What has happened?

Over the course of a week, ACCC Chairman Rod Sims has made two speeches which reflect that the ACCC has commenced a new and significant policy battle in the regulation of infrastructure.

In recent speeches at the ABARES Outlook Conference on 2 March and to the Australian Domestic Gas Outlook (AGDO) Conference on 9 March 2016, Mr Sims has called for major reform of the approach adopted in Australia to regulating non-vertically integrated infrastructure.  This would include most ports, airports, railways, gas pipelines and, in the wash up of structural reform in the telecommunications market, even the national broadband network.

The speeches follow a number of other recent developments, including:

  • Strong comments made by Mr Sims last year in relation to state government approaches to privatisation – the ACCC went as far as to take the unusual step of making direct submissions to the Victorian parliamentary committee in relation to the regulatory framework proposed as part of the privatisation package for the Port of Melbourne;
  • A speech in October 2015 at the Gilbert + Tobin Infrastructure Policy Conference, in which Mr Sims heavily criticised the inadequacy of the kind of ‘price monitoring’ frameworks commonly used for ports and airports; and
  • A recent decision by the Acting Treasurer on 8 January 2016 not to declare the Port of Newcastle, in a decision that has subsequently been sent by the applicant Glencore to the Australian Competition Tribunal (Tribunal) for review.

The ACCC has clearly identified Part IIIA of the Competition and Consumer Act 2010 (CCA) (and similar regimes, such as those that apply to gas pipelines under the Gas Law) as a policy target for 2016 and beyond.  

In particular, Mr Sims appears committed to a different and more direct model of regulatory oversight of pricing for non-vertically integrated infrastructure, to respond to what the ACCC considers are ‘monopoly pricing’ issues not adequately addressed through Part IIIA or similar frameworks.  It appears that the ACCC wants a combination of a lower threshold for regulation, and more extensive powers to control the terms of access for non-vertically integrated assets.

In response to these comments, the chief executive of one of Australia’s largest pipeline owners, APA, has hit back at Mr Sims’ comments, pointing to the success of the current pipeline regulatory framework, which has delivered approximately $30 billion of investment over the last 15 years in 5,000km of new and expanded pipelines.  He argues that there is no sign of price gouging by current owners and no policy “problem” to be solved.

So do we need major reform of our access rules to better address monopoly pricing, or is the ACCC calling for a solution without a problem?

Who is affected and why does it matter?

The policy debate we are about to have is significant, given the nature and economic value of the infrastructure which will be affected.

Any change to the current framework will affect a wide range of assets and stakeholders:

  • In commodity and agricultural supply chains – which often rely upon railway, terminal and port assets, of a kind which the ACCC suggests may presently be under-regulated;
  • In the gas market – Mr Sims has made clear that the ACCC will recommend changes to the approach adopted to regulation of gas pipelines (at present, very few pipelines satisfy all of the criteria required under the Gas Law to be subject to regulation – including because they face competition from other pipelines);
  • For governments and bidders in privatisation processes – the prospect of more direct tariff regulation of key assets will have a direct impact on a range of future privatisation processes involving ports, water infrastructure and railway assets (such as any potential sale of Australian Rail Track Corporation (ARTC) by the Commonwealth);
  • Ports and airports – the position of airports under Part IIIA has been a longstanding point of controversy, Mr Sims has made clear in the past that he is not convinced about the merits of existing price monitoring arrangements.  It appears that ports and airports could be squarely in the ACCC’s sights.

In this update, we offer a brief overview of the looming debate, including:

  • Developments over the last 12-18 months that has brought the issue of ‘monopoly pricing’ into focus;
  • The two sides of the debate; and
  • What it all could mean in terms of policy changes – and who might be affected.

The question of monopoly pricing

The recent comments by Mr Sims brings to a head a debate over the philosophical soul of Part IIIA that has been playing out for two decades (since the Hilmer Report in the mid-1990s) as to whether an access regime:

  • Should be limited to addressing ‘vertical’ issues, by unlocking access to bottleneck infrastructure where this is needed to promote competition in related markets; or
  • Has a broader role to promote socially efficient investment in, and use of, natural monopoly infrastructure including to avoid monopoly pricing and other unreasonable terms of access.

Recently, the ACCC has shown a considerable amount of interest – and frustration – about the issue of perceived ‘monopoly pricing’ by owners of major infrastructure.  In his speech on 9 March to the AGDO Conference, Rod Sims foreshadowed that the ACCC’s report on the East Coast Gas Inquiry due 13 April 2016 will include recommendations for increased price regulation of gas pipelines.  Less than 20% of pipelines in the east coast are currently subject to any form of economic regulation and Mr Sims argued that the ACCC does not consider that the current model of regulation under the Gas Law (which is modelled on Part IIIA), is acting as an effective deterrent to monopoly pricing.  

The controversy is caused by the legislative criteria that must be satisfied by a gas pipeline under the Gas Law, or any other facility under Part IIIA, in order to become ‘declared’ and subject to regulation.  To become subject to ACCC oversight, it is necessary for an access seeker to first demonstrate that access to the facility is necessary to promote a material increase in competition in a related (upstream or downstream) market.  This is another way of saying that the declaration criteria require the access to unlock a ‘bottleneck’ that is preventing competition in a related market.  

However, this is most clearly an issue when the owner of a monopoly asset is vertically integrated, and competes in a related market, giving it the incentive to restrict access.  If an owner is not vertically integrated, it would generally have an incentive to maximise the profitability of the facility by ensuring it is fully utilised.  The fact that the facility is a ‘bottleneck’ and relied upon to access related markets may give the owner an ability to increase the price of access, but it generally has no incentive to prevent access.  

The two sides of the debate

The question at the heart of the upcoming debate is whether Part IIIA was ever intended to address this issue of pricing power and, indeed, whether it is appropriate to do so.  

The first perspective: if it ain't broke...

On one side of the debate, there is an argument that the ACCC has overreacted to recent events at the Port of Melbourne and Port of Newcastle by using them to argue that Part IIIA (and the Gas Law) are fundamentally broken.  

Those who support this position argue that Part IIIA isn’t broken.  Indeed, the history of Part IIIA and the Gas Law demonstrates that it can operate flexibly and in relation to non-vertically integrated infrastructure across a range of sectors and, where necessary, has been used to address tariff and so-called ‘monopoly pricing’ issues.  

For example:

  • Melbourne Airport, Sydney Airport and Sydney International Airport have all been declared at different points in time – and none are vertically integrated.

Indeed, the Full Federal Court in the Sydney Airport Corporation decision (which arose from an application by Virgin for declaration of Sydney International Airport) is often seen as giving the criterion a broader role – and not one that is limited to preventing refusals to supply access:

The context and background and evident purpose of the legislation make clear that the regime is not only engaged when some denial, or restriction of supply of the service can be demonstrated. Such a construction would limit the operation of this Part and impede it by an anterior and collateral factual enquiry. Further, to the extent that the found denial or restriction acts as a focal point or governor of the enquiry as to the promotion of competition contemplated by s 44H(4)(a) the section would be acting more like a remedy for a wrong, rather than as a public instrument for the more efficient working of essential facilities in the economy.

Similarly broad statements had previously also been made by the Tribunal in the same matter.2

  • A large number of gas pipelines have been declared over the years, despite the comments made by Rod Sims now about the problems associated with the criteria.  While it is true that a number of these have had coverage revoked on the basis that the ‘bottleneck test’ was no longer met, the NCC often explicitly considered any potential for monopoly pricing as a factor taken into account in its decision.3
  • The NCC has recommended that a number of facilities under Part IIIA be ‘certified’ over the years on the basis, amongst other things, that access is “necessary to permit effective competition in upstream and downstream markets”.4   These include a number of examples of non-vertically integrated infrastructure, including a number of ports, railways, water infrastructure and the Western Australian electricity network access regime.
  • There has been evidence over the years of Part IIIA effectively performing its ‘backstop’ role, with the threat of declaration being used to drive commercial outcomes on price and other terms, rather than relying on regulation.

This supports an argument that to introduce wide ranging and intrusive price-setting powers for the ACCC (or AER) would be likely to provide a chilling effect on investment in substantial and important infrastructure.  Recent and controversial tariff decisions by the AER in energy5 and the ACCC in telecommunications6 highlight the risks associated with allowing direct regulatory oversight of pricing.

Where tariff oversight of pricing is considered to be required, this is typically done in a targeted way, with specific frameworks for different industries informed by close consultation with those industries, such as electricity distribution and transmission, gas distribution networks, telecommunications, water, rail and some ports.

Moreover, to the extent that the ACCC is relying on the decision in relation to the Port of Newcastle to support the argument for change, that decision has been referred to the Tribunal and so it is too early to form a view about what it means in terms of the debate.

Finally, it is relevant to point out that neither the Productivity Commission in its review of Part IIIA in 20137 or the Harper Review last year recommended the kind of sweeping changes now being proposed by Rod Sims to address a perceived issue of monopoly pricing.  To the contrary, the Harper Review found that the criterion that requires a facility to be a bottleneck “sets a low threshold for declaration”.8 

The second perspective:  we have a problem…

In the opposing corner are those that share Rod Sims’ concerns about Part IIIA and monopoly pricing. For this group, the problem stems from the fact that Part IIIA was never intended as a mechanism for regulating monopoly pricing.  Recently, in its final recommendation in relation to the Port of Newcastle, the National Competition Council (NCC) made its position on the issue clear:9 

Declaration under the National Access Regime is not a mechanism for imposition of price regulation and was never intended to be such. “Excessive”, “monopolistic” or “gouging” pricing per se is not the focus of Part IIIA. Where such pricing in one market merely transfers income or value from one party in a supply chain to another without materially impacting competition in any other market, Part IIIA does not provide a remedy. The focus of the Regime is on promotion of competition in markets where the lack or restriction of access to infrastructure services provided by facilities that cannot be economically duplicated would otherwise limit competition.

