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Speech Notes: Lianne Dalziel on Commerce Act

Address by Commerce Minister Lianne Dalziel on Commerce Act Review

22 November 2007
Speech Notes
Energy Trusts of New Zealand 2007 Spring Conference

Address by Commerce Minister Lianne Dalziel to the Energy Trusts of New Zealand 2007 Spring Conference
16 floor, Conference Room: Chancellor 1, James Cook Hotel,
147 The Terrace, Wellington

Thank you for inviting me to speak to you today.

The topic you have invited me to address is 'The Commerce Act Review' which is very timely, because today I released the outcomes of that review.

First, I would like to acknowledge those of you who made submissions and thereby contributed to the policy development process. The weight of evidence regarding the costs and benefits of different regulatory options was invaluable in informing our decisions.

The feedback we received was generally supportive of the overall objectives of the review. Essentially the submissions confirmed that for any regulatory regime to be effective and credible it needs to promote clarity, certainty, timeliness and predictability for business. As far as possible, it should outline the rules as to what is permitted business conduct and then essentially let firms get on with running their businesses within those rules.

Parts 4 & 4A of the Commerce Act are designed to cater for a business environment where there is no competition and no prospect of competition and therefore the purpose is to ensure that market power is not used to extract monopoly rents from those who cannot take their business elsewhere.
But at the same time there must be provision for innovation and investment; and indeed there have been examples of such businesses repatriating profits off-shore rather than maintaining basic infrastructure let alone investing in improvements.

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So a balance needs to be struck and that is what the government has delivered.

This can be seen in the first decision, which is to provide a specific purpose statement for the new Part 4. This purpose statement will guide decisions on whether to intervene in any markets for goods or services and, if so, the form of any intervention. It will read:

"The purpose of this part is to provide for regulation of prices and quality of goods and services to promote the long term benefit of consumers in markets where there is little or no competition or prospect of competition. And regulation provided for under this Part should promote outcomes such that suppliers:

  • (a) have incentives to innovate and invest, including in replacement, upgraded and new assets and in related businesses;

  • (b) face strong incentives to improve efficiency and provide services at a quality that reflects consumer demands;

  • (c) share the benefits of efficiency gains with consumers, including through lower prices;

  • (d) are limited in their ability to extract excessive profits."

The problems identified in the course of the review relate to the fact that there have been advances in overseas regulatory practice which mean that forms of regulation other than price control can be very effective. Our knowledge of regulation of sectors with natural monopoly characteristics has advanced significantly since the Act was passed in 1986, and even since the 2001 amendments relating to electricity lines businesses.

To date, the Commerce Commission has carried out two Part 4 control inquiries in relation to gas pipeline services and airfield activities for the three major airports. In carrying out these inquiries, the Commerce Commission was not able to consider alternative forms of regulation as a means to address the competition problems.

If the Commission considers that a more light-handed regime than price cap regulation may be desirable, the government may be required to separately legislate to introduce the new regime. For example, the Commission suggested that new legislation should be considered following its inquiry into gas pipeline services and that other forms of control, such as commercial negotiation based on pricing principles, may be more appropriate for airport airfield activities. This need for a separate inquiry on forms of control, or the development of new legislation, creates further uncertainty and delay for business as to how they will be regulated.

Furthermore, electricity lines businesses have told us that the Part 4A thresholds regime is discouraging investment. 27 of the 28 lines businesses have breached the thresholds at some point and there have been over 100 individual instances of breaches since the regime was introduced in 2003. Some breaches have been minor or technical in nature, or related to the need to engage in major new investment. However, the potential consequences of any breach under the Act may be significant and disproportionate to the nature of that breach. This uncertainty undermines business incentives to maximise efficiency gains within the price cap threshold and discourages future investment. The government has decided that this flaw in the scheme of the Act needs to be corrected.

The decision on whether to intervene in a market will in future be made by the Minister of Commerce, jointly with the relevant portfolio Minister, after receiving a report from the Commerce Commission.

The threshold for whether to intervene in a market will be simplified and will bring the focus more in line with a standard quality regulation framework. That is, the case for intervening will be made based on the nature and extent of the competition problem in the market, and after having regard to the costs and benefits of different options. Regulatory intervention would only be proposed where it achieves the policy objectives as outlined in the purpose statement.This change in the criteria for determining when intervention may be desirable also reflects that the Act will provide for a wider range of forms of regulatory intervention to address the problems of limited competition. Part 4 and 4A come together in a single regulatory framework, which will provide for alternative forms of regulation in addition to conventional price control including:

  • information disclosure

  • a negotiate/arbitrate regime; and

  • a 'default/customised price path' regime, which replaces the threshold regime

A prerequisite for the new framework to come into effect will be a requirement for the Commerce Commission to develop input methodologies at the 'front-end' of the process. As you are aware input methodologies are rules relating to how costs should be calculated. The way in which these input methodologies would be used would depend upon the form of regulation for each sector.

For those sectors subject to information disclosure only, input methodologies would apply to how the firms prepare their disclosure statements. Under the price/quality control regimes, input methodologies would define how the performance of businesses is to be assessed against the relevant price/quality path.

Given the importance of input methodologies in defining the parameters of any intervention, they will be prepared by the Commerce Commission in advance of any regulation being imposed. This will ensure that businesses know upfront what is expected.
Given that that the setting of the input methodologies becomes a critical component of the framework, the decisions of the Commerce Commission will be subject to merits review on appeal to the High Court.

