Further Advice from Panel of Expert Advisers
Outline of Report
Draft Outline prepared for PEA Meeting on 12 June 2013
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186285.2
Executive summary
[Pithy and not intended to summarise the whole report – instead it would focus on PEA’s conclusions,
the key reasoning, and proposed way forward]
1- Overall goal
The overall goal is to ensure that New Zealand’s transmission pipeline access and capacity pricing
arrangements are dynamically efficient. In particular, the arrangements should:




Transparently provide for the efficient utilisation of physical pipeline capacity, especially at
times of scarcity
Enable and facilitate efficient investment by pipeline owners, gas consumers, and gas
producers
Offer transport services that, to the extent it is efficient, meet the needs of pipeline users
Be harmonised across both transmission systems, to the extent it is efficient.
In addition, the pipeline access and capacity pricing arrangements should include a governance
framework. This framework should promote common approaches across both pipelines where this
will reduce user costs/increase efficiency, and facilitate the ongoing evolution of the access and
capacity pricing arrangements.
2 – Overview of current arrangements and state of the market
Current arrangements
Describe Maui and Vector arrangements, and explain that while they appear to be different, in fact
they share many common features – note also that for the most part, the two pipelines are
complementary and need to operate in a coordinated way.
Illustrate using table along lines below
Governance and operations
Maui
Vector
Common
feature
Multilateral contract between
pipeline owner and users
Yes - MPOC
Yes - VTC

Technical & System Operation
Vector
Vector

Pipeline Owner
MDL
Vector
Vertical Integration
Yes
Yes

Transparency of aggregate daily
delivery information
Yes
Less relevant
x
Transparency of individual
shipper pipeline information
No
No

Availability of entry rights
Yes – available on the
day
Yes – available by
contract

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Pipeline management features
Maui
Vector
Common
feature
Interruptible service offered
Yes – flow on nom’s
Yes – new non-firm
service

Firm service offered
Yes – via AQ provision
but not yet offered
Yes – via reserved
capacity service

Nominations required
Yes – for all service
Yes - for non-firm

Penalty for nomination violations
Yes
Yes

Shipper security without
congestion
Run to desired
nomination
Run to contractual
maximum

Allocation of firm capacity rights
Via AQ allocated based
on historical usage
Via grand fathered
contracts
x
Welded points
All injection/offtake
points
[Subset of
injection/offtake points]
Scarcity pricing for congestion
No
Some (unclear related
to non-firm pricing)
Scarcity price set by willingness
to pay
No
No: tradability gives
potential price
Other issues
Maui
Vector
[x]
x
Common
feature
Gas balancing market
Yes
[Yes - indirectly]
[]
Critical Contingency
Common Process
Common Process

Point to point service
Yes
Yes

State of use relative to capacity
Presently uncongested,
congestion with
demand growth
Presently uncongested,
congestion with
demand growth

Commerce Commission price /
revenue regulation
Yes
Yes

State of market
Provide brief description of current capacity utilisation/commitment. Key points include:




There is generally sufficient capacity on the Maui and Vector systems to meet current gas
demand [include pie charts showing capacity utilisation for major zones on Vector and Maui
along lines below]
However, Vector North system would have been at full capacity without recent renegotiation of
transmission contracts for gas-fired power stations in Auckland to introduce non-firm contracts
There is significant uncertainty about when congestion will arise again – affected by
uncertainties in relation gas demand, gas-fired electricity generation needs, gas field uncertainty,
and electricity transmission investment
Shape of demand is important – gas demand is becoming increasingly peaky
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
While significant congestion may not occur for some years, it could emerge relatively swiftly
under some scenarios, and Maui and Vector may approach congestion at similar times
Southdown & Otahuhu B
Power Stations
Glenbrook
C
Rotowaro
Compressor
Station
Waitoa
Mt Maunganui
Pokuru
Compressor
Station
Mahoenui
Compressor
Station
C
Rotorua
C
C
Kawerau
Compressor Station
New Plymouth
Derby Road
Compressor
Station
C
Taupo
Taranaki
Combined
Cycle
Power
Station
Kaitoki Compressor Station
Gisborne
Hastings
C
Rotowaro
C
Pohokura Production Station
Huntly Power Station
C
C
Pie areas represent amounts of used and available capacity
Greater Auckland
Maui
Pokuru
Mokau
Compressor
Station
Oaonui Production Station
Available Capacity on M aui Transmission System
Waitoki
Henderson
Compressor C
Station
Pie areas represent amounts of committed and uncommitted capacity
Whangarei
Uncommitted Capacity on Vector Transmission System
Vector
Kauri
Frankley Road
Palmerston North
Waitangirua
North System
Central North System
Bay of Plenty System
Central South System
Frankley Road to Kapuni
South System
Maui system
3 - Current arrangements not suited to addressing pipeline congestion
Key issues to cover:




