ‘templates’ for providing accounting information to the Commission under the account keeping rules. The Costs Allocation Policy is
1 Section 38X of the Rail Management Act 1996
Metro AAI_V1 5
Access Arrangement Information March 2011
provided as Attachment D and the Pro-forma Regulatory Accounts Templates are provided as Attachment E of the Access Arrangement;
• a Capacity Allocation Protocol under the capacity use rules. This Protocol is provided as Attachment F of the Access Arrangement;
• a ‘network operating handbook’ and ‘rolling stock interface standards’ under the network management rules, provided by Metro as Attachment G of the Access Arrangement;
• system and business rules as set out in the Information Handling Protocol, being Attachment H of the Access Arrangement for:
o The use or handling of information supplied to the access provider in confidence by an access seeker or a user, including the use or handling of that information by an officer, employee or agent of the access provider;
o The disclosure of information supplied to the access provider in confidence by an access seeker or a user, including the disclosure of that information by an officer, employee or agent of the access provider; and
• This Access Arrangement Information.
1.7 Approval of Metro’s Access Arrangement
In deciding whether to approve a proposed access arrangement, the Commission will be required to take into account the following matters:
1. whether the proposed access arrangement is consistent with: a. the Commission’s objectives namely: In performing its functions and exercising its powers, the primary objective of the Commission is to protect the long term interests of Victorian consumers with regard to the price, quality and reliability of essential services. In seeking to achieve its primary objective, the Commission must have regard to the following facilitating objectives – a. to facilitate efficiency in regulated industries and the incentive for efficient long-term investment; b. to facilitate the financial viability of regulated industries; c. to ensure that the misuse of monopoly or non-transitory market power is prevented; d. to facilitate effective competition and promote competitive market conduct; e. to ensure that regulatory decision making has regard to the relevant health, safety, environmental and social legislation applying to the regulated industry; f. to ensure that users and consumers (including low-income or vulnerable customers) benefit from the gains from competition and efficiency; g. to promote consistency in regulation between States and on a national basis; and h. the objectives set out in the Transport Legislation (Further Amendment) Act 2005, namely:
Metro AAI_V1 6
Access Arrangement Information March 2011
to ensure that access seekers, and any other person that the Commission considers may want to be provided declared rail transport services, have fair and reasonable access to declared rail transport services; and to promote competition in rail transport services to achieve an increase in the use of, and efficient investment, in rail infrastructure; 2. the access provider’s legitimate business interests and investment in the rail network owned or operated by that access provider; 3. the costs to the access provider of providing access, including any costs of extending the rail network owned or operated by that access provider but not including costs associated with losses arising from increased competition in upstream or downstream markets; 4. the economic value to the access provider of any additional investment that an access seeker or the access provider has agreed to undertake; 5. the interests of users; 6. existing contractual obligations of the access provider and users of the rail network owned or operated by that access provider; and 7. the operational and technical requirements necessary for the safe and reliable operation of the rail network owned or operated by the access provider; 8. the efficient operation of the rail network owned or operated by the access provider; 9. the benefit to the public in having competitive markets; and 10. any other matters that the Commission considers relevant. In addition, the Commission will be required to determine whether the proposed Access Arrangement: • is consistent with the account keeping rules, the ring fencing rules, the capacity use rules and the network management rules; • contains the requisite Access Arrangement Information, that is, information that an access seeker would reasonably require to understand the derivation of the elements of the access arrangement so as to form an opinion as to whether the access arrangement complies with the access regime; and • includes all the elements that an Access Arrangement is required to contain.
1.8 Interpretation
Terms used in this Access Arrangement Information have the same meaning as they have in the Access Arrangement. Monetary values shown in tables are in real dollars as at 1 July 2011 unless indicated otherwise.
