What has happened

On 22 April 2016, the ACCC released the final report of its inquiry into the East Coast gas market (Report).  The Report makes 13 recommendations to government and noted two areas of future work for the ACCC, which may result in formal investigations.

The Report is the most recent of a slew of regulatory and parliamentary reviews into the Australian gas market.  The heightened interest arises from a period of increasing gas prices (particularly for retailers and industrial users) and certain supply issues caused by the impact of LNG exports commencing in Queensland, which has redirected domestic gas supply and exposed the East Coast market – for the first time – to international gas prices.

While the Report looks at gas production and supply, its recommendations in that area are modest and appear framed by political realities (i.e. the key constraint on increased supply is politically sensitive, state government moratoria on new CSG developments). 

Instead, the regulatory “solutions” proposed by the ACCC are focused on substantially expanding regulation of gas infrastructure, and in particular gas pipelines.  When read alongside a discussion paper released by the Australian Energy Market Commission (AEMC) in March 2016, which also proposed major changes to pipeline regulation,¹ there is growing regulator pressure for the most significant overhaul and ‘re-regulation’ of the Australian gas pipeline industry since liberalisation of the gas market in the late 1990s.

Looking more widely, the Report is the latest in a series of statements, speeches and decisions by the ACCC that show an intention under the current ACCC Chairman, Rod Sims, to seek to expand regulation of non-vertically integrated infrastructure – a policy debate we previously discussed here. While the ACCC published an issues paper and held hearings during its Inquiry, unlike the AEMC process, the findings and proposals of the ACCC in the Report were not subject to any draft report or public consultation.

Rod Sims has expressed the view that the regulation of non-integrated facilities is a “gap” in the current operation of the access regime under Part IIIA.  The Report describes this as a failure in the operation of statutory criteria common to both pipeline regulation and Part IIIA and uses this to justify the development of a new and lower threshold test for the regulation of pipelines, which is intended to extend access and tariff regulation to most existing pipelines. The Report tries to play down the implications of this for other industries, saying that the link between the National Gas Law (NGL) and Part IIIA is unique and that the proposal “should not be construed as a more fundamental criticism of Part IIIA.²

Nonetheless, in this wider policy sense, the Report has implications for a range of assets which are similarly not caught by the current Part IIIA test, but which would be if the new threshold was applied – including railway networks, ports, state water and wastewater infrastructure and some telecommunications networks.

What does this mean?

Almost all major Australian gas pipelines were made subject to access regulation immediately following liberalisation of the sector in the late 1990s. However, since that time, most have had regulation removed and new pipelines have not typically become regulated. Of the 27 major gas transmission pipelines currently operating in the East Coast gas market, only five and a half of are currently subject to any form of direct access regulation.³

Under this ‘light touch’ regulatory model, the Report acknowledges that pipeline owners have undertaken substantial investment in new capacity and have responded flexibly to changing market needs.  Nonetheless, the Report argues that returns earned on pipeline capacity in Australia are simply too high, compared with estimated regulatory returns for similar assets.⁴ This is in contrast to public claims by pipeline owners that historical price increases on certain pipelines have been reasonable and in line with CPI increases.⁵

The ACCC also seems strongly influenced in its view by the different approach adopted in comparable jurisdictions, such as Europe and the United States, which both have more regulated pipeline sectors.
In short, the Report recommends the following:⁶

• Replacing the current test in the NGL for “coverage” (i.e. regulation) of major pipelines, which is based on demonstrating a risk to competition in a related market, to one that is framed around the existence of sustained market power.  The ACCC appears to believe that on this new and lower threshold formulation, more pipelines would be likely to be become re-regulated. 
• The ACCC wants to beef up the access negotiation and dispute processes under the existing National Gas Rules (NGR) (Parts 8-12) and has recommended that the AEMC look further at reforming this framework as part of its own review. The ACCC is particularly concerned about the dispute resolution mechanism in Part 12.
• The other key recommendations in the ACCC Report are directed at increasing market transparency (through the publication of a monthly netback LNG price, the mandatory reporting of reserve and resource information and the possibly reporting of a periodic price series of actual commodity gas prices paid to producers) and improving capacity (possibly through the introduction of a central capacity trading platform and an auction process for pipeline capacity). 
• Despite proposing to expand regulation of existing pipelines, the Report states that it recognises the effect that regulation can have on investment and innovation and recommends that existing safeguards for greenfield projects in the NGL and NGR be retained, including the option of a 15-year no‑coverage determination for greenfields pipelines, protection given to commercially negotiated contracts, and the possibility of full or light handed regulation.

