Chorus Limited

Level 9 Datacom House

68-86 Jervois Quay
P O Box 632
Wellington
New Zealand
Email: company.secretary@chorus.co.nz









Background Q and A on UBA decision


What were the copper prices at demerger?
The combined price of the two copper services (UCLL and UBA) was $45.92 at demerger.
UCLL was $24.46 and UBA was $21.46. Both prices were regulated, having been set by
the Commerce Commission prior to demerger.


Why have the prices been reviewed?
There has been no request to review these prices. They have only been reviewed as part
of the updates to the legislation made to reflect the fact that Chorus became a separate
wholesale only open access infrastructure company at demerger. These updates simply
required the Commission to:

(1) Average the UCLL price. Previously the price in rural areas was higher than in urban
areas. With one nationally averaged price, urban prices now effectively subsidise
rural; and

(2) Calculate a cost-based UBA price. This was a change to the retail minus pricing
principle, simply because Chorus does not have a retail business post demerger on
which to set the retail minus price.
The purpose statement in the legislation was also updated to include a signpost (section
18(2A)) to guide the Commission to take into account the significant investment in UFB
when implementing its decisions.


So what happened at implementation?

Section 18(2A) was given limited consideration by the Commission.
UCLL price was averaged. It was then reduced.
UBA price has been significantly reduced.
Both UBA and UCLL were reviewed using benchmarking of prices in other countries
that bear no relation to actual costs or the New Zealand environment.
A second process means both prices can be reviewed by complex cost modelling
something that hasnt been completed in New Zealand before and an approach
abandoned in Australia.

Didnt a change from retail minus pricing to cost-based pricing mean copper
broadband prices would automatically go down?

No, there is no reason to assume that a change to cost-based UBA pricing would result in
a decrease in price, particularly given the fact that prior to demerger:

The retail broadband market was competitive, which means that retail-minus prices
would be trending towards cost.
Chorus had spent around $500m upgrading the copper network with
FTTN/cabinetisation. A number of parties thought these costs werent reflected in the
retail-minus price.
There was no consultation on the level of any price drop. Nobody knew actual costs
prior to demerger, as there was no cost-based pricing process completed or
underway.
The issues raised by the industry related to the averaging of copper line prices, the
impact of the FTTN investment on prices and general statements that prices could go
up or down. The industry was simply seeking certainty.
The UFB prices were deliberately set lower than fibre prices to support uptake. There
was no suggestion that copper prices would or should be lower than fibre prices.
The stated aims of the copper regulatory changes in 2011 were largely to hold the status
quo notwithstanding structural separation.


So why was there not price certainty at demerger to avoid all this?

Setting the copper prices at demerger would have avoided all of what has happened and
meant no price increases or decreases would have occurred.
This would have been consistent with new fibre products and services (with a cheaper
entry level fibre product) that are set until 2020.

Many in the industry raised the importance of stability, certainty and coherency in 2010.
But this didnt happen.


What happens with other regulated infrastructure companies?

It is widely recognised that to incentivise infrastructure investment you need a clear,
stable regulatory framework that takes account of the ability to finance investments.
For most infrastructure utilities this means a building block model pricing model with a
price path that is typically stable and manageable for the regulated company and its
customers. Pricing is set to provide a fair return on capital invested and costs incurred.
As costs change over time, pricing will change to reflect those trends.

It is widely acknowledged that infrastructure-related costs have been rising in New
Zealand. For example, the cost of trenching alone has increased significantly in the last
ten years (our aggregate contracted rates for trenching have increased by up to almost

200%.)
1
For other regulated industries, prices also increase via CPI adjustments, which is
a common mechanism for adjusting regulated prices to account for inflation.
2


Very large price decreases are rare and tend to involve unusual circumstances. For
example, the large decreases which have recently been applied to Vectors gas
transmission and distribution pricing were in the context of building block pricing
methodologies being applied for the first time. Before these decisions, prices were not set
by the regulator directly.


Why is copper pricing relevant to UFB build?

Chorus balance sheet and existing revenues are helping build the replacement network
ahead of demand and Chorus is borrowing heavily to make the estimated $3 billion
investment for UFB.

