GST Implications

for the

Electricity Supply Industry

in Tasmania

Occasional Paper

June 2000 iv

Comments on the matters raised in this Paper should be directed to:

Ms Heather Wilson Assistant Director Office of the Tasmanian Electricity Regulator GPO Box 770 HOBART TAS 7001

Telephone: 03 – 6233 5603 Facsimile: 03 – 6233 5666 Email: [email protected]

Printed June 1999 Office of the Tasmanian Electricity Regulator Level 5, 111 Macquarie Street HOBART TAS 7000 AUSTRALIA

ISBN 0724650199

Copyright © Office of the Tasmanian Electricity Regulator 2000 iii

Table of Contents

OVERVIEW ...... v

1 INTRODUCTION...... 1

1.1 BACKGROUND...... 1 1.2 INDICATIVE ANALYSIS BY THE COMMONWEALTH TREASURY...... 3 1.3 ESAA – ARTHUR ANDERSEN STUDY RESULTS ...... 3 1.3.1 ACCC Estimates ...... 5 1.3.2 Applicability to the Tasmanian Context...... 5 1.4 OTHER ISSUES...... 6 1.4.1 GST and CPI-Linked Pricing...... 6 2 REGULATORY AND POLICY FRAMEWORK...... 9

2.1 ACCC GUIDELINES ...... 9 2.1.1 Guidelines 1999...... 9 2.1.2 Amendments to the 1999 Guidelines...... 10 2.1.3 Price Exploitation Regulatory Test...... 12 2.2 PRICING DETERMINATION ...... 12 2.3 OTHER POLICY CONSIDERATIONS...... 13 2.4 REVIEW OF GST IMPLEMENTATION – AUDIT REQUIREMENTS ...... 13 2.5 ANALYSIS UNDERTAKEN BY THE ENTITIES ...... 14 3 HYDRO-ELECTRIC CORPORATION ESTIMATED IMPACT ON ENERGY PRICES...... 15

3.1 BACKGROUND...... 15 3.2 MONASH MODELLING...... 15 3.3 ASSUMPTIONS ...... 16 3.4 COMPARISON WITH OTHER GENERATORS...... 18 3.5 COMPLIANCE PROCESS...... 18 3.6 ESTIMATED IMPACTS HYDRO TASMANIA...... 19 3.6.1 Recommended Pricing...... 19 3.7 CONCLUSION...... 21 4 SYSTEM CONTROL...... 23

4.1 BACKGROUND...... 23 4.2 PRICING IMPACT ...... 23 4.2.1 Conclusion ...... 24 5 TRANSEND ESTIMATED IMPACT ON TRANSMISSION PRICES...... 25

5.1 METHODOLOGY...... 25 5.1.1 Modelling Objective ...... 25 5.1.2 Econtech Methodology...... 25 5.2 MONITORING TO PASS ON ACTUAL COSTS ...... 27 5.3 ALTERNATIVE MODELLING OUTCOMES ...... 28 5.4 ESTIMATED IMPACTS...... 29 5.4.1 Main Findings at a Glance ...... 29 5.4.2 Major Costing Impacts on Transend...... 30 iv

6 AURORA – ESTIMATED IMPACT ON RETAIL ELECTRICITY AND OTHER SERVICES...... 33

6.1 ISSUES ...... 33 6.1.1 Number of pass through rates for each service category ...... 34 6.2 MODELLING APPROACH AND KEY ASSUMPTIONS...... 35 6.3 ESTIMATED IMPACTS AURORA ENERGY...... 35 6.3.1 Electricity Prices:...... 36 6.3.2 Other Services...... 38 6.3.3 Summary...... 39 6.4 COMPARISON WITH OTHER MODELS...... 39 6.5 NEXT STEPS ...... 40 7 REGULATOR’S ASSESSMENT...... 41

7.1 ISSUES ...... 41 7.1.1 Potential Differences between a hydro and thermal based ESI...... 41 7.1.2 Comparative Estimates ...... 41 7.1.3 Comparison with other Jurisdictions...... 42 7.1.4 Limitations of Modelling...... 42 7.1.5 Savings arising from the New Tax System in Tasmania ...... 42 7.2 SUMMARY...... 44 7.3 FUTURE ACTION ...... 45 v

Overview

The Terms of Reference for the 1999 Electricity Supply Industry Pricing Policies Investigation required the Regulator to set maximum prices for the three years from 1 January 2000 for certain electricity services, being: § electricity generation on mainland Tasmania for tariff sales; § system control functions and ancillary services; § transmission services; § distribution services; § electricity retailing for tariff customers on mainland Tasmania; and § retail supply for customers of King and Flinders Islands (the Bass Strait Islands). At the time the Determination was made the entities were unable to ascertain the net impact of the Commonwealth Government’s tax reform package, The New Tax System (TNTS) which incorporates a goods and services tax (GST). Provision was made in the Determination for the net impact to be estimated during the six months prior to the commencement of TNTS on 1 July 2000. All three electricity entities, Hydro-Electric Corporation (Hydro Tasmania), Transend Networks Pty Ltd (Transend) and Aurora Energy Pty Ltd (Aurora), will be subject to the GST. There are two issues in regard to the impact of TNTS on electricity prices: § the direct impact whereby the entities are required to calculate any cost savings arising from TNTS prior to adding the 10 per cent GST; and § the potential indirect effect where the CPI is used as an escalator for price increases during the period of the current Price Determination. The focus of this Paper is the first issue.

With the introduction of GST, wholesale sales tax equivalent (WSTE) obligations of all State-owned companies and Government Business Enterprises, including the electricity entities, under State legislation will be removed immediately and, over a five-year period, a range of other State Taxes also will be removed. These include Financial Institutions Duty (1 July 2001), Stamp Duty on marketable securities (1 July 2001), and Bank Account Debits Tax (1 July 2005). Subject to Ministerial review by 2005, Stamp Duty on credit cards, rental agreements, leases, mortgages etc will be removed as budgets permit. Cost savings arising from these charges are required to be taken into account prior to adding the 10 per cent GST to prices. The three electricity entities separately undertook an initial analysis of the net impact of TNTS on their businesses. Following initial discussions with the three entities, the vi

Regulator suggested that there could be benefits from a more co-operative approach. In March 2000, an informal working group was established to provide a forum for discussion. The working group consisted of representatives from all three entities and the Regulator and his staff. The group met on a fortnightly basis during March and April 2000. However, each entity was responsible for undertaking its own assessment and retains responsibility for ensuring that the price increases sought comply with the ACCC Price Exploitation Guidelines. The entities all used established recognised models for assessing the likely impact of TNTS on their businesses. Hydro Tasmania used the ‘Monash Model’, supported by PriceWaterhouseCoopers, whilst Transend and Aurora used the Econtech Model, supported by KPMG. The entities then separately provided the Regulator with detailed submissions in relation to the approach adopted, assumptions made and estimated outcomes. The Regulator has assessed the submissions provided by each of the three entities and accepts as reasonable the estimated net impacts being: § For the supply of electricity to retail customers on mainland Tasmania:

1 July 2000 to 31 December 2001 % Energy 9.872 Transmission 9.901 System Control 9.883 Retail/Distribution 9.275 Total 9.559

§ For the supply of other services to all customers:

1 July 2000 to 31 December 2001 % Other Service 9.534

§ For the supply of electricity to customers on the Bass Strait Islands:

1 July 2000 to 31 December 2001 %

Net GST Price Increase 9.743 (10 per cent less savings)

As provided in the 1999 Pricing Determination: vii

§ the Regulator requires the entities to make a ‘retrospective adjustment to their prices to ensure that only the actual net impact of the GST is passed on to customers’; and § the Regulator will require the entities to have an independent assessment of the actual impact for the period 1 July 2000 to 30 June 2001. This review will be undertaken during the period July 2001-September 2001 - with a view to make tariff/price adjustments for the period commencing January 2002 following review and approval by the Regulator. The entities will also have to monitor the actual impact of TNTS on their businesses over the coming year to ensure compliance with the ACCC Price Exploitation Guidelines. If the actual impact is less than the estimated impact, to ensure compliance with these Guidelines, prices and/or tariffs will need to be adjusted downwards accordingly.

GST IMPLICATIONS FOR THE TASMANIAN ESI 1

1 INTRODUCTION

1.1 Background

The Terms of Reference for the 1999 Electricity Supply Industry Pricing Policies Investigation required the Regulator to set maximum prices for the three years from 1 January 2000 for certain electricity services, being: § electricity generation on mainland Tasmania for tariff sales; § system control functions and ancillary services; § transmission services; § distribution services; § electricity retailing for tariff customers on mainland Tasmania; and § retail supply for customers of King and Flinders Islands (the Bass Strait Islands). At the time the Determination was made the entities were unable to ascertain the net impact of the Commonwealth Government’s tax reform package, The New Tax System (TNTS) which incorporates a goods and services tax (GST) would have on its costs and prices. However, provision was made in the Determination for the net impact to be estimated during the six months prior to the commencement of TNTS on 1 July 2000. These estimates would then be applied, in accordance with the Determination, from 1 July 2000. All three electricity entities, Hydro-Electric Corporation (Hydro Tasmania), Transend Networks Pty Ltd (Transend) and Aurora Energy Pty Ltd (Aurora), will be subject to the GST. There are two issues in regard to the impact of TNTS on electricity prices: § the direct impact whereby the entities are required to calculate any cost savings arising from TNTS prior to adding the 10 per cent GST; and § the potential indirect effect where the CPI is used as an escalator for price increases during the period of the current Price Determination. The focus of this Paper is the first issue.

