Breaking Telstra - Is the Government looking for a better market structure, or just buying a monopoly?

Is Telstra being denied procedural fairness through the forced splitting of the copper network from the retailing and mobile networks? And, is the government forcing the split for the right reasons?

The front page (and pp 50-51) of the Fin Review today spouts off against the splitting of Telstra, suggesting that the telephony super-power has been denied ‘procedural fairness’ and suggesting that the government is forcing the split purely to ensure a monopoly over the broadband network? The Opposition is trying to stop the split or at least put discussion of the split off to next year.

And, for once, I think I’m probably sitting on the opposition’s side of the fence.

Whilst I’m all for the splitting of Telstra for the competitive benefits stemming from the split, I’m the whole situation smells a little to me. Is the government forcing the split to promote competition in the telecommunications industry, or is it forcing it to ensure it has a monopoly in the future broadband network? Moreover, how dare the government sell Telstra off and then institute this type of reform. If I were a Telstra shareholder, I would be livid.

As briefly touched on yesterday, there is considerable benefits from splitting up vertically integrated companies trading in non-competitive markets. However, the Government’s bill to force Telstra to sell its copper network is just shifting the monopoly from the telephone industry to a monopoly in the broadband industry. If Telstra does not sell its copper network to the NBN Co. it could become NBN Co’s largest (and only) competitor. This, to me, is anti competitive behaviour that the ACCC should look at very carefully before it allows any such changes.

Clearly shareholders are suffering too. The Telstra Share Price has dropped significantly since ‘Conroy’s convoy’ first entered the arena. As seen below, Telstra’s stock price has depreciated strongly, even in light of an upward moving market.

Australian Securities Exchange 2009

Whilst I think that the move to split Telstra is a good one, I this is another example of mediocre policy, crap timing and poor planning. The split should have been completed prior to selling Telstra. Telstra should be allowed to keep its copper network; if for no other reason, it should be able to keep it to promote competition in the new broadband network. If nothing else, Telstra should only sell its copper network at a price that is acceptable/beneficial to shareholders – just like any other acquisition.

The green light for vertical integration in the energy market

At what stage in the development of a competitive industry does vertical integration become a good thing?

This question arises as the NSW Government enters the process of selling off their electricity generators, and the energy retailers are expected to be the buyers.

Today the Australian had an article discussing the sale of about $6 billion worth of NSW state-owned electricity generation assets. Whilst the sale process will be open to all investors, the article suggests that interest will come from major electricity retailers including Origin Energy, Integral Energy, TRUenergy and ERM. Yet, governments and regulators across Australia have put in so much work to remove vertical integration from the energy market. So why would we be allowing this shift back to vertical integration? Because it can reduce electricity prices.

Vertical integration often leads to market inefficiencies (particularly in monopoly, monopsony, oligopoly or oligopsony markets). This has been highlighted in the recent discussion regarding the de-vertical integration of Telstra (vertical disintegration is a different thing altogether). Vertical integration in market structures where a few participants have price discrimination power enables the vertically integrated company to price gouge in the monopoly/oligopoly components of the business. The company can then cross-subsidise those components of the business that are open to competition - effectively opening up a cartel pricing scheme. So why then, if vertical integration these markets is a bad thing, would the government be happy to allow for re-vertical integration of the energy market?

To my mind, there are three reasons why this re-integration is a positive (or at least an acceptable) outcome:

1. The perfect hedge – currently, retailers and generators minimise their risk through over the counter transactions. This enables retailers to purchase the majority of their load at a pre-arranged price, rather than facing the volatile NEM price. It also enables generators to guarantee demand even in low-consumption periods. Whilst this is a good system, the contracts are agreed to ahead of time and any variance between the agreed contract consumption and the actual consumption has to be bought on the NEM at an unknown price.

When retailers and generators merge, they are able to better hedge their demand and price risks. So long as the price the generator offers the NEM is low enough so that the generator’s offer is accepted and dispatched, the retailer and the generator can have a perfect hedge.

2. The market structure of the NEM – the NEM is not a typical Oligopoly or Oligopsony, rather, it is both. There are a few large generators and there are a few large retailers. Having both the buyers and sellers in a market with considerable power in some ways removes any price discrimination power that could occur in a standard oligopoly/oligopsony.

3. The regulation of the NEM – even with vertical integration, the dispatch system used in the NEM ensures that the energy needs of the market are met by those generators willing provide the energy at the lowest possible price.

There is still considerable room for gaming on the margins of the market, but not considerably more than is currently going on.