Pipeline congestion can cause high costs to participants and society when it occurs – or even
before it occurs when it affects future plans
Current arrangements largely rely on administrative responses to manage congestion
Reliance on administrative approaches is not ideal
o Allocation does not reflect willingness to pay (econ efficiency)
o Curtailment may occur even though capacity not fully utilised
o Fosters perception that arrangements favour some parties – entry/expansion barrier for
retailers
o Impedes those end-users, producers & retailers needing more assurance to make longer
term commitments
o Obscures price signal re value of pipeline capacity, which can hinder efficient pipeline
investment
Furthermore, when actual or threatened congestion emerges, there can be strong pressures to
act quickly – creating risk of sudden and poorly framed responses as external forces take control
and overwhelm an industry-led approach
4 - Characteristics of a sound pipeline access and capacity pricing regime
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This section will set out what sound arrangements to manage pipeline capacity/congestion would
look like – the description in this section would be at the level of principles rather than MPOC or VTC
specific matters
Sound arrangements would:
A. Offer a mix of capacity rights that can be utilised across both pipelines - open access for
significant fraction of pipeline capacity, firm rights with varying terms for the balance of
capacity, and harmonised arrangements across both pipelines to reduce costs to users
o Users/producers wanting high degree of ex ante assurance able to obtain firm
product (i.e. priority rights if congestion arises, for some defined horizon)
o Users/producers that place less value on certainty able to obtain flexible products
o Ideally the contract terms/durations would be determined via a process that reflects
users’ preferences – expect relatively simple alternatives to start with (firm, non-firm,
limited choice of durations) which could evolve in response to user needs over time
B. Provide for available capacity to be allocated based on willingness to pay if scarcity arises
o Ensures scarce capacity allocated to most valuable uses
o Rewards efficient demand curtailment/conservation
o Can provide signal for investment (pipeline, storage)
o Ensures available capacity is utilised
o Degree of sophistication in congestion pricing mechanism can evolve over time to the
extent warranted by changing circumstances
C. Provide information on pipeline capacity, utilisation, existing contracts, and available
headroom in a very transparent and user-friendly form
o Information allows parties to better assess likelihood of congestion and optimise
their plans
o Transparency promotes robust discovery of price of capacity – the price will more
closely reflect the ‘real’ situation, rather than some subset of available information
o Transparency promotes confidence in arrangements by industry, customers,
regulators
D. Provide for efficient governance of pipeline access and capacity pricing issues
o There is a strong case for pricing scarcity across the Maui and Vector pipelines in a
common way - otherwise users and pipeline managers will face inefficiencies and
costs as they grapple with two distinct sets of arrangements
o To achieve convergence in pricing of scarcity, it is necessary to provide for a common
framework for making changes to the pipeline access and capacity pricing
arrangements, and for enforcing compliance with their terms (i.e. common
governance of pipeline access and capacity pricing issues)
o Other desirable features of the governance framework include:
 Transparency – there should be clear and open processes to be followed in
amending and enforcing the arrangements
 Neutrality – the processes for amending and enforcing arrangements should
not provide for a bias towards the interests of any party or class of parties,
and should limit the ability of any party to amend the arrangements in a way
that introduces unjustifiable bias
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
Balance – the processes for amending the arrangements should achieve an
appropriate balance between certainty and flexibility, so that the
arrangements evolve in a way that promotes dynamic efficiency
5 – Evolutionary convergence is attractive and feasible
This section will explain why evolutionary convergence of the VTC/MPOC access and capacity pricing
arrangements to a common form is both attractive and feasible
Comparison of options
Key points:

PEA has considered five options that span the continuum of alternatives:
1. Status quo
2. Capacity follows end user
3. Capacity auctioning
4. Evolutionary convergence
5. Full Integration (aka market carriage)

Set out main features of each option in table like that below
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1 - Status Quo
3- Capacity auctioning
4- Evolutionary convergence
5 – Full integration
 When large end user on
constrained pipeline changes
retailer, TSO transfers the ‘old’
retailer’s capacity to the ‘new’
retailer
 Described in paper: Retail
Competition and Transmission
Capacity: Statement of
Proposal, November 2010)
 Water down grandfather
rights when capacity is
scarce
 Auction un-grandfathered
capacity
 Greater transparency
 Progressive modifications to
Maui and Vector
arrangements to address
issues and draw access
arrangements together
 Create integrated gas and
capacity markets across both
pipelines to establish ‘market
carriage’ regime
 Proposed by Larry Ruff of
Market Reform)
 May entrench current
arrangements and
inhibit further evolution
 Vector only
 May entrench current
arrangements and inhibit
further evolution
 Vector only
 May entrench current
arrangements and inhibit
further evolution
 Vector and Maui
 Can progress in stages
 Could go as far as a single
common access regime if
justified (for example to
achieve economies of a
single IT system)
 Requires a ‘big-bang’
transformation of current
transport and gas trading
arrangements rather than
progressive changes
 Requires common governance
over many issues at outset
 New problems may arise not
identified in the current
problem definition
Option
Discussion
2 - Capacity follows end user
 No change to existing
arrangements
Problem Definition
Access arrangements do not provide for:

efficient allocation of scarce capacity, both
physical and commercial (ie as defined by
contracts/codes);
X Not resolved
X Only commercial capacity
addressed
X Only commercial capacity
 Resolved, if demand
management (DM) is
addressed
 Resolved

price signals to facilitate efficient investment;
X Not resolved
X Not resolved
 Some improvement
 Resolved, if DM is
transparent
 Resolved

transparency on physical state of the
pipelines and contractual arrangements for
use of the pipelines.
X Not resolved
X Not resolved
 Resolved
 Resolved, if transparency is
addressed
 Resolved

unnecessary costs may arise from different
Maui and Vector access arrangements
(governance);
X Not resolved
X Not resolved
X Not resolved
 Increasingly resolved with
more convergence and if
governance addressed
 Resolved
grandfathering of capacity may reduce
competition to supply downstream users;
X Not resolved
 Resolved
 Resolved
 Resolved, if AQ is efficient
 Resolved
end users do not secure long term capacity
rights on the Maui pipeline; and
X Not resolved
X Not resolved
X Not resolved
 Resolved, if AQ is efficient
 Resolved
vertical integration demands special care that
arrangements cannot favour affiliates.
X Not resolved
X Not resolved
X Not resolved
 More easily managed as
convergence progresses
 Resolved
Also:
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


Explain why Status Quo doesn’t get off the runway (lack of transparency, price signals etc,
also relies on interruptibility of two large users being available)
Explain why ‘capacity follows end user’ and ‘capacity auctioning’ can get airborne but only
gain limited altitude – neither provides adequately for future evolution etc
Real choice is between Evolutionary Convergence or Full Integration –explain that former is
preferable because:
o User needs – Evolutionary Convergence fits much more closely with users’ needs –
given that congestion is not expected to be a major issue in near term. Furthermore,
even when congestion does arise, not clear that market carriage is needed to address
issues
o Cost – High degree of common characteristics of MPOC and VTC means convergence
model should be much easier and cheaper to implement – e.g. can work within
existing IT systems to allow convergence, whereas much of current IT system would
be junked in the Integration option. It would also encourage common approaches on
issues where significant costs can arise – for example the Coding of curtailment rules
give rise to significant IT costs, and maintenance of a common approach could help
to minimise such costs
o Low risk – Evolutionary Convergence allows for progressive change. Integration has
much higher execution risk. It requires design choices at outset that may turn out to
be inappropriate to actual needs – e.g. changes in future patterns of gas usage and
production could alter design requirements etc
Evolutionary Convergence option appears feasible



