4. HoustonKemp.com
What is competition policy?
• Improves the economic welfare of Australians…
• by making markets work as well as they can
› by making markets be as competitive as possible,
compelling businesses to be more efficient
eg prevent monopolies from forming by firms merging
› by ensuring that markets work for consumers
eg consumers understand what they are buying
‘policies and laws which ensure that competition
in the marketplace is not restricted in a way that is
detrimental to society’ Massimo Motta
4
AIM
HOW
ACHIEVED
5. HoustonKemp.com
Several elements to competition policy
• Government policies
› eg ensuring that government policies don’t raise unnecessary
barriers to entry
• Interaction between government businesses and
private sector
› eg how ABC competes with private sector
• Competition law
› eg laws regarding which mergers are allowed to occur
• Structural reform and regulation of monopolies
› eg regulation of electricity networks
• Access to third party infrastructure
› Accessing railways, ports, airports etc
5
6. HoustonKemp.com
Economic regulation is government intervention in
markets
• Intervention by the government to affect
› structure of an industry, eg, number of firms
› conduct of firms,
eg pricing, investment and quality
eg terms on which access is provided to other firms
• These sorts of decisions are not usually directly
affected by government policies
• Economic regulation may be combined with other
types of regulation, eg environmental or social policy
6
‘Government-imposed restrictions on firm decisions
over price, quantity, and entry and exit’ Viscusi et al
7. HoustonKemp.com
Ex post competition law and ex ante economic
regulation
• Competition law prohibits certain conduct -
assessment of whether the law has been broken is ex
post
› In essence: do whatever you like, as long as you don’t break
the law
› ACCC (or other) will investigate and prosecute ex post if law
is broken
• Economic regulation typically describes detailed
rules that are set ex ante
› In essence: do exactly what I tell you
› Conduct must be consistent with detailed rules – much less
freedom
› Eg regulator sets prices ex ante
7
8. HoustonKemp.com
Two problems addressed by economic regulation
8
Airport
Airline A Airline B Airline C
Natural
monopoly
Potentially
competitive
market
Airport A
Airline A
9. HoustonKemp.com
When should ex ante regulation be used?
• Significant and enduring market power is present
• Very likely that market power will be used to the
detriment of consumers
• Regulation is feasible
• Benefits of regulation outweigh costs, relative to
having competition law alone
9
10. HoustonKemp.com
Costs and benefits of competition law and ex ante
regulation approaches
• Costs
› Administration cost of ex ante regulation is greater because it
requires much more work to set detailed rules
In contrast, threat of action (deterrence effect) may prevent
anticompetitive conduct in ex post approach
› Cost and likelihood of errors is greater with regulation because
More decisions in regulatory approach
Less information available ex ante
› Lose dynamic benefits from competition
• Benefits
› Both approaches can help to lower prices (towards the efficient
level) and increase service delivery
But competition law and regulation are not perfect substitutes
› Competition law focuses on conduct that increases market
power or abuses market power
But it does not prevent a monopolist from charging monopoly prices
10
12. HoustonKemp.com
Alternatives to traditional economic regulation
• Competition for the market
› Eg Port of Singapore
• Contestability/threat of entry
• Competition law
• Negotiated settlements
› Eg federal energy regulation in USA and
Canada
• Monitoring
› Eg airports in Australia
• State ownership
› Eg NBN and some electricity distributors
state owned but these are also regulated
12
No regulation
Light-handed
regulation
Government
control
14. HoustonKemp.com
Characteristics of airports
• Very large fixed sunk costs
• Significant economies of scale (up to a point)
• Need to be integrated into transport infrastructure
• Important part of Australian economy
• Monopoly (sometimes)
14
15. HoustonKemp.com
Some airports have substantial market power
• Barriers to entry are high (sunk costs)
• Potential for substitution depends on type of
passengers and whether there are other airports
nearby
• Brisbane, Melbourne, Perth and Sydney found to
possess a high degree of market power in domestic
markets because
› High proportions of business travellers
› No close alternative to air travel (10 hour road trip anyone?)