1.9 Contact Details
The contact person for further details in relation to this Access Arrangement Information and the Access Arrangement to which it relates is:
Vickie Steward Commercial Contracts Manager Metro Trains Melbourne Pty Ltd Level 24, 1 Spring Street MELBOURNE VIC 3000 Phone: (03) 9610 2480 Fax: (03) 9610 2407
Metro AAI_V1 7
Access Arrangement Information March 2011
2 Key Features of the Access Arrangement
2.1 Background
The current Access Agreement dated July 2006 expires on 30 June 2011 and Metro submits this Access Arrangement Information under section 38W of the Rail Management Act 1996 and believes that it meets the requirements of sections 38W of the Rail Management Act 1996.
The definitions within the Rail Management Act 1996 require that the Access Arrangement Information provides “information that an access seeker would reasonably require to understand the derivation of the elements of the access arrangement so as to form an opinion as to whether the access arrangement complies with this Part”.
Metro has provided the information required under section 38X and a considerable amount of additional information to allow Operators to understand both the derivation of elements of the Access Arrangement and how it complies with the Rail Management Act 1996 and the various guidelines issued by the Commission. Metro therefore believes that this document complies with the requirements of the Rail Management Act 1996.
2.2 Scope of this Access Arrangement
The Access Arrangement applies to the provision of Rail Transport Services, including Freight Reference Services and Passenger non-reference services.
It does not apply to parts of the Network not included in the definition of the Network or to extensions of the Network or tracks that other track owners may connect to the Network. The Undertaking does not affect existing access agreements.
The term of the Access Arrangement is five years after approval of the Access Arrangement by the Commission.
In line with the Commission’s instructions Metro notes the requirements that an Access Provider has under Clause 7(c) of the Capacity Use Rules.
2.3 Train Path Request Process and Protocol
Attachment B to the Access Arrangement sets out the framework within which Metro will negotiate with Operators wishing to have access to services on its Network. It covers matters such as:
• the initial negotiation procedures, issues relating to confidentiality, the actual application of request for access, negotiations following the lodgement of an application; and • the finalisation of an Access Agreement and dispute resolution. The principal issues arising in the framework are: • A commitment to negotiating in good faith by Metro and agreement to follow a number of steps in negotiating access; • Requirements in relation to the parties that Metro will negotiate with. An Operator must meet certain criteria to commence negotiations, including that it is solvent, has adequate insurances and that it has not defaulted on other access agreements. If these criteria are not met, Metro may refuse to negotiate with an Operator. • An agreement by Metro to provide a response within 20 days of receiving a request. In responding to a request for access from an Operator, Metro will provide information to the Operator including: a. the extent of available capacity on the part of network where access has been sought;
Metro AAI_V1 8
Access Arrangement Information March 2011
b. a copy of Metro’s standard terms and conditions, Access Agreements and Protocols for access to its network; and c. the applicable access charges under the Access Arrangement. • A commitment to commence negotiations as soon as the Operator notifies Metro of its intention to do so following receipt of a response from Metro; • A requirement to assess additional capacity works; and • Dispute resolution processes whereby the parties will use reasonable endeavours acting in good faith to settle any dispute as soon as is practicable. There is provision for a three-step approach to dispute resolution including: a. Negotiation between the parties; b. Determination by an independent expert; and c. The Dispute Resolution process by the Commission taking into account the provisions of the Access Arrangement and the applicable legislation.
2.4 Pricing Principles
Metro’s objective is to apply reference tariffs for Reference Services which achieve a practical balance between Metro’s legitimate business interests and the interests of Operators. In doing so, Reference Tariffs have been designed to:
• recover reasonable costs incurred by Metro in providing access and a fair and reasonable return on investment which reflects the risks involved; • promote efficient use and investment in the Network; and • stimulate customer confidence and growth of the Victorian rail industry. The Reference Tariffs:
• will be uniformly applied and will not differentiate between types of Operators; and • will be structured as a variable tariff to be related to distance and mass and be levied in terms of dollars per gross tonne kilometres travelled ($/‘000 GTK). The Reference Tariff will be open to negotiation.
