Good afternoon and thank you for the opportunity to provide an update of Commerce Commission activity in the energy sector.
I would like to start with a brief overview of the role of the Commission, and focus on the Commission's current enforcement and regulatory activities relating to energy.
The Commission is New Zealand's primary competition regulatory agency.
The Commission enforces the Commerce, Fair Trading and Credit Contracts and Consumer Finance Acts, in addition to a number of industry specific legislation in the electricity, telecommunications and dairy sectors.
"The purpose of the Commerce Commission is to promote dynamic and responsive markets so that New Zealanders benefit from competitive prices, better quality and greater choice."
The Commission makes no secret of wanting market driven solutions.
Competition provides benefits to consumers on prices, quality and choice.
Competition also provides benefits to businesses by ensuring that market rewards go to the firms that innovate and are price and quality competitive.
The Commission's preference is to encourage commercial negotiation to resolve access issues in network industries. Commercially negotiated outcomes are likely to be superior and quicker than decisions imposed by regulators. These commercial outcomes will be more likely if participants understand what the regulatory answer might be if negotiations fail.
I will now talk specifically about our enforcement focus, and unfortunately today I start with a negative.
It is our view that the energy sector has been very slow to understand their obligations under the Fair Trading Act.
The Commission continues to receive a wealth of complaints about electricity. Last year, we received in excess of 250 complaints or enquiries from New Zealand consumers.
The Fair Trading Act is an important vehicle for promoting dynamic markets - markets in which New Zealanders benefit from competitive prices, better quality and greater choice.
Although the Act does not oblige businesses to provide information to consumers in all circumstances, businesses are obliged to ensure that the information they do provide is accurate, and that important information is not withheld. This enables consumers to make informed choices.
The Fair Trading Act also protects businesses that comply, and in this way promotes the Commission's aim of achieving effective competition.
Honest businesses are disadvantaged when consumers are misled into buying competitor's products or services.
The Commission recently settled with three energy companies - Meridian Energy, TrustPower and Contact Energy - and has a further four investigations underway under the Fair Trading Act.
In addition, the Commission is currently prosecuting Empower. The allegations include switching consumers without their agreement, making statements that were liable to mislead customers into thinking they needed to switch and for misleading consumers about the rates they would be charged.
In the past, the Commission has prosecuted Mighty River Power for misleading television advertising that promised monthly meter readings.
Many of the misleading statements reported to the Commission have the potential to reduce customers' propensity to switch, thereby reducing choice and competition.
This is because the tenor of the statements suggests to consumers that there is little point in changing retailers as the reasons for price increases are both outside the control of those retailers and likely to apply no matter which retailer they choose.
We consider that any breach of the Fair Trading Act by a major corporate is serious.
I would like to come back to the Commission's settlement with Contact Energy to reinforce this position.
Over a four month period, Contact Energy, and its subsidiary Empower, sent out over 250,000 notifications to its customers explaining price changes that would affect their electricity bills.
Our investigation established that a percentage of Contact's customers were advised that changes in their bills were due wholly or in part to increases in the network charges for use of electricity lines when in fact the lines charges had decreased.
These customers were therefore provided with misleading explanations for the price changes, which incorrectly and unfairly inferred that changes were due to increases imposed by network lines companies.
The Commission's main concern was that Contact's customers may have been discouraged from switching to another electricity retailer by believing that it was a lines charge increase, not Contact, which was primarily responsible for an increase in electricity costs.
In this case Contact's behaviour had the potential to be harmful to competition in the electricity sector.
For competition to be effective, consumers must be prepared to switch in response to reliable information about charges. The Commission views any misleading and therefore anti-competitive behaviour that is likely to discourage switching seriously.
In the Commission's settlement:
- Contact admitted breaching the Fair Trading Act;
- Contact agreed to apologise to affected consumers and network lines companies;
- Contact published public apology notices in national newspapers;
- Contact agreed to make a $30,000 donation to the Citizens' Advice Bureaux; and finally
- Contact agreed to overhaul its compliance systems.
Having entered into a number of settlements and having widely publicised these, the Commission is unlikely to consider further settlements as appropriate and is likely to prosecute future breaches of the Act.
Moving onto the Commerce Act, the aim of this legislation is to promote competition in markets within New Zealand. It prohibits conduct that restricts competition and the purchase of a business's shares or assets if that purchase leads to a substantial lessening of competition in that market.
The Commerce Act applies to all individuals and businesses, including state-owned enterprises, local government and government departments.
The Commission is particularly interested in the state of competition in the electricity retail market. Consequently, we monitor any structural or behavioural changes that might impact on the level of competition between retailers.
The Commission is especially interested to the extent to which there might be pockets or areas of market power that might have the potential to, or might actually be, impacting competitive outcomes.
Recent merger activity for the Commission includes the clearance granted to Vector to acquire NGC in December last year. The Commission made a decision under the Commerce Act that the acquisition would not substantially lessen competition in the relevant markets.
