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• 5.1 Proposed ODV Methodology for use in Financial Performance Measures
• 5.1.1 Proposed Requirements
• 5.1.2 Rationale for Proposal
• 5.2 Frequency of Valuations for Disclosure Purposes
• 5.2.1 Proposed Requirements
• 5.2.2 Rationale for Proposal
• 5.3 Disclosure of Valuation Reports
• 5.3.1 Proposed Requirements
• 5.3.2 Rationale for Proposal
• 5.4 Certification of ODV Reports
• 5.4.1 Proposed Requirements
• 5.4.2 Rationale for Proposal
• 5.5 Derivation Table of Adjustments to Disclosed Financial Statements for the Purposes of Financial Performance Measures
• 5.5.1 Proposed Requirements
• 5.5.2 Rationale for Proposal

5.1 Proposed ODV Methodology for use in Financial Performance Measures

5.1.1 Proposed Requirements

46. The Ministry proposes to introduce a mandatory Optimised Deprival Valuation (ODV) methodology for pipeline business system fixed assets. The ODV of an asset is the minimum of the Optimised Depreciated Replacement Cost (ODRC) and Economic Value (EV). The ODRC is a measure of the cost of replicating the network (or part of the network) in the most efficient way possible, from an engineering perspective, given its service capability and the age of the existing assets. The EV is the earnings based value of the network (or part of the network), and is obtained by calculating the NPV of future cash flows.⁶ EV should be used to value uneconomic parts of the network, which are not able to fully recover their costs (including their cost of capital).

47. Pipeline owners would be required to use the ODV in their disclosed financial performance measures, although there would be no requirement for their ODV to be used in their financial statements (pipeline owners could use ODV in their financial statements, if their ODV complies with GAAP).

48. As well as complying with the ODV methodology, pipeline owners would be required to make their ODV reports publicly available.

5.1.2 Rationale for Proposal

49. A mandatory ODV methodology would:

• ensure that (natural monopoly) pipeline business profitability is measured in a robust and consistent way; and
• mitigate the risk that pipeline owners could over-inflate their valuations in order to hide monopoly profits.

50. Most (if not all) pipeline owners use a form of ODV methodology, which would substantially mitigate the initial compliance costs from imposing a mandatory ODV methodology.

5.2 Frequency of Valuations for Disclosure Purposes

5.2.1 Proposed Requirements

It is proposed that:

1. A valuation report used as input to financial performance measures relating to a given financial year should be no more than 3 years old at the end of that financial year;
2. Valuations be adjusted annually for:
1. depreciation;
2. acquisitions and disposals of assets; and
3. changes in net working capital.
3. If the capacity of the assets covered by the valuation report, or the system length increases or decreases by 10% compared to the capacity or system length at the time of the last valuation report, a new valuation report be prepared.

5.2.2 Rationale for Proposal

52. The Ministry does not propose to impose the requirement for valuation reports any more frequently than necessary, in view of the compliance costs. A three-year interval seems reasonable. However, the valuations used in disclosed financial performance measures should reflect current asset values - hence the application of depreciation and the requirements to reflect acquisitions and disposals and redo valuations in the event of material changes to the network.

5.3 Disclosure of Valuation Reports

5.3.1 Proposed Requirements

53. It is proposed that:

1. Disclosed valuation reports should contain:
1. The asset replacement costs and lives used, the quantity of assets in each category of costs and lives, and the replacement cost of the network;
2. The amount of depreciation charged, and the depreciated replacement cost (DRC) of the network
3. The components of the network which were optimised, and the optimised depreciated replacement cost (ODRC) of the network; and
4. Comparison of ODRC with economic value (EV) for those parts of the network that may not be able to sustain tariffs based on ODRC (including specific assumptions used for the purpose of calculating the EV of that part of the network).
2. All valuation reports be publicly disclosed within 5 working days of completion.
3. The completion of a valuation report, together with the date and the valuation, must be notified on the Internet.
4. A report of interim adjustments to ODV (i.e. depreciation and acquisitions and/or disposals) be disclosed annually with financial performance measures, and certified by the auditor (see section 5.4).

5.3.2 Rationale for Proposal

54. ODV information should be as transparent and accessible as possible to encourage self-regulation.

5.4 Certification of ODV Reports

5.4.1 Proposed Requirements

55. It is proposed that two certification forms be introduced relating to valuations:

1. On completion of a valuation report, two directors/principals of the pipeline owner would be required to certify:
1. the values of the ODRC and ODV of the pipeline business' system fixed assets;
2. the total valuation of the pipeline business assets (including non-system fixed assets and net working capital);
3. that the ODRC and the ODV have been determined in accordance with the prescribed methodology; and
4. that the valuation report itself complies with the requirements of the Regulations.
2. The auditor of the pipeline business' financial performance measures would be required to certify, annually when financial performance measures are disclosed:
1. that the valuations have been made in accordance with the prescribed methodology;
2. the value of the depreciation applied to the pipeline business valuation in the preparation of the financial performance measures;
3. the value of acquisitions and sales applied to the pipeline business valuation in the preparation of the financial performance measures; and
4. that the value of depreciation of system fixed assets has been determined in accordance with the prescribed methodology.

5.4.2 Rationale for Proposal

56. The valuation of pipeline business assets is critical to the financial performance measures. The Ministry aims to maximise confidence in valuations and to require a high degree of accountability for valuations.

5.5 Derivation Table of Adjustments to Disclosed Financial Statements for the Purposes of Financial Performance Measures

5.5.1 Proposed Requirements

57. The Ministry proposes to develop a table (in Excel format) for derivation of financial performance and efficiency measures from the financial statements. The table will mirror the derivation table used in the Electricity (Information Disclosure) Regulations.⁷ All pipeline owners will be required to complete and disclose the table.

5.5.2 Rationale for Proposal

58. The table would assist companies in preparing the performance measure calculations and make the compliance process easier and more consistent and transparent.

6 For the mandatory ODV methodology that applies to electricity companies, refer to the Handbook for Optimised Deprival Valuation of Electricity Line Businesses, 3rd edition, published 14 April 1999.

7 See Electricity (Information Disclosure) Regulations 1999 - Derivation Table Template.