Open and Competitive Gas Markets

  • Max Bradford
Energy

Ladies and gentlemen, thank you for inviting me to speak at the opening of your conference.

As the theme of my speech this morning is "Open and Competitive Gas Markets", I'm pleased to tell you that I see the Gas industry as having be been well ahead of the electricity industry of embracing the needs of a competitive marketplace.

I haven't had "anti-competitive" concerns raised with me about the gas industry, nor do I get complaints about access to pipelines - which was a key complaint in the electricity and telecommunications sectors.

As you know, a major focus for the Government this year has been to introduce real competition into the electricity industry.

Our reforms - particularly the ownership split of lines and retail/generation businesses - have been controversial, borne out of the history of the industry and a reluctance to face a genuinely competitive market where consumers have choice and monopoly practices are eliminated.

The Electricity Industry Reform Act was passed only a couple of months ago, yet we're already seeing evidence of the benefits for consumers. If you live in Auckland you can't miss the advertising war between Contact Energy, Power New Zealand and Mercury Energy.

This is clearly significant because it means hundreds of thousands of consumers now have a choice about who they buy their electricity from - and this competition is bringing with it lower prices and hopefully better service.

In the South Island, look at Southpower. In its recent Annual Report, the company recognises the importance of splitting ECNZ as well as the reforms to the retail market. The Chairman expresses support for greater competition in residential markets, which is the overall objective of the reforms. This company has also recently announced a significant price reduction for residential consumers.

And I'm confident it won't be long before similar benefits reach the rest of New Zealand.

So, are similar structural reforms in the pipeline for the Gas industry? The answer is no.

It's true that parallels between the electricity and gas industries, and for that matter telecommunications, can be drawn - both deliver energy to the consumer through a natural lines monopoly.

But the difference between the electricity and gas sectors is significant. Gas faces competition from other fuels. For example, householders usually rely on electricity for lighting - but have choice about the fuel they use for heating and cooking. In other words, gas already competes as an alternative energy source. It is not true of electricity to the same extent.

But this doesn't mean the gas industry can relax. The sector is dominated by a few large players, and has significant natural monopoly characteristics - namely the transmission and distribution network. Looking back, the use of Maui gas in the 1970s and 80s was encouraged by heavy government involvement. Large players, exclusive arrangements and long-term contracts were the order of the day, all inimical to the development of true competition.

It's hardly surprising that it's taking some time to unravel these elements. Progress has been made in developing competition in the gas sector through Gas House, but some questions still remain.

As no doubt you're aware, the Government's energy policy is strongly focused on developing competition in energy markets. The central mechanism for delivery competition policy for the New Zealand economy as a whole, including the energy sector, is the Commerce Act. This Act has had some very important implications for your sector.

The Commerce Commission made it clear that the 1980 contracts between NGC and gas retailers were not compatible with the Commerce Act (which into force some years after the contracts).

What was unacceptable from a competition policy view were:

the contracts bundled line and energy charges;
they made it difficult to buy capacity only;
they contained exclusivity clauses which prevented utilities from sourcing gas from elsewhere.
I note that those contracts have been re-negotiated, so that the offending clauses are no longer a feature of the market.

The Commerce Act has also played a major role in the resolution of the recent dispute between Shell Todd and NGC/Fletchers over Kapuni gas. The Court found that the contract under which Kapuni gas was supplied to NGC contravened section 27 of the Commerce Act. The reason for this finding was that such a contract, which gave the entire supply of gas to NGC for the life of the Kapuni field, eliminated competition for the foreseeable future.

The Court therefore decided to vary the contract, which it is able to do under the Commerce Act. The Court decided to divide the output from the field between the two sets of parties to the dispute. The Court's decision has therefore brought about a welcome increase in competition in relation to the Kapuni field.

In one sense, the Court has done what the Government and Parliament did with the Electricity Industry Reform Act: namely, to require of market players a change in the structure of the gas market. So too in the case of the Employment Contracts Act - the structure of the labour market was changed to the benefit of employees and employers, and to the country as a whole

It is heartening to see New Zealand's competition statute has got teeth. The Government is keen to ensure that the Commerce Act is effective because of its importance to all sectors of the economy, especially network industries including the gas sector, where it is a major component of the Government's regulatory regime.

One aspect of the Commerce Act which we're currently looking at is the question of penalties. A discussion paper was issued in January and submissions have been received and analysed. We expect to make decisions in the next couple of months on increasing the penalties and the remedies available under the Commerce Act.

The problem areas we see, and are looking to remedy, include:

Maximum penalty limits under the Commerce Act are too low to deal with the worst case scenarios, and we will probably link penalties more closely with the value of the illegal gain;
There may be a case for criminal fines for so-called "hard core cartel" offences;
We need to increase the deterrence effect of damages awards. We could achieve some improvement by providing for penalty awards in private actions or, by going for multiple damages;
With regard to interim injunctions, we want to increase the emphasis on consumer welfare and the competitive process. To date the Courts have been reluctant to grant interim injunctions. This has worked against the interests of consumers in particular;
We're also looking at how to improve the efficiency of court processes relating to the Commerce Act, without compromising justice.
I also want to preview whether the implicit threshold of 60 to 70 per cent before the Commerce Commission is prepared to look at monopolistic practices, or anti-competitive behaviour, is low enough.

