How did the light handed regulation of monopolies become no regulation?

Mr Rod Sims, Chairman
Gilbert + Tobin Regulated Infrastructure Policy Workshop, Melbourne
29 October 2015

Speaking at the Gilbert + Tobin infrastructure workshop in Melbourne, ACCC Chairman Rod Sims calls for a return to the approach to regulation of monopoly infrastructure envisaged by the Hilmer Committee. Mr Sims also argues that it is wrong to suggest that we should not be concerned about high monopoly pricing of infrastructure because the result is only a pure transfer of economic rent. Mr Sims also refers to the ACCC’s work with Australian governments to highlight the importance of privatising assets to promote competition, rather than just the sale price.



Check against delivery


It’s a pleasure to be here today in the company of many colleagues who have an interest in infrastructure. And I’m particularly pleased to be discussing infrastructure policy; this is an issue that I see to be of key importance to Australia’s competitiveness.

Australia’s infrastructure is vitally important for our productivity and living standards, as we all know.

Unfortunately, years of poor infrastructure policies and practices have limited the productivity of our infrastructure. We see policies that prevent competition in coastal and liner shipping, inadequate dedicated rail freight paths, a poor policy framework for road investment, limits on supply and competition in urban water, extremely costly and loose past rules for energy network regulation, limits on infrastructure competition in many areas, and I could go on.

I was pleased that the Harper Review had a lot to say that is relevant to infrastructure. It recommended important and wide-ranging reforms in energy, water and transport.

Today, I’d like to focus on three areas relevant to Australia’s infrastructure settings.

First, I would like to call for a return to the approach to regulation of monopoly infrastructure envisaged by the Hilmer Committee. Hilmer recognised that the regulation of monopoly infrastructure would require, at a minimum, the implementation of a negotiate / arbitrate framework. As I will explain today, I have always considered this to be true light handed regulation.

I would like to suggest that the current interpretation of light-handed regulation of monopoly infrastructure, which in essence has come to mean price monitoring, is not only ill-conceived in economic theory, it has failed in practice.

Second, and related, I will argue that it is wrong to suggest that we should not be concerned about high monopoly pricing of infrastructure because the result is only a pure transfer of economic rent.

Third, I will refer to the ACCC’s work with Australian governments to highlight the importance of privatising assets to promote competition, rather than just the sale price.

In addition, and as requested by the organiser, I will make some brief comments on the calls made by the Harper Review and a few others, for the ACCC to be broken up, and for its regulatory functions to be separated out from the rest of the ACCC.

Price monitoring for monopolies is ill-conceived in theory and not working in practice

It is now common to hear that regulation of natural monopolies should be ‘light-handed’ and that some form of ‘price monitoring’ regime is best-practice in these circumstances.

As I have said, the mantra that light-handed regulation means price monitoring is ill-conceived in economic theory and not working in practice.

The ACCC’s view is, of course, that competition, or the threat of competition, is the best constraint on the market power of infrastructure operators. Indeed, competition is always preferred to regulation. The information available to regulators is necessarily highly imperfect, so regulators cannot hope to mimic the outcomes that would be secured by efficient markets.

However, inevitably there are some situations where the conditions for effective competition are absent; such as where firms have a legislated or natural monopoly. Many of Australia’s key infrastructure assets, including many ports and railways, exhibit such monopoly characteristics.

In these circumstances the owner of the infrastructure is able to reduce output and service levels while charging monopoly prices, as basic economic theory suggests, causing significant detriment to users and the economy as a whole.

Experience has shown that, in circumstances of natural or legislated monopoly, price monitoring will have little or no longer term impact on the conduct of the monopoly infrastructure owner.

Why are we surprised? Price monitoring is not price regulation. What would you or any commercial owner of monopoly infrastructure do when there is no constraint on monopoly pricing? If you did not exploit this situation your board or shareholders would likely sack you, and deservedly so.

