Formula One – and two

Elsewhere in this issue, Bruno Alves reflects on the eyebrow-raising decision of Norway’s Ministry of Petroleum (MPE) and Energy to cut tariffs for future Gassled gas transportation contracts by 90 percent (see p.10) – and the effect it has on the asset’s private investors. That column deals very well with much of the detail, which we will therefore not go into here.

The case did remind us, however, of the “Gassled tariff formula”, which we found in a Deloitte document whose title the financial services firm may now be regretting a little: “Norwegian gas infrastructure is an attractive investment opportunity in volatile global markets”.

Be that as it may, the formula itself is an object of beauty for those who like such things. It is as follows (with the elements of the formula explained underneath):

t = (K + I/Q = U) x E + O/Q

t = Unit tariff for a given area or service
K = Fixed tariff element to reflect initial capital investment and to target 7% pre-tax real return
I = Annual amount of qualifying investments set to generate a 7% pre-tax real return
Q = Projected booked capacity for a given area or service for the year
U = Fixed tariff element calculated for new investments related to extension of the system
E = Escalation factor – Norwegian CPI index
O = Projected operating costs for a given area or service for the year
Source: Deloitte

The issue, following the notable Norwegian decision, is with the ‘K’ element of this formula. We’ll let Standard & Poor’s explain the signficance of the decision for this ‘K’ element as follows:

“The proposal from the MPE is to reduce the current ‘K’element of the tariff by 90 percent for all new bookings. Although varying over time as a result of changing operating expenses and maintenance capital expenditure requirements, the ‘K’ element currently constitutes the greatest share of forecast revenues, averaging about 55 percent of total annual revenues over the remaining life of the licenses”.

Suddenly, the formula doesn’t look like quite as beautiful for investors in Gassled as it did at the outset. Indeed, the new ‘K’ element might have stood for ‘Killer’ if it had been part of the original agreement – as in, Deal Killer.