› Few alternative airports nearby
15
16. HoustonKemp.com
Potential effects of market power
• Charge airlines higher prices (leading to lower
consumption)
› Note: harm is lower consumption, not higher prices
• Reduce quality
• Allow costs to increase
• Price and cost increases only affect consumers
indirectly and airport charges are only small part of
cost of flight
• Airlines may price discriminate to reduce or eliminate
any effects on consumption
16
BUT
17. HoustonKemp.com
Brief history
1717
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Major airports
owned by the
Federal
Airports
Corporation
Airport
privatisation
begins
The Productivity Commission (PC)
found that price regulation faced
information challenges and:
Prices regulated
by the ACCC
using CPI-X
‘Light-handed’
price and
service
monitoring
replaced price
regulation
• distorted production
• chilled investment
• discouraged commercial negotiation
• sent poor price signals
• increased compliance costs
PC found
• increase in
investment
• no evidence of
use of market
power
• satisfactory
quality
18. HoustonKemp.com
Current regime
• ACCC monitors and reports annually on prices and
quality of service at Sydney, Melbourne, Perth and
Brisbane
• Self-administered monitoring scheme for Canberra,
Darwin and Gold Coast
• Government can direct ACCC to undertake a public
inquiry if monitoring indicates that further
investigation is required – could result in
reintroduction of price controls
18
19. HoustonKemp.com
Recent history of monitoring reports
• 2012-13: higher margins and low investment
› Higher margins underpinned by growth in traffic volumes
› Insufficient investment to accommodate growth and improve
service quality
› Particular congestion in landside infrastructure
• 2014-15: lack of competitive pressure facilitates high profit
margins
› Increased profit margins on aeronautical and car parking
revenue (up to 50% and 73% respectively)
› Service quality unimproved despite profit levels
› Record-level investment in aeronautical assets may lead to
future improvements in service quality
19
But no action taken or recommended by the ACCC so far
20. HoustonKemp.com
Limitations to monitoring
• What exactly is being monitored?
› How prices, profits and quality changes over time
› Not assessing returns against long run costs
› Airport that was already setting monopoly prices would only
gradually raise prices
• It is very difficult to assess whether profits are
‘excessive’
• Monitoring cannot distinguish between reasons for
changes in profits (efficient operation or poor service
level)
• What is the trigger for public inquiry?
20
22. HoustonKemp.com
Characteristics of rail services
• Above rail – operate the trains
› Pay below rail operator
› Revenue from transporting freight and passengers
› Potentially competitive
• Below rail – operate the track
› operate and manage track
› charge above rail users
22
23. HoustonKemp.com
Example – Hunter Valley Coal Network (2017)
• 867 km of regulated network
• $2.2 billion asset value
• $523 million revenue
• 201 million tonnes of coal
23
24. HoustonKemp.com
Below rail operators have market power in some
instances
• Natural monopoly
› Large fixed costs, very low variable costs – therefore
economies of scale
• Some competition from road and sea transport
• Significant market power in some instances
› High prices
› Foreclosure of above rail operators if above and below rail
are vertically integrated
24
25. HoustonKemp.com
Allow negotiated prices within limits
• Regulated price is not flexible
› Could be too high when there is competition from road
› Preclude commercial negotiation
• Solution: Allow negotiation of prices within certain
limits
• Ceiling price
› Stand alone cost of providing the service, ie, price above
which entry would be profitable (with no barriers to entry and
only one provider)
• Floor price
› Marginal cost of providing a service to each customer
25
26. HoustonKemp.com
Advantages of floor and ceiling approach
• Price is never below marginal cost
› Reduced risk of foreclosure
• Revenue is never above cost of a new entrant
› Monopoly pricing is prevented
• Prices can be negotiated
› Reduced administration cost
• Prices can fall to competitive level when there is
competition from road
• Price discrimination is possible
26
27. HoustonKemp.com
Price discrimination can increase welfare
27
Average cost
Marginal cost
Demand
Welfare loss
$
Q
P1
P2
Welfare loss if must break even with linear price
Q2
Q1
AC1
28. HoustonKemp.com
Price discrimination can increase welfare
28
Average cost
Marginal cost
Demand
Welfare loss
$
Q
P3
P4
Price discrimination allows price to customers
with lower willingness to pay to be reduced,
whilst still breaking even
Charge these
customers P3
Q2 Q4
29. HoustonKemp.com
Wide variety of methods for valuing assets
• Capital cost is very substantial proportion of below rail
costs
› So valuation of assets has substantial effect on allowed revenues
• Backward looking estimates
› Depreciated actual cost - a written down value of actual asset
purchases, using an economic treatment of depreciation
• Forward looking estimates
› Gross replacement value - full economic cost of modern
equivalent assets required to provide the services
› Depreciated optimised replacement cost – the economic value
of the existing assets, given the opportunity to replace them with
modern equivalent assets
29
Ceiling price is costs that new entrant would incur if assets
are valued using GRV approach
31. HoustonKemp.com
Electricity supply chain
• Electricity generation and retail have been
deregulated because competition can be effective
in these sectors
• Transmission and distribution are regulated as they
are natural monopolies
31
32. HoustonKemp.com
Characteristics of electricity distribution
• Supply side
› Assets comprise primarily of poles and wires
Ausgrid: 500,000 power poles and 50,000 km of cables
› Very high fixed costs
› Very low marginal costs
› Strong economies of scale
› Natural monopoly
• Demand side
› Electricity is essential to vast majority of consumers and
businesses
› Safe and reliable supply of electricity is critical to economic
performance and consumer welfare
32
33. HoustonKemp.com
What is the problem?