Consider an example. The Port of Newcastle, the world’s largest coal export port, is subject to a fairly typical price monitoring regime. The obligations include the requirement to publish information on charges, give advance notice of changes to charges, and provide an annual report to the Minister with specified information on charges and revenue.

In 2014 the Port of Newcastle was privatised for $1.75 billion, amounting to a multiple of 27 times earnings. Pre privatisation, it was making around $20 million. Less than a year later, the new owner revalued its port assets to $2.4 billion. At around the same time the new owner increased the navigation charges by 40 per cent, which increased their profit or cash flow by about $20 million—that is, they more or less doubled it.

As you would expect the monitoring regime covering the Port of Newcastle has had no visible impact in dealing with this price increase. In fact, Glencore is currently seeking declaration of the shipping channel service at the Port of Newcastle due to these price rises. It is interesting to note that the NCC’s Draft Determination acknowledged that the existing regime provides very limited constraint on pricing practices, meaning that the Port of Newcastle has a largely unfettered ability to impose future price increases.

Indeed, the NCC noted that the price monitoring regime covering the Port of Newcastle would be highly unlikely to meet the requirements for certification under Part IIIA of the National Access Regime.

The incentives of a monopolist are such that they are unlikely to be substantially affected by the largely non-financial impact of monitoring regimes. They will effectively be able to act in an unconstrained manner with little incentive to undertake efficient investments and operation of infrastructure services. In these circumstances something more than price monitoring is required.

This was recognised by the Hilmer committee when setting out the framework for Australia’s national competition policy. The Hilmer review favoured private agreement between access seekers and infrastructure service providers on access terms and conditions, but this was to be underpinned by binding arbitration by a regulator in the event that the parties could not reach agreement.

The Competition Principles Agreement, agreed to by Commonwealth, State and Territory governments in 1996, also envisages a process of binding independent dispute resolution where commercial negotiations fail.

However, ten years on, Australian governments appeared less convinced of the benefits of the negotiate / arbitrate regime and the importance of appropriate price regulation.

In 2006, the Australian, State and Territory governments agreed to the Competition and Infrastructure Reform Agreement (CIRA). The agreement sets out commitments for simpler regulation of nationally-significant infrastructure, including for ports, railways and other key infrastructure.

Under the CIRA governments agreed the introduction of price monitoring for significant infrastructure facilities should be considered where this would improve the level of price transparency, as a first step where the potential introduction of price regulation may be required.

This position ignores the need to give the parties negotiating with the monopolist some strength to their arm. They cannot threaten not to use the facility, so at least give them the threat of referring a dispute over prices or terms to binding arbitration.

Indeed, I believe a negotiate / arbitrate framework is true light handed regulation. It actually allows a commercial negotiation, where both parties have some negotiating leverage; without this there is no ability to negotiate commercially.

As we all recognise, for some assets we have full price regulation, such as the electricity poles and wires, Telstra’s legacy copper wire and the NBN. This is because negotiate / arbitrate, like any other form of economic regulation, can be gamed by its participants, as the early experience with the telecommunications access regime shows.

For many sectors though, a lighter handed negotiate / arbitrate can work. I do not see why we would want to move further to what I would call no effective regulation, which is how I see price monitoring when it is applied to a natural or legislated monopoly.

Of course, price monitoring can be an appropriate tool.

Regulators have a range of price monitoring roles and often there is value in them. For many years now, the rationale for price monitoring has been to address a high level of community concern about the operation of a market through providing some transparency. In addition, it may also be appropriate where policy-makers are seeking to understand the impact on a market of a change in policy.

An example was the ACCC’s milk monitoring program following deregulation of farm gate prices. Although hard to imagine now, at the time there was significant public concern that deregulation would lead to increased milk prices. The ACCC’s monitoring report, finding that consumers benefited from reduced milk prices as a result of deregulation, helped to reassure consumers of the positive outcome of deregulation.

These types of scenarios are quite different from the question of best-practice regulation of monopoly infrastructure.