Where the GST has been paid on goods or services (inputs) that have gone into producing an item or service sold by the entity, the GST component of the total production cost of the good or service will be able to be claimed back as input tax credits. In simple terms this means each entity will be required to pay GST on all the goods and services it purchases and will collect GST on the goods and services it sells 2 GST IMPLICATIONS FOR THE TASMANIAN ESI

to other entities. The amount paid to the tax office in any one period will be equal to the excess of GST collected over the GST paid to suppliers. Where the amount paid is greater than the amount collected in any one period the business will be entitled to a tax credit. Effectively this means that entities pay no GST on their inputs. With the introduction of GST, wholesale sales tax equivalent (WSTE) obligations of all State-owned companies and Government Business Enterprises, including the electricity entities, under State legislation will be removed immediately and, over a five-year period, a range of other State Taxes also will be removed. These include Financial Institutions Duty (1 July 2001), Stamp Duty on marketable securities (1 July 2001), and Bank Account Debits Tax (1 July 2005). Subject to Ministerial review by 2005, Stamp Duty on credit cards, rental agreements, leases, mortgages etc will be removed as budgets permit. Cost savings arising from these charges are required to be taken into account prior to adding the 10 per cent GST to prices. The Commonwealth Government has also provided for transitional arrangements. These arrangements include a phase down of the 32 per cent wholesale sales tax (WST) to 22 per cent from 29 July 1999 and special treatment in relation to input tax credits for GST paid on cars. The State Government’s WSTE arrangements mirrored the Commonwealth’s transitional arrangements. Special arrangements have also been instituted on the supply of goods and services under contract. Contracts in existence at the date of Royal Assent of the relevant legislation will generally not attract GST. However, all new contracts entered into from 1 July 1999 were required to have GST factored into the contract price. If it was not explicitly included in the price, a business (and the Government) is entitled to assume that 1/11 of the price is GST and thus a business customer is entitled to request a tax invoice to this effect to enable it to claim an input credit. The supplier is also required to remit this amount (ie the 1/11 of the sale price) to the Australian Tax Office (ATO).

Given the phased removal of WSTE and State taxes, the quantum of the net short-term and long-term impact on the electricity entities was uncertain at the time the 1999 Pricing Determination was made. At that time the entities had not undertaken any detailed analysis of the potential impact of TNTS. Uncertainty of the actual impacts also partially arises from the time expected to be taken for the positive effects of the removal of WSTE (especially in relation to capital goods) to flow through to prices and the uncertainty as to the quantum of compliance costs for the new arrangements.

In total, the net impact of GST on the cost of electricity will be something less than 10 per cent. In preparing this paper, and in considering the analysis undertaken by the three electricity entities, the Regulator was cognisant of the analysis previously undertaken by the Commonwealth Treasury and that undertaken by Arthur Andersen for the Electricity Supply Association of Australia. GST IMPLICATIONS FOR THE TASMANIAN ESI 3

1.2 Indicative Analysis by the Commonwealth Treasury

Prior to release of the Commonwealth Government’s proposed New Tax System in 1998, the Commonwealth Treasury (Treasury) undertook an analysis of the impact of the tax reform proposals on industry costs and consumer prices. Industry costs and consumer price impacts were estimated using the Treasury Price Revenue Incidence Simulation Model (PRISMOD). Treasury1 describes PRISMOD as a large scale, highly disaggregated model of the Australian economy, incorporating all of the detail of inter-industry flows captured by the input-output tables produced by the Australian Bureau of Statistics (ABS). It is a price input-output model that only captures inter-industry transmission of price changes and ignores quantity (output) changes. It also assumes that all cost and price impacts are passed on in full to final purchasers (governments and households). PRISMOD was used to model price changes for each of the 107 industry outputs and these were then used to calculate the price impact on private final consumption expenditure. The model ‘says’ nothing about the timing of price changes, rather the price impacts calculated by the model are long-run impacts not short-run changes. However, the Treasury noted in its paper released at the time the introduction of TNTS was announced that the major impacts of changes in indirect taxes flow through within the first twelve months.

The total impact on consumer prices as measured by the private final consumption expenditure deflator was an increase of approximately (+)2.2 per cent. The CPI impact was expected to be an increase of (+)1.9 per cent. However more recent statements by the Commonwealth Government expect the impact on the CPI to be in the order of 5 per cent (see section 1.4.1). The Commonwealth Treasury’s estimate for the cost savings effects of the indirect tax changes on the electricity industry was approximately (–)3.1 per cent. This implies that the price impact on consumers would be an increase in the order of (+)6.9 per cent. The Commonwealth Treasury has not published revised estimates subsequent to the Government revising the TNTS package.

1.3 ESAA – Arthur Andersen Study Results

The Electricity Supply Association of Australia2 commissioned a study by Arthur Andersen to examine the potential impacts for each sector of the ESI - generation, transmission and distribution/retailing. The initial Report was published in March 1999. This Report was revised and re-issued in February 2000. In contrast to the Commonwealth Treasury, Arthur Andersen modelled both short-run (with tax changes

1 Commonwealth Government, The New Tax System – White Paper, Chapter 5. A copy of this paper may be found on the Commonwealth Government’s website, http://www.treasury.gov.au

2 Arthur Andersen for the Electricity Supply Association of Australia, GST Cost Impact Study, March 1999, revised February 2000. 4 GST IMPLICATIONS FOR THE TASMANIAN ESI

effective during the first year of implementation and before the abolition of WST on capital goods is fully reflected in production costs) and long-run impacts (with full implementation of indirect tax reform). In the revised Paper, three phases were considered, the first three months to September 2000, the next 15 months to December 2001 and from 2002 onwards.

The estimates presented in the ESAA/Arthur Andersen Report are for ‘representative’ electricity generators, transmitters and distributor/retailers using data from a sample number of firms. The results were generated using the STATAX model, which is a detailed model of the Australian indirect tax system (similar in form, although not identical, to that used by the Commonwealth). The estimates were compiled using weighted averages of the estimates prepared for each of the eight ESAA members that participated in the study.

The results generated by Arthur Andersen in its original study suggested that the long term cost savings for the electricity supply industry would be in the range of 1.2 per cent for generation and 2.0 per cent for transmission, with a slightly lower impact for a distributor/retailer of 1.9 per cent. The short-term cost savings are likely to be less than this and thus the short term impact on prices may be higher than the 8 per cent indicated by the model. However, the revised Report suggested smaller percentage savings, and thus higher cost impacts on consumers than the original estimates. Table 1:1 below provides a summary of the revised findings. Table 1:1: Estimated Cost Savings February 2000

Phase 1 Phase 2 Phase 3 July –September 2000 September 2000 – 2000 onwards December 2001 % Savings % Savings % Savings Generation 0.07 0.64 1.20 Transmission 0.09 1.08 1.69 Distribution/Retailer 0.37 1.28 1.94

Source: ESAA GST Cost Impact Study

Arthur Andersen noted, as with the Commonwealth Treasury modelling, that the estimates from its own modelling should be interpreted as a maximum potential cost saving. In practice capturing these savings will be contingent on a number of factors including the ability to successfully renegotiate supply contracts to fully reflect the cost savings captured by the suppliers. The net impact on consumer prices in the short term, September 2000 to December 2001, was estimated to be (+)8.7 per cent, based on 1.3 per cent net overall cost savings for the distributor/retailer including the costs of energy and transmission. This is illustrated in Table 1:2. Table 1:2: Calculation of Consumer Price Impact

Pre GST $ Post GST $ GST IMPLICATIONS FOR THE TASMANIAN ESI 5

Total Expenditure 1 000 Total Expenditure 978 (including 1.3% cost reductions) Add Net Margin 100 Add Net Margin 100 Add GST at 10% 109 Pre GST Sales 1 100 Post GST consumer 1 196 price Percentage increase 8.7% in consumer price Source: Arthur Andersen/ESAA

The net impact on consumers in the longer term, based on the percentage savings calculated for Phase 3 in Table 1:1 of 1.94 per cent, was estimated to be approximately (+)8 per cent. The differences in results between the two sets of modelling may arise in part from the differences in the assumptions and methodology applied by the Commonwealth Treasury and Arthur Andersen. In addition, as noted above, the Arthur Andersen results are based on estimates provided by a sample of firms (eight) and analysed using the STATAX model.

1.3.1 ACCC Estimates

To assist it in its monitoring role, the ACCC3 has undertaken an analysis of the estimated net impact of TNTS on a range of goods and services. The ACCC’s estimates that the net impact Australia wide on retail electricity prices will be in the order of 9 to 9.5 per cent.

1.3.2 Applicability to the Tasmanian Context

The Commonwealth Treasury model examined the impact of the GST on the Australian economy and the various sectors, including the electricity sector as a whole (that is, the Treasury did not examine the impact on individual firms). The Arthur Andersen study used a sample of mainland ESI firms as a basis for assessing the impact of the sector as a whole. The impact on an individual firm within the ESI is dependent on the firm’s individual cost structure and the extent to which it can capture cost savings arising from TNTS. Cost savings arise in the first instance in two ways: direct savings on wholesale sales tax on intermediate goods and diesel fuel rebates. Only during the second phase and thereafter does wholesale sales tax savings on capital goods have any impact, the timing of this impact depending on the nature of the capital goods and capital

3 ACCC Media Release 23 May 2000, as published in the major daily newspapers Australia wide on 24 May 2000. The information is also available from the ACCC GST website http://gst.accc.gov.au. 6 GST IMPLICATIONS FOR THE TASMANIAN ESI

investment profile of individual firms. However, the Australian ESI is dominated by thermal generation. A hydro-electric system (such as in Tasmania) can be expected to have quite a different cost structure to a thermal system in that it has less reliance on diesel fuels and longer average asset lives. Thus, since Tasmania’s hydro system does not have the same cost characteristics as mainland thermal generation, it was recognised that the potential impacts may be different between the two types of systems. Thus caution would need to be exercised in using either the Commonwealth Treasury or Arthur Andersen’s modelling as a benchmark indicator of the likely outcome in the Tasmanian ESI. The entities have also undertaken a comparative analysis between the Arthur Andersen results and their own. A short discussion in relation to generation, transmission and distribution/retail is provided in each of the relevant chapters below.

1.4 Other Issues

There are two issues in regard to the impact of TNTS on electricity prices, the direct impact as discussed above, and the potential indirect effect where the CPI is used as an escalator for price increases during the period of the current Price Determination.

1.4.1 GST and CPI-Linked Pricing

Under the Pricing Determination tariffs may be adjusted at the start of each calendar year by the CPI. In the context of the current Determination prices may be increased on 1 January each year using the previous ‘June on June’ ‘All Capital Cities CPI’. The CPI will reflect the GST inclusive prices post 1 July 2000.

The introduction of the GST will have an impact on the CPI index predominantly in the year it is introduced. That is, in the 2000-2001 financial year. Given that the Regulator requires the use of a lagged CPI, the potential impact on electricity prices from the application of a GST inclusive CPI would not evident until the 2002 calendar year.

The Regulator understands that the Commonwealth’s initial estimates were for a possible impact on the CPI of between 1.9 per cent and 3.2 per cent. However, since that time there have been a number of adjustments made to the GST tax package and the Commonwealth Government4 has stated:

The effect of indirect tax reform on prices will not be felt evenly through 2000-01, with the main effect occurring in the September quarter 2000. In that quarter, the impact of the Goods and Services Tax (GST) on retail prices will be only partly offset by the removal of Wholesale Sales Tax (WST) on final consumption items. While estimating quarterly outcomes is inherently difficult, the overall increase in the CPI in the September quarter could be of the order of 4½ per cent, of which a

4 Commonwealth Government Budget Papers May 2000: GST IMPLICATIONS FOR THE TASMANIAN ESI 7

little over 3¾ per cent would be the result of one-off price changes associated with indirect tax reform.