• Electricity distributors are natural monopolies
• Very substantial and enduring market power
• Essential service
• High willingness to pay
• Low elasticity of demand
33
Very high risk of market power being
used to the detriment of consumers
34. HoustonKemp.com
Revenue cap based on a forward looking
assessment of efficient costs
• Firms have total revenue caps each year (for 5 year
period)
• Cap is determined by estimate of efficient costs,
based on
› demand projections
› requirements to maintain reliability
• Firms can set their own prices (subject to certain
rules)
• Firms keep profit earned by reducing their costs (over
the five year period)
• Firms cannot earn additional revenue if costs were
higher than expected
34
35. HoustonKemp.com
Benefits from cost savings
• Previous system
› Electricity distributor kept benefits from cost savings but then
lost them in the next regulatory period
› Result - strong (weak) incentive to reduce costs at beginning
(end) of period
• Current system
› New schemes such that benefits from cost savings are the
same in each year of regulatory period
35
36. HoustonKemp.com
Some cost increases can be passed on
• Risk to firms that costs go up whilst revenues do not
• Costs that increase due to external standard
obligation can be ‘passed through’
• Cost increases for major projects that are caused by
external factors can be passed through
• Some risks remain
36
37. HoustonKemp.com
Building block model used to determine revenue
cap
37
Operating
expenditure
Return on capital
(rate of return
multiplied by
value of capital)
Return of capital
(ie, depreciation)
Capital
costs
Others, eg, tax
38. HoustonKemp.com
Regulatory asset base (RAB)
• RAB: value of assets
• Lock in, and roll forward approach
38
Initial RAB
Take away
depreciation
Add capex
Period 1
Period 2
39. HoustonKemp.com
Application of the building block model to Ausgrid,
current regulatory control period ($m, nominal)
39
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000
Return on
Capital
Operating
Expenditure
Regulatory
Depreciation
Corporate
Income Tax
Revenue
adjustments*
Meters, ANS
and ERW
Costs**
Allowed
Revenue
(unsmoothed)
$million(nominal)
42. HoustonKemp.com
What is the problem?
• Monopolies in infrastructure services can inhibit
competition in up or downstream markets through
› denial of access (foreclosure)
› monopoly pricing
• Occurs where access to infrastructure services is
required to compete in upstream or downstream
markets
› Eg, airlines need to access airport services to compete
• Challenge is to balance
› potential reduction in incentive to invest in infrastructure as a
result of access regulation with
› allocative efficiency in dependent markets
42
43. HoustonKemp.com
What is the access regime?
43
Application for
declaration
DeclaredNot declared
Negotiate prices
Prices set by ACCC
Agree prices
Negotiate prices
Declaration decisions made by the Minister on recommendation of
National Competition Council. Decisions can be reviewed by the
Australian Competition Tribunal and/or the Courts.
Cannot reach agreement
Prices set by negotiation
44. HoustonKemp.com
Criteria for declaration
• Access would promote a material increase in
competition in at least one dependent market
• Uneconomical for anyone to develop another
facility
• Facility is of national significance
• Access is not already available through other
regulation
• Access would not be contrary to public interest
44
46. HoustonKemp.com
Case study: Railways in the Pilbara
• Conflict over access to privately owned railways in Pilbara region
• BHP Billiton and Rio Tinto operated railways to transport iron ore from
mines to the ports
› BHP: Mt Newman and Goldsworthy lines
› Rio Tinto: Hamersley and Robe lines
• Fortescue Metals Group (FMG), emerging as a major producer, sought
access to run its own trains on these lines.
46
48. HoustonKemp.com
Timeline
48
2004 2006 2008 2010 2012 2013 2014
FMG begins
applications
to the NCC
to declare
‘below rail’
services
Minister does
not declare the
Mt Newman
line. No further
appeals
High Court
Decision.
Returns to Tribunal
for “review for
which Act
provided”
Australian Competition
Tribunal Decision.
Declared Goldsworthy.
Overturned declaration
of Hammersley and
Robe
Federal Court
upholds Tribunal’s
decision on
Hammersley and
overturned on
Robe
The Minister
declares the
Hammersley,
Goldworth
and Robe
lines. BHP and
Rio appeal
Second Tribunal
decision.
Hammersley
and Robe lines
should not be
declared.
FMG
opens its
own open-
access
railway
49. HoustonKemp.com
Outcome after ten year process
• Only the Goldsworthy line declared
› BHP has reported that no third party access, or requests for
access, have occurred.
• High Court decision led to a Productivity Commission
review of the National Access Scheme (2014)
› Found that the Regime should be retained but scope limited
› Proposed that the declaration criteria altered to reflect the
role of natural monopoly
49
50. HoustonKemp.com
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