QCA’s Final Decision on Queensland Rail’s Draft Access Undertaking

Overall outcome

QR’s initial objective was to create a light handed regulatory framework, consistent with it being a vertically separated provider of freight services with little, if any, potential to earn monopoly rents given the nature of its users. While the QCA’s recommended regulatory framework is clearly less onerous than for the neighbouring Aurizon Network, this final decision will still create significantly more intensive regulation than QR had sought.

Application of QCA Act

In this decision, the QCA has affirmed its legal interpretation of some key principles in the QCA Act, which has set the basis for its decision:

• In making its decision, the QCA must have regard to a range of factors, including the object of the access regime and the pricing principles, along with other factors.  While the QCA considers the pricing principles to be a fundamental consideration, it does not believe that they have primacy over other considerations.  Further, the QCA believes that the weighting attributed to the various factors is the prerogative of the decision maker – the QCA.  On this basis, the QCA considers it reasonable to make a decision that is not fully consistent with the objects clause or pricing principles, if it considers that this is justifiable based on other considerations.
• The QCA continues to take the view that the pricing principle that ‘prices should generate revenue to at least meet the efficient costs of providing access …’ should be interpreted as allowing for ‘no more than’ efficient costs, given the other factors that it will consider in approving a DAU, such as the interests of access seekers and the public interest.

West Moreton Reference Tariffs

The most contentious aspect of this regulatory review has been the development of a reference tariff for West Moreton coal services. This has been complicated as the West Moreton system was developed over 100 years ago for agricultural freight purposes and remains a mixed use railway, and coal services also need to traverse the Brisbane metropolitan area, designed for high frequency passenger services.

The QCA has rejected QR’s proposed reference tariff of $19.41/000gtk – which reflected a continuation of the current tariffs, instead recommending $17.92/000gtk west of Brisbane, and $16.66/000gkt through the metropolitan network (on average, around $17.54/000gtk for the entire journey – 10% lower than sought by QR). Further, the QCA requires that QR refund approximately $32m to users, to reflect the difference between actual tariffs applied from July 2013 to June 2016 compared to the reference tariff that the QCA considers should have applied from that date. While there are significant differences between the QCA’s draft and final decision, we note that the overall financial impact is similar, with the October 2015 draft decision reflecting a proposed average reference tariff of around $17.50/000gtk and an estimated tariff adjustment of $27m.

Tariff methodology

QR had calculated a ceiling price of $34.92/000gtk, but proposed a lower ‘commercially prudent’ reference tariff. The QCA has rejected this ‘de-coupled’ approach as providing no regulatory certainty for users beyond the current regulatory period and instead requires that the tariff be based on a well understood process that derives the price from the underlying costs and revenues.

Key elements of the QCA’s methodology are:

• The fixed and common costs of providing the route be allocated between coal and non-coal users based on a maximum contracting capacity for coal services of 80 out of 113 return paths/week, to align with the maximum number of coal paths that the Queensland Government had allowed through the metropolitan system.   The QCA has maintained this approach notwithstanding QR’s claims that the constraint was not legally binding and is no longer pursued by the Queensland Government.  This issue turns on the interpretation of the QCA Act.  QR has argued that it has no commercial ability to recover the remaining efficient costs (that is, those costs attributable to the remaining 33 paths) from the non-coal services that operate each week, highlighting that there is currently only 2 non-coal services per week.  The QCA has dismissed this concern, stating that QR’s ability to recover the efficient costs allocated to non-coal services is a commercial matter for QR. 
• While the QCA and QR agree on the proportion of maintenance costs that are fixed and common, this is not the case with future capex, with the QCA taking the view that all capex should be treated as common costs, whereas QR had submitted that a large proportion of capex only occurred because of the track degradation caused by coal services.
• 100% take or pay will apply to contracted services, with the tariff to be reviewed if any mine contracts for paths in excess of QR’s forecast.
• The metropolitan system element of the tariff will continue to be set using the West Moreton cost structure as a proxy, given the difficulty in deriving a cost based tariff for coal services in this system.  However, the QCA has recommended the metropolitan system tariff be set based on its recommended 2013 tariff as escalated to 2016, rather than using its recommended 2016 tariff.

Building block components

The age and condition of the West Moreton System means that the infrastructure standard is well short of that required for a modern, heavy haul railway. The QCA has recognised the high expenses incurred in sustaining this rail infrastructure, while acknowledging that these are driven by the nature of the underlying assets. Key elements include:

• The QCA has allowed $124m maintenance costs over 5 years, 84% of the amount sought by QR.  Only minor adjustments to QR’s forecast operating costs and capex have been made. 
• While adopting a Depreciated Optimised Replacement Cost (DORC) valuation method, the QCA has predictably maintained its view that many of QR’s assets are already life expired, and only still in use due to high maintenance expenditure (noting that the QCA has largely accepted that expenditure).  As a result, the QCA has assessed an opening asset value for the common network infrastructure of $254.5m – a 45% reduction to QR’s proposed $463.6m. 
• The QCA has required a WACC of 5.73% – a reduction from the draft decision of 6.93% reflecting updated market parameters (i.e. risk free rate and debt margin).

Adjustment for past over-recovery

Contrary to prior expectations, QR’s 2015 DAU did not provide for retrospective application of the new tariffs to the expiry date of the previous ones (July 2013). The QCA has maintained its approach of requiring a tariff adjustment to reflect its assessment of the resulting over recovery of revenue by QR, albeit in a modified form. In its response to the draft decision, QR had argued that this would be a retrospective application of regulation and as such beyond the QCA’s powers.

Negotiation of access agreements

Consistent with its draft decision, the QCA accepts QR’s general approach to negotiating access, but requires significant amendment to clarify arrangements and create more stringent obligations on QR.

• In order to encourage balance in access negotiations, the QCA requires QR to report annually on system costs (including maintenance, operating costs, past and forecast capex) and volumes.
• In order to ensure that QR has no ability to inefficiently price discriminate between access holders in a way that distorts competition in related markets, the QCA has removed the ability for QR to negotiate different access charges in agreements set at different times in order to reflect changes in the market for that product over time.  This ability has been a long standing feature of previous access undertakings applicable to this network, and remains permitted under the QCA’s final decision on Aurizon Network’s access undertaking. 
• Noting concerns about how access charges may be set for renewing access agreements, particularly where the parties have sunk investments still to be fully recovered, the QCA has recommended constraints on access charges which effectively lock in QR’s cost recovery for these services at their current level.  This requirement only applies on the first renewal of the agreement, in order to encourage users to contract for a term that matches their remaining investment life. 
• The QR standard access agreement will apply to all freight products on its network, and be a tripartite agreement giving an end user the option of being a party to the access agreement alongside the rail operator.  This contrasts with the ‘split form’ access agreements implemented for Aurizon Network and ARTC’s Hunter Valley, which provide for a separate capacity agreement with end users, and operational agreement with rail operators. 

Investment in network expansion

• Considering recent declining network volumes and the substantial spare capacity that exists on much of QR’s network, QR’s DAU had proposed high level principles for negotiating network expansions, but deferred development of detailed arrangements until such time that demand for the expansion eventuated.
• While the QCA partially accepted this approach, it has broadly retained the approach recommended in the draft decision, and as such requires substantially more detail in the expansion principles, in order to provide users with greater certainty around how expansions will be negotiated and funded.