There is provision in the Access Arrangement for the Reference Tariffs to be adjusted annually by a CPI-X factor where X is set at 1.0.
Using these pricing principles Metro has proposed a reference tariff in this Access Arrangement that continues the price path approved by the Commission in the 2006 to 2011 Access Arrangement.
Metro believes that this approach will continue to provide the right balance between reasonable cost recovery for Metro and the right incentive to continue to grow the Victorian rail freight industry.
Historically this can be demonstrated, as since the commencement of the 2006 to 2011 Access Arrangement, a number of new freight contracts on the Melbourne metropolitan train network have been successfully negotiated.
As part of the Metro franchise, the infrastructure maintenance on the network has substantially increased (doubled). As a consequence of this increase, the reference tariffs for the Reference Services has increased to a level which Metro believes would be uneconomical for potential freight operators to seek access under and also not in the best interests of promoting customer confidence and further use of the Metro network i.e. it discourages more efficient asset utilisation by rail freight operators. To demonstrate this impact on the reference tariffs a model of forecast revenue requirement has been used and is set out in the following sections.
Metro AAI_V1 9
Access Arrangement Information March 2011
The outcome of using the historic Reference Tariff adjusted for inflation for financial year 2011 is $6.21 / 000 GTK. Under this Access Arrangement Metro is proposing to use this revised Reference Tariff.
2.5 Variation of the Access Arrangement
Metro also proposes to re-open the Access Arrangement where Passenger Timetable changes are approved by the Director of Public Transport. Such a decision may have a material impact on the Reference Tariff.
Metro would comply with the process set out in section 38ZO of the Act such that the proposed variation will be consistent with the account keeping rules, the ring fencing rules, the capacity use rules, the network management rules, the negotiation guidelines, the pricing principles and any methodology for the calculation of prices determined by the Commission under the Pricing Principles Order, and the principle of passenger priority.
Metro AAI_V1 10
Access Arrangement Information March 2011
3 SERVICES
3.1 Freight Reference Services
Metro proposes to provide one Reference Service, being a Freight Reference Service.
The Freight Reference Service covers:
• mainline running of a Freight Train from its origin to its destination; including
a. the use of passing loops to facilitate mainline running of the Freight Train; and b. the use of sidings for operational and incidental purposes. Access includes, in addition to the use of the Network, the benefit of other services essential to the use of the Network such as signalling and train control services. Access explicitly excludes the use of electric trains by an Operator.
The standard Reference Service and Reference Tariff are based on the following conditions, as well as other any other conditions set out in the standard Access Agreement in Attachment A:
• maximum speed and axle load/configuration consistent with the Addenda; • compliance with Metro standard Terms and Conditions and Protocols as set out in the standard Access Agreement; and • compliance with nominated sectional running times. Metro believes that the proposed Freight Reference Services are the services that are likely to be sought by a significant part of the market during the Access Arrangement Period. These services are identical to those currently being provided to Operators.
Metro is unaware of any changes in circumstances or future developments that are likely to materially affect this situation during the Access Arrangement Period.
Metro AAI_V1 11
Access Arrangement Information March 2011
4 FORECAST REVENUE REQUIREMENT
The Forecast Revenue Requirement is made up of revenue forecast to be received from the provision of Freight Reference Services to Operators and revenue from non-reference services. This comprises a return on infrastructure assets attributable to the provision of Freight Reference Services and non-reference services, depreciation on those assets, and associated operating and maintenance costs attributable to the delivery of the Reference Services and non-reference services.
The Forecast Revenue Requirement (FRR) is established using the formula below:
FRR = (AV*WACC) + D + OM
where AV = average Capital Base value WACC = weighted average cost of capital D = depreciation OM = Operations and Maintenance Costs
The FRR is calculated on a real basis (1 July 2011) using:
a Capital Base of zero as at 1 July 2011; a real pre-tax rate of return of 6.44%; and the proportion of operating and maintenance costs attributable to Freight Reference Services and non-reference services. Each of these matters is discussed in more detail in the referenced sections.
