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• Mandatory Avoidable Cost Allocation Methodology
• Treatment of Gas Distribution and Gas Transmission under the Avoidable Cost Allocation Methodology
• Avoidable Cost Allocation Methodology Principles

Mandatory Avoidable Cost Allocation Methodology

1. The avoidable cost allocation methodology (ACAM) defines the Pipeline business as the "stand-alone" business and makes an assessment of the expenses, revenues, assets and liabilities ("items") that would be avoided by the pipeline owner if it did not operate its Other ("incremental") business. The components of the items that would not be avoided are allocated to the line business, and the components that would be avoided are allocated to the Other business⁶.

2. Explanatory note: Conceptually there are two approaches to ACAM: (a) a "bottom-up" approach which asks what would the pipeline owner's financial statements look like if it only provided Pipeline business services; and (b) a "top-down" approach which asks what the pipeline owner's financial statements would like if it ceased operating its Other business (assuming away transitional factors, such as redundancy costs and down-sizing of fixed assets). With the bracketed assumption in (b), the bottom-up and top-down approaches should provide identical financial statements.

Treatment of Gas Distribution and Gas Transmission under the Avoidable Cost Allocation Methodology

3. Pipeline owners are required to disclose the following Pipeline business financial statements:

1. stand-alone financial statements for gas distribution (SAC[GDB]), if they provide gas distribution services; and
2. stand-alone financial statements for gas transmission (SAC[GTB]), if they provide gas transmission services; and
3. stand-alone financial statements for the combined gas transmission + distribution (SAC[GDB + GTB]), if they provide both distribution and transmission services.

Exemption - If the common costs and assets accounted for less than 5% of the pipeline owner's Pipeline business costs and assets, the pipeline owner would not be required to disclose the combined set of financial statements. (Explanatory note: If this threshold was satisfied the maximum level of the monopoly profits understatement through "double counting" of common costs would be too small to worry about.)

4. Explanatory note: These requirements are illustrated diagrammatically below:

1. SAC[GDB] = IC[GDB] + CC;
2. SAC[GTB] = IC[GTB] + CC; and
3. SAC[GDB + GTB] = SAC[GDB] + SAC[GTB] - CC.

Where SAC = stand-alone cost, IC= incremental cost, CC = common (or shared) costs, R = Revenue, GTB = Gas Transmission Business, GDB = Gas Distribution Business and OB = Other Business.

Avoidable Cost Allocation Methodology Principles

5. ACAM consists of two mandatory principles:

1. Principle I. The stand-alone and incremental businesses would be defined in such a way that: (i) the stand-alone business is confined solely to provision of natural monopoly gas activities; and (ii) all contestable (and potentially contestable) activities are provided by the incremental businesses.

Explanatory note: Defining the stand-alone and incremental businesses in this way may mean they provide each other with goods and services. Transfer payments are made for any goods and services businesses provide each other.

2. Principle II. The expenses, revenues, assets, and liabilities ("items") would be allocated to the stand-alone and incremental businesses in such a way that: (i) those items (and components of the items) that would not be avoided if the pipeline owner did not operate the incremental business are allocated to the stand-alone business; and (ii) those items (and components of the items) that would be avoided are allocated to the incremental business.

Explanatory note: Items that are directly attributable to one of the stand-alone or incremental businesses would be allocated to those businesses. Items that are shared amongst some or all of the businesses would be allocated amongst those businesses, by:

1. direct allocation of any components of these items which are directly attributable to one of the businesses; and
2. for any components that are not directly attributable;
1. assessing the proportions of these components which are avoidable and non-avoidable; and
2. allocating these components amongst the businesses on the basis of those proportions (in a manner consistent with Principle I).

⁶The "stand-alone cost" of a service is the cost that would be incurred if that was the sole service provided. The "incremental cost" of a service is the cost incurred in supplying that service, excluding all costs which would not be incurred if that service were not supplied.