The Policy Rules ‘Reasonable Price Heat Act’

Introduction
On 23 September 2009 the Dutch Competition Authority NMa has published the draft policy rules 'Reasonable Price Heat Act'. The policy rules set out the elements of, and the calculation method for, the 'reasonable price' of heat as referred to in the Heat Act.

Pursuant to the new Heat Act (the 'Act'), that was adopted by Parliament on 10 February 2009 with the aim to protect users against a potential abuse by heat suppliers of their monopoly position, the price of heat shall be regulated by two elements: the reasonable price and the maximum price. Under the Act heat shall have a 'reasonable price' which shall not exceed a certain maximum (the 'maximum price'). Pursuant to the Act the terms and conditions for determination of the reasonable price shall be included in policy rules to be adopted by the NMa, whereas the maximum price shall be set out in a governmental decree (in Dutch: AMvB) in accordance with the 'No More Than Otherwise' principle .

Applicability
According to the explanatory rules the policy rules apply to all suppliers of heat, both permit holders as well as parties that do not require a heat supply permit pursuant to the Act. This is not clear from the Act, which only refers to the applicability of the policy rules in relation to permit holders. The reasonable price is to be determined by the heat suppliers themselves. They are not allowed to charge fees for the supply of heat in excess of the reasonable price. Where necessary the NMa can impose an order for incremental penalty payments (last onder dwangsom) or issue a binding instruction.

The reasonable price shall compensate the heat supplier for costs incurred in relation to a specific heat net. It may therefore differ per heat net. The fact that the reasonable price is determined per heat net and not on the basis of a portfolio increases transparency and allows for compensation of loss making heat projects with profitable projects within the portfolio of the same supplier pursuant to article 43 of the Act ('pooling').

It should be noted that unlike gas and electricity, no distinction is made between supply and distribution of heat. The reasonable price includes both costs related to supply and distribution. Therefore, where in this briefing - and in the draft policy rules - reference is made to 'supply' this should be understood to also include the distribution of heat.

Supply independent and supply dependent costs
Pursuant to the draft policy rules the reasonable price can be distinguished into a supply independent element (leveringsonafhankelijk deel) and a supply dependent element (leveringsafhankelijk deel).

Supply independent costs are (nonrecurring) connection costs, depreciations, maintenance costs, a reasonable return on investment, fixed costs in relation to the purchase of heat, as well as costs of administration, innovation, R&D and overhead (such as back office, asset management, local levies, insurance). These costs shall be reduced with the amount of subsidies received, if any, as well as with losses incurred in previous years.

Supply dependent costs are variable costs for the purchase of heat (related to the fuel costs passed on to the supplier by the producer) and costs for facilities for supplemental fuel and buffers (i.e. auxiliary facilities in the heat network).

WACC
The reasonable return on investment (that forms part of the supply independent costs) is determined on the basis of the calculation of the WACC pursuant to the Capital Asset Pricing Model . According to the explanatory notes to the draft policy rules the exact WACC could not yet be determined since this would require additional information on the maximum price, the pooling mechanism and the subsidy scheme. However, based on a report by Oxera the WACC is expected to be in the range of 5.1% - 7.6% .

Allocation principles
The reasonable price constitutes the sum of the supply independent and the supply dependent costs, provided that such costs are reasonable and are directly related to the supply of heat on the basis of 'generally accepted commercial principles' ('cost-plus' approach).

The draft policy rules do not further elaborate on this. Pursuant to the explanatory notes suppliers are free to determine the manner in which they allocate costs, provided that the allocation is commercially sound. Cost allocation therefore needs to be based on IFRS or financial reporting standards that are generally accepted in the Netherlands. In addition, allocation needs to comply with the following principles:
- cost orientation: there should be a clear distinction between costs related to heat supply and costs that are not related to heat supply. The latter may not be taken into account when calculating the reasonable price;
- proportionality: in case of costs that are not entirely related to the supply of heat, costs should be apportioned pro rata to the use of resources for the actual supply of heat. For certain situations (e.g. heat/cold supply) the policy rules contain a specific formula for cost apportionment;
- market terms: costs should be allocated in accordance with accepted standards of business administration. In case of intercompany supply, costs should be on market terms;
- consistency: once a party opts for a certain allocation method it should continue to use such method and may not adopt another method without justification.

Reasonable price formula
The policy rules distinguish three categories of users ('verbruikers'): (i) users with a connection of 0 - 35 kW, (ii) users with a connection of 36 - 150 kW, and (iii) users with a connection of 151 - 1,000 kW. The reasonable price shall be determined for each group of users and per heat net in accordance with a formula set out in the policy rules. In addition to the (supply independent and supply dependent) costs of heat supply, the formula requires input on the number of users, their capacity and the estimated supply volume per user.

What next?
Parties may comment on the draft policy rules until 17 November 2009. A public hearing will take place on 5 November 2009. After the adoption of the policy rules (which is expected to take place in March 2010), the Act and policy rules shall simultaneously enter into force around mid 2010. The governmental decree on the minimum price has not yet been published. Both the reasonable price and the maximum price will have retroactive effect from 1 January 2007.