Metro AAI_V1 12
Access Arrangement Information March 2011
5 CAPITAL BASE
5.1 Opening Asset Values as at 1 July 2011
The opening asset base as at 1 July 2011 is zero.
Metro AAI_V1 13
Access Arrangement Information March 2011
6 FORECAST CAPITAL EXPENDITURE
Metro is an operator of rail infrastructure. Capital expenditure for Metro’s rail network is planned and implemented by the State Government.
The recently elected State Government is currently reviewing various capital programs relating to the rail network such as the Regional Rail Link. Consequently it is not in a position to forecast these expenditures.
Metro will submit a variation to the Access Arrangement under section 38ZO of the Rail Management Act 1996 in the event that the State Government advises that forecast capital expenditure that is material, is to occur that impacts on the network used by the freight operators.
Metro AAI_V1 14
Access Arrangement Information March 2011
7 FORECAST DEPRECIATION
In line with the initial asset base being zero, Metro’s forecast for depreciation of the asset base is zero.
Metro AAI_V1 15
Access Arrangement Information March 2011
8 COST OF CAPITAL
8.1 Metro Approach
Metro has adopted a real pre-tax WACC of 6.44% for the Network. It has been calculated using a WACC/CAPM approach.
This section sets out, in turn, Metro’s :
• risk free rate;
• capital structure;
• Cost of equity, calculated by the Capital Asset Pricing Model;
• Market risk premium;
• Gamma;
• Equity beta; and
• Cost of debt.
8.2 Real Risk Free Rate
Metro has calculated the real risk free rate using the Commonwealth Government’s 10 year bond rate together with an inflation assumption. The real risk free rate has been derived using the Fisher transformation.
The observed yields on the Commonwealth Government 10 year Government Bonds (over the past 20 days to 30 March 2011) is 5.43%.
The inflation assumption is based on the Melbourne - All Groups Index over the past year to the end of the December 2010 quarter. The inflation factor over this period is an average of 3.1%.
Applying the Fisher transformation, the real risk free rate applied is 2.26%.
8.3 Capital Structure
Metro does not own any material assets; therefore this calculation of a gearing level for its notional asset base has been undertaken without the benefit of recourse to an actual gearing level.
After reviewing the available regulatory precedent, however, Metro believes that a gearing level of 55% debt and 45% equity is a reasonable benchmark because:
• Queensland Rail (QR) sought and the Queensland Competition Authority approved a gearing level of 55% debt and 45% equity for QR’s Coal Reference Tariffs in December 2005. The gearing level has been reconfirmed in the June 2010 draft decision regarding QR Networks 2010 (DAU) (Pricing); and • In 2008, the Economic Regulation Authority (Western Australia) reviewed the gearing ratio for freight network (Westnet Rail) and the Urban (Public Transport Authority) Railways Network and determined that the gearing ratio in both cases is 35% debt and 65% equity.
Metro AAI_V1 16
Access Arrangement Information March 2011
8.4 Equity Beta
The equity beta represents the market risks associated with the operating cash flows of a firm’s assets and its use of debt to finance its operations. A firm with a risk profile comparable to the rest of the market has an equity beta of 1.0. A firm with cash flows that are less stable than the market average or with relatively higher levels of debt suggests a riskier profile and therefore an equity beta above 1.0, whereas a firm with relatively more stable cash flows and lower gearing levels suggests a lower level of risk and an equity beta below 1.0. In selecting an appropriate precedent for beta, it is therefore critical to account for gearing levels and to adjust approved equity betas accordingly.
The overall risk profile for Metro has not materially changed when compared to previous franchise for the Melbourne metropolitan train network managed by Connex Melbourne Pty Ltd.