Convergence approach is facilitated by existing foundation of common features across the
Maui and Vector pipelines as set out in section 2 – in terms of operational matters, changes
would be focussed on following areas:
1. Offer a mix of capacity rights that are harmonised across both pipelines. The
harmonised firm service could be evolved from the (yet to be activated) Maui AQ
provisions and Vector Reserved Capacity service. The non-firm service could be
evolved from Maui ‘flow on nominations’ service and Vector’s recently introduced
non-firm service
2. ‘Bolt on’ arrangements for capacity pricing when scarcity occurs – to ensure pricing
reflects willingness to pay and capacity flows to parties that value it the highest - this
would be new for Maui and Vector systems
3. Improve transparency of information – to provide the information needed for
market participants to be able to form prices efficiently - this applies to Maui and
Vector systems
The other key change is to establish common governance framework for pipeline access
and capacity pricing issues across the two pipelines
The governance evolution is made easier by the fact that the two pipelines are
complementary to each other (opportunities to compete are limited) and due to similarities
in governance arrangements for MPOC and VTC – as set out below
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Code change process
Maui/MPOC
Vector/VTC
Common
feature
Any contracted party can
propose Code change
Yes
Yes

Publication and consultation of
proposed Code changes
Yes (by GIC)
Yes (by Vector)

Code change proposal assessed
against published criteria
Yes (by GIC)
Yes (by Vector)

Initial decision on proposed Code
change
By GIC
Requires support of
75% of contracted
parties (no weighting)
x
Ability to review initial decision
on proposed Code change
No (other than judicial
review)
Yes – appeal to GIC

Final decision maker
GIC*
GIC*

Veto rights for pipeline owners
Limited veto – e.g.
imposition of
unrecoverable cost
Limited veto – e.g.
imposition of
unrecoverable cost

Dispute resolution
[include information on
dispute resolution]
[include information on
dispute resolution]
?
* - subject to limited veto rights of relevant pipeline and judicial review


Another factor that facilitates evolution in governance arrangements is that both the Maui
and Vector pipelines are subject to revenue control under Part IV of the Commerce Act. This
means that pipeline owners should be relatively neutral to pipeline access and capacity
pricing arrangements, provided they do not materially affect their regulated revenues or
costs. In particular, although it may be feasible under Part IV of the Commerce Act for
pipelines to retain rents generated when capacity scarcity occurs, pipeline owners are likely
to find such retention problematic in practice. This arises because rents could be volatile from
year to year, exposing pipelines owners to increased risk of under-recovery in a revenue cap
environment. This suggests that they may prefer a more predictable revenue stream based
on throughput/distance charges.
Lastly, as noted in section 4, the governance framework should not allow any single party to
exert an undue bias in determining the evolution of pipeline access and capacity pricing
arrangements. This suggests that governance responsibilities will need to be shared in some
fashion between pipeline users and owners, and (possibly) independent parties. In this
context, the absence of common ownership across the Maui and Vector pipelines is likely to
be advantageous. It should help in exposing issues to full scrutiny, particularly where they
involve highly technical matters.
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6 – A road map for moving forward with Evolutionary Convergence
This section will describe what needs to be done to move forward with the evolutionary convergence
approach. It will address each of the four areas discussed in section 4 (i.e. offer range of firm/nonfirm services in coordinated way across both pipelines, allocate capacity based on willingness to pay,
improve transparency, provide for efficient governance)
In each area, examples of possible approaches are shown in perforated boxes – these illustrate possible ways
for moving forward in each area but are not definitive or exhaustive
Offer a mix of capacity rights that are harmonised across both pipelines
A harmonised set of firm services should be established across both pipelines to allow Shippers to
develop contract portfolios that match their likely needs (which will generally entail shipping across
both pipelines). Harmonised services will also facilitate standardised IT and demand management
arrangements.
Harmonised firm services would be developed from AQ on the Maui system, and the reserved
capacity service on the Vector system.
Harmonised non-firm services would be developed from the ‘flow on nominations’ service on the
Maui system and non-firm service on the Vector system.
Rights to firm service would be allocated based on willingness to pay (see pricing below).
‘Capacity’ should be defined in a transparent measurable and compatible way across both pipelines –
this is important to assess when and where congestion is likely to arise, and hence the value of firm
and non-firm services. The related issue is how the ‘security standard’ is defined – since this affects
how much capacity can be offered.
The pipeline owners should determine the total capacity that is available to be offered, for a given
security standard – since they should have reasonably balanced incentives in setting this figure for
their pipelines. Furthermore, this aligns with the investment incentive. If a pipeline owner expands
capacity (e.g. via compressor investment), it should be able to offer a greater volume of capacity for
sale, for a given security standard.
The split of total capacity between firm and non-firm services, and the duration profile of firm
contracts offers needs to reflect a balance of wider producer, user, shipper and TSO interests. For
example, it should ensure that sufficient capacity is available on non-firm basis to facilitate
competition in downstream markets. This suggests that the split between firm and non-firm rights
should not be unilaterally decided by the TSO or pipeline owner. Instead it should via a process that
reflects wider interests.
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186285.2
Possible models
Firm service
 Term: firm contracts should be offered for various durations – starting with 1 year and 5 year, say
 Free renewal options (such as the Vector’s current ‘grandfathering’ arrangement, and MPOC historical
use) should be phased out
 Quantity: firm contracts should be for a specified (maximum) capacity entitlement for the full term of
the contract
Non-firm service