In addition to receiving a clearance, Vector sought and was granted an exemption under the Electricity Industry Reform Act, known as EIRA, in respect of its ownership of electricity networks and cross-involvement through its ownership of an interest in the Kapuni Energy Joint Venture, Wanganui Gas Limited, and in two residual hedge arrangements.
For those who are not familiar with EIRA, it was introduced in 1998 to mitigate Government concerns about electricity companies being vertically integrated natural monopolies. EIRA delivers a structural solution to deal with cross subsidisation, and it prohibits common ownership of electricity distribution businesses and of either an electricity retailing or electricity generation businesses (other than minor cross-ownerships).
EIRA is intended to create a better environment for increased efficiency and consumer benefits through increased competition in generation and retail markets. The Commission has powers to exempt businesses and persons from the provisions of EIRA. In considering applications for exemption under EIRA, the Commission focuses on the impact that any cross ownership has on competition.
In other words, an exemption is granted only if it is considered that consumers are still able to gain the benefits of competition, particularly in terms of competitive retail prices. In all cases, the Commission has granted exemptions subject to a range of conditions intended to ensure these benefits to consumers are realised.
The Act does allow distribution companies to own a small amount of generation. Over time, the amount of generation distribution companies are permitted to own may increase as any excess profits are removed by the thresholds regime, but this is a policy matter for the government.
Another recent EIRA decision was an exemption granted to the Westfield Group. Westfield owns and operates numerous shopping centres in New Zealand, and it typically sells electricity to tenants.
We are presently assessing exemption applications from the Asquith Group, David Henderson and related companies and also the Multiplex Group, with decisions on all three expected by the end of this month.
The Commission currently has a number of alleged anti-competitive behaviour investigations underway.
The Commission is currently investigating allegations that Vector, and its predecessor United Networks Ltd, has taken advantage of its market power in gas distribution markets to deter Nova Gas.
Nova Gas alleges that Vector deterred it as a competitor in retail gas markets because Vector recognises that Nova Gas has, and may in the future, build its own gas pipelines to bypass Vector's own network. Nova Gas says that its acquisition of a large retail gas customer may provide it with a collateral pipeline bypass opportunity and that Vector is attempting to prevent this occurring. This investigation is continuing.
The Commission is also currently investigating allegations that Contact Energy is using its market power to limit the level of competition in the commercial retail energy market.
Contact Energy has a contractual arrangement with its commercial customers which ensures that Contact has a right of first refusal if one of their customers wishes to seek a new contract. This investigation is at an early stage.
Many of you will be aware of the Commission's long running prosecution of Bay of Plenty Electricity. This case goes back to 2001, when Bay of Plenty Electricity was allegedly refusing to grant access to the use of its meters to other retailers within the region, and therefore alleged to be using its dominant position for anti-competitive purposes.
In this case, the Commission has adopted a regional market due to Bay of Plenty Electricity's ownership and control of electricity meters as the incumbent retailer. The Commission alleges that Bay of Plenty has market power through the ownership of the meters.
The case is currently proceeding with interlocutory disputes being resolved, and it is likely to be heard in 2006.
I finish the enforcement update with the Commission's preliminary view to revoke the authorisation it granted 18 months ago in respect of the Pohokura gas field.
The Commission granted the authorisation despite its detrimental impact on competition, principally because it was persuaded by the three parties involved that a joint approach was necessary to realise the benefits associated with early production of gas from the Pohokura field.
In April 2004, the parties - Shell, Todd and OMV - advised the Commission that because they had been unable to agree on issues associated with the joint marketing and sale of the Pohokura gas, it would be necessary to market and sell the gas separately.
On information we currently know, we consider the Pohokura authorisation was granted on the basis of information that was false or misleading, or that there have been material changes in the circumstances since the authorisation was granted.
One material change is that the nexus between joint marketing and sale and early production no longer exists. Without that, the public benefit analysis is substantially altered in a way that was discussed by the Commission when it initially granted the authorisation. At that time, the Commission indicated without that nexus, the authorisation would not have been given.
We released our draft determination last week, and the Commission's preliminary view is to exercise its discretion under the Commerce Act and revoke the authorisation.
I now move onto our regulatory activities.
Part 4A of the Commerce Act, relating to electricity lines businesses, came into effect on 8 August 2001.
Part 4A encompasses a targeted control regime for the 28 distribution businesses plus Transpower, and also an information disclosure regime. The targeted control and the information disclosure regimes share a common overall purpose - that is to promote the efficient operation of markets directly related to electricity distribution and transmission services.
The Commission established two performance thresholds to assess the lines businesses:
- a CPI-X price path threshold; and
- a quality threshold
The Commission completed its first assessments in September 2003, and five lines businesses were found to have breached the thresholds for significant reasons.
The Commission completed its second assessments in March 2004.
The second assessments (including initial quality threshold assessments) have established to date that 16 businesses breached the price path threshold, with compliance being checked for a further two businesses.
Of the identified sixteen breaches, five are under post-breach inquiry and seven have been cleared because of mitigating factors, with no further action warranted. Additional information is being sought from another four businesses.