In subsequent quarters, increases in the CPI will be smaller than would otherwise have been the case, as the removal of WST and the reduction in the cost of fuel to business reduce embedded production and transportation costs and hence put downward pressure on retail prices. As a result, and as noted in the 1999-2000 Mid-Year Economic and Fiscal Outlook (MYEFO), The New Tax System is expected to add around 2¾ percentage points to the CPI through the year to the June quarter 2001, less than the projected increase for the September quarter. Taking together the estimate of ongoing inflation and the impact of The New Tax System on prices, the CPI is forecast to rise by around 5¼ per cent through the year to the June quarter 2001.

The key issue is whether the use of the CPI to index prices, tariffs and revenues has the potential to provide windfall gains that may be contrary to the price exploitation provisions of the Trade Practices Act 1974 (TPA) in this regard.5 During the course of the 1999 Pricing Investigation the Regulator considered whether the CPI used to adjust prices and revenues during the regulatory period would need to be adjusted to remove the impact of the GST. This issue was also raised in the NSW Report on Pricing for Electricity Networks and Retail Supply.6 In this Report the Independent Pricing and Regulatory Tribunal (IPART) suggested that the Australian Bureau of Statistics (ABS), Reserve Bank or the Commonwealth Treasury might publish an official measure exclusive of the impact of GST. At the time of the publication of the 1999 Pricing Investigation Final Report there was no official indication as to whether the ABS would produce a ‘GST exclusive’ CPI. Since then the ABS has indicated that it ‘will compile an experimental constant tax rate measure which will abstract from the direct or first round effects of the tax changes on the prices of consumer goods and services’. It is expected that this will be published one month after the publication of the September quarter CPI. IPART in the aforementioned Report, suggested that if an official ‘index’ was not produced it would commission an independent estimate of the impact of GST on the CPI and adjust accordingly. Given the uncertainty as to whether the ABS would publish a ‘same tax basis’ CPI, the Electricity Regulators agreed in early 2000 to co- operate in this regard and will be seeking to undertake an independent assessment.

The Regulator was also aware that the ACCC was concerned with the potential impact of the use of the CPI in calculation of the annual increases of prices or revenues. The ACCC supports the Regulator’s view that the use of a GST inclusive CPI will provide an effective ‘windfall’ gain to the entities where the CPI is used to calculate prices or

5 Trade Practices Act 1974 Section 75AU.

6 Independent Pricing and Regulatory Tribunal NSW, Pricing for Electricity Networks and Retail Supply, July 1999 p19. 8 GST IMPLICATIONS FOR THE TASMANIAN ESI

revenues where the entity is otherwise able to pass through the net GST impacts to its customers. On this basis, the 1999 Pricing Determination provided for the indexation of tariffs and revenues based on a CPI exclusive of the estimated GST impacts. The ACCC’s response to this issue is discussed in more detail in Chapter 2. GST IMPLICATIONS FOR THE TASMANIAN ESI 9

2 REGULATORY AND POLICY FRAMEWORK

This Chapter discusses the regulatory and policy framework within which the entities were required to analyse the impacts of TNTS on their segment of the Tasmanian ESI and that within which the Regulator is required to assess the reasonableness of each entity’s submissions. In addition to the requirement to comply with the Commonwealth legislation per se, the entities are also required to comply with the provisions of: § the ACCC Price Exploitation Guidelines; and § the Price Determination. These are discussed in more detail in the following sections.

2.1 ACCC Guidelines

2.1.1 Guidelines 1999

As part of the taxation reform measures, the Commonwealth Government amended the TPA to prohibit price exploitation in relation to TNTS arrangements. The amendments required the ACCC to develop guidelines7 on the application of the amendments, which also include substantial penalties for breach of the TPA.

Under the ACCC Guidelines,8 the Commission noted it would liaise with other regulatory agencies to ensure that there is not an excessive pass through of the effect of GST, especially where regulated prices are linked to movements in the CPI. To assist it in monitoring the implementation of the GST, the ACCC will provide information and guidance on its GST website http://gst.accc.gov.au/. At the time the Pricing Determination was being prepared, the ACCC indicated that there would be some additional amendments to the TPA. Following the implementation of these amendments the ACCC was proposing to revise the Price Exploitation Guidelines to, amongst other things, specifically deal with matters relating to regulated industries including those regulated by State Regulators.

7 Australian Competition and Consumer Commission, Price Exploitation and the New Tax System, General Principles, Information and Guidelines on When Prices Contravene Section 75AU of the Trade Practices Act 1974.

8 ACCC, ibid, p6. 10 GST IMPLICATIONS FOR THE TASMANIAN ESI

The ACCC also was of the view that the development of a co-operative framework was appropriate so that the regulated entities would only have to directly interact with one regulator and not two. This was not to suggest that the ACCC was delegating or side stepping its legislative responsibilities rather it was aiming to reduce the administrative burden on the regulated entities by ensuring that there are not two sets of regulatory requirements and two sets of reporting requirements. That is, the information collected, or a review conducted, by the State Regulator will also be sufficient to satisfy the requirements of the ACCC. The ACCC will also provide any necessary support and advice to the State Regulators. The ACCC also sought assurance that the State Regulators would have regard to the regulated business provisions of the Price Exploitation Guidelines in making their decisions or determinations and was seeking to ensure that there is a common approach across all jurisdictions. In this regard it should be noted the State and Commonwealth Governments agreed that: § all statutory corporations and authorities will comply with the Guidelines; § the ACCC will have power to monitor compliance with the implementation of the GST and the Guidelines; and

§ the States would adopt the relevant sections of the TPA into their own relevant legislation. The Tasmanian Government had, at the time of producing this Report, introduced legislation into Parliament to give effect to this agreement. The New Tax System Price Exploitation Code (Tasmania) Act 1999 became effective in December 1999, the date set down in the Commonwealth-State agreement. By importing the relevant sections of the TPA into State Statute, all State authorities and Government business (including the electricity entities) are bound to the ACCC Price Exploitation Guidelines. It should be noted that under the Guidelines it is the responsibility of each entity to comply with the Guidelines and the relevant provisions of the TPA.

2.1.2 Amendments to the 1999 Guidelines

The initial Guidelines issued in July 1999 were revised and re-issued in March 2000. A number of amendments were made to clarify issues that had implications for all businesses. Of key significance for the electricity entities were the changes made in regard to regulated businesses (which include, electricity, gas, water and sewage). In this regard the Guidelines state:

Government bodies

1.40 The benefits of indirect tax reform should be fully reflected in the pricing decisions of Commonwealth, State, Territory or local government bodies carrying on a business. GST IMPLICATIONS FOR THE TASMANIAN ESI 11

1.41 During the development of the New Tax System package, the Commonwealth, State and Territory Governments agreed to a package of financial assistance that will ensure State and Territory budgets are no worse off following the implementation of the New Tax System. In providing this assistance the governments have provided for the effects of indirect tax reform on States and Territories. This agreement will be taken into account in any examination of the pricing behaviour of State and Territory general government agencies.

Regulated prices

1.42 Prices in a number of industries are subject to direct regulation. For example, the ACCC and State and Territory general regulators have oversight of elements of the following services: telecommunications (Telstra), postal services (Australia Post) prices, airport aeronautical charges, electricity and gas transmission prices, water, public transport and some other prices.

1.43 The ACCC has worked closely with regulators to ensure compliance with the legislation. In this context, regulators have been requested to:

· apply the guidelines in their own determinations; and

· inform and consult with the ACCC on the application of the guidelines.

1.44 In turn, the ACCC has agreed to consult with regulators on the application of the guidelines.

Regulators and CPI escalators

1.45 Where regulated enterprises are subject to both CPI-related price or revenue caps and tax pass-through arrangements, there is the potential for over- recovery of costs associated with the New Tax System changes. Over- recovery may arise when an enterprise:

· recovers its GST liability (net of any input cost reductions); and

· also increases its prices for CPI adjustments, which may include the effect of the GST.

1.46 This over-recovery may be a contravention of the prohibition on price exploitation.

Other changes that may impact on the entities included:

§ changes to the diesel and alternative fuel grants scheme and clarification as to the dates of abolition of the specified state taxes; § clarification of the ACCC’s focus in evaluating prices, with specific reference to upstream and down stream markets and supplier retailer relationships; 12 GST IMPLICATIONS FOR THE TASMANIAN ESI

§ clarification as to a businesses entitlement to recoup reasonable net costs of compliance; and

§ clarification as to where it is appropriate to average the impact of taxes and costs across goods and services and apply the dollar margin rule to a ‘basket’ of closely related goods or services.

2.1.3 Price Exploitation Regulatory Test

The Regulatory Tests for establishing whether there has been price exploitation are also included in the Guidelines. In this regard the ACCC will have regard to both the size and the timing of the price changes. The key determinants in relation to the size of the price changes are: § the net dollar margin rule – that is businesses should not increase the net dollar margins on their goods and services as a result of TNTS changes alone; § there is to be no mark-up on the GST component of the price; and § no price should rise by more than 10 per cent as a result of TNTS. The key determinants in relation to the timing of price changes are: § prices should be immediately adjusted to pass on any savings. Depending on the frequency of price adjustments, it may be necessary for businesses to reflect in prices some anticipation of cost savings to ensure compliance with the net dollar margin rule. Capital cost savings should be reflected in lower depreciation charges and prices from the time new capital is acquired; and § prices should not be adjusted in anticipation of the imposition of the GST.

2.2 Pricing Determination

In making his Determination the Regulator considered he had three options available to him for adjusting prices to take account of the net impact of the GST: § amend the Determination prior to 1 July 2000; § incorporate the forecast net impact in the Determination; or § treat the net impact of the GST as a pass through item. The third option was assessed as the most appropriate method and this was incorporated into 1999 Pricing Determination.

To give effect to this proposal, the entities were required to estimate the net effect in the first half of 2000, to enable Aurora to incorporate the net impact in its tariffs on 1 July 2000. GST IMPLICATIONS FOR THE TASMANIAN ESI 13

The pass through of the net impact of GST was provided on the basis that the entities provide the Regulator with an audited statement of the net impact of the New Tax System following 12 months experience, and also at the end of the following 12-month period. Any under or over-recovery of revenue will then be required to be passed on to customers in the following calendar year of the regulatory period. This will provide assurance regarding appropriate compliance with the Determination.