To complement the Commerce Act, we have industry-specific regulations, the Gas (Information Disclosure) Regulations. These are an important component of the regime governing the gas industry. It's important that they're fully effective, and therefore we'll be closely examining what needs to be done to achieve that goal.

This includes examining the changes to the Electricity (Information Disclosure) Regulations currently underway to see which of those amendments should be incorporated into the Gas (Information Disclosure) Regulations.

Gas industry participants have been asked to give their views on what changes need to be made to the Gas (Information Disclosure) Regulations. Those comments were due a week ago. The Ministry of Commerce has received some comments from the industry - but if you haven't had your say, I urge you to contact the Ministry. If you don't have an input, it's difficult for us to reach any conclusions on your views.

Another point I'd like to touch on is retail gas prices, and I have to say I'm a little disturbed by the statistics.

Statistics collected by the Ministry of Commerce show that between 1993 and 1998 there has been a real price rise for domestic gas consumers of 50 per cent and a real price rise for industrial consumers of 24 per cent. Admittedly, the figures are calculated using a sample of gas company tariffs for industry and residential consumers and are not therefore necessarily indicative of what has happened across the whole sector. But they do not make good reading, particularly when compared with other energy sectors.

For example, during the same 1993 to 1998 period petroleum prices fell - real retail prices for petrol fell by 18 per cent and the wholesale diesel price fell by 10 per cent.

And in the electricity sector, real prices to residential customers rose by 13 per cent between 1993 and 1997, while commercial prices fell by 10 per cent and industrial prices fell by 3 per cent.

Internationally, gas prices in most of western Europe have dropped significantly in recent years, particularly to industrial users. Only in Australia and New Zealand have prices to industrial customers risen and nowhere in the OECD have we seen price rises similar to those which our domestic customers have experienced.

The reasons for these gas price increases are unclear - but let me remind you that while the Government doesn't currently plan reforms in the gas sector, the Electricity Industry Reform Act was borne out of our concerns that consumers, and particularly household consumers, weren't reaping the benefits of sustainable competition.

So if competition and markets don't go hand in hand with lower real prices, there is a prima facie case which bears examination by the relevant authorities.

Having said this, I'd like to take this opportunity to congratulate your industry for developing the Gas Pipeline Access Code. The chairman of Gas House, Derek Johnston, who is to speak to you about the development of the Code, deserves your approbation for his leadership.

From the Government's perspective, the Code will complement existing legislative and regulatory requirements. It appears the Code will assist in ensuring certainty and transparency for pipeline users, and it should, if widely adopted, enhance competition in the gas industry.

Many of the important issues relating to pipeline access will be contained in information memoranda to be issued by pipeline owners. I note, for example, that the Code will require that pipeline owners offer posted price services providing access to all capacity by users. The posted prices will be described in the information memoranda, as will the methodology used to arrive at the posted prices.

The Code is constructed in a way that many important issues will still be dealt with outside it, but it does outline some important principles, such as not providing favourable treatment to affiliates.

As it is an agreement negotiated by the industry, the Code doesn't have the force of law behind it. But it is certainly a very welcome step in the right direction, and I'm looking forward to seeing exactly what the impact will be.

Another interesting development in the industry, is the move being contemplated by some into the electricity businesses. The electricity reforms offer new opportunities for gas - and other - businesses. Let me make it clear that I have no problem with gas companies entering either electricity lines or retailing. They cannot, of course, do both except as the Electricity Industry Reform Act provides.

The only caveat on this statement is that it must be crystal-clear that there are no cross-subsidies from the monopoly pipes business to the contestable electricity retailing business.

You may find over time that voluntary ownership separation of gas pipes and retailing is the way to go. This has proved to be highly successful for British Gas. Competition in gas retailing has subsequently taken a huge leap forward in the UK. Enerco's recent announcement that it proposes to sell its retailing business is therefore particularly interesting.

You will be aware, as I am, that there are economies of scope in utility retailing. Convergence of utility retailing is becoming more common overseas for electricity, gas and water in particular. Crucial for such converged retailing is access to lines and pipes. We have ensured open access to electricity lines, and hope that the information available from the Gas (Information Disclosure) Regulations combined with the access code and Commerce Act will ensure such access is available in the gas sector.

You can be assured the Government will be keeping a close eye on developments in your industry. I would hope the gas industry will be able to develop a successful self-regulation framework similar to that administered by the Bankers Association on behalf of the commercial banks in New Zealand.

New Zealand industry depends greatly on a competitive cost structure to enable it to survive and prosper in an open world economy. A liberal, open economy here and abroad has delivered very significant growth, jobs and higher living standards than any closed shop model favoured by those economists and politicians who would have us hark back to policies of the 1960s and 1970s.

Your industry plays a very important role in industry having a competitive cost structure. Energy is a pervasive and unavoidable cost to us all, whether we are business people or consumers.

My message is therefore very simple. If your industry embraces a truly competitive energy market, and leads from the front as you are now doing, you will play an enormously important role in New Zealand's economic recovery.

The leadership the gas industry is showing now, is leadership we need in other sectors too.