1. The Government has signalled that it may implement price control on the electricity lines businesses if they do not reduce costs and prices. In examining requirements for the new electricity sector price control provisions, a small number of areas have been identified where the existing Commerce Act provisions may be deficient. It is proposed that change be made to the Commerce Act provisions on price control, relating to all sectors (not just electricity). The proposed amendments are outlined below. It is emphasised that these proposals do not signal any change to the Government's approach to price control generally. The changes discussed below will merely bring the Commerce Act provisions into line with current approaches to price control overseas and have been driven by the need to allow for an up-to-date approach to price control for electricity lines.

The Proposals

Current Approach to Price Control

2. Under the Commerce Act in its current form, once an Order-in-Council has been promulgated under section 53 of the Act declaring that the prices for goods or services be controlled, the responsibility for imposing price control passes to the Commerce Commission.

3. Section 70(1) of the Commerce Act provides that the Commission may "authorise a maximum, actual or minimum price". Section 70(4) says that the Commission shall "authorise prices in such manner as it thinks fit". Section 71 allows the Commission to authorise a provisional price and section 72(1) allows the Commission, instead of authorising a price, to "obtain or accept a written undertaking from the supplier of those goods or services in relation to the price".

4. Broadly speaking, therefore, the existing provisions of the Act allow the Commission to specify a price for goods or services. That is the approach that the Commission took when it last administered price control (the early 1990s).

5. The Government has no role in deciding the form of price control to be used by the Commission, if, in the future, price control is imposed on any goods or services. It does, however, have a role in ensuring that the relevant Commerce Act provisions allow the Commission to apply whichever form of price control it deems most appropriate within the framework provided by the Act. The current narrow provisions described above would not allow this.

Newer Approaches to Price Control

6. The CPI-X (or price cap) approach was developed in the UK in the 1980s. Since then it has been more widely adopted and is generally considered to work reasonably well in comparison with other methods of price control in its objective of introducing a proxy for competition on companies which operate in markets where competition is limited.

7. CPI-X involves the regulator (in this case the Commerce Commission) developing a formula for capping the average prices or total revenue for a firm so that price or revenue increases in one year do not exceed the percentage increase in the Consumer Price Index, minus (or plus) X. X is set by the regulator as a number which will impose a productivity incentive on the regulated firm, while at the same time allowing it to make an adequate rate of return if it meets the productivity level set. The regulator can also set any other parameters deemed necessary (such as service quality, or allowing the company to pass on to consumers increased costs that the regulator considers are outside the control of the firm).

8. Sliding scale or profit sharing has been suggested as an approach which might be useful as an alternative to CPI-X. However, it has not generally been taken up. Using this approach, the regulator would set a profit-sharing rule which divided excess profits between customers and shareholders by allowing dividend or rate-of-return increases only if prices were simultaneously cut.

9. Price control by itself does nothing to encourage the provision of acceptable quality goods or services. It is entirely possible, in a market where competition is limited, that a company would attempt to recover the revenue it had been forced to forgo under price control by reducing the quality of the goods or services it provided. This issue is particularly important in a CPI - X regime where one obvious way to recoup the revenue foregone by the imposition of the regime is to simply lower the quality (and therefore the cost to the regulated company) of the service it provides. Since the regulated company is, under the New Zealand regime, operating in a market where competition is limited or likely to be lessened, it is highly likely that the users of the company's goods or services will not have alternative sources of supply. The regulator may, therefore, wish to include in the price control an approach mandating a requirement that goods or services sold be of a specified quality.

Proposed Amendments to Provide for New Price Control Approaches

10. It is proposed that sections 70 - 74 in Part V of the Commerce Act be amended by adding to the existing provisions for authorising prices, provisions which would allow for the following:

the use by the Commerce Commission of a formula approach to determine allowed revenue or prices;
relating prices or revenue allowed to forecast movements in the CPI;
inclusion in the formula of:

any productivity incentive factor which the Commission may set from time to time;
a correction factor to reflect under or over recovery; and
any other adjustment factors as the Commission may determine from time to time;

requiring a company to price its goods or services in accordance with a schedule which links the rate of return achieved by the company with the price the company may charge for the provision of goods or services (in order to permit sliding - scale price control);
clarifying that the Commission may set any service quality requirements and any requirements for verifying service quality it deems necessary.