Of interest to you will of course be the new customised/default control regime, which will differ from the existing control regime as currently provided for in the Commerce Act. For those sectors subject to control, the Commerce Commission would set a default price/quality path for a specific regulatory period, such as five years. The default path would be based on factors such as productivity trends and comparative benchmarking. It would not be based on a building blocks approach. In this respect it would be very similar to the current thresholds specified for electricity lines businesses in Part 4A. The intention is that this path could be set relatively quickly to give businesses some certainty.

Individual businesses would have the choice of either accepting the default path or applying to the Commerce Commission for a customised price / quality path. A customised price/quality path would be based on a proposal by the individual business as to how it can meet the policy objectives given its particular circumstances. By this means, regulated businesses can get approval in advance from the Commerce Commission where they need to increase prices to cover major new investments. The Commerce Commission would be required to consider these proposals within specified time frames. If approved, the customised price/quality path would apply to that business for that regulatory period.

The consequences of contravening the default or customised path would also be clarified. The Commerce Commission would determine the appropriate action based on the seriousness of the contravention. Possible outcomes may include: no action if the contravention was minor, or in more serious cases, a requirement to remedy the fault and compensate affected consumers.

So that is a quick outline of the general new framework that is proposed to apply under the Act.
But you will be interested in what this means for the twenty eight electricity lines businesses currently subject to regulation, and, in particular, energy trusts.

As of 1 April 2009, it is proposed that the current threshold regime under Part 4A of the Act will be repealed. The Commerce Commission would continue to carry out its current reset of the thresholds, but the price/quality paths that it sets are proposed to form the default paths under the new customised/default control regime. Lines businesses would have the choice of accepting the default price/quality paths reset by the Commission, or of proposing their own customised price/quality paths. Any negotiated settlements between lines businesses and the Commerce Commission that are still current as at 1 April 2009 would be saved as customary paths applying to that business. Transpower would also be subject to this regime.

At the same time, however, we recognise that problems are less of a concern where smaller lines companies are servicing their local community and which run a cost minimisation rather than profit maximisation model, because the company is essentially owned by the people using the power. Consequently, we propose that from 1 April 2009 certain lines businesses that are wholly owned by consumer or community trusts would move to a new information disclosure regime and would no longer be subject to price/quality control.

The proposed qualifying criteria for selecting which energy trusts would be eligible to have their lines businesses move to the information disclosure regime are:

  • there is an overlap of at least 90 per cent between the owners and the customers of the lines business who elect the trustees;

  • all of the lines business' consumers are entitled to receive the benefits from a distribution of profits by the business; and

  • the lines business is relatively small, having less than 100,000 consumers.

The Commerce Commission will monitor the information disclosed by the qualifying lines businesses on a regular basis and prepare reports.
However, any lines businesses owned by an energy trust that is subject to information disclosure may be moved to the customised/default regime if it ceases to meet the eligibility criteria or a substantial proportion of its consumers petition the Commission for such a change.

Other Sectors
So, that is in summary the proposals for the electricity sector. Other sectors affected by the proposals are the gas pipeline companies and the three major international airports and for the sake of completeness I will comment on them briefly.

The government has previously decided that the gas pipelines of certain companies, excluding Nova Gas and Taranaki pipelines, should be made subject to a targeted thresholds regime under the Commerce Act (similar to the electricity lines businesses). It is proposed that, as from 1 April 2009, these same gas pipelines would be subject to a customised/default gas control regime under the Act.

The gas pipelines of Vector and Powerco are currently subject to control. The Commerce Commission is in the process of setting control terms for these companies. Once the control terms are finalised by the Commission, they will apply until the end of the first regulatory period. Thereafter, Vector and Powerco will be subject to the customised/default control regime that other gas pipelines will be subject to.

And in terms of airports, the new legislation will transfer the competition aspects of the Airport Authorities Act to the Commerce Act; and Auckland, Wellington and Christchurch International Airports will become subject to an enhanced information disclosure regime in line with input methodologies developed by the Commerce Commission.

The requirement that these airports consult with the airlines will continue under this regime, however the Commission will monitor the way the airports set charges against non-binding pricing principles and rules around calculating the weighted average cost of capital, and report on those. If the Commission finds that stricter controls are needed, it will be able to recommend that a higher level of regulatory intervention be imposed.

In addition, MED will lead a review next year of whether additional forms of regulation should be considered and whether the scope of airports' coverage should be widened.

So that concludes my summary of the proposed reforms, which reflect a fresh look at the way in which we regulate businesses that have natural monopoly characteristics. I am confident that the changes will provide greater certainty to businesses, investors and consumers. They will also ensure that regulatory intervention is proportionate to the competition concerns and that business compliance costs are kept to a minimum. This will help businesses plan and make investments.

The process from here is that I have asked my officials to carry out further informal consultation on the detail of these proposals before the end of the year. I intend to introduce amending legislation into the House in March next year. There will then be the opportunity for interested parties to make further submissions to the Select Committee considering the bill.

Overall, I believe that the proposals will deliver the right incentives for business to commit to the innovation and investment necessary to ensure that New Zealand's infrastructure is world-class.

Thank you once again for allowing me the opportunity to put flesh to the announcements I made this morning to your Conference.


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