 Quantity: Some proportion of capacity should be non-firm (‘common carriage’). The MPOC presently
limits ‘AQ’ firm entitlements to 70% of capacity, leaving 30% available as common carriage (ie first to
be interrupted when a constraint occurs). Vector makes all capacity available as firm, which can make
it difficult to say how much firm capacity is available for sale, and may constrain the entry of new
shippers when firm capacity is sold out.
 Availability: There should be no restrictions on the amount of non-firm capacity available for sale
Nominations
 Firm contracts should give Shippers a right, but not the obligation, to nominate daily requirements up
to the specified firm contract entitlement
 Non-firm service would be based on a daily nomination process – and shippers not holding firm
entitlements would have their nominations scaled down if capacity scarcity situation were to arise
 This implies that nominations will be required at least for those welded points where congestion could
arise
Capacity measurement
 This could be based on existing arrangements – subject to any necessary changes to ensure
compatibility across the two pipelines
Security standard
 This could be based on existing arrangements – subject to any necessary changes to ensure
compatibility across the two pipelines
‘Bolt on’ arrangements for capacity pricing when scarcity occurs
Useful to distinguish between ex ante pricing of capacity when firm service is sold months or years in
advance (referred to as initial sale) and any subsequent ‘re-sales’ when capacity scarcity actually
arises (secondary sales).
As regards the initial sale, desirable to use a ‘willingness to pay’ mechanism to establish whether
there is any price difference between firm and non-firm service. The existence of any difference
provides an important signal for potential investment in pipeline capacity and/or demand side
response capability.
Any such difference would imply the existence of ‘congestion rents’. As noted earlier, it is likely to be
problematic for pipelines to retain these rents given their volatility and the revenue cap regime in
Part IV of the Commerce Act. Instead propose that any congestion rents be allocated in a way that
will not distort short term incentives – e.g. as a rebate on transmission charges paid by shippers, or
used to offset common costs.
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186285.2
If scarcity does arise, it is important that available capacity be used by the parties that most value it.
This implies that rights to firm service should be tradable, or that some equivalent secondary sale
mechanism should be provided to allow for efficient reallocation. That said, given how infrequently
constraints are likely to occur, complex mechanisms for re-allocating capacity at the time of the
constraint are not justified at this point.
Possible models
Initial allocation and pricing:






Offer contracts for firm service via a simple auction process – at least for welded points where
congestion may arise during the term of the offered contracts
Where there is clearly excess capacity, there may be justification for using a simpler allocation method
such as assigning to existing users (or perhaps not assigning firm rights for the time being since
scarcity is not expected – this would allow rights to be offered later if the situation changes)
The price established via an auction process would indicate whether any premium was attached to the
firm right over the non-firm right
One approach would be to treat the non-firm service as the ‘vanilla’ product, which can be made more
secure via the acquisition of the firm right to nominate. In this model, all shippers would face
throughput/distance based charges etc from the pipeline owner since they all (at least) use the vanilla
service. The throughput/distance based charges would be set by the pipeline owner consistent with
Part IV of the Commerce Act
Under this model, if any rents arose in the auctioning of the firm rights (and assuming it is problematic
for pipelines to retain these rents because of their unpredictability), they would be distributed to
minimise any distortion to short term price signals – e.g. via a rebate on pipeline charges
An alternative approach would be to treat the firm service as the ‘vanilla’ product, and use an auction
process to discover the price of the non-firm service. In this model, any price difference would manifest
as a discount to the firm price if scarcity were expected to arise. This might introduce greater
variability into the pipeline revenue, which would need to be accounted for under Part IV of the
Commerce Act
Secondary allocation and pricing