The second assessment has also found that 12 businesses breached the quality threshold, with three of these cleared on the basis of events that were not fully controllable. To resolve breaches attributed by other electricity lines businesses to events that were not fully controllable, the Commission is consulting on appropriate standards by which to measure both a normal variation and an extreme event. By extreme event I refer to a rare, high impact occurrence such as the Manawatu flooding 12 months ago.
The Commission is currently reviewing all 28 self-assessments to evaluate ways in which the businesses communicate with consumers concerning the trade-offs between price and service quality, with a view to establishing best practice criteria.
Transpower occupies a key position in the electricity system - simply put, all users that connect to the national grid rely on Transpower. Transpower owns and operates the national transmission grid, which primarily consists of over 12,000 km of high voltage transmission lines. Transpower is also regulated under Part 4A of the Commerce Act.
Last month, the Commission advised Transpower that it had opened a post-breach inquiry into Transpower's breaches of the initial price path threshold as at 6 September 2003 and 30 June 2004. The Commission is now awaiting further information providing detailed explanation of the reasons for the breaches.
I would like to make a few observations about the impact of the targeted control regime, which has now been in place since June 2003.
Experience to date indicates that desired outcomes can be largely achieved without resorting to the more intrusive Part V control.
Around two-thirds of lines companies have had to reduce their prices in real terms over two consecutive years and face further reductions over the next three years.
However, while only 3 lines companies will be able to increase prices in real terms over the five year price path threshold, given the current CPI, most firms can increase prices in nominal terms.
Furthermore, outcomes of post-breach inquiries could sanction further nominal price increases.
As a consequence, there is also a growing need to improve public awareness of the regime and mitigate pejorative perception of some "breaches".
Analyses of smaller businesses could raise questions about efficient scale.
For trust-owned businesses, any evaluation of broader efficiency implications of providing rebates may continue to draw attention.
Finally, differential sub-network returns are likely to draw regulatory focus if lines companies do not move to restructure prices, where this is appropriate. The Commission would be concerned to find significant uneconomic cross-subsidisation across sub-networks.
While the perception may be that New Zealand is moving closer to other
Jurisdictions' approaches to regulating electricity sector monopolies, the targeted control regime is still a light handed regime that allows companies to make their own business decisions about price, quality and investment. The direct control of prices, revenues and/or service quality will likely continue to be the exception rather than the rule.
Also, as experience with the regime is gained over the next few years, the Commission may find that more targeted thresholds, involving lower compliance costs across the industry, might be able to meet the purpose of the legislation at the time the thresholds are reset.
For example, it may be possible for the Commission to exercise its discretion not to assess all businesses every year where it is clear that businesses are achieving efficiencies and quality improvements, and cost savings are being passed on to consumers.
The Commission has initiated a review of the Electricity Information Disclosure Regime and is currently considering submissions to a discussion paper and a draft decision on implementing valuation choice for system fixed assets, both of which were released in December 2004.
This is a far-reaching review which considers the fundamental question of what regulatory performance accounts should look like in the context of Part 4A, while at the same time assessing the compliance costs to lines businesses of producing disclosure information.
The Commission will be holding a public conference later this month to hear submissions and will continue this year to work towards publishing a new set of Information Disclosure Requirements.
The new requirements, together with the targeted thresholds regime, will constitute the two pillars of a coordinated and effective regulatory framework.
I finish the regulatory update with an overview of the Commission's recommendations to the Minister following the conclusion of the gas control inquiry.
In November last year, the Commission recommended to the Minister of Energy that direct control under Part V of the Commerce Act should be imposed on gas distribution companies Vector Limited and Powerco Limited.
The Commission did not recommend direct control for NGC Transmission, NGC Distribution, Wanganui Gas, Maui Development, Nova Gas and the individual transmission pipelines located in the Taranaki area.
The Commission's inquiry found that Vector and Powerco each have substantial market power and are earning excess returns above their cost of capital to an extent that the Commission is satisfied that it should recommend direct control.
Control under Part V is high cost relative to other regulatory options. The Commission noted that the Minister has a wider discretion than the Commission to consider other matters including alternatives to control under Part V.
In its advice to the Minister, the Commission considered the regulatory constraints on NGC Transmission, MDL, NGC Distribution and Wanganui Gas should be strengthened and suggested that the Minister consider applying a regime comparable to the targeted control regime applicable to electricity lines businesses under Part 4A.
If the Minister were to introduce alternative mechanisms for those companies, there may be benefits in having all businesses, including, Powerco and Vector, under the same regime.
The Commission also requested that the Minister consider strengthening the gas pipeline information disclosure regime.
The Minister has invited submissions on those recommendations, and we understand that the Minister expects to make a decision by June.
In closing, the energy sector continues to be an ongoing priority for the Commission, as the effective working of the electricity and gas markets are important to New Zealand's economy.
Where there are competition or structure issues, the Commission will undertake anti-competitive investigations.
If consumers are not receiving accurate or reliable information to make informed choices, the Commission will investigate under the Fair Trading Act.
And where it is demonstrated that regulation is necessary and desirable, the Commission will look for targeted, incentive-based regulation that is cost-effective and as non-intrusive as possible.
Thank you for your time today