Therefore Metro has used an equity beta of 0.74 which is in line with the Commission’s view of an equity beta for the 2006 to 2011 Access Arrangement.
8.5 Market Risk Premium
Metro has proposed market risk premium (MRP) of 6% because:
• there is considerable research available which supports an MRP of this range; and
• the Economic Regulation Authority of Western Australia in its final decision for the 2008 Weighted Average Cost of Capital for Freight (Westnet Rail) and Urban (Public Transport Authority) Railway Networks has used a market risk premium of 6%
8.6 Value of Imputation Credits
Metro is aware that there has been considerable debate over the issue of dividend imputation over the last several years, with much of the debate focussed on the issues of whether the marginal investor in a benchmark utility is foreign based.
Metro is conscious that Regulators, including the Commission, have anchored on a value of 0.5 for gamma in regulatory decisions since a report on Dividend drop off analysis by N 2 J Hathaway and R R Officer (‘Hathaway & Officer’) in 1995. Only recent decisions by IPART, ERA and the ICRC have contemplated a gamma lower than 0.5 as part of a range. Metro is proposing a gamma of 0.5.
8.7 Debt Margin
Metro is aware that the Commission estimates debt margins by assuming the credit rating that could be maintained with the benchmark gearing level, and by deriving a margin from Australian corporate bond yields. Metro is also aware that the Commission has a pre-disposition towards via credit rating of BBB+.
Metro supports such an assessment and proposes a debt margin of 300 basis points.
This is supported by the Economic Regulation Authority of Western Australia in its final decision for the 2008 Weighted Average Cost of Capital for Freight (Westnet Rail) and Urban (Public Transport Authority) Railway Networks.
2 Hathaway, N and Officer, R (1995), The Value of Imputation Tax Credits, Finance and Research Group, Graduate School of Management, University of Melbourne.
Metro AAI_V1 17
Access Arrangement Information March 2011
8.8 Real Pre-Tax Weighted Average Cost of Capital
The real pre-tax WACC using the parameters discussed above is 6.44%.
The WACC parameters have been summarised in the table below.
Metro WACC Parameter Value Range Real Risk Free Rate 2.26% Debt Risk Margin 3.0 Market Risk Premium 6.0% Equity Beta 0.74 Value of Imputation 0.5 Credits Real Pre Tax WACC 6.44%
Metro AAI_V1 18
Access Arrangement Information March 2011
9 FORECAST OPERATIONS AND MAINTENANCE COSTS
9.1 Summary of Operations and Maintenance Costs
Metro’s forecasts of efficient operations and maintenance costs for Reference and non- reference services for the Access Arrangement Period are in line with the Commission’s preferred approach for the 2006 to 2011 Access Arrangement are shown in the following table.
O and M Summary $’000 2011/12 2012/13 2013/14 2014/15 2015/16 ($2010/11 real)
Total (Ref and Non Ref) Services - Maintenance Costs 17,033 16,601 17,074 17,457 17,936 - Operations Costs 4,250 4,163 4,256. 4,314 4,399
TOTAL $’000 (real) 21,284 20,765 21,331 21,772 22,336
Reference Services Only - Maintenance Costs 3,375 3,289 3,383 3,459 3,554 - Operations Costs 483 478 483 488 493.
TOTAL $’000 (real) 3,858 3,767 3,866 3,947 4,047
Details of relevant components of expenditure are set out below.
9.2 Operational Costs
The Victorian Access Regime has a level of complexity and regulatory burden due to costs being incurred which include:
The Access Arrangement preparation and approval process - dedicated resources within Metro are preparing access arrangements and submissions. Tasks undertaken during the determination process include:
o preparing access arrangements and submissions;
o responding to the Commission’s and Government’s requests for further information and/or clarification, following the submission of draft access arrangements;
o responding to the Commission’s draft decision. This can be a substantial exercise, involving collection, analysis and presentation of additional information; and
o assessing the implications of the final determination and amending tariffs and operational plans accordingly.
ongoing regulatory compliance – including:
o preparation and audit of returns and information submissions;
o planning and managing the regulatory risks of outcomes that are contingent on uncertain future regulatory decisions;
o participating in consultations on changes to regulatory pricing process or license/operating conditions; and
o planning for the next determination.
