Renewal Options
25. The current and likely future investments by incumbents in these bands provide a reasonable case to renew the present management rights. However, analysis (see Paragraph 32) suggests that the incumbent right holders already hold ample cellular spectrum.
26. Offering renewal of all of the rights to the incumbents would minimise the risk of stranding investment. This option, however, would reduce the opportunity for non-incumbents to gain access to these bands, as it would make them dependent on the secondary market.
27. Auctioning all of the rights to be renewed in 2011 and 2012, on the other hand, would increase the risk of stranding investment, through the incumbents losing their spectrum at auction. There is also the risk of undue disruption of services during the transition from one period to another.
28. Given the ample spectrum currently available to incumbents and the expressions of interest from non-incumbents in these bands, it would be appropriate for incumbents to retain part of their spectrum that is reasonably required to operate their networks and avoid unreasonably stranding their existing investment. The remainder could be auctioned, providing opportunities for entry of competition.
29. It is important that incumbents are allowed to bid at auction. This will allow them to regain spectrum that was not renewed if this was seen to be essential for their future business plans. It would also ensure that there is contestable bidding for the spectrum.
30. NZ Communications has expressed concern that incumbents could easily outbid other operators at auction. However, any serious nationwide investor should be capable of competing in this scenario. There are no clear reasons why constraints should be applied to favour any particular parties.
Quantities to Be Offered for Renewal and Auction
31. MED engaged Network Strategies Ltd (NSL) to estimate the quantities of spectrum that current right holders and new entrants require for the period 2011 to 2031. Telecom has total holdings of 20 MHz in the 800 MHz band, which are all expiring in 2012. Vodafone has some 22 MHz (and some 4 MHz unpaired that is unusable for its current GSM technology) in the 900 MHz band. About two-thirds of Vodafone's holdings will expire in 2011 and 2012.
Actual Utilisation of Spectrum
32. NSL found that Vodafone uses 14-16 MHz, which is approximately 75% of its usable 900 MHz spectrum. They also found that Telecom significantly uses at least 6-9 MHz, excluding guard bands. While Vodafone's possession of a companion band would allow alternative means for managing capacity constraints that may occur if its spectrum holdings are reduced, this is not the case for Telecom. NSL suggested that the cost to Telecom of having less spectrum would be more significant.
33. A peer review of the NSL report by economist Matt Burgess, suggested that the policy decisions should also take into account a) the impact of legacy systems on spectrum demand, considering incumbents' sunk costs, b) the need for sufficient spectrum to enable incumbents to migrate to advanced technologies ("spectrum slack"), and c) the uncertainty of entry by other operators, who could purchase spectrum but might end up not using it for any reason. These factors imply that the actual usage could be higher than indicated above.
Optimal Deployment Cost
34. The NSL study also shows that, assuming the likely entry of a new operator in each band, the amount of spectrum that would lead to the lowest overall (optimal) deployment cost for all operators is for the new entrant to gain access to a parcel of spectrum in the range of 25%-50% of the total spectrum available or 5-10 MHz in each band. If no companion band is available, as is the case with Telecom (and its current technology), the optimal deployment cost would require a 75%-25% allocation split in favour of the incumbent.
New Entrant Requirements
35. NSL advised that the minimum amount of spectrum that a new entrant would usefully require is 5 MHz, which is the smallest useful size of a UMTS (3G) carrier used by Vodafone, utilising its 2.1 GHz spectrum. This is also the minimum size of the carrier of the future CDMA technology (W-CDMA), which Telecom may choose to adopt.
36. NSL also advised that cellular operators in similar countries with access to additional spectrum in companion bands are able to deliver services using approximately 5 MHz to 7.5 MHz in the 800 or 900 MHz band [see Appendix 1]. Operators such as Orange Nederland, Telfort Netherlands, O2 Ireland, Vodafone Ireland and Telia Denmark have between 5 MHz to 7.5 MHz, with subscribers of more than one to two million each (which is already about a quarter to half of the New Zealand population).
37. MED engineers have confirmed that 5 MHz should be sufficient for the likely new entrants, given that they already have cellular spectrum in higher bands for high-density areas, but 7.5 MHz would further reduce technical constraints and costs.
Quantities for Renewal Offers
38. On balance, auctioning 7.5 MHz (the midpoint between the quantity required for the smallest UMTS or W-CDMA carrier and the highest quantity sought by any new entrant) would strike the best balance between a) providing certainty for existing investment and sufficient spectrum for incumbents' migration to new technologies without excessive costs, and b) making the mobile market more attractive to new entrants. This quantity is also within the optimal range of deployment costs for all operators, which is for a new entrant to gain 5-10 MHz in each band.
39. […].
40. […] it is proposed that, as a default, 7.5 MHz of the spectrum that expires in 2011 or 2012 in each band should not be offered for renewal. Renewal offers will be made to existing right holders for their remaining spectrum and 7.5 MHz would be offered by auction. Existing right holders will have some ability to choose which spectrum pairs should be offered for renewal or auction.
41. However, if Telecom or Vodafone sell at least 5 MHz of 800 or 900 MHz spectrum on the secondary market to a person who does not currently hold spectrum in these bands within six months of the renewal offer being made, then:
- If the rights sold expire after 2012, (Vodafone has some rights expiring in 2022) then the seller (Vodafone) will be offered the 7.5 MHz otherwise intended for auction.