Chorus business today largely comprises copper revenues 80% of which are determined
by the regulator. Around 65% of Chorus FY13 revenues were reinvested in capital
expenditure, most of it for fibre. Shareholders are investing for a return and, because the
fibre network is being built ahead of demand, they are taking on additional risk.
Regulatory uncertainty increases this risk. If copper revenues are significantly reduced,
there are no other revenues, so the business case to build UFB and support uptake is
materially altered.

Its a bit like your income being significantly reduced while you need to service a large
mortgage, at the same time as the cost of living increases. You have to keep borrowing
more each year and the bank has to consider how creditworthy you are. The overall cost
of financing increases as a result.

While the ability to finance is considered in other infrastructure regulatory regimes
particularly with long term and significant investment occurring - this is absent from the
legacy framework the Commission is working within today.


Are end users being ripped off if copper prices arent reduced?

No, Chorus believes that todays aggregate UCLL and UBA copper price of $44.98 (which
was set by the regulator) reflects costs. If prices were held stable, there would be no
changes for end users and no change in the RSPs ability to compete on a level playing
field. It would also mean fibre pricing remained attractive, as intended.
The axe the tax lobby group is running a misleading campaign.

Calling the Governments proposed prices a tax is misleading and wrong: A
government tax is one in which consumers are required to pay a mark up on the cost
and/or actual price of that product. The price proposed by the Commission for copper

1
TrenchingratesquotedinChorusReviewsubmissionatp.86.
2
CPIhasincreasedby28%inthelasttenyears. StatisticsNewZealanddataquotedinChorusReviewsubmissionat
p.86.

services does not reflect the actual costs to Chorus of providing these services it is
based on a flawed benchmarking methodology.

Benchmarking is not reliable: No other countries that we usually compare ourselves to
use this pricing methodology because it is not reliable. It is not supported by experts
in regulatory pricing or a number of ex regulators. The Governments discussion
document released in August also acknowledges that benchmarking is unreliable.
TUANZ has also previously stated a preference for a cost-building block pricing
approach to UBA, because: It reflects the actual costs structures rather than the
theoretical ones implicit in modelling methodologies. Further, it takes account real
costs incurred in New Zealand, rather than the costs in other countries which are the
foundation of benchmarking.
3


There is no guarantee that retailers will pass regulated price cuts through to
consumers: While CallPlus and Orcon have committed to passing through some of the
reduction, neither has committed to full pass through. Telecom and Vodafone (who
make up 80% of the retail market) have not made a commitment to pass any price
decrease to end-users but they stand to gain from any price reductions.

Similar Commerce Commission reductions in the Electricity and Gas Markets, have not
flowed through to consumer prices. Vector was recently forced to drop its prices by
10%, and MBIE have confirmed that only a small minority of retailers have dropped
their prices in response.
Covec has previously advised the Commission against making price decreases without
evidence that the decrease will pass through to end users. Covec said that if pass-
through levels for mobile termination rates were lower than expected,
telecommunications firms would be the only beneficiaries of regulation and all end
users will be made worse off.


Arent those in non UFB areas paying for the benefit of those in UFB areas?

No, nationally averaged prices also mean that lower cost urban areas are subsidising
higher cost rural areas today. This is a valid policy choice, and consistent with the TSO.
In partnership with the Government and as part of the Rural Broadband Initiative, Chorus
is also taking fibre to 1,011 schools, 51 hospitals and to libraries in rural communities.
There are many examples of the benefits this fibre rollout is delivering. For example,
Chorus connected Kaingaroa Village School, located in one of New Zealand's most remote
areas and in the largest planted forest in the southern hemisphere, with fibre. As a
result, five families and local business have also been able to connect via wireless.

3
http://www.med.govt.nz/sectorsindustries/technologycommunication/pdfdocslibrary/communications/telecom
separation/submissions/telecomstructuralseparationsubmissiontuanz.pdf/at_download/file

By the end of the RBI rollout, VDSL is expected to be available to over 30% of rural
households. This means a third of rural households will have access to the most common
high-speed broadband technology available in Europe.



ENDS