The AEMC discussion paper

Whether, or how, the ACCC’s proposals are implemented will follow the completion of the East Coast Wholesale Gas Market and Pipeline Frameworks Review being undertaken by the AEMC (AEMC Review).⁷

The ACCC has asked COAG to task the AEMC as part of the AEMC Review with considering how a number of its proposals could be implemented through amendments to the NGR.  In a recent discussion paper as part of the AEMC Review, AEMC itself raised the prospect of significant changes to the operation of gas market, including the following:

• Establishing two primary trading hubs on the east coast, one in the north and one in the south, with exchange-based trading applying to each, deriving two reference prices respectively at any one time.
• A day-ahead auction process overseen by the AER for contracted but un-nominated pipeline capacity subject to a reserve price.
• Capacity trading platforms to facilitate a secondary market for capacity sales by capacity holders ahead of the auction process supported by product standardisation and publication of information relating to such secondary trades.
• Greater information transparency on primary capacity purchased via the Gas Bulletin Board.

The AEMC Review’s final report is expected to be released in May 2016.

Overview of the Report and the final recommendations

The ACCC undertook the review using its powers under Part VIIA of the CCA and following a direction from the Minister for Small Business to hold a public inquiry into “the competitiveness of wholesale gas prices and the structure of the upstream, processing, transportation, storage and marketing segments of the gas industry.”

This Minister’s direction was in response to concerns (mostly from industrial gas users and retailers) around gas supply and pricing.  Their concerns arose from significant industry changes over the last four years most of which were caused by the opening up of the Australian domestic gas market to international pricing through development and commissioning of LNG facilities in Gladstone.  The ACCC conducted the inquiry over twelve months.

Ultimately, the Report’s findings are framed around three areas:

The competitiveness of the current gas supply market and its future

Here, the ACCC found that:

• Current gas supply offers are characterised by higher prices, shorter durations, and more restrictive non-price terms and conditions, which have likely decreased industry margins and increased wholesale gas prices and household gas bills.
• Future supply outlook is uncertain and affected by (a) significant demand from the LNG projects, (b) low oil prices reducing exploration and development, and (c) the moratoria on onshore gas exploration and development and other regulatory restrictions.
• Southern states in particular need to increase the level and diversity of gas supply.

Monopoly pricing concerns and effective regulation of gas pipelines

The primary focus of the Report was on the pipeline sector, where the Report found that:

• Pipeline operators typically have sustained market power, in that they are not being effectively constrained by competitive forces including the current regulatory framework, with less than 20% of transmission pipelines on the east coast currently subject to regulation (in contrast to other comparable jurisdictions).
• Despite this, the Report finds that pipeline owners have invested substantially and responded flexibly to changes in the market (such as investment in bi-directional capability).  There was also no, or only limited, evidence of pipeline owners engaging in any market abuses, such as restricting access, anti-competitive discrimination, strategic reduction in service quality or anti-competitive tying.
• However, pipeline operators were found to have engaged in monopoly pricing (i.e. obtaining returns higher than would be able to be achieved in a workably competitive market).  This is said to give rise to higher delivered gas prices and, ultimately, is described as having an adverse economic effect.
• Information asymmetries are limiting shippers’ ability to identify any exercise of market power and negotiate effectively with pipeline operators.

In response to these findings, the Report makes its most substantial and significant recommendations.  Here, the ACCC recommends that the “coverage” criteria used under the NGL to determine regulation of pipelines be amended to focus on whether a pipeline has and is likely to maintain market power and would be likely to contribute to the National Gas Objective.⁸

The ACCC also recommends that the AEMC be instructed to review the access rules under the NGR and consider whether they need to be expanded – in particular, the process for managing access disputes.

The current state and transparency of the East Coast Gas Market

Finally, the Report recommends a range of changes to increase transparency around elements of the gas market, including:

• Gas pipelines be required to expand the information made available to shippers to include more financial information to assist them in negotiating shipping agreements.
• Increased and mandatory reporting (on a standardised basis) around reserve levels and commodity and transport pricing (including AEMO publishing a monthly LNG ‘net back’ price to the Wallumbilla compound).
• The AEMC should consider requiring the introduction of a centralised capacity trading platform to facilitate secondary capacity trading and day-ahead auctioning of unutilised capacity.
• The AEMC should consider the benefits of a short-term auction process for hub services if it decides to implement the day-ahead auction for pipeline services.

Finally, the ACCC indicated that it is continuing to review certain elements of the market under the competition provisions in Part IV of the CCA, including the competitive effect of the joint marketing arrangements of the Gippsland Basin Joint Venture in Victoria and whether the bundling and pricing approach adopted by retailers using lower-capacity regional pipelines may involve misuse of market power or conduct that otherwise lessens competition, by excluding other shippers.  The ACCC looks likely to further review regional pipelines.