- If the rights sold expire in 2011 or 2012, the purchaser would be offered corresponding renewed management rights at the price and substantially on the same terms offered to Telecom or Vodafone, and the present rightholders will be offered renewed management rights over the remaining part of the 7.5 MHz otherwise intended for auction.
42. If any renewal offer is rejected by the existing right holder, then all of the rights will be reallocated by auction. All interested parties, including current right holders, will be allowed to bid at auction, subject to any Commerce Act requirements.
43. The legal form of arrangements to implement the above policy proposals will be finalised prior to renewal offers being made to Telecom and Vodafone.
Length of the Renewal Period
44. Telecom and Vodafone prefer a 20-year renewal period. TelstraClear supports a 20-year period only if some spectrum is reallocated to new entrants. Otherwise, TelstraClear suggests a shorter period of say, eight years, so that other operators will not be precluded from gaining access to these bands for a longer period. NZ Communications did not make any comment on how long an appropriate renewal period should be.
45. A 20-year period, the maximum possible renewal period under the Radiocommunications Act 1989, is a reasonable timeframe, considering the investments that have been made by current right holders or that will potentially be made by any new entrant in deploying a cellular network. This timeframe would also be consistent with the likely future use of these bands for the evolution of advanced cellular technologies. It is also desirable to allow for a common expiry date by slight adjustment of the term of the renewal offer.
Pricing Approach
46. PwC and NZIER jointly recommended an incremental optimised deprival (incremental ODV) pricing approach for the renewal of cellular rights, which Cabinet noted in July 2006 [CBC Min (06) 13/7]. This approach calculates the costs that a generic New Zealand cellular operator, operating an optimal network, would incur to maintain the quantity and quality of services to customers if deprived of spectrum at the margin. The incremental ODV-calculated price will then be checked to ensure that it is within a reasonable range from New Zealand and overseas spectrum values.
47. Incremental ODV is mainly an engineering exercise, where every costing step has a basis, and thus, has a strong underlying logic as to how it approximates market value. Given the difficulty of implementing alternative approaches, including the Covec formula, incremental ODV represents the best compromise and most practical methodology for forming an estimate of market value for cellular rights.
48. TelstraClear, Telecom and Vodafone give conditional support to the incremental ODV pricing approach, subject to the technical input parameters being reasonable. NZ Communications does not agree with this approach, stating that it will subsidise incumbents. MED notes that the incremental ODV price is intended to be a proxy for a market price based on objective information and, therefore, would not represent a subsidy to any party.
49. Following Cabinet approval of the proposed arrangements, MED will engage a consultant to develop a working model that will be used in the calculation of the incremental ODV price. MED will consult with stakeholders on the technical details of the model.
50. It is proposed that the Minister of Communications be authorised to approve and announce the renewal price offer, the terms of offer and settlement, and the timing of the auction as soon as practicable. This would allow current right holders to consider their options as soon as practicable.
51. It is further proposed that right holders be given six months to consider the renewal price offer. This is considered to be a reasonable length of time, given the amounts likely to be involved, and noting that Vodafone may need to obtain overseas approval from its parent company for a decision in relation to the renewal offer.
Use Conditions
52. There is a small risk that the spectrum in each band which is to be reallocated by way of renewal offer or auction may remain substantially unused by the new owner, and this would not be a desirable outcome in terms of promoting investment in new infrastructure.
53. It is proposed that conditions of use can be applied to mitigate this risk and encourage the new owners to invest in infrastructure. Failure to comply with the conditions would result in revocation of spectrum without compensation and/or other penalties being applied.
54. To date, conditions of use have not generally been applied to spectrum allocations in New Zealand, rather reliance has been placed on the secondary market to redistribute unused spectrum. However, our 2005 review of Radio Spectrum Policy identified a lack of secondary market transactions as a key issue in spectrum policy. Accordingly such conditions have been authorised in two recent cases; the allocation of the 3.5 GHz Crown reserved spectrum included a two year implementation requirement, and the reallocation of the 2.3 GHz band includes a requirement for the rights to be sold with conditions of use that managers must meet or face revocation without compensation. Neither of these two cases has yet reached the date of application.
55. Such conditions need to be carefully crafted to ensure that they are workable and do not have the unintended consequences of discouraging investment or providing less than a fair return to the Crown. A definition of use would need to be developed and would be enforced through a management rights deed which the purchasers are required to enter into as a condition of settlement of purchase of these new rights, requiring demonstration of use within a specified time frame. Both the definition and the timeframe require further consideration but the Ministry's current thinking is that a five year timeframe might be appropriate.
56. Under the recommendations in this paper, substantially the same conditions of use would apply to purchasers of all the new management rights, whether they purchase the rights through a renewal offer process (i.e. Vodafone and Telecom), through an auction process, or by a renewal offer subsequent to a secondary market transaction.
57. Appropriate consequences of failing to use also require further consideration. There are a range of potential options including a requirement to relinquish the right or, alternatively, requiring the owner to grant licences or allow access to other operators on an open access basis. An additional possible condition, that of financial penalties for non-use, may require additional statutory authority and may be unnecessary in addition to the other use conditions described above. For this reason they are not recommended at this time.
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