2.3 Other Policy Considerations

In framing his Determination, the Regulator noted that the Government in its submission indicated an intention to change the Price Control Regulations to ‘…establish a clear framework for assessing the implications of changes in taxation arrangements on pricing determinations made by the Regulator…’ The amendments will provide for the pass through of increases in taxes by the electricity entities, where this would be the normal practice in the private sector, subject to the approval of the Regulator. Further, the Regulations would require any reductions in taxes to be passed through.

2.4 Review of GST Implementation – Audit Requirements

To ensure that the entities could justify the price increases the Regulator requested that proper ‘audit trails’ be established for both the estimate and any adjustments they would be seeking under the provisions of the Determination. That is, the entities have been required to establish and document robust policies and procedures for assessing the net impact of the GST. In addition, any modelling undertaken had to be based on valid assumptions such that the outcomes were reproducible. In summary the entities were required to: § use an established model for assessing the net impact (noting that the ACCC has recommended the use of a dynamic model);

§ document all assumptions made, including any adjustments made to the model to accommodate entity specific requirements and the amount, if any, of any compliance costs associated with the introduction of the GST included in the calculations;

§ document the projected savings in business inputs resulting from embedded taxes and the cash flow impacts; § establish and document the methodology to be used for ensuring compliance with the ACCC’s Price Exploitation Guidelines in regard to dollar margins and 10 per cent price increase cap;

§ document where the entity intends to/has used the provision enabling averaging across ‘a line of related goods and/or services’; 14 GST IMPLICATIONS FOR THE TASMANIAN ESI

§ establish procedures for testing the validity of assumptions made and model outcomes against the actual outcomes during the period between 1 July 2000 and 1 July 2001; and § document any other information necessary to justify the proposed price increases.

2.5 Analysis undertaken by the Entities

The three electricity entities, the Hydro-Electric Corporation (Hydro Tasmania), Transend Networks Pty Ltd (Transend) and Aurora Energy Pty Ltd (Aurora), separately undertook an initial analysis of the net impact of TNTS on their businesses. Following initial discussions with the three entities, the Regulator suggested that there could be benefits from a more co-operative approach. In March 2000, an informal working group was established to provide a forum for discussion. The working group consisted of representatives from all three entities and the Regulator and his staff. The group met on a fortnightly basis during March and April 2000. However, each entity was responsible for undertaking its own assessment and retains responsibility for ensuring that the price increases sought comply with the ACCC Price Exploitation Guidelines. The net impact of TNTS on System Control must be separately identified in accordance with the 1999 Pricing Determination. On 1 July 2000 statutory responsibilities and obligations of System Control will be transferred to Transend. However, until the transfer is effected Hydro Tasmania has control and responsibility for the accounting functions of System Control. On this basis, Hydro Tasmania, in consultation with Transend separately assessed the net impact of TNTS on System Control. The approach adopted by each entity in undertaking its analysis, discussed below, was prepared by the relevant electricity entity. GST IMPLICATIONS FOR THE TASMANIAN ESI 15

3 HYDRO-ELECTRIC CORPORATION ESTIMATED IMPACT ON ENERGY PRICES

3.1 Background

As requested by the Office of the Tasmanian Electricity Regulator (OTTER), Hydro Tasmania undertook an analysis of the impact of the Commonwealth Government’s TNTS package, incorporating the Goods and Services Tax (GST). In undertaking this analysis, Hydro Tasmania considered the flow and timing of items such as GST on supplies, revenue, savings from the abolishment of WSTE and minor stamp duties and taxes and the associated rebates to/from the Australian Tax Office (ATO). Analysing the impact of TNTS on Hydro Tasmania took direction under two phases:

§ the first involved contracting PriceWaterhouseCoopers to analyse cost savings arising from TNTS by utilising the services of the Monash University dynamic business model; and § the second involved adapting Hydro Tasmania corporate model to report the impacts of TNTS on the profit and loss, balance sheet and cash-flow statement.

3.2 Monash Modelling

In calculating the cost saving as a result of the GST package, Hydro Tasmania chose to have the analysis undertaken by Monash University under the direction of PriceWaterhouseCoopers.

The Monash model, used to calculate the cost savings as a result of the GST package, is a dynamic equilibrium model. It has been designed to project changes in the economy as a consequence of changes in economic or industry policy, general economic conditions or demand and supply conditions, both within industries and more broadly across the economy. As a dynamic equilibrium model, the model’s parameters adjust over time to changing conditions. The Monash model provides a direct consideration of the effects of the changes on depreciation charges. This is an important feature of the Monash model in relation to Hydro Tasmania given that electricity generation is capital intensive and that the capital items concerned are likely to be long-lived. In this context, the effects of the GST package on depreciation charges can only be phased-in in proportion to the replacement of pre-1 July 2000 capital with post-1 July 2000 capital. 16 GST IMPLICATIONS FOR THE TASMANIAN ESI

For most companies: § the overwhelming effect of the GST package on input costs is through the removal of WST; and § the fuel rebate arrangements tends to be of secondary importance. Neither case is directly relevant to Hydro Tasmania as: § as a manufacturer, electricity generation is exempt from WST; and § rebateable fuels do not form a large proportion of Hydro Tasmania ’s input costs. Key impacts on Hydro Tasmania from the GST package arise from:

§ the effects of the removal of WST from Hydro Tasmania ’s activities not directly associated with electricity generation; and § the removal of embedded WST across the broad range of Hydro Tasmania ’s input costs (ie where the dynamic capabilities of the Monash model cover indirect effects as well as the direct effects of the flow through of cost and price changes).

3.3 Assumptions

The following assumptions were made during the Monash modelling: § modelling was based on the 1999-00 Hydro Tasmania budget; § the percentage change for each year represents the difference between the outcome under TNTS and the outcome that would have applied if TNTS was not introduced (that is, the same tax policy basis); § the modelling assumes no ‘wages push’ as a result of the GST package;

§ the Monash numbers do not include the costs of ‘net additional compliance costs reasonably incurred’; § an aggregate depreciation charge is used, and aggregate changes for depreciation recorded; § modelling is from the perspective of Hydro Tasmania being a WST-paying entity. This perspective is based on the assumption that Hydro Tasmania 's WSTE payments mirror WST that would be payable; and § fuel, (that is, water) used in generation is treated as a ‘no cost change’ item. In allocating the cost savings (principally savings in WSTE) across activities within Hydro Tasmania, two alternative methods were considered: § a weighted average revenue method; or GST IMPLICATIONS FOR THE TASMANIAN ESI 17

§ an energy basis. Hydro Tasmania, on the advice of PriceWaterhouseCoopers, and in consultation with the Regulator chose to use the weighted average revenue basis. The weighted average revenue basis was considered more appropriate as it generated results that were consistent with the ‘net dollar margin’ rule for each supply under the ACCC Price Exploitation Guidelines. Discussions with the ACCC supported the approach adopted.

In addition to the assumption made regarding the allocation of cost savings, Hydro Tasmania adopted the following additional assumptions for analysing the impact on its business: § savings in Generation and Corporate divisions were passed on to Retail, Major Industrial and Bass Strait Islands customers, while Consulting and Systems savings have been passed onto the external customers in each of these divisions; § cash-flow modelling was done on a financial year basis; § electricity supplied will be invoiced monthly, with invoicing on the 7th day of the month following supply and payment due 7 days thereafter; § the GST liability collected on the supply of electricity is equal to total revenue less calculated savings multiplied by 10 per cent; § compliance costs of $0.1million per annum were included;

§ where a net payment is due to the ATO in any given month (as will usually be the case) this payment is made on the 21st of that month, as this is the last day allowed for lodgement under the legislation. This will maximise interest earned on GST collected. This is illustrated in Table 3:1. Table 3:1: GST Payments - Timing Impacts

Revenue Electricity Supplied Revenue Invoiced Revenue/ GST GST Passed to Received ATO 1-31 July 2000 7 August 2000 14 August 2000 21 September 2000 Expense Purchase Date / GST ATO Rebate to Paid Hydro Tasmania 1-31 July 2000 21 August 2000 Source: Hydro Tasmania

As demonstrated above there will be a timing lag in GST received compared to GST remitted to the Australian Tax Office (ATO) in the first period. From then on, while it is true to say that GST will be collected in one month and remitted the next, the amount of inflows and outflows each month should not be materially different. That is, the GST paid should be almost identical to the GST collected within the one month and there 18 GST IMPLICATIONS FOR THE TASMANIAN ESI

will be no positive cash-flow impact. Thus it is assumed there will be no material interest advantage after the initial 6 week timing lag. The benefit has been calculated to be approximately $0.014 million based on the average weekly receipt of $2.2 million and an assumed interest rate of 5.75 per cent for six weeks: $2.2 million * 5.75% for 6 week = $0.014 million

3.4 Comparison with Other Generators

Savings projected by the Federal Government and ESAA have been mostly based on thermal generators as the Australian electricity market predominantly consists of thermal generators. Thermal generators incur significant direct costs in relation to fuel and transport/shipping and the treatment of such inputs under the tax package vary markedly in comparison to the inputs utilised in hydro generation. On the basis of the significantly different input cost mixes amongst generators, it is inappropriate to use modelling results derived from one kind of generation and apply those results to the other kind of generation. Table 3:2 provides a comparison of savings calculated by Hydro Tasmania and those generated using alternative models. Table 3:2 Savings calculated under each model Model Short Term % Long Term % Monash – Projections for Hydro Tasmania -0.1590 -0.2790 STATAX - Generators -0.0600 -1.2000 PRISMOD – Whole national electricity industry -3.1000 MM303 – Whole national electricity industry -0.2921 -3.6469

Note: Negative represents a saving, positive a cost.

In undertaking this comparison Hydro Tasmania noted that models

…such as Econtech’s MM303 model, Arthur Anderson’s STATAX model or the PRISMOD model used by the Federal Government assume certain characteristics of the economy and maintain these into the future. Static models tend to be based on a broad perspective of long-run and short-run changes.

3.5 Compliance Process

As a result of abiding by guidelines and establishing and documenting robust policies and procedures for assessing the net impact of the GST and ensuring that any modelling undertaken be based on valid assumption to ensure results are reproducible, the following compliance process has been adhered to: § an established model and dynamic model has been used for cost saving projections; § all assumptions have been documented; GST IMPLICATIONS FOR THE TASMANIAN ESI 19

§ projected savings in business inputs resulting from the abolishment of embedded taxes and the cash-flow impacts have been fully documented; § the dollar margin has been maintained; and

§ a process will be established to audit actual cost savings during the first year of operation of the GST package and acted upon appropriately.

