The Commerce Commission (Commission) has announced that it will appeal against Vector's win in a High Court case against a Commission proposal to set new prices for its electricity and gas businesses. This is the first Court decision under the new Part 4 of the Commerce Act 1986, which is the latest incarnation of price control in New Zealand.

What does Part 4 do?

Part 4 of the Commerce Act, which was significantly amended in 2008, is a special regime for the regulation of monopolies and near-monopolies.

Part 4 allows the Commission to impose at least one of three types of regulation on a supplier through an inquiry process, if that supplier meets certain tests.  One of the crucial tests is whether the relevant good or service is supplied in a market where there is both little or no competition and little or no likelihood of a substantial increase in competition.

Although conducting an inquiry is the legislated process for imposing Part 4 regulation, a number of industries are already directly regulated under Part 4.  These are electricity lines businesses, gas pipeline businesses, and the three major airports.

The Vector decision

The Vector decision involved the Court overturning a Commission proposal to reset the prices for Vector's electricity lines services.  Vector's electricity lines services are directly subject to price-quality path regulation, one of the types of regulation under Part 4.  As Vector is also a gas distribution business, the decision applies equally to the approach that the Commission is required to take regarding the price-quality path regulation of gas pipeline services.

Price-quality path regulation

Price-quality path regulation requires the Commission to determine the maximum revenue or maximum prices, and quality standards, for the supply of the regulated goods or services.  They are called "paths" because they usually provide for prices to increase or decrease year to year, in order, for example, to drive efficiencies, allow businesses to retain profits for investment, or to reflect increases in costs.

At present, all gas pipeline businesses, some electricity distribution businesses (including Vector), and Transpower are subject to price-quality regulation.  Some price-quality paths are still being developed, and the Commission is currently resetting the existing price-quality path for gas pipelines and electricity lines.  It was this reset that gave rise to the Vector decision.

Input methodologies

Input methodologies are part of the changes to the regulatory regime introduced in 2008.  Their purpose is to set methodologies, rules, processes, requirements and evaluation criteria for services that are regulated under Part 4 – for example, how to work out a supplier's cost of capital or how to value assets.  The intention is that the pricing and other determinations made by the Commission under Part 4 adopt the input methodologies.

The High Court decision

The High Court decision is essentially about whether the Commission is using the right document and process to set out the detail of the reset prices.  The Commission proposed that the detail be specified in a pricing determination.

Vector successfully contended that this detail was methodological, and therefore should be specified in input methodologies to which the pricing determination would refer, rather than being specified in the pricing determination itself.  This is an important point, not least because there are merit-based appeal rights from input methodologies, but not from determinations.

One of the major reasons for the Court's decision was evidence of Parliament's intent to create greater regulatory certainty through the use of input methodologies.  Vector argued that the failure to specify the detail of the reset prices as input methodologies meant that the Commission would be able to change its mind in the future without regard both to the constraints on changing input methodologies that Part 4 provides, and the certainty those constraints give to regulated suppliers.  Vector was able to show that such uncertainty would have a significant negative impact on its business.

The High Court decision also found that the Commission had misinterpreted Part 4 by not specifying input methodologies for the valuation of assets, the allocation of common costs, and the treatment of taxation.

What happens now?

Following the decision, the Commission temporarily suspended the reset of the relevant default price-quality path (originally scheduled to be completed by 20 October 2011).

On 21 October 2011, the Commission announced that it would appeal the High Court decision, saying that it does not believe that an input methodology for starting prices was intended when Part 4 was enacted.  Dr Mark Berry, the Commission Chair, also said that the Commission is concerned that the High Court's decision could potentially require the Commission to develop other process input methodologies that the Commission does not believe were intended by Parliament.

If the appeal fails, options for the Commission are to:

  • Consult on an input methodology providing for its proposed starting price adjustment, or
  • Consult on an input methodology setting out a different approach to the starting price adjustment.

It is currently unclear how much further work the Commission will in fact carry out.  For the moment, Vector's challenge has successfully stalled the Commission.