Metro AAI_V1 19
Access Arrangement Information March 2011
In addition, operating costs also relate to all aspects of operating control for Reference Services and non-reference services including:
the planning of freight train paths;
the operational control of freight movements on the network; and
relevant information processing.
We have reviewed the operating costs in line with the 2006 to 2010 Access Arrangement and these amounts are shown in the table below.
Operating costs of $100,000 per annum in real terms for the Access Arrangement period have been allocated to Reference Services, and $886,000 in real terms have been allocated to non-reference services.
Metro’s estimate of operational costs over the Access Arrangement period is set out in the table below.
Operations $’000 2011/12 2012/13 2013/14 2014/15 2015/16 ($2010/11 real)
Reference and Non- 4,250 4,163 4,257 4,314 4,399 Reference Services
Reference Services Only 483 478 484 488 494
9.3 Maintenance Costs
The infrastructure that makes up the metropolitan train network is owned by the State and leased to the franchisee for the term of the franchise.
The State has a continuing strong interest in ensuring that the franchisee maintains the infrastructure to ensure the long term condition and integrity of the network. Under the current Franchise the level of maintenance costs has approximately doubled compared to previous franchise in recognition of deterioration and under investment in maintenance of the asset base in prior years. The new level of maintenance and renewal spend is a direct outcome of the competitive tender process for the current Franchise based on the State’s tender requirements.
In the lead up to the re-franchising of the metropolitan rail operations the State defined its desired approach to asset management and embodied this in the Asset Management Plan (AMP) framework - the concepts of which have been incorporated into the current franchise arrangements with the franchise operator.
The State’s objectives in requiring the implementation within the franchise of the Asset Management Plan (AMP) framework (which includes an AMP for the franchise period and derivative Annual Works Plans (AWPs) for each period of the franchise) is for the franchisee to develop an input-based asset management regime which protects the State’s interests as long term custodian of the infrastructure assets. As a general principle, the franchisee will be responsible for ensuring that the infrastructure is in a condition which:
• Enables the franchisee to comply with its obligations under the Franchise Agreement and the Rail safety Act
• Enables the infrastructure to be safety used for its intended purpose, and
Metro AAI_V1 20
Access Arrangement Information March 2011
• Does not compromise the operation of the Melbourne metropolitan rail network as an integrated transport system.
The purpose of the AMP is to give the State confidence that the condition of its rail infrastructure is being protected, and that over the long term the network will continue to be able to meet the standards required of it. The franchisee will be required to develop an AMP that adopts a ‘whole-of-life’ approach, designed to ensure the safety, reliability and integrity of the infrastructure managed over a period of at least 30 years.
To support the State’s objectives, Metro is utilising proven asset management techniques which have been demonstrated by its main shareholder, MTR. The key ones include:
• Using whole of life asset management techniques
• Using risk management based techniques
• Using asset management software to collect, collate, and analyse asset configuration, condition and costs
• Forecasting of system and asset degradation and failure rates based on future estimated service levels, with resultant yearly adjustments to maintenance and renewal quantities and locations, and
• Inclusion of additional planned renewals to renew life expired assets.
The AMP developed by the franchise will be supported by the AWP. The franchisee will be required to prepare and submit an AWP for each of the three forthcoming financial years. Each AWP should describe the scheduling and location of all maintenance and renewal works to be carried out by the franchisee during these three years. The works specified in the AWP must be consistent with the objectives of the AMP.
Quality of Network
The forecast network maintenance costs discussed in the maintenance costs section are intended to ensure that the quality of the metropolitan rail network is maintained in a manner consistent with that set out in the Infrastructure Lease – Train dated 31 August 2009.
Importantly, the quality of the network needs to be maintained in a state “fit for purpose” and consistent with the following requirements:
Ensure that the rail infrastructure is maintained and renewed in accordance with the Asset Management Plan, Annual Works Plan for each year together with other relevant vegetation and environmental plans;
Ensure that the infrastructure is maintained in a condition which enables it to be safely used for its intended purpose;
Maintain, at a minimum, the functionality and capacity of the Infrastructure;
Ensure the Infrastructure is maintained in a condition which does not compromise the operation of the Melbourne metropolitan transport network as an integrated transport system; and
Preserve the Infrastructure in a functional state and fit for its intended purpose.
Metro AAI_V1 21
Access Arrangement Information March 2011
Ensure that the Infrastructure is always in a condition which enables the Franchisee to comply with the requirements of its Accreditation of the Rail Safety Act 2006 (Vic). There is also a requirement under the Infrastructure Lease – Train to ensure that any works conducted under the maintenance regime conform to a set of asset maintenance standards covering the different network assets.
The level of maintenance spend is designed to ensure the above approach is implemented to ensure that the quality of rail network is maintained.
Forecasts of Maintenance Expenditure over the Access Arrangement Period
Metro has established its maintenance costs for Reference Services and non-reference services in line with the Commission’s preferred cost allocation approach derived from 2006 to 2011 Access Arrangement and Metro’s Cost Allocation Policy. The maintenance costs are set out in the table below:
Maintenance Costs Summary 2011/12 2012/13 2013/14 2014/15 2015/16 $’000 ($2010/11 real) Total Track and Signalling Costs 125,428 122,228 125,707 128,528 132,060 Adjusted Proportion of lines used by 44% 44% 44% 44% 44% freight Total costs on freight lines 55,512 54,096 55,636 56,884 58,447
Freight incremental costs (5%) 2,776 2,705 2,782 2,844 2,922 Freight share of TKs 1.48% 1.48% 1.48% 1.48% 1.48% Total indirect costs (73%) 40,524 39,490 40,614 41,525 42,666 Total indirect costs allocated to 600 584 601 615 631 freight Total Maintenance Costs allocated 3,375 3,289 3,383 3,459 3,554 to Reference Services Total Costs allocated to Reference 17,033 16,6012 17,074 17,457 17,937 and Non-Reference Services
Metro AAI_V1 22
Access Arrangement Information March 2011
10 FORECAST REVENUE REQUIREMENT
10.1 Derivation of Forecast Revenue Requirement
The elements of the Forecast Revenue equation result in a revenue requirement for each year of the Access Arrangement Period as shown in the following table. This revenue requirement is for Reference Services and Non-Reference Services and is in line with the Commission’s preferred Forecast Revenue approach.
Cost Reflective Revenue Derivation 2011/12 2012/13 2013/14 2014/15 2015/16 $’000 ($2010/11 real) – All Services
Average Regulatory Asset Base 0 0 0 0 0 WACC 6.44% 6.44% 6.44% 6.44% 6.44%
Return on Assets 0 0 0 0 0 Regulatory Depreciation 0 0 0 0 0
O and M Costs 21,2834 20,765 21,3301 21,772 22,336
Revenue Requirement ($’000 real) 21,284 20,765 21,331 21,772 22,336
In line with the Commission’s preferred cost allocation methodologies derived from the 2006 to 2011 Access Arrangement, Metro’s forecast revenue requirement for Reference Services is set out in the table below.