3.6 Estimated Impacts Hydro Tasmania

3.6.1 Recommended Pricing

The pricing impact was modelled in two parts, energy for retail customers on mainland Tasmania and energy sales for the Bass Strait Islands. The recommended pricing impacts based on the savings calculated under the Monash model are: Table 3:3: Energy for Retail Customers on Mainland Tasmania

2001 2002 2003 2004 2005 2006 $‘000 $‘000 $‘000 $‘000 $‘000 $‘000

Total Savings due to -173 -184 -209 -237 -260 -270 TNTS

Revenue Pre-TNTS 149 947 156 918 162 218 161 947 151 109 132 508 % % % % % %

Weighted Contribution -0.115 -0.117 -0.129 -0.146 -0.172 -0.204 to Savings Net GST Price Increase 9.873 9.871 9.859 9.839 9.811 9.776 (10 per cent less savings)

Note 1: Total Savings excludes savings in Consulting, Systems, IT & Bass Strait Islands expenses Note 2: Negative numbers represent savings, positive numbers increases. Data based on financial years.

The recommended net GST pricing increase for the period 1 July 2000 until 1 January 2002 (the review date set by OTTER) has been interpolated on a straight line basis between the 2001 and 2002 rate noted in the table above and is recommended to be 9.872 per cent, being: C Interpolated rate = A - (A - B) ´ D 6 = 9.873 - (9.873 - 9.871)´ 12 = 9.872% Where A = 2001 rate B = 2002 rate 20 GST IMPLICATIONS FOR THE TASMANIAN ESI

C = Months between the 30 June 2001 and 1 January 2002 D = Months between the 30 June 2001 and 30 June 2002 Table 3:4: Bass Strait Island Customers

2001 2002 2003 2004 2005 2006 $’000 $’000 $’000 $’000 $’000 $’000

Total Savings due to -18 -18 -19 -20 -21 -22 TNTS

Revenue Pre TNTS 7 844 7 757 7 951 8 149 8 353 8 562 % % % % % %

Weighted Contribution to -0.235 -0.232 -0.243 -0.250 -0.253 -0.253 Savings

Net GST Price Increase 9.741 9.744 9.732 9.725 9.722 9.722 (10 per cent less savings) Source: Hydro Tasmania Note: Negative numbers represent savings, positive numbers increases. Data based on financial years.

Generation on the Bass Strait Islands (BSI) is based on diesel fuel with some wind generation on King Island. Amendments to the diesel fuel rebate scheme have widened the entitlement base to include rail transport and the marine industry. However, there remains no entitlement to the rebate in respect of diesel fuel used in the generation of electricity. Furthermore, the diesel and like fuels grants legislation provides no benefit in respect of electricity generation. These grants are restricted to the use of certain vehicles on public roads and Hydro Tasmania does not meet this criterion.

In accordance with the ACCC requirements savings will need to be allocated between the customers on the BSI and the Government in relation to the revenue provided for the BSI CSOs. At the time of preparing its submission, Hydro Tasmania had calculated the total net impact in accordance with the Price Determination. As discussed in the Final Report for the 1999 Pricing Investigation9, the actual tariff paid by the BSI customers depends on the quantum of the CSO provided by the Government. The quantum of the CSO and the allocation between the BSI customers and the Government is currently subject to discussion. Following finalisation of these arrangements OTTER will be provided with a full submission on BSI tariffs. The recommended net GST pricing increase for the period 1 July 2000 until 1 January 2002 (the review date set by OTTER) has been calculated using the same formula as the Retail rate and is recommended to be 9.743 per cent. These results were then tested for compliance with the ACCC Price Exploitation Guidelines regarding the pass through of savings and the maintaining of the dollar margin. To ensure compliance, revenue was decreased by the amount of saving incurred. Similarly expenses to produce the given revenue were decreased by the

9 Electricity Supply Industry Pricing Policies, Final Report, November 1999, p231 GST IMPLICATIONS FOR THE TASMANIAN ESI 21

calculated saving and compliance costs have been included. This is demonstrated in Table 3:5. Table 3:5: Profit and Loss Summary

Profit and Loss 2000-01 2001-02 2001-02 $m $m $m Total Revenue Pre-GST 323.0 337.1 347.3 Post-GST 322.6 336.7 346.8 Total Expenses Pre-GST 104.9 108.6 109.0 Post-GST 104.6 108.3 108.6 Profit After Tax Pre-GST 9.7 22.3 30.8 Post-GST 9.6 22.2 30.8

Source: Hydro Tasmania

In undertaking this analysis it has been assumed that a full rebate is available for GST paid on supplies, and as a consequence the profit and loss impact is zero. Also as the impact on an accrual basis is the same on both the payment of GST and the rebate of GST, the cash-flow impact is also zero

3.7 Conclusion

All analysis was undertaken to ensure that Hydro Tasmania complied with ACCC price exploitation guidelines and OTTER requirements and confirmed the financial impact of the introduction of the GST on Hydro Tasmania will be minimal. It is therefore estimated that the net GST pricing increase for the period 1 July 2000 till 1 January 2002 will be: § Retail customers on Mainland Tasmania 9.872 per cent; and § Bass Strait Islands 9.743 per cent. 22 GST IMPLICATIONS FOR THE TASMANIAN ESI GST IMPLICATIONS FOR THE TASMANIAN ESI 23

4 SYSTEM CONTROL

4.1 Background

To comply with the 1999 Pricing Determination the net impact of TNTS on System Control must be separately assessed. Changes in System Control costs and prices have a flow through Aurora and impact on customer tariffs. Hydro Tasmania included in its analysis of the net impact of TNTS a detailed study of the Systems Division. Systems Division has historically provided 4 services: § Statutory role of System Controller; § Generation operations; § Network operations; and § Administration of operating standards for all associated entities.

The Government in conjunction with Hydro Tasmania and Transend, as part of the preparations for the prospective entering into the National Electricity Market (NEM), reviewed the structure of Hydro Tasmania. Following this review, it was recommended that Generation Operations remain within Hydro Tasmania, but that the remaining services including the System Controller function should be transferred to Transend. The transfer will be effected on 1 July 2000. However, until the transfer is effected Hydro Tasmania has control and responsibility for the accounting functions of System Control. On this basis, Hydro Tasmania, in consultation with Transend separately assessed the net impact of TNTS on System Control.

4.2 Pricing Impact

The model used and the methodology adopted by Hydro Tasmania for analysing the net impact of TNTS on System Control costs was the same as that used for analysing the net impact on energy prices for retail sales and the Bass Strait Islands. That is, the analysis was undertaken by Monash University, using the Monash Model, under the direction of PriceWaterhouseCoopers. The key effects on System Control from the TNTS package arise from the removal of WSTE from activities and the removal of embedded WSTE across input costs. The cost mix within the System Control structure is such that the majority of expenses are labour related, leading to minimal cost savings as a result of TNTS. 24 GST IMPLICATIONS FOR THE TASMANIAN ESI

The recommended pricing for System Control, based on the savings calculated under the Monash model, is: Table 4:1: System Control

2001 2002 2003 2004 2005 2006 $‘000 $‘000 $‘000 $‘000 $‘000 $‘000

Total Savings due to -9 -11 -12 -12 -13 -13 TNTS

Revenue Pre-TNTS 9 400 9 400 9 400 9 400 9 400 9 400 % % % % % %

Weighted Contribution -0.094 -0.119 -0.126 -0.133 -0.137 -0.137 to Savings Net GST Price Increase 9.896 9.869 9.861 9.854 9.850 9.849 (10 per cent less savings)

Source: Hydro Tasmania

The recommended net GST pricing increase for the period 1 July 2000 till 1 January 2002 has been interpolated on a straight line basis between the 2001 and 2002 rate noted in the table above and is recommended to be 9.883 per cent.

4.2.1 Conclusion

It is recommended that the net TNTS pricing increase for System Control, for the period 1 July 2000 till 1 January 2002, be 9.883 per cent. GST IMPLICATIONS FOR THE TASMANIAN ESI 25

5 TRANSEND ESTIMATED IMPACT ON TRANSMISSION PRICES

Transend Networks Pty Ltd (Transend) commissioned a modelling exercise via its tax advisers, KPMG, to determine the effect of the Commonwealth Government’s TNTS on its costs. The modelling (using the Econtech model) includes the amendments to TNTS announced on 28 May 1999.

5.1 Methodology

5.1.1 Modelling Objective

The objective of the Econtech model was to assist Transend predict the potential impacts of the TNTS on its business. In undertaking its analysis with the Econtech model, Transend notes that other users of the Econtech model had reported two important uses for the model:

§ Documentation of the business pricing strategy – The ACCC expects each business to pass on sales tax and other savings to customers. If it does not substantial fines may be imposed. The use of an established model and rigorous documentation of pricing strategies and methodologies will assist a business in the event that a customer lodges a complaint with the ACCC. On this basis the use of the Econtech model is viewed as an invaluable tool for substantiating the position of Transend; and

§ Input into negotiations with suppliers – That is, it provides relevant data for the assessment of suppliers’ new prices, and will assist with negotiation with suppliers to ensure they pass on all tax reform savings.

5.1.2 Econtech Methodology

The results and findings from the modelling undertaken on behalf of Transend were based on the 1999-00 budget data supplied by Transend to KPMG, who made a number of assumptions in classifying that data. The Econtech MM303 model requires all data to be classified according to the ANZSIC industry codes. This classification of the data provided by Transend was undertaken by KPMG and reviewed by Econtech. The findings were obtained in a two-step procedure: § firstly, Econtech used its MM303 model to estimate the cost savings arising from TNTS for over 300 different goods and services in the Australian economy; and 26 GST IMPLICATIONS FOR THE TASMANIAN ESI

§ secondly, these cost savings were applied to the cost structure of Transend, as represented by its budgeted profit and loss statement and other financial information for the 12 months ending 30 June 2000. For the purpose of the modelling, budget information has been consolidated by general ledger code to trace the overall cost savings.

Transend in its submission noted that Econtech believes that MM303 is the leading model for estimating the detailed industry effects of TNTS. However, like all models in its class, MM303 relies on imperfect data published by the Australian Bureau of Statistics, and necessarily uses assumptions that are simplifications of reality. Therefore, estimates from MM303 are subject to margins of error. However, care has been taken to ensure that the statistical variation is kept to a minimum. That is, the findings from use of the model are subject to unavoidable statistical variation and care must be used whenever using this information. In carrying out this modelling: § it was recognised that Transend currently pays very little wholesale sales tax on materials bought and used in its activities, but does pay wholesale sales tax equivalents. This has been reflected in the model; and

§ the modelling was performed at an entity level and not for each product and service. This reflects KPMG’s view that Transend provides a homogeneous output and it is not appropriate to isolate cost savings to any particular product or customer grouping.