There may soon be an opportunity to remedy misconceptions about light handed regulation, and when price monitoring can be effective. One of the important recommendations of the Harper Review was that all Australian governments commit to a revitalised set of competition principles. I would like to suggest that the relative merits of price monitoring versus some form of price regulation (including negotiate / arbitrate) are taken into account in any revised agreement.

Ill-conceived notions concerning a pure transfer of economic rent

I would also like to address the argument, very closely linked to my first point, that economic regulation is not required for monopoly or near monopoly assets because any monopolistic pricing amounts to a pure transfer of economic rents between parties within the supply chain.

On this issue, the Productivity Commission noted in its 2013 inquiry into the National Access Regime that the transfer of economic rents between parties within a commodity export supply chain could occur without any impact on the supply decisions of existing suppliers. This seems to suggest that policy makers should pay no attention to the ability of a bottleneck monopolist to extract rents from upstream or downstream firms in a commodity export supply chain.

I take a different view.

To produce or extract an important commodity like coal requires a major sunk investment in mining equipment and infrastructure. These sunk investments give rise to what are known as “quasi-rents” which are subject to the threat of hold-up.

The threat of expropriation of rents by a monopoly service provider in such a situation does not merely result in a pure transfer. Rather, the threat of such expropriation can limit future investment and innovation by the upstream firms.

What miner would invest in reducing its extraction costs if it knew that the lower extraction costs would simply be met by higher transportation charges? More generally, what miner would invest in its mines knowing that the benefits of that investment could be expropriated by a monopoly somewhere else in the supply chain?

This effect is, of course, not just limited to mining. The threat of expropriation of rents by a monopoly service provider may also discourage Australian farmers from investing in, for example, farm machinery or new seed technologies.

This is an illustration of a more general point that should be more widely recognised. Monopolies can be harmful in that they can limit investment and innovation in upstream or downstream industries.

Privatisation should promote economic efficiency, not the maximum proceeds from sale

The ACCC has, of course, been vocal on privatisations of significant infrastructure in recent months. For example, the ACCC recently had some engagement with the Victorian government regarding the privatisation of the Port of Melbourne, and I was pleased with the outcome there.

But before I get to that, it is important at the outset to make it clear that the ACCC is in no way against privatisation. Private owners will usually operate assets more efficiently and at a lower cost than government owners.

It follows that privatisation should benefit the economy. Indeed, unless government ownership is critical to meeting a clearly stated public policy goal, private ownership will always provide a better outcome than public ownership.

However, with most governments facing fiscal challenges, there is a temptation to privatise to maximise proceeds. This is fine if there is a competitive market, or there are sound regulatory arrangements in place.

With many infrastructure assets these requirements are not in place.

There are strong financial motives for governments to structure their privatisation processes in a manner that maximises the sale price they receive. In order to maximise sale prices, governments will have little incentive to closely examine whether the market structure and regulatory arrangements that will apply post-privatisation are conducive to competition and appropriate outcomes.

But the immediate financial benefit comes at a potentially significant cost of an effective ‘tax’ on future generations.

For example, while privatising two potentially competing assets as a package may increase the sale price, as compared to selling the assets to separate owners, this increased sale price would be received at the expense of competition. In the longer term, a less competitive market structure will lead to higher priced and lower quality goods and services for consumers.

We are also concerned about the selling of monopoly or near monopoly assets without appropriate access and/or pricing controls, such as Part IIIA undertakings or robust State or Territory access regimes. When privatised, such assets will result in the transfer of market power, and so economic rent extraction, to private hands.

Without appropriate pricing and access mechanisms in place prior to the sale, there is a strong likelihood that under non-government ownership users of privatised infrastructure will face higher prices and restricted access.

In the ACCC’s experience, the access undertaking provisions of Part IIIA of the Competition and Consumer Act 2010 (Cth) are effective in facilitating efficient use of, and investment in, infrastructure and competition in related markets. The level of regulation can be tailored to the level of market power held by the acquirer or operator, but importantly, would include a negotiate/arbitrate mechanism for dispute resolution.

