But we must adopt a harder line on future acquisitions
Claims by a federal Coalition MP that AGL’s closure of the Liddell power station in 2022 is anti-competitive and veiled threats to force AGL to divest Liddell are overblown.
However, MPs have inadvertently touched the tip of a real iceberg: our too-lenient approach to acquisitions has left us with elec- tricity markets that are far less competitive than they should be. What can be done?
Last Thursday, Liberal MP Craig Kelly claimed that it would be “potentially anti-competitive” if AGL closed Liddell and didn’t offer to sell it to a competitor. He also implied that in that case the ACCC could force AGL to divest Liddell. However, ACCC chair Rod Sims has correctly stated that the closure and non-sale of Liddell would not pass the legislative tests for anti-competitive conduct.
Nevertheless, the government can pass legislation to force divestiture of any assets. But should it? The issue is broader than just Liddell. Substantial consolidation in the industry in recent years has raised major competition issues.
In the lead-up to the 1998 commencement of the National Electricity Market, our governments took considerable steps to avoid two potential market structure problems: horizontal concentration and vertical integration. Horizontal concentration is when a few firms control a large market share in a particular industry segment, such as generation or retailing. Vertical integration in when one company operates in multiple industry segments, such as generation and retailing.
Horizontal concentration reduces competition: market power causes profit-maximising firms to supply less output and charge higher prices. Vertical integration reduces competition even further: profit-maximising vertically integrated firms have incentives to supply even less and charge even higher prices in an upstream segment (generation) to put their stand-alone (non-vertically-integrated) rivals in a downstream segment (retailing) at a competitive disadvantage and raise barriers to entry.
As a result, vertical integration can cause even higher prices and less supply at the retail level.
That’s why our governments substantially restructured the industry pre-NEM. The generation and retail arms of vertically integrated monopolies were separated and broken up to create competition in wholesale and retail markets. Victoria banned crossownership of retailers and generators, but the ban was subsequently lifted.
However, acquisition activity in recent years has substantially reversed the pre-NEM industry restructuring and re-created the twin problems that restructuring was designed to avoid.
Today, our wholesale and retail markets are highly concentrated. Three big vertical integrated “gentailers” now account for 70 per cent of retail customers and 48 per cent of generation. This industry reconsolidation has occurred despite the ACCC’s objections.
The ACCC did allow some acquisitions that they believed didn’t significantly lessen competition or passed a “public interest” test — that is, they generated benefits (such as scale economies or risk management) that outweigh the lessening of competition. However, it violently objected to others.
In 2003, the ACCC opposed AGL’s acquisition of a minority stake in the Loy Yang A generator, the industry’s first major step towards vertical reintegration, because it would “result in higher prices, increased barriers to entry and a substantial lessening of competition”. AGL appealed to the Federal Court, which overruled the ACCC.
In 2014, the ACCC opposed AGL’s 2014 acquisition of the Liddell and Bayswater generators, saying that if the acquisition proceeded “the three largest generators in NSW will have been sold to the three largest retailers … These vertically integrated retailers will dominate electricity supply”. AGL appealed to the Australian Competition Tribunal, which overruled the ACCC.
While we shouldn’t ban acquisitions if they really do pass the “public interest” test, we must recognise that acquirers have incentives to overstate the benefits and understate the competition effects and we’ve been too lenient on them.
Putting the Liddell case to one side, it is true that the twin market structure problems that we have recreated may well cause existing generators to be closed earlier than they otherwise would have — and not offered for sale.
Suppose a generator’s life could be extended by five years if a significant investment was made and that the additional net cash flows from this generator would deliver a good return on investment. If the generator was a stand-alone busi- ness, it would rationally decide to make the investment. However, if the generator’s owner was vertically integrated with high wholesale and retail market shares, its owner may rationally decide not to, for two reasons.
First, closure would benefit its other generators through higher wholesale prices.
Second, its retail businesses also would gain from through higher retail margins and market share (as higher wholesale prices and lower supply would weaker retail competition). But these broader benefits are only realised if the generator is not only closed, but also not sold to a competitor.
Nevertheless, while we shouldn’t have let our twin problems get this bad, trying to unscramble the egg through forced divestment would be a step too far.
True, there are examples of governments forcing company breakups for competition reasons, such as the US government’s breakup of AT&T in the early 1980s. However, those examples are rare and exceptional. A key reason why is the risk that forced divestment will undermine a critical factor on which markets rely: property rights. Forcing owners to divest assets lawfully obtained through acquisitions that were vetted and approved by the relevant institutions is an extreme step to take.
Nevertheless, we should certainly adopt a harder line on future acquisition proposals. We shouldn’t ban them, as it is always possible that an acquisition might pass the public interest test. However, the assessment needs to take full account of the adverse effects on both wholesale and retail competition.