5.1.2.1 Assumptions

The model is only a tool to predict certain tax reform related cost savings. The tool employs assumptions to reach its conclusions. Therefore users of the output from the model need to consider how and why actual tax reform cost savings will differ from the models predictions. In this regard, the issues that need to be considered include: § the model excludes additional professional consulting fees and management time from its analysis; § the model ignores the cash flow costs and benefits that may arise;

§ the model assumes that savings will be passed on immediately, in the short term and in the long term. Market forces are ignored; § the model ignores movements in interest rates; § the model is based upon 1994 data of the Australian economy that has been updated to some extent. However the model ignores short-term events such as the spike in oil prices in 1999; § on a macro level, the model assumes certain outcomes in the economy namely: GST IMPLICATIONS FOR THE TASMANIAN ESI 27

– long term increase in the CPI of 1 per cent;

– export pricing decreasing by 1.3 per cent in the short term and 3.4 per cent in the long term assuming the Australian dollar will appreciate; and

– cost of capital goods, on average across the economy, decreasing by about 8 per cent (although the actual amount for each industry will vary from this average);

§ labour costs are not impacted by the imposition of GST; and § relevant capital assets were acquired in a sales tax exempt environment. For the purposes of the completion of this model, both internal and external labour costs have been excluded from the calculations performed. Whilst “out-sourced” labour will attract the GST, given that Transend will obtain a credit for such amounts, this has no impact on the model. Allowance is made in the long-term projections of cost savings for the reduced amortisation costs associated with capital assets used by Transend. No allowance is made for the same in the immediate and short-term projection of savings. The assumption in regard to the sale tax exempt status of capital assets is consistent with the findings of the Regulator, at least in respect of assets acquired pre 1 July 1998. To this end, the projected savings on depreciation reflect the assumed impact of the flow-through of indirect savings (arising from the abolition of embedded taxes) upon replacement of the assets.

5.2 Monitoring to pass on actual costs

Only savings in operating costs arising from TNTS need to be taken into account in setting new prices. Transend will monitor and quantify the actual cost savings achieved and pass on those cost savings as required in accordance with the ACCC Price Exploitation Guidelines and the Regulator’s Pricing Determination. If the savings predicted by this model are not realised, the Determination provides for an adjustment in the final year of the Pricing Period, that is in the 2002 pricing year. To assist in the identification and quantification of savings, Transend has written to each supplier and requested details of anticipated benefits. These will be matched against the expectations of the model and further investigation will be conducted on suppliers who indicate savings where there are major price discrepancies with the modelling performed.

The ACCC’s Price Exploitation Guidelines specify that the net dollar margin cannot be increased under TNTS. Transend has taken this to mean that the level of earnings before interest and tax (EBIT) can be maintained. This is illustrated in Table 5:1, where it is assumed that a business has one ‘product’ line and the actual tax cost savings was $10: 28 GST IMPLICATIONS FOR THE TASMANIAN ESI

Table 5:1: Pre and Post TNTS Dollar Margins

Table Headings Pre-TNTS Cost Savings Post TNTS Revenue 200 190 Expenses (100) 10 (90) Net Profit 100 100 Source: Transend

5.3 Alternative modelling outcomes

As discussed in section 1.3, Arthur Andersen on behalf of the ESAA modelled, on a representative basis, the cost savings for electricity generators, transmission companies and distributors. Table 5:2 provides a comparison of the results from the STATAX and the Econtech model used by Transend: Table 5:2: Alternative Modelling Outcomes

Immediate Short-Term Long-Term STATAX – expressed as 0.09% 1.08% 1.69% percentage of total costs Total Transend annual projected $32.683m $32.683 $32.683 costs Annual Savings using STATAX $29 415 $352 978 $552 345 Econtech Model (Transend costs) $42 500 $87 090 $763 152 Difference in modelled result $13 085 $265 888 ($210 807) Diesel Fuel Rebate Adjustment1 ($35 000) ($31 000) Adjusted Difference $13 085 $230 888 ($241 807) Difference as a percentage of 0.04% 0.71% -0.74% Transend’s costs Difference as a percentage of 0.02% 0.35% -0.37% Transend’s Revenue Source: Transend Note 1: Adjustment required to account for a discrepancy arising from the diesel fuel rebate assumptions made by Arthur Andersen in the STATAX model.

It is difficult to draw a direct comparison between the ESAA results and those derived for Transend as:

§ Arthur Andersen utilised the STATAX economic model while Transend has used the ECONTECH model. Given that the models have been developed independently, and both are forecasts only, it is not expected that they would derive identical results.

§ Arthur Andersen’s data is based on a single representative transmission company only, with total expenditure of some $264 million. The ECONTECH model has GST IMPLICATIONS FOR THE TASMANIAN ESI 29

been applied to the actual cost structure of Transend – a business with only $32 million in costs.

To the extent to which the current cost structure or revenue profile of Transend differs from the representative company used by Arthur Andersen (which is likely given the differences in scale), then different outcomes would be observed even if the same underlying model were used. To this end, the only manner by which a meaningful comparison could be obtained between the Arthur Andersen outcome and that derived by Transend, would be if the Transend cost structure were loaded into the STATAX model.

Notwithstanding the above, it is clear that while the models are suggesting results which differ materially relative to the projected cost savings, the difference is minor relative to the total revenue of Transend. Given that both models are mere forecasts, it is unlikely that a higher degree of accuracy could be obtained without significant additional work and potentially greater expense.

5.4 Estimated Impacts

5.4.1 Main Findings at a Glance

The projected impacts are shown in Table 5:3. It should be noted that the projected impacts do not take account of Transend’s proposed capital expenditure program. Table 5:3 Overall Cost Savings

Immediate Short Term Long Term $’000 $’000 $’000 Post GST Expenditure 32 640 32 596 31 920 Pre GST Expenditure 32 683 32 683 32 683 GST Cost Savings 43 87 763

Immediate Short Term Long Term % % % Percentage Saving as 0.1 0.3 2.3 a percentage of cost Percentage Saving as 0.1 0.1 1.1 a percentage of 2000 income Source: Transend

Transend noted in its submission that the projected cost savings estimated using the Econtech model are only estimates and represent the estimated maximum obtainable cost savings. The actual cost savings achieved will be reliant on a number of factors, including the ability of Transend to successfully negotiate contracts with suppliers to ensure that all savings realised by its suppliers are fully passed on to Transend. 30 GST IMPLICATIONS FOR THE TASMANIAN ESI

5.4.2 Major Costing Impacts on Transend

The following tables list the five major business inputs that will result in the greatest cost savings for Transend. Table 5:4 depicts the five business inputs, which in the short term provide the biggest cost savings. It is anticipated that these short-term savings should be largely realised within twelve months. As can be seen from this Table, wholesale sales tax equivalent changes provide the greatest cost saving in the short term. The estimated saving to Transend available immediately upon the implementation of TNTS is $44,000 representing the total removal of the existing wholesale sales tax equivalents system and revision of the fuel excise. Table 5:4 Forecast Changes from 2000-01 Expenditure Expenditure 2000-01 Immediate Immediate Short term Short term Long term Long term Item $‘000 $‘000 % $‘000 % $‘000 % Wholesale 40 (40) (100.0) (40) (100.0) (40) (100.0) tax equivalent Purchased 452 (0) (0.0) (12) (2.7) (25) (5.5) services Contracted 512 (0) (0.0) (5) (1.0) (18) (3.5) services - materials Fuel 50 (4) (8.4) (4) (8.9) (5) (10.6) IT Services 213 (0) (0.0) (3) (1.2) (8) (3.5) (44) (64) (96) Other 1 (23) (667) Total cost (43) (0.1) (87) (0.3) (763) (2.3) change (savings) Source: Transend

5.4.2.1 Immediate Cost Savings (1 July 2000)

The estimated cost savings to Transend available immediately upon the implementation of TNTS as a percentage of recurrent expenses, but excluding labour and depreciation, total $42 543 per annum or 1.1 per cent. Relative to total expenses, the estimated cost savings are 0.1 per cent. This decrease in costs arises directly from the removal or reduction of taxes on Transend’s recurrent business expenses, primarily wholesale sales tax equivalents. These savings are not dependent on pass-through of upstream cost savings by any suppliers.

The immediate impact on costs is therefore considered to be small. It is expected that (ignoring market forces) GST exclusive pricing to customers on 1 July 2000 will not be too different from prices as at 30 June 2000. GST IMPLICATIONS FOR THE TASMANIAN ESI 31

5.4.2.2 Short-term Cost Savings (12 months after 1 July 2000)

The estimated cost savings to Transend, which should be largely realised after approximately one year, as a percentage of recurrent expenses, but excluding labour and depreciation, total $87 090 per annum or 2.3 per cent. Relative to total expenses, the estimated cost savings are 0.3 per cent. Transend notes that these short term cost savings include the immediate cost savings of 1.1 per cent from 1 July 2000 and additional cost savings of 1.2 per cent emerging in the 12 months following the introduction of TNTS, assuming that all upstream suppliers pass on their cost savings in full.

5.4.2.3 Long-term Cost Savings

The Econtech model predicts that the costs of Transend are estimated to fall by a maximum of 4.0 per cent of recurrent expenses and depreciation, but excluding labour, in the long term10. As a percentage of total expenditure, savings of 2.3 per cent are expected.

This saving will occur from the savings within recurrent expenses, in the form of amortisation and depreciation of the capital of Transend and from suppliers passing on their direct and capital cost savings in the form of lower prices. The savings on capital will only be realised when the capital purchased under the existing tax system is replaced with capital purchased under TNTS. This could take many years and the impact of market and inflationary forces may intervene in the interim.

