In this long running case, the Court of Appeal has granted Dwr Cymru (on 26 July) leave to appeal the Competition Appeal Tribunal's (the CAT) finding that Dwr Cymru had abused its dominant position by setting an access charge that resulted in a margin squeeze on Albion Water (Albion).

The Court of Appeal is due to hear the case later this year. The judgement is likely to be important not just in relation to the Court of Appeal's approach to margin squeeze, but also on the impact, if any, the judgement will have on the interpretation of section 66E of the Water Industry Act 1991 (WIA91). Section 66E WIA91, which was not in force at the time of Albion's substantive complaint, seeks to provide a framework in which access charges are calculated in the English and Welsh water industry. Meanwhile, the CAT has now received Ofwat's further report on Albion's allegation of excessive pricing and its conclusions can be expected in the near future.

Background

The introduction of the Competition Act 1998 led a number of new entrants, including Albion, to seek access to an incumbent water supplier's infrastructure in order to offer an alternative water supply to customers located in the incumbent's licensed area. Specifically, Albion sought access to Dwr Cymru's infrastructure in order to supply water to a paper producer, the Finnish owned Shotton Paper. Albion subsequently complained to Ofwat that the access charge offered by Dwr Cymru was both excessive and resulted in a margin squeeze, contrary to (principally) UK competition law. Ofwat rejected the complaint and Albion appealed Ofwat's decision to the CAT.

The CAT's conclusions on margin squeeze

In a long and detailed ruling, the CAT concluded that (i) a "notional" retail business of Dwr Cymru could not have traded profitably if it were to have paid the access charge Dwr Cymru had quoted Albion; and (ii) a reasonably efficient downstream operator (such as Albion) could not earn (at least) a normal profit when paying the input prices set by Dwr Cymru. On this basis the CAT held that there had been an unlawful margin squeeze.

Likely arguments before the Court of Appeal on margin squeeze

It is likely that Ofwat/Dwr Cymru will argue before the Court of Appeal that the case should be distinguished from previous margin squeeze cases. In particular, that earlier cases were all based on the idea that the price charged by the dominant supplier failed to take into account the supplier's avoided costs, whereas, here, the access price did reflect the, albeit minimal, costs that Dwr Cymru avoided by supplying Albion and not Shotton. Underlying this view is the apparent feeling, which comes out strongly from the arguments before the CAT, that there should not be a legal presumption that a new entrant is entitled to a margin if all it is doing, in reality, is "retyping the invoice" (though the CAT was quick to point out that, in its view, a new entrant was likely to do far more than this).

The CAT's view was that in none of the previous margin squeeze cases was the reasoning based on an avoided cost approach: the question was whether either an efficient competitor, or the incumbent's downstream arm, could compete and earn a normal profit in the supply of water at the quoted access charge- "[If] that is not the case, it is for the dominant firm to show objective justification" e.g. by demonstrating a proper allocation of costs, so that the margin is not open to criticism.

Where the Court of Appeal comes out on these points will have a significant impact of the continuing development of this area of abusive conduct.

Access charges and excessive pricing

Albion's other central argument before the CAT was that Dwr Cymru's access price was excessive. In its judgement, the CAT was highly critical of the lack in the Ofwat decision of any "detailed, or verifiable, break down of the components" of the distribution costs, the main constituent of the access price. Fundamentally, the CAT considered that there were potentially significant differences between the costs involved in distributing non-potable and potable water supply and this had not been sufficiently recognised (or explored) by Ofwat. The CAT asked Ofwat to re-think its conclusions on excessive pricing subsequent to a further investigation on those costs reasonably attributable to the distribution/partial treatment of water by Dwr Cymru, generally, and through the relevant local system in particular. We understand that Ofwat has now reported back to the CAT, though its revised conclusions are not yet publicly available.

The most recent consideration of excessive pricing was by the Court of Appeal in Attheraces (see the March Competition e-bulletin) where the Court noted that the central concept is not the "cost of producing the product or the profit made in selling it, but whether the selling price of a product bears no "reasonable relation to its economic value". Further, the law against excessive pricing is not a law "under which the courts can regulate pricing by fixing the fair price for a product on the application of a purchaser who complains that he is being overcharged for an essential facility by the sole supplier of it." It falls now to Ofwat and the CAT to consider further whether, even if the access price in question is excessive relative to the costs, the price in addition bears no "reasonable economic value" to the service offered. In its initial judgements, the CAT assessed the excessiveness or otherwise of the access charge very much so by reference to the costs involved in granting access. Any adjustments the CAT may be prepared to make to cater for the Court of Appeal's decision in Attheraces will make interesting reading.

Section 66E WIA91

Section 66E WIA91 was not in force at the time of Albion's substantive complaint. In obiter statements, the CAT did however doubt whether the interpretation of section 66E WIA91, as proposed by Ofwat, was in conformity with UK competition law. Whether the Court of Appeal takes the opportunity to assess section 66E remains to be seen. Any comments in this respect would be obiter, but would offer a useful clarification as to how the section can and should be interpreted (in the light of both UK competition law and the potential application of EC competition law).