11. Sections 52 -57 in Part IV of the Commerce Act (Declaration of Price Control) and sections 86 - 87 in Part I (Control of Prices) include references to the price for controlled goods or services. It is proposed that these sections be amended consequentially, to allow for the adoption of a formula approach instead of the specification of a price and to reflect that revenue rather than price may be controlled.

Additional Amendments

Advice from Commerce Commission on Price Control Criteria

12. Section 54 of the Commerce Act provides that the Minister for Enterprise and Commerce can ask the Commerce Commission to report on whether price control should be imposed. However, the Commerce Act in its current form does not provide for the Minister to obtain advice from the Commission on the thresholds or criteria for the application of price control. It is considered that such advice could be helpful. Therefore it is proposed to add such a provision to Part IV of the Commerce Act. The Government's agreement in principle to add such a provision was announced by the Minister for Enterprise and Commerce in April 1998, as part of a package of announcements on electricity sector reform.

Amendment to Price Control Criteria

13. The existing section 73 in Part V of the Commerce Act is:

`73. Considerations to be observed by Commission - In exercising its powers under section 70 and section 72 of this Act, the Commission shall have regard to -`
`a)`	`The extent to which competition is limited or is likely to be lessened in respect of the controlled goods or services;`
`b)`	`The necessity or desirability of safeguarding the interests of users, or consumers or, as the case may be, of suppliers;`
`c)`	`The promotion of efficiency in the production and supply or acquisition of the controlled goods or services.`

14. Sections 70 and 72 relate to the mechanics of imposing price control. When this section comes into play, the decision to impose price control has already been taken by the Government under section 53 of the Act. Under section 53 the Minister shall not make a recommendation that goods or services shall be placed under price control unless the Minister is satisfied that:

`a)`	`Goods or services to which the recommendation relates are or will be supplied or acquired in a market in which competition is limited or is likely to be lessened; and`
`b)`	`It is necessary or desirable for the prices of those goods or services to be controlled in accordance with this Act in the interests of users, or consumers, or, as the case may be, of suppliers.`

15. It is considered redundant for the Commission to take section 73 a) and b) into account, as the Minister would already have considered these criteria under section 53. It is suggested that the only criterion which should be considered by the Commission in deciding on price control methodology is that contained in section 73 c). It is therefore proposed that sections 73 a) and b) be deleted from the Act.

Right to Appeal Commerce Commission Price Control Decision

16. Section 91 of the Act provides a right of appeal to the High Court against any determination of the Commission and section 92 of the Act sets out the persons who may appeal Commerce Commission determinations. Section 92 (a) allows an appeal against a decision by the Commission in connection with an application for an authorisation of a restrictive trade practice. Section 92 (b) allows the recipient of such an authorisation to appeal a Commission decision to revoke or vary such an authorisation. Section 92 (c) allows appeals concerning Commission decisions on business acquisitions.

17. Sections 92 (d) and (e) permit appeals against price control authorisations (that is the mechanics used by the Commission to arrive at a particular price) under section 70 of the Act. The bodies subject to price control and substantial consumers or purchasers have the right to appeal. The substantive decision to impose price control will have already been made by the Minister for Enterprise and Commerce under section 53. There is no right of appeal against decisions made under section 53.

18. Thus appeals under sections 92 (a) - (c) are against substantive Commission decisions to grant or decline applications for clearances or authorisations. Appeals under section 92 (d) - (e) however, must be confined to the technicalities of the approach taken by the Commission in setting a controlled price.