Shippers should be permitted to trade their firm capacity rights (including firm capacity not nominated
on a day) without prior approval of the TSO to ensure that rights are utilised efficiently
One approach would be to use the existing trading provision in MPOC (s7.7) that allows AQ to be
traded, and in VTC that allows reserved capacity to be traded (and there is now a bulletin board to
facilitate trades). This would allow capacity to be re-allocated at the time of a constraint and for a
scarcity price to be discovered
An alternative would be to use a ‘spot price’ for gas (from a spot market or gas balancing market) as a
proxy for the value of capacity when scarcity arises
This approach could make use of the (likely) greater liquidity in a spot/balancing market as compared
to a gas bulletin board, and should be a reasonable proxy as long as capacity scarcity occurs at, or
upstream of, the point where the balancing or spot price is established
The ‘proxy’ price could be used to determine payments to/from parties that lose/gain capacity rights
via reallocation in a scarcity situation
Under either approach, it is important that the rules for reallocation and any associated payments are
clear – since these affect the value that will be established in the ex ante allocation process
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Improve transparency of information




All pipeline information that is relevant to the formation of prices for capacity rights should
be readily available – e.g. historic and projected flows, volume of firm and non-firm contracts
sold, volume of firm and non-firm pipeline capacity that has been nominated and approved
each day, available capacity
Information should be accessible by pipeline users to facilitate effective price discovery and
efficient utilisation in scarcity situations. Information should also be accessible by other
parties (e.g. consumers, regulators) to promote trust in the arrangements
Timeliness of information provision is very important – need to ensure it is up to date
Form of presentation also very important – presentation of information needs to be user
friendly, and with an ability for users to take raw data for further analysis if they wish
Possible models






As a starting point, a detailed list of information that is material to price formation for capacity rights
could be developed by a group that includes gas shippers, producers and users, as well as the TSOs
This list could be compared to existing information available for each pipeline system, along with the
timeliness and accessibility of existing information provisions
Where gaps are identified, they could be addressed by the relevant TSO, with Code changes made if
needed
A further possible evolution would be to externalise the information provision function from the two
pipelines – e.g. to a joint service provider
This could assist in building confidence in information provision (especially to address potential
concerns re vertical integration and affiliate businesses)
Costs of information provision should be recoverable under Part IV of Commerce Act (as part of
pipeline charges) and/or a separate fee for users
Governance for pipeline access and capacity pricing issues


As noted above, desirable to evolve towards common governance arrangements across both
pipelines in respect of pipeline access and capacity pricing issues
In effect, this would create an ‘island’ of issues over which common governance
arrangements would apply, as shown in diagram below. Important to note that the common
governance need not span all pipeline issues.
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186285.2
Maui pipeline
Issues governed
solely under Maui
pipeline governance
framework
Vector pipeline
Issues governed
solely under Vector
pipeline governance
framework
Pipeline access and capacity pricing issues
under a common governance framework

Rather, it would need to cover those issues that are central to defining and allocating access
rights, and establishing prices for capacity rights when scarcity occurs
Possible models
Evolving a common governance framework for access and capacity pricing issues could occur in a number
of different ways:
 A distinct governance framework for these specific issues could be established, with MPOC and VTC
‘delegating’ governance over these matters to this framework. For example, both pipelines could
agree to use a common and externally defined set of arrangements for setting prices in capacity
scarcity, and the governance of these processes could be distinct from MPOC and VTC
 The governance framework applying to one of the pipelines could be adopted as the ‘host’ for defining
access and capacity pricing arrangements, and the other pipeline could automatically follow the ‘host’
pipeline
 The overall governance arrangements could be conformed across both MPOC and VTC to a common
approach
7 - Conclusion
[insert]
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