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The preference for factual inferences from oral testimony in SEA Swift’s acquisition of Toll Marine

A recent decision by The Australian Competition Tribunal brings into sharp focus a difference between economists and the courts in their approach to facts. The decision is Application by Sea Swift Pty Limited [2016] A Comp T 9. Frontier Economics examines this case and suggests how the Tribunal’s approach to the facts contributed to the outcome.

Economists are trained to be sceptical of people’s statements about their motivation or their intentions. They have a strong preference to characterise people’s behaviour based on their past conduct. In contrast, lawyers have a strong tradition of relying on the oral testimony of individuals and testing that testimony by means of cross-examination.

The case

Sea Swift applied to the Australian Competition Tribunal for authorisation of its proposed acquisition of Toll Marine Logistics (TML). Prior to 2013, Sea Swift operated scheduled marine transport services in far-North Queensland and Toll Marine operated similar services in the Northern Territory. In January 2012, Sea Swift commenced an assault on the traditional business of Toll Marine. Toll Marine retaliated by expanding into the traditional areas of Sea Swift. The result was that both parties were losing money. The parties decided to solve this problem through a merger and sought an informal clearance from the ACCC. The ACCC refused to grant an informal clearance; and Sea Swift applied to the Tribunal for authorisation on two grounds. The first ground was that the merger would not lessen competition. The second ground was that its undertakings to continue operation of services to remote communities, and to submit these services to a regime of price controls, would create benefits to the public. The Tribunal accepted both these propositions.

The ACCC’s case

The ACCC opposed the acquisition on the ground that Sea Swift was willing to pay a ‘substantial premium’ over the value of tangible assets that it intended to acquire from TML. According to the ACCC, this substantial premium was a payment for the transfer of customers. The ACCC contended that the fact that Sea Swift was willing to pay a significant price for the “certainty” of acquiring the TML contracts showed that, in the future without the proposed acquisition, Sea Swift was uncertain whether it would win those contracts. The Tribunal stated:

In saying this, the ACCC relied on the evidence of Mr Readdy (an executive of CHAMP Ventures [ the private equity firm that controlled Sea Swift] and non-executive director of Sea Swift) that Sea Swift considers the certainty of picking up TML’s Largest Contracts to be a benefit of the Proposed Acquisition. The ACCC asserted that Sea Swift was prepared to pay a “substantial premium” despite TML’s announcement that it would exit the market in the short term if the Proposed Acquisition was not authorised because it avoided the risk posed by competitive forces which would exist if the Proposed Acquisition did not proceed. (at para 210)

The Tribunal acknowledged that this argument was fine in theory; but found it was inconsistent with the facts:

In theory, the payment of a consideration greater than the value of a company’s tangible assets may indicate that the purchaser is paying for a market share that could result in a significant lessening of competition. However, in the Tribunal’s consideration of Sea Swift’s Application, theory must give way to fact. (at para 211)

The key fact that the Tribunal found ‘fatally undermined’ the ACCC’s theory of harm was that Sea Swift would win all of TML’s large customers either by subcontract or as a result of winning a new contract whether or not the authorisation was granted (paras 248 and 249). In other words, competition wouldn’t be lessened as a result of the merger. It formed this view after considering the evidence in chief and cross-examination of the executives of competitor companies. The Tribunal rejected the evidence of those competitors which claimed they could win major contracts in competition with Sea Swift; and it accepted the oral evidence of those competitors which said they had no plans to compete for any contracts that might become available in the near future.

Weighing up

In its assessment of the likely effect of the proposed acquisition on competition, the Tribunal relied entirely on its assessment of the evidence in chief and cross-examination of industry participants. These prompted its factual findings that Sea Swift would gain all of TML’s key customers with or without the proposed acquisition; and, because of these factual findings based on evidence in chief and cross-examination, the Tribunal decided that it did not need to deal with (i) the premium that Sea Swift was paying and (ii) Sea Swift’s perception that it needed to pay this premium to avoid the risk of not winning TML’s key customers.

The Tribunal stated:

These factual findings fatally undermine much of the ACCC’s theory of harm. On this basis, the Tribunal does not consider that it is necessary to deal with the ACCC’s submission that Sea Swift was willing to enter into the ARASSA on 17 March 2016 and pay a “substantial premium” to avoid the risk of failing to capture the revenue streams from TML’s Largest Contracts. Suffice it to say that as there was no evidence given to the Tribunal of the present value of the vendor note or the shares in Sea Swift which Toll will receive as consideration under the Proposed Acquisition, the foundation for the ACCC’s contention that there was a “substantial premium” was not made out. Further, Sea Swift’s perception of risk without full knowledge of TML’s intentions or the intentions of TML’s Largest Customers, and the amount that it was willing to pay for TML’s assets as a result, is irrelevant to the Tribunal’s evaluation of the impact on competition with and without the Proposed Acquisition. (Para 249)

At the close

In the end, the Tribunal found that it knew more about the competition faced by Sea Swift than did Sea Swift itself. The opinion of Sea Swift (and its private equity owners) in March 2015 was that it had to pay something for the certainty that it would be able to secure all of TML’s major contracts. However, the Tribunal found, as a matter of fact, that Sea Swift was mistaken.