19. In hearing an appeal under section 92 (d) (Auckland Bulk Gas Users v. Commerce Commission [1990] 1 NZLR 448) the Court commented that, in a case of price control and complicated detailed accountancy matters, ... it is important that the Court should give full regard to the decision of the Commission. It is not for this Court to overturn the Commission if it simply disagrees or thinks some other figure or figures or some other formulas might be preferred unless it appears that the Commission has gone wrong in principle or law or policy.

20. In Welgas Holdings Ltd v. Commerce Commission ([1990] 1 NZLR 484) there were three issues. The first concerned an issue of natural justice and therefore is outside the existing appeal right. The second concerned whether the Commission had been correct in taking account of take-or-pay liabilities. The Court decided the Commission's decision was reasonable in the circumstances.

21. A third appeal related to the use by the Commission of a tax factor within the Capital Asset Pricing Model it employed. The Court considered the issue in some detail; independent experts gave evidence for each side of the argument. The Court noted that the Commission was palpably better placed to make decisions than an appeal Court working fairly closely to the adversarial mode. The Court found in favour of the Commission.

22. In Mercury Energy Ltd v. Transpower NZ Ltd (High Court 18 December 1998) the Court noted:

Whilst the Court is not unaccustomed to dealing with matters of complex economic theory, pricing methodologies and the like, and whilst it has mechanisms available to assist it in deciding those questions, it was common ground that the setting of pricing principles would be a protracted matter of considerable complexity, ill-suited to the adversarial process and one which would require to be regularly if not continuously repeated.

Options

23. The Courts generally have therefore taken the view that the Commission's price control calculations and methodology are not appropriate matters to be appealed to the Courts. There is therefore an issue as to whether sections 91 and 92 are effective in their existing form. There would appear to be three options relating to these sections.

24. First, the appeal rights can remain in their existing form. In this case, companies would continue to be able to appeal the Commission's methodology.

25. Second, the right of appeal from price control determinations could be removed by repealing sections 92 (d) and (e). The right of judicial review would remain. Thus, if there were any assertions that the processes followed by the Commission were deficient, then judicial review would be the appropriate avenue for such challenges. Section 91 of the Act would also need to be amended to reflect the fact that there is no longer a right of appeal against any determination made by the Commission under section 70 of the Act.

26. The third option would be to restrict the appeal rights relating to price control determinations to issues of law. Under this option, decisions of the Commission would only be appealable if, in arriving at its decision, the Commission made an error of law. This option could be achieved by appropriately amending section 91 of the Act.

Penalties Provisions

27. Sections 86 and 87 contain the penalties and remedies for contraventions of price control orders. Under section 86 (1) fines of $10,000 can be levied for a contravention of section 55 by a person other than a body corporate and $30,000 in the case of a body corporate. Currently, penalties for contraventions of Parts II and III of the Act are $500,000 for persons and $5,000,000 for bodies corporate.

28. On 11 February 1999 the Minister for Enterprise and Commerce announced amendments to the penalties and remedies sections of the Commerce Act to combat anti-competitive behaviour. The changes include:

A maximum penalty of up to three times the value of the illegal gain or ten per cent of the firm's annual turnover.
prohibiting firms from indemnifying their agents for any breaches of the Act, making these individuals accountable;
giving the courts the discretion to ban offenders from directing or managing a body corporate for up to five years.

29. It is suggested that it is appropriate for the price control penalties also be amended in line with the changes outlined above.

30. If the Commission, as part of the price control regime, were to impose service quality standards, the normal penalty provisions in the Act would apply for any contravention. Additionally it will be appropriate to allow the Commission to set service quality standards which apply for individual consumers. In this case the penalty for not meeting the standard would be a rebate off the customer's bill (e.g. a rebate of $20 for every hour over 4 if a company fails to restore power to a customer within 4 hours where the fault is within the control of the supplier). Some customer contracts already contain a similar provisions. The penalties provisions of the Act will need to be amended to allow for such an approach.

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Printed: 24/11/2009