5.4.2.4 Cost savings passed on into pricing

Having regard to the above findings, the anticipated timing of the savings being realised and after making due allowance for the impact of the estimated compliance with TNTS, Transend is of the view that it is appropriate to pass onto its customers the following cost savings (in $’000’s):

Year ended 30 June 2001 Average cost savings: $’000 Immediate savings + 75% of short term savings = $43 + $44*.75 or 77 Less costs of compliance – external costs only 27 Average cost savings to be passed on 50 Year ended 30 June 2002 Average cost savings: Short term savings + 5% of long term savings = $87+33 120

10 This is not a defined period, however as a guide it is suggested that it is in the vicinity of a 3 to 6 year period 32 GST IMPLICATIONS FOR THE TASMANIAN ESI

Less costs of compliance – external costs only 30 Average cost savings to be passed on 90 Period to 31 December 2002 Average cost savings: Short term savings + 15% of long term savings = $87+101 187 Less costs of compliance – external costs only 30 Average cost savings to be passed on in a full year 153 Say for ½ year 80

On the basis of the above, Transend has estimated that the average impact on transmission prices for the period 1 July 2000 to 31 December 2001 that will be passed through to retail customers to be 9.901 per cent. GST IMPLICATIONS FOR THE TASMANIAN ESI 33

6 AURORA – ESTIMATED IMPACT ON RETAIL ELECTRICITY AND OTHER SERVICES

This Chapter discusses the issues and methodology adopted by Aurora in determining the net impact of TNTS and thus the required adjustment to retail tariffs required post 1 July 2000. Aurora has determined that the savings arising from TNTS are mainly from the abolition of WSTE payments to the State Government, and in savings accruing to certain of its suppliers as a result of TNTS. Offsetting these savings are the immediate and on-going costs of complying with the GST legislation, over and above the cost of compliance with the WSTE regime.

6.1 Issues

Aurora considers that the key issue relates to how to approach the allocation of savings. To ensure compliance with the ACCC Price Exploitation Guidelines, the Regulator requested Aurora to distinguish at least two separate categories of services for the purposes of the allocation of savings. These categories are: § the supply of electricity; and § the supply of other services11 provided by Aurora. Aurora notes that costs directly relating to the supply of electricity are strongly dependent on the pass through of costs from Hydro Tasmania and Transend. Of the remainder, depreciation does not give rise to any savings in the short-term (ie within the Pricing Period) for Aurora. Labour and interest charges also do not give rise to any cost savings. For other services, which include service connections, meter replacement and contract services provided to external parties by Aurora Services, costs are principally determined by labour and materials costs. Aurora also notes that although these two groups have been distinguished for modelling purposes, ‘this is not to say that there need to be great differences in the pass-through rates as the main cost elements in both cases have only small offsetting cost savings. For purposes of transparency, however, the distinction has been maintained.’

11 Other Services include charges for the supply of new installations, connection fees, special meter readings, disconnection etc. 34 GST IMPLICATIONS FOR THE TASMANIAN ESI

6.1.1 Number of pass through rates for each service category

Aurora proposes that only one pass-through rate should apply to each service category. In proposing this, Aurora also notes that for the ‘other services’ category, although there are a large number of individual services provided, the only significant difference between them for the purposes of calculating the net impact of TNTS lies in the WSTE attributable to the materials component of each service. However, relative to labour and capital costs, these differences were not regarded as material.

The issue is more complex for the electricity supply charges. The December 1999 Regulator’s Determination recognised three groups of retail customers: § Business – High Voltage § Business – Low Voltage § Residential – Low Voltage For each customer class, the Determination set out a pass-through formula that could provide for different rates of pass through for each class. Such differential rates would principally arise from differences in the energy or transmission services charges attributable to the overall costs of supplying each group. Table 6:1 sets out the relative proportions of energy and transmission costs for each class, based on the energy costs, the transmission and distribution annual average revenue requirement allocations (AARR) and system control costs provided in the Determination: Table 6:1: Proportion of Costs

Proportions of Energy Transmission Distribution Systems Other total input % % % % % costs Business (High 57.28 12.08 29.15 1.34 0.15 Voltage) Business (Low 44.06 12.04 42.37 1.14 0.40 Voltage) Residential 46.84 9.77 41.89 0.73 0.78 (Low Voltage) Source: Aurora

The Regulator agreed that if there were any differences between the pass-through rates for the energy and transmission charges and these differences were relatively immaterial and less than any estimated statistical margin of error in the modelling, then a uniform pass through rate would be acceptable. GST IMPLICATIONS FOR THE TASMANIAN ESI 35

6.2 Modelling Approach and Key Assumptions

Aurora used the services of KPMG, and through them, the Econtech MM303 model, to assess the net impact of TNTS on retail prices. Following careful internal review, detailed cost element based information was provided to KPMG for processing. After separation of the effects of MI contracts (dominated by the pass-through costs from Hydro Tasmania and Transend), two analyses were undertaken to assess the impacts on: § prices for the supply of electricity; and § prices for the supply of other services. The critical assumption used in the modelling by Aurora was the level of ‘savings’ achieved in input costs. In Aurora's case, there were two dominant items - the supply of electrical energy and transmission services from Hydro Tasmania and Transend respectively. Aurora has used these rates for its modelling of the estimated net impact of TNTS and has not attempted to validate these projections. That is, they represent an exogenous input into Aurora’s modelling. These estimates have also been provided directly to the Regulator and are: § Hydro Tasmania 9.872 per cent; and § Transend 9.901 per cent. In addition, the net impact on System Control costs also flow through to the retail tariff price. Aurora completed its modelling and submission prior to the finalisation of the net impacts on System Control costs. The pass through rate assumed by Aurora for System Control costs for modelling purposes was 9.874 per cent. As discussed in Chapter 4 above, the final estimate was in the order of 9.883 per cent. Aurora undertook some supplementary analysis and concluded that the 0.009 per cent increase over the previous estimate had no material impact on the retail tariff estimate. As noted above, the majority of Aurora's other input costs provide no savings. These include interest payments, depreciation charges, the Electricity Entities Contribution Levy and labour costs. The other cost elements (supplies on which savings may be realised as a result of TNTS) account for less than 13 per cent of the total input costs of the business. For these categories the generic national estimates incorporated in the Econtech model have been used except in a few specific cases where the actual prices from particular suppliers have been available.

6.3 Estimated Impacts Aurora Energy

As discussed above Aurora estimated the impacts on the costs and prices charged in two distinct categories, being: § for the supply of electricity; and 36 GST IMPLICATIONS FOR THE TASMANIAN ESI

§ for the supply of other services:

6.3.1 Electricity Prices:

Prices for the supply of electricity include all electricity tariffs and products and thus cover all non-MI electricity sales including contracts, street lighting, HydroHeat, Winterpac, and PAYG. Aurora has estimated that these prices will rise by 9.559 per cent. Table 6:2 summarises the model results. Table 6:2: Total Impacts: Electricity Prices

Pre GST Post GST Item Revenue Cost Revenue Cost $’000 $’000 $’000 $’000 Retail Sales 358 239 356 7711 Energy purchases 137 441 137 2652 Transmission costs 34 970 34 9353 Interest 40 477 40 477 Depreciation 37 292 37 292 Labour 42 479 42 479 WSTE 1 010 0 Fuels & lubricants 1 156 1 053 Purchased Services 3 044 3 009 Contracted Services (L)4 6 746 6 746 Contracted Services (M)5 1 721 1 701 Other Recurrent exp 18 837 18 685 Service contribution6 (5) System Control7 8 750 8 740 Net GST Compliance 110 Totals 358 239 333 923 356 771 332 455 Margin 24 316 24 316

Notes: 1: Post GST revenue (net of GST) required to maintain constant % margin 2: Hydro Tasmania generation escalation factor applied (+9.872%) 3: Transend transmission escalation factor applied (+9.901%) 4: Contracted services providing labour 5: Contracted services providing materials 6: Amount of other service cost changes borne through electricity tariffs under the present rules – Regulator’s Determination p176. 7: System control escalation factor applied (+9.874). GST IMPLICATIONS FOR THE TASMANIAN ESI 37

Retail Electricity Sales Escalator Calculation ($’000)

Pre GST Sales 358,239 less savings 1,468 356,771 plus 10% GST 392,448

392488 Price Rise =1.09549 358239 = 9.559%

The above analysis is sufficient for the purposes of calculating the net impact on retail tariffs. However, to fully comply with the Price Determination, the impact on Aurora Distribution needs to separately identified. As a first step Aurora has estimated the net impact on the distribution/retail component of prices. That is an analysis was undertaken with the generation and transmission components removed. The gross impact is estimated to be plus 9.256 per cent as demonstrated in Table 6:3. Table 6:3: Price Impacts - Retail/Distribution Only

Pre GST Post GST Item Revenue Cost Revenue Cost $’000 $’000 $’000 $’000 Retail Sales 185 828 184 571 Interest 40 477 40 477 Depreciation 37 292 37 292 Labour 42 479 42 479 WSTE 1 010 0 Fuels & lubricants 1 156 1 053 Purchased Services 3 044 3 009 Contracted Services (L) 6 746 6 746 Contracted Services (M) 1 721 1 701 Other Recurrent Expenditure 18 837 18 685 Service Contribution6 (5) System Control 8 750 8 740 Net GST Compliance 110 Totals 185 828 161 512 184 571 160 255 Margin 24 316 24 316 Source: Aurora 38 GST IMPLICATIONS FOR THE TASMANIAN ESI

Retail/Distribution Cost Escalator Calculation ($’000)

Pre GST Sales 185 828 less savings 1 257 184 571 plus 10% GST 203 028

203,028 Price Rise = 1.09256 185,828 = 9.275%

Aurora has undertaken to do a further breakdown of the distribution component prior to 30 June 2000.

6.3.2 Other Services

In relation to other services provided by Aurora, such as special meter reading, connection charges etc, the price increase estimated by the modelling is 9.534 per cent. Table 6:4 summarises the results for this category of services Table 6:4: Impact on Other Services12

Pre GST Post GST Item Revenue Cost Revenue Cost $’000 $’000 $’000 $’000 Income 1 700 1 693

Labour 1 080 1080 Fuels & lubricants 26 24 Materials 8 8 Contracted Services (L) 141 141 Fleet Charges 74 73 Recovery 5 Overheads and Management 871 862 Fees Totals 1 700 2 200 1 693 2 193 Margin (500) (500) Source: Aurora

12 Other Services include charges for the supply of new installations, connection fees, special meter readings, disconnection etc. GST IMPLICATIONS FOR THE TASMANIAN ESI 39

Service Escalator Calculation

Pre GST Income 1 700 Total Costs 2 200 Loss Funded through Electricity Prices 500 Total Savings 12 Savings allocated to electricity customers 5 Savings allocated to service costs 7 Pre GST Income 1 700 less Savings 7 1 693 plus 10% GST 1 862

1,862 Price Rise =1.09534 1,700 = 9.534%

6.3.3 Summary

In summary the net impact of TNTS on electricity and related charges are: Table 6:5

Component Increase due to net GST Impact % Energy Generation Charges 9.872 Transmission Charges 9.901 System Control1 9.874 Retail and Distribution Costs 9.256 Retail Electricity Charges 9.549 Retail Other Services Charges 9.534

Source: Aurora Note 1: System Control impact assessment prior to finalisation, revised estimate = 9.883 per cent

6.4 Comparison with other Models

Aurora also assessed the outcomes of its modelling against the outcomes of the Commonwealth Treasury and Arthur Andersen/ESAA modelling. The submission notes, and as also noted above, the Commonwealth Treasury assessed an average economy wide impact and the Arthur Andersen work used sample firms operating in the mainland environment, dominated by thermal generation. Tasmania’s hydro system 40 GST IMPLICATIONS FOR THE TASMANIAN ESI

has a different cost structure with low fuel costs, and hence lower potential savings from tax impacts on fuel costs, and higher capital charges which do not attract GST related cost savings. Therefore, cost savings accruing in the Tasmanian ESI and reflected in retail tariffs could be expected to be substantially lower than those estimated for the mainland.