Although the Tribunal characterised its reasoning as facts fatally undermining theory, the truth is more subtle. The ‘facts’ found by the Tribunal were based on its assessment of the evidence in chief and cross-examination of business executives. On the basis of accepting some of this evidence and rejecting others, it decided on ‘facts’ which made the magnitude of the premium and the reasons paid for the premium to be irrelevant.

Early competition cases in Australia often reflected tension between the approaches of lawyers and those of economists. This tension largely disappeared over the years as lawyers and economists came to understand each other’s reasoning. However, the decision of the Tribunal in Sea Swift shows that remnants of the tension remain.

 

 

 

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The COAG Energy Council announced today that the energy Ministers of Australia’s States and Territories had agreed that the rights of parties affected by the decisions of the Australian Energy Regulator to seek limited merits reviews by the Australian Competition Tribunal (the Tribunal) would not be abolished. Instead, the COAG Energy Council agreed to implement a series of reforms to the existing limited merits review arrangements. This decision followed a three month inquiry into four policy options: (1) maintain the existing appeal arrangements as they are; (2) pursue legislative amendments to reform the appeal arrangements; (3) reform the way the Tribunal makes its decisions; and (4) scrap limited merits review rights altogether. The inquiry was initiated by the COAG Energy Council after some Ministers expressed concerns that there had been an excessive number of expensive and time-consuming appeals recently, and that the existing arrangements may not be serving the long-term interests of consumers properly.

During the inquiry, Frontier Economics and leading law firm Herbert Smith Freehills were engaged by Energy Networks Australia to prepare a policy paper explaining why limited merits review rights were essential to providing checks and balances on regulatory decision-making and promoting confidence in the regulatory system. The report also proposed a range of reform options targeted at addressing the concerns expressed by policymakers. The report was consistent with the ultimate findings of the COAG Energy Council that the limited merits review regime should be retained but reformed.

A working group of officials has been tasked with developing detailed legislative amendments, which the COAG Energy Council is due to consider in the first quarter of 2017.

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For a recent inquiry by the COAG Energy Council into limited merits reviews, Frontier Economics and leading law firm Herbert Smith Freehills were engaged by Energy Networks Australia to prepare a policy paper explaining why limited merits review rights were essential to providing checks and balances on regulatory decision-making and promoting confidence in the regulatory system. The report also proposed a range of reform options targeted at addressing the concerns expressed by policymakers. The report was consistent with the ultimate findings of the COAG Energy Council that the limited merits review regime should be retained but reformed.

The report's authors from Frontier Economics include team members from Frontier (Asia-Pacific) - Danny Price and Dinesh Kumareswaran; and Frontier (Europe) -Mike Huggins and Aria Rodgarkia-Dara.DOWNLOAD FULL PUBLICATION

RenewEconomy’s David Leitch interviewed Frontier Economics (Asia-Pacific) managing director Danny Price regarding emissions intensity schemes on 10 December.

The interview (16 minutes) discusses what an emissions intensity scheme is and includes details on the modelling that Frontier Economics has done on these schemes for the Australian Energy Market Commission (AEMC).  This interview has been published by Radio ITK as a podcast.

Frontier Economics advised the AEMC on a range of options to reduce emissions as part of the AEMC's future energy policy planning.

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The Australian Government has today released details of its reform package on proposed changes to the regulatory regime applying to superfast broadband. The legislation is designed to give effect to the Australian Government's response to the Independent Cost-Benefit Analysis and Review of Regulation (Vertigan Review) and has been informed by the detailed analysis undertaken by the Bureau of Communications Research (BCR) on funding NBN Co Limited's (nbn) non-commercial services to rural and regional Australia.

The reforms cover three policy areas:

The Government’s reform proposals reflect its rejection of funding mechanisms for cross-subsidies, such as direct budget finance or accepting a lower rate of return on investments, contrary to the recommendations of the Vertigan Review. The levy is narrowly focused on operators of competing superfast fixed line broadband networks; contributions to the net costs of the cross-subsidy are not required from fixed wireless broadband or mobile broadband service providers.

Frontier Economics (Asia Pacific) prepared submissions for service providers both to the Vertigan Review and on the BCR’s analysis of funding nbn’s non-commercial services.

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The Australian Energy Market Commission (AEMC) today provided advice to the COAG Energy Council that analyses the impacts and characteristics of mechanisms to reduce emissions in the electricity sector in line with Australia’s Paris accord commitments.

The report is in response to a request from energy ministers for advice on the alternatives that could be applied to the wholesale electricity generation sector to help achieve Australia’s 2030 emissions reduction target.

The AEMC examined the potential impacts of three mechanisms on prices to consumers, costs to the economy and power system security:

Frontier Economics (Asia-Pacific) prepared a report for the AEMC on the theory and design of alternative options for reducing emissions in the electricity sector and to model the impacts of these alternatives.

Our analysis shows the emissions intensity target delivers the best outcomes for consumers in terms of lower prices, better power system security and certainty of meeting the emissions target.

Frontier Economics regularly advises clients regarding energy and climate change, as well as other infrastructure sectors, including transport and water.

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A Land Tax By Any Other Name

Australia needs at least $300 billion, and up to $700 billion, spent on infrastructure over the short to medium term if it is to maintain and improve its productivity and liveability [1]. However, short-termism and budgetary pressures mean governments are often unwilling to directly fund infrastructure even when it can deliver enormous value over the longer term. Opposition to user pays pricing, raising taxes or increasing debt mean more sophisticated ways of funding infrastructure need to be considered. Value capture mechanisms (VCM) are currently being explored by Infrastructure Victoria and represent a key component of the latest proposal for high speed rail linking Sydney and Melbourne. This bulletin explores the benefits, costs and challenges associated with implementing value capture mechanisms.

What is value capture

According to the Smart Infrastructure Facility, value capture “describes the process of government capturing’ (via taxation) a proportion of any increase in the unimproved value of privately-owned land caused by the construction of new (or improved) publicly-funded infrastructure.” [2]

Value capture mechanisms can include:

“Land uplift levies” or “betterment levies”: A levy is imposed on private land holders, individuals or businesses related to an estimated increase in the unimproved land value. Betterment levies were used to fund the Sydney Harbour Bridge, public infrastructure in Columbia, and more recently the London’s CrossRail project.

The sale of development rights: Private contractors are granted rights or sold public land typically as part of a tender involving the development of the desired infrastructure. The Melbourne Central station redevelopment was funded this way, as well as public infrastructure in Sao Paulo and New York City.
Change of use charge: A charge associated with the rezoning of land to reflect its improved value because of its potential new use – for example, a change from commercial only to residential use. A change of use charging regime is currently in place in the ACT.

The latest high speed rail proposal linking Sydney and Melbourne proposes to finance the $200 billion venture through something akin to value capture. The private venture intends to purchase land along the development site and then develop eight new cities along the route. The uplift in the value of the land will then be used to generate funding for the project. [3]

Who should pay for infrastructure?

As a starting point, we are all better off when the beneficiary of a service bears the costs of its provision. However, since the beneficiaries of infrastructure, and the extent to which they benefit, can vary widely, there is no single best approach to determining who should pay for public infrastructure projects. Examples of beneficiaries, and what this means for who should pay include:

In practice, new infrastructure benefits many different stakeholders, and can reasonably and efficiently be funded from one or a combination of these groups.

Value capture has a lot going for it

Value capture mechanisms could help overcome government’s inability to fund economically-beneficial infrastructure while also improving economic efficiency.

Firstly, value capture mechanisms are typically applied to land, and land taxes can be more efficient than general taxation. In fact the noted free market economist Milton Friedman described them as the “least bad tax”! When set correctly, they do not distort people’s choices, unlike for example, a tax on income which may cause you to work less. Indeed, rather than resulting in a deadweight loss to society like other taxes, they actually reduce the overall burden of taxation on the domestic economy (see Figure 1).  This is because a portion of broad-based land taxes will be paid by foreigners who own land in Australia, resulting in an income transfer from overseas to domestic residents.

Second, they can reduce the incentive for the potential beneficiaries of infrastructure investments to lobby politically for them. If the beneficiaries know they will pay for some or all of the benefits they will receive, they are less likely to invest effort in diverting resources to “their” project. This is good because such rent-seeking behaviour in itself creates a burden on society, and it reduces the potential for infrastructure projects with the loudest proponents being prioritised over projects that would deliver greater benefits.Source: L, Cao, et al, (2015) Understanding the economywide efficiency and incidence of major Australian taxes, Treasury Working Paper , 2015-01, ISBN: 978‑1‑925220‑26‑1.

So what’s the catch?

While there is no doubt about the potential for value capture mechanisms to support infrastructure development there are some challenges in assessing and capturing the new value created:

The potential for value capture mechanisms to break the infrastructure funding bottleneck needs to be considered on a case-by-case basis, and only used where benefit attribution and administrative complexity can be cost effectively overcome.

This can be seen in relation to betterment levies, where careful consideration needs to be given to how the levy will be determined, how monies will be collected, what the appeals process will look like, how revenue will be invested, and how disadvantaged stakeholders will be assisted. This process will identify legislative and administrative barriers and highlight where the administrative costs of collection and compliance cost are high.

Too Much of a Good Thing?

Governments may be tempted to prioritise projects that can be partially or fully funded by value capture mechanisms, as they reduce the call on already stretched budgets.

Focussing on the potential for using value capture to fund projects, instead of the net benefits those projects deliver, risks certain types of projects may being systemically prioritised. For example, rail projects would seem most likely to lend themselves to value capture. This is because the beneficiaries can be more easily identified in an immediate region around a station. Furthermore, development contributions can be collected from rezoning the land as part of any station re-development that occurs.

However, to generate the greatest welfare for society, infrastructure projects with the highest net benefits, regardless of funding sources, should instead be prioritised. Net benefit can be determined using a cost benefit analysis that can (and should) take into account a wide range of impacts. Projects funded using value capture will have the additional benefit of reducing the tax burden compared with projects funded directly by the public purse (see Figure 1). However, this benefit can be monetised and captured within the traditional cost benefit analysis framework. It is projects with the highest benefit relative to cost that should be prioritised.

Independent assessment and prioritisation of infrastructure projects based on robust and transparent cost benefit analyses is therefore essential to guide government priorities.

A Fair Go

Value capture mechanisms are commonly viewed as being fairer and more equitable than other funding mechanisms ─ by virtue of ensuring those who benefit pay ─ but they can create equity concerns of their own.

For example, where a project is part of a larger state wide program of works – such as rail grade separation programs – it would seem inequitable to use a value capture mechanism where similar works, in other regions, have previously been funded through general taxation. Of more direct concerns are the cash flow issues value capture mechanisms can cause for those who are asset rich but cash poor, such as retirees. Some individuals may find themselves unable to pay a tax bill for a new infrastructure investment that has substantially increased their property value. This might require the owner to sell the asset or rent it out and move elsewhere. While this can be addressed through specific exemptions, or deferment (for those that can demonstrate they do not have the current means to pay), this adds to administrative complexity and cost.

What’s the hold up?

Value capture mechanisms tick a lot of important boxes: they can be efficient, resolve funding issues and they have been successfully used to fund important and large infrastructure projects around the world.

So why are value capture mechanisms used so infrequently in Australia?

The answer to this could lie in government and public concern about the application of any new tax. As with any reform, it is critical that politicians and the public understand what these mechanisms are intended to deliver, why they are necessary, and how they will be delivered, otherwise their existence will be short lived. Given their apparent appeal on paper, it’s puzzling that betterment levies are not more widely used as a funding mechanism.

There is ample evidence of the need for, and potential value of, new infrastructure in Australia and value capture mechanisms can enable this. But in going forward, governments need to ensure the prospect of additional revenue raising does not dominate project selection, that only projects with the highest net benefits are pursued and demonstrate to the public how value capture mechanisms can be implemented.DOWNLOAD FULL PUBLICATION[1] $300 Billion in $2012 from Infrastructure Australia, National Infrastructure Plan, June 2013, and $700 Billion in $2007 from Infrastructure Partnerships Australia, Australian Constructors Association & Australian Industry Group, Submission to Infrastructure Australia Discussion Paper 2: Public Private Partnerships, October 2008.[2] Smart Infrastructure Facility Submission to The House of Representatives Standing Committee on Infrastructure, Transport and Cities began conducting an inquiry[3] See http://www.abc.net.au/news/2016-07-14/new-plan-for-high-speed-rail-link-between-melbourne-and-sydney/7628316 and http://www.clara.com.au/funding-the-clara-plan.html

Frontier Economics (leading a consortium including Norton Rose, Singapore-based lawyer Gary Maguire and an engineer) has recently been retained by the Singapore Energy Market Authority to design a secondary gas trading market (SGTM) for Singapore.

The core of the project incorporates two phases:

The project is expected to be completed in 2018. Frontier regularly advises clients, including energy market regulators, in the gas sector across the Asia-Pacific.

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The Singapore Energy Market Authority (EMA) has completed a review of the vesting contract regime in Singapore and released the final report.

The EMA implemented the vesting contract (“VC”) regime on 1 January 2004. The objective of the VC regime is to mitigate the exercise of market power by the generation companies. Frontier Economics (Asia-Pacific) was engaged to undertake the review on behalf of the EMA.

The review examined the mechanisms used to mitigate market power in the Singapