In December 2013, the High Court released an important decision about the regulation of natural monopolies under Part 4 of the Commerce Act 1986 (Wellington International Airport Ltd v Commerce Commission [2013] NZHC 3289). In a judgment running to 661 pages, the Court dismissed a number of appeals brought by regulated businesses against input methodologies set by the Commerce Commission. In doing so, the Court made some useful observations in relation to a key concept in the Act – that of “workable competition”.

Context

As section 52 explains, Part 4 of the Act provides for the regulation of markets where there is little or no competition and little or no likelihood of a substantial increase in competition. The purpose of Part 4 is then set out in section 52A:

52A Purpose of Part

  1. The purpose of this Part is to promote the long-term benefit of consumers in markets referred to in section 52 by promoting outcomes that are consistent with outcomes produced in competitive markets such that suppliers of regulated goods or services—
  1. have incentives to innovate and to invest, including in replacement, upgraded, and new assets; and 
  2. have incentives to improve efficiency and provide services at a quality that reflects consumer demands; and 
  3. share with consumers the benefits of efficiency gains in the supply of the regulated goods or services, including through lower prices; and 
  4. are limited in their ability to extract excessive profits.

The idea of competition thus underpins Part 4, as it does the rest of the Act. Crucially, section 3(1) provides that “in this Act competition means workable or effective competition”.

In carrying out its duties under Part 4, the Commission issued a number of “input methodologies” which are important ingredients in the regulation of airport, electricity and gas businesses. Dissatisfied, those businesses appealed to the Court. In essence, they asked the Court to determine whether their proposed alternative approaches would be “materially better” in achieving the aims of Part 4 than those adopted by the Commission. This required the Court to consider carefully the purpose of Part 4, and so the meaning of “workable or effective competition”.

Court’s analysis

The following propositions can be distilled from the Court’s reasoning in relation to those words:

  • The theoretical ideal of perfect competition is unattainable in reality.
  • In practice, markets demonstrate varying levels of competition. The outcomes produced by a more competitive market (including productive efficiency, allocative efficiency, and dynamic efficiency) are better for society than those produced by a less competitive market.
  • A strongly competitive market is one where prices reflect efficient costs, and firms earn no more than a normal rate of return.
  • A workably competitive market is one that produces outcomes that are reasonably close to those found in strongly competitive markets. In a workably competitive market, no firm has significant market power. The tendencies are thus towards cost-reflective prices and normal rates of return (although those outcomes may never in fact be achieved).
  • Ultimately, whether a market is workably competitive is a judgment to be made in light of all of the available information.

This logic led the Court to conclude that the purpose of regulation under Part 4 is to promote the outcomes in section 52A(1)(a)-(d), consistent with the outcomes that would occur in a workably competitive market.

The Court then sought to apply that touchstone in determining the issues presented by the appeals. For instance, one of the key issues in the appeals concerned the appropriate regulatory asset base (the greater that asset valuation, the higher the regulated prices that could be charged in the future). According to the appellants, that valuation should have been calculated by reference to the costs a hypothetical new entrant would face. The Court concluded that such an approach was not mandated by the reference in section 52A to promoting outcomes consistent with those produced in workably competitive markets.

Comments

Several observations may be made:

  • The Court itself notes in passing that the reference to workable competition in section 3(1) may just be a recognition that perfectly competitive markets do not exist in reality. If that is so, then it may not be helpful to try to understand exactly what is meant by “workable competition”. It may be better simply to acknowledge that markets demonstrate varying levels of workable competition (unless they are characterised by little or no competition, such as markets which require regulation under Part 4). In the context of Part 4, the focus would fall instead on the outcomes in section 52A(1)(a)-(d).
  • Although section 3(1) in fact refers to “workable or effective competition”, the Court does not consider in detail the meaning of “effective competition”. The inference seems to be that “effective” adds nothing to “workable” in section 3(1). Given that the phrase “effective competition” was used in sections 2A and 21 of the Commerce Act 1975, and that the Courts are usually reluctant to conclude that a statute includes redundant words, that inference may not be entirely safe.
  • As noted above, section 3(1) is not specific to Part 4. The concept of “competition” underpins the entire Act (such as the section 27 prohibition on agreements which have the purpose or effect of substantially lessening competition in a market). The Court’s reasoning may therefore be relevant in other contexts. For instance, the Supreme Court has already established that determining whether a party has taken advantage of its substantial degree of market power under section 36 involves asking whether a defendant would have acted as it did in a workably competitive market (Commerce Commission v Telecom Corporation of New Zealand Ltd [2011] 1 NZLR 577 at [34]).

Perhaps the key point is that, even 28 years after the Commerce Act was passed, there remains real uncertainty about the meaning of “workable competition”. It may be hoped that the appellate courts will have an opportunity to consider this fundamental issue soon.

This article first appeared in Law News Issue 4 (28 February 2014), published by Auckland District Law Society Inc.