Cost Reflective Revenue Derivation $’000 ($2010/11 real) – Freight 2011/12 2012/13 2013/14 2014/15 2015/16 Reference Services Average Regulatory Asset Base 0 0 0 0 0
WACC 6.44% 6.44% 6.44% 6.44% 6.44%
Return on Assets 0 0 0 0 0 Regulatory Depreciation 0 0 0 0 0
O and M Costs 3,858 3,767 3,866 3,947 4,047
Revenue Requirement ($’000 real) 3,858 3,76 3,866 3,947 4,047
10.2 Smoothing of the Revenue Requirement for Reference Services
The revenue requirement for Reference Services was “smoothed” across the forecast period, taking into account forecasts of demand for Freight Reference Services. The revenue smoothing is designed to produce a constant X factor across the Access Arrangement Period (apart from the first year).
The smoothing equates the net present value (at a discount rate equal to the WACC) of the cost reflective revenue stream and the forecast tariff revenue stream.
Metro AAI_V1 23
Access Arrangement Information March 2011
11 REFERENCE TARIFFS
11.1 Derivation of Reference Tariffs
The reference tariffs required to be obtained from Freight Reference Services was established by a two step process:
• Establishing the total revenue allocated to Freight Reference Services in line with the Commission’s preferred cost allocation approach which is derived from the 2006 to 2011 Access Arrangement and Metro’s Cost Allocation Policy; and
• Dividing the total revenue attributable to freight by Metro’s forecasts of freight GTKs over the Access Arrangement period. Tariffs were then designed to meet the revenue requirement on a present value basis, taking into account a 1% per annum reduction in real terms in line with Metro’s proposed CPI-X methodology. A Reference Tariff price path is shown in the table below that uses the above approach and the updated maintenance, operations and WACC figures. It is clear form this table that there has been a significant step increase in the Reference Tariff compared to that in the 2006 to 2011 Access Arrangement.
Tariff (1% Real reduction pa) - $2010/11 2011/12 2012/13 2013/14 2014/15 2015/16
$/GTK (‘000) $ 17.86 $ 17.68 $ 17.50 $ 17.33 $ 17.16
Consequently, in line with Metro’s approach to reasonable cost recovery and growth of the Victorian Rail Freight Industry as outlined in section 2.4 – Pricing Principles, the proposed Reference Service tariffs for the Access Arrangement are set out in real terms in the table below. These Reference Tariffs apply the Reference Tariffs determined for the 2006 to 2011 Access Arrangement, updated for inflation, to the proposed Access Arrangement period 2011 to 2016.
Tariff (1% Real reduction pa) - $2010/11 - 2011/12 2012/13 2013/14 2014/15 2015/16
$/GTK (‘000) $6.15 $6.09 $6.03 $5.97 $5.91
11.2 Tariff Structure
The Freight Reference Service Tariff is the same across the network and is to be charged on the basis of a single GTK based tariff for all usage.
Metro AAI_V1 24
Access Arrangement Information March 2011
12 Rail Movement Forecasts Rail movements on the metropolitan rail network cover passenger and freight trains. The majority of these movements are passenger movements, comprising the metropolitan passenger trains and the V/Line passenger operated regional train services.
Volume forecasts used in the submitted access arrangement are based on a gross tonne kilometre (“GTK”) basis and are underpinned by the following assumptions:
• The passenger master timetables for both Metro and V/Line will not materially change for the access period; and
• Freight GTK forecasts will increase by GDP starting at 207 million GTK for 2010 over the access period. Passenger master timetables must be agreed by the State prior to implementation.
Freight volume movements have historically varied year to year, in part due to the volatility of grain production and more recently, the Global Financial Crisis (GFC). However, the overall level in calendar year 2010 was 207 million GTK which is much lower than that assumed in the previous Access Arrangement. As the economy continues to grow after the GFC, it is proposed that a GDP growth of 3% per annum be applied to freight volumes over the proposed Access Arrangement. This is also based on the fact that there has already been a significant increase of 15% in freight volumes for calender year 2010 compared to 2009.
Metropolitan Freight Rail Volume Forecasts (000 GTK)
2011/12 2012/13 2013/14 2014/15 2015/16
Freight 209,974 216,273 222,761 229,444 236,328
Metro AAI_V1 25