Aurora’s results differ significantly, from the Commonwealth Treasury original estimates of 6.9 per cent estimated by the Commonwealth Treasury. Given the changes made to TNTS since this modelling was complete, this is not considered a valid basis for comparison. However, as discussed above, the Arthur Andersen modelling undertaken earlier this year, gave a simple average estimate of 9.18 per cent for a distributor/retailer for the period to 30 June 2001. As, Aurora notes its estimate of 9.275 per cent adjusted for the 5 per cent levy, it is comparable with the Arthur Andersen estimate.

6.5 Next Steps

Aurora notes in its submission the following steps will need to be undertaken over the remainder of the pricing period.

§ Following the Regulator’s review and endorsement of the submissions the new tariffs will be published in the normal way and implemented from 1 July 2000. § Between 1 July 2001 and 31 December 2001 the Regulator will audit the impacts of the GST and authorise a further price adjustment to provide for any ‘unders or overs’ in the current estimate. These prices will apply from 1 January 2002 through to 31 December 2002. § CPI adjustments are to be provided as permitted under the Order (CPI adjustments are to be net of any GST impact). GST IMPLICATIONS FOR THE TASMANIAN ESI 41

7 REGULATOR’S ASSESSMENT

7.1 Issues

7.1.1 Potential Differences between a hydro and thermal based ESI.

As noted in Chapter 1 and by the entities, savings projected by the Commonwealth Government and Arthur Andersen/ESAA have been estimated on what is predominantly a thermal based electricity generation system. Thermal generators incur higher direct costs in relation to fuel and transport/shipping and the treatment of such inputs under TNTS varies markedly in comparison to those inputs utilised in hydro- electricity generation.

7.1.2 Comparative Estimates

The Regulator in making his assessment considered the estimates provided from the earlier modelling, by the Commonwealth Treasury and Arthur Andersen. In relation to theses estimates the Regulator noted that: § Commonwealth Treasury estimates were based on the Commonwealth Government’s earlier proposals regarding TNTS. These estimates were not revised following the changes made to TNTS and embodied in the legislation. Therefore, there is no current official Commonwealth Government economy wide impacts on electricity prices available for comparative purposes; and § the revised Arthur Andersen modelling predicted lower net impacts than have now been estimated by the Tasmanian ESI. However, this was as expected given the predominantly hydro system in this State and the sampling methodology employed by Arthur Andersen. Aurora, as noted in its submission, has undertaken a comparative analysis of the ESAA results and the results of its own analysis. In this regard Aurora notes:

The most recent ESAA analysis considered three time periods: immediate, by the end of 2001, and beyond 2002. The first two are relevant to this submission. Arthur Andersen predicted immediate savings for a retailer/distributor of 0.37% and savings by the end of 2001 of 1.28%. A simple average of these savings is 0.82% for an average GST inclusive rise of 9.18%. Aurora’s estimate of 9.256% for the distribution/retail component is compatible with the ESAA estimate. The removal of the 5% levy from the cost base renders the two estimates almost identical. 42 GST IMPLICATIONS FOR THE TASMANIAN ESI

Both Treasury and Arthur Andersen noted that these savings should be interpreted as maximum potential cost savings. Both analyses were conducted in the context of the mainland environment, dominated by thermal generation. Tasmania’s hydro system has a different cost structure with low fuel costs, and hence lower potential savings from tax impacts on fuel costs, and higher capital charges which do not attract GST related cost savings.

The Regulator agrees with the assertion made by both Hydro Tasmania and Aurora that, given the significantly different inputs utilised in a thermal based system and a hydro based system, the modelling outcomes prepared by Arthur Andersen on behalf of the ESAA must be treated with caution. However, the Regulator is of the view that the primary differences should arise in the generation sector of the ESI, rather than in the transmission and distribution and retail businesses.

7.1.3 Comparison with other Jurisdictions

At the time of publishing this Report, the Regulator was aware that estimates being published elsewhere are suggesting that the Arthur Andersen estimates are also lower than the estimates provided by modelling undertaken by the various jurisdictional ESIs. For example, the impact of TNTS in Western Australia and the Northern Territory, where electricity generation is principally thermal based generation, is also estimated to add 9.3 per cent and 9.5 per cent respectively. EnergyAustralia has also announced that residential and small business prices are likely to rise by 9.3 per cent as a result of TNTS. However, IPART is not expected to announce its decision for each of the regulated monopolies until 9 June 2000. The ACCC estimate for household electricity is in the order of 9 to 9.5 per cent.

7.1.4 Limitations of Modelling

Modelling of future impacts has its limitations, as all modelling requires that assumptions be made about the future that may or may not be realised. For example, in each model assumptions have to be made about the level of actual cost savings achieved and passed on by suppliers and the economic parameters, such as inflation, exchange rates etc. Thus there is potential for the actual outcome to differ from the estimated outcome, ie there may be differences between the estimated net impact of TNTS and the actual net impact of TNTS on electricity prices.

7.1.5 Savings arising from the New Tax System in Tasmania

Savings accruing to businesses from TNTS may be realised in the short-term or accrue over a longer time period. Typically savings will arise over an extended time period and only a small proportion will be realised at the commencement of TNTS on 1 July 2000. The savings arise from: § wholesale sales tax savings on intermediate goods (realised in the short term); GST IMPLICATIONS FOR THE TASMANIAN ESI 43

§ wholesale sales tax savings on capital goods (realised in the medium to long term); § diesel fuel rebate; § reductions in other indirect taxes. The quantum and timing of the savings will in part depend on:

§ the amount and timing of the pass through by suppliers of their savings. In the interim, the entities must estimate these. Differences are likely to arise between the estimates made in anticipation of 1 July 2000 and those savings actually passed through after 1 July 2000;

§ the quantum and timing of each entity’s capital investment program. Where average lives of assets are relatively long, capital savings will be deferred compared to entities with assets with relatively short average lives. In making his assessment of the estimated impact on electricity prices, the Regulator: § looked to whether the entities had used an established model, that was generally accepted for this purpose and had taken into account their obligations under the ACCC Price Exploitation Guidelines; § examined the assumptions made in relation to each entities cost structures; § acknowledges that electricity generation, transmission and distribution activities:

– are capital-intensive activities; and

– enjoyed extensive exemptions from WSTE prior to disaggregation on the basis of Hydro Tasmania’s status as a manufacturer;

– that generation has continued to attract WSTE exemptions on the basis of its status as a manufacturer;

§ notes that the majority of any WSTE savings will accrue over the medium to long term, and will not be realised in the short-term; § that the majority of other costs, such as labour and interest payments contain no embedded taxes and thus no cost savings will accrue on these post 1 July 2000, therefore cost savings accruing in the short term are likely to be relatively small; § acknowledges that the diesel rebate will have minimal impact on the cost structure of the entities; § accepted that the cost savings and thus the net impact of TNTS could be averaged in accordance with the ACCC Price Exploitation Guidelines.

Following analysis of each of the entity’s submissions, the Regulator was satisfied that the entities’ approach was appropriate. The Regulator was also satisfied that the entities 44 GST IMPLICATIONS FOR THE TASMANIAN ESI

have established reasonable ‘audit trails’ and that the results would be ‘reproducible’. The results were also consistent with the ACCC’s estimates and indications of potential impacts elsewhere. As indicated above, the Regulator also acknowledges that any forward modelling is limited and that the true impact can only be determined post 1 July 2000. This is provided for in the 1999 Determination, whereby the entities will be able to adjust prices in 2002 to account for any difference between the modelled outcomes and the actual outcomes. However, the Regulator in his discussions with the entities, has sought assurance that the entities will monitor the actual net impact during 2000-01. If the price increases applied from 1 July 2000 are in excess of the actual adjustments that were required (to account for the actual net impact) the Regulator is of the view that the entities have an obligation under the ACCC Price Exploitation Guidelines to adjust prices downwards. That is, the tariff prices approved to apply from 1 July 2000 are the maximum prices.

7.2 Summary

The Regulator has assessed the submissions provided by each of the three entities and accepts as reasonable the estimated net impacts being: § for electricity supply to retail customers on mainland Tasmania: Table 7:1: Net Impact of TNTS on Electricity Supply to Retail Customers

1 July 2000 to 31 December 2001 % Energy 9.872 Transmission 9.901 System Control 9.883 Retail/Distribution 9.275 Total 9.559

§ for supply of other services to retail customers: Table 7:2: Net Impact of TNTS on Other Services

1 July 2000 to 31 December 2001 % Other Service 9.534 GST IMPLICATIONS FOR THE TASMANIAN ESI 45

§ for electricity supply to retail customers on the Bass Strait Islands: Table 7:3: Bass Strait Islands

1 July 2000 to 31 December 2001 %

Net GST Price Increase 9.743 (10 per cent less savings) to be applied from 1 July 2000 to 31 December 2001.

7.3 Future Action

As discussed in the Final Report for the Pricing Investigation and provided for in the Pricing Determination: § the Regulator requires the entities to make a ‘retrospective adjustment to their prices to ensure that only the actual net impact of the GST is passed on to customers’; and

§ the Regulator will require the entities to have an independent assessment of the actual impact for the period 1 July 2000 to 30 June 2001. This review will be undertaken during the period July 2001-September 2001 - with a view to make tariff/price adjustments for the period commencing January 2002 following review and approval by the Regulator. The entities will also have to monitor the actual impact of TNTS on their businesses over the coming year to ensure compliance with the ACCC Price Exploitation Guidelines. If the actual impact is less than the estimated impact, to ensure compliance with these Guidelines, prices and/or tariffs will need to be adjusted accordingly.