In recent months we have been having discussions with the Northern Territory (NT) and Victorian Governments in relation to the privatisations of the Port of Darwin and Port of Melbourne, respectively. This work has been part of the ACCC’s wider advocacy relating to the privatisation of nationally-significant infrastructure, and is separate from our role under the merger provisions of section 50 of the Competition & Consumer Act 2010 (Cth).

In relation to the Port of Darwin, which was recently leased to the Landbridge group for $506 million, the NT Government initially proposed a price monitoring regime to apply to limited services provided by the Port of Darwin post-privatisation. We had concerns about how effective this regime would be to constrain the monopoly power of the port and discussed with staff from the NT Government the benefits of a negotiate / arbitrate regime, as envisaged by Hilmer.

Pleasingly, the NT Government decided to strengthen the regime to set out a form of negotiate / arbitrate through an ‘access policy’ that is to be developed by the successful bidder and must be approved by the NT Utilities Commission. This regime appears to be similar to the process by which access is gained under a Part IIIA access undertaking.

Our dialogue with the Victorian Government has been even more productive. The Victorian Government has proposed significant improvements to the current regime applying to the Port of Melbourne.

These include capping certain charges to CPI for at least 15 years, regular reviews by the Essential Services Commission of the lessee’s compliance against strengthened pricing principles, and the ability for more direct forms of regulation to be imposed. I consider the proposed amendments move the dial towards a more robust regulatory regime to apply post-privatisation, and are more rigorous than measures in place at other major Australian container ports.

A comment on institutional arrangements

Finally, and as requested, I will briefly address the proposal by the Harper Review to break up the ACCC with the separation of pricing and access functions and the establishment of a new and “converged” national infrastructure regulator.

I will simply point out a number of concerns with this proposal.

Competition law, consumer protection and economic regulation are complementary tools, with the single objective of improving the economic welfare of consumers.

Both the ACCC and proposed new agency would be economic regulators. That is, both agencies would have a common base in economics. The synergies between, and the complexities of separating, competition, consumer protection and economic regulation are evident when the practical operation of two separate regulatory agencies is considered. The potential overlap between the two agencies would be considerable, and should concern businesses.

For example, in telecommunications, the ACCC would investigate claims of anti‑competitive conduct in the communications sector under Part XIB, deal with consumer protection issues such as broadband advertising under the ACL, and monitor and report on prices and competition in the telecommunications sector also under Part XIB of the CCA.

The new agency would assess and enforce terms of access to the NBN in the special access undertaking from NBN Co, assess and enforce Telstra’s structural separation undertaking and plan to migrate its customers to the NBN, and set wholesale prices and wholesale terms of access for declared services under Part XIC of the CCA.

Under this model, where an issue arises in relation to network access or NBN migration, telecommunications access providers, access seekers and end-user groups would have to engage with both the ACCC and the new agency.

The creation of a separate access and pricing regulator would, I believe, make it more confusing and burdensome for both businesses and consumers who would have to deal with two agencies. Further, common issues will no longer be addressed consistently across the agencies.

In general, of course, there is a link between section 46 and the National Access Regime. Many in this room will recall that one of the drivers for the establishment of the National Access Regime was the perceived limitations of section 46 to deal with access to essential infrastructure.

Today, in many respects, section 46 and the National Access Regime are two sides of the same coin. Complaints about access to essential facilities can often be considered under both section 46 and the National Access Regime. Breaking up the ACCC would see that such complaints considered by different agencies and so would be inefficient and duplicative.

Closing remarks

To conclude, it is excellent to see that infrastructure policy is back on the agenda, as evidenced by today’s workshop.

The time is right to progress pro-competitive infrastructure policies. I hope I have provided a few policy ideas to put in the mix.

Thank you for your time.