Proponents of this side of the debate will likely argue that, from the outset, it has been acknowledged that monopoly pricing is a problem associated with monopoly infrastructure, and one that needs to be remedied in order to avoid inefficient and distortive effects for users as well as in other markets. 

The grandfather of access regulation in Australia (and, in many respects, globally), Professor Fred Hilmer identified the problem in the final report of the Independent Committee of Inquiry in 1993 (the Hilmer Review). In respect of monopoly pricing, the Hilmer Committee noted that:

Where the conditions for workable competition are absent – such as where a firm has a legislated or natural monopoly, or the market is otherwise poorly contestable – firms may be able to charge prices above the efficient level for periods beyond those justified by past investments and risks taken or beyond a time when a competitive response might reasonably be respective. Such ‘monopoly pricing’ is seen as detrimental to consumers and to the community as a whole.10 

The Hilmer Committee recommended that a third party access regime be introduced to apply to essential facilities in circumstances where the owners are vertically integrated.  In circumstances where owners are not vertically integrated, however, the Hilmer Committee acknowledged that either direct access regulation or a prices oversight mechanism may be appropriate.11 

More recently, those in this camp also point to the final Harper recommendations.  While it is true that the Panel did not call for changes to the Part IIIA declaration criteria, their first recommendation included a call to ensure that “independent authorities should set, administer or oversee prices for natural monopoly infrastructure providers.”12 

Furthermore, the outcome in the Port of Newcastle process is referred to as a case in point.  In that case, despite a new owner of the Port increasing navigational charges by approximately 60%, without any justification based on an increase in costs, the NCC and Minister found that declaration was not supported.  Both the NCC and the Minister accepted that the Port was a natural monopoly.  It was also the case that users had substantial sunk investment in mines that were wholly reliant on the use of the Port to export product.

However, the declaration application was rejected because the cost increase, in the context of the overall coal supply chain, was a very small component of the landed cost of the end product and so regulation through declaration would not materially promote competition in a downstream market.

As well as the cost of port charges, this debate could play out again for coal producers in the Hunter Valley given the potential for privatisation over coming months or years of the ARTC, which operates the rail infrastructure used to transport coal in the Hunter Valley to Newcastle. 

What might all of this mean?

While the question at the heart of this debate is as old as Part IIIA, the immediate policy battle lines are yet to be drawn.  It is therefore hard to predict what it might mean for infrastructure owners, users, regulators and others.

From a policy perspective, it seems clear that the ACCC intends to drive a significant regulatory agenda to respond to the gap it perceives in Part IIIA.  

This could take various forms, but could include:

  • A drive for an alternative general pathway to regulation for non-vertically integrated facilities, which is not subject to the same ‘bottleneck’ criterion. Some commentators suggest that this could be through the application of a more general 'efficiency' based test.
  • It is clear that the ACCC intends to use the East Coast Gas Inquiry to press for changes to the Gas Law to expand regulatory coverage – to align the approach adopted for pipelines with the National Electricity Law applicable to electricity transmission networks.
  • A push for mandatory undertakings to form part of the Part IIIA suite of remedies – this could include giving the ACCC a wider set of powers to direct tariff and other access arrangements (rather than merely being able to respond to those proposed by the owner of facilities).
  • Additional COAG commitments around government privatisation processes to ensure direct tariff regulation forms part of privatisation packages – the  ACCC may also seek a broader role under s 50 of the CCA to consider the competitive effects of any privatisation of assets for the first time (as it is currently unable to assess the initial grant of a licence by a government because it is not an acquisition under section 50 of the CCA).
  • Continued and outspoken involvement in the policy debate around asset privatisations, as the ACCC did with the Port of Melbourne.
  • Focused market studies – in a recent CEDA speech, Mr Sims indicated that another of the ACCC’s priorities in 2016 will be to do more market studies. In particular, he singled out competition issues in agricultural supply chains as a candidate for a market study, the results of which will no doubt feed into ACCC’s other agricultural and supply-chain focused advocacy and enforcement work in 2016.

Much is at stake.  The issue is complex and the implications of any of these policy adjustments would be significant for those who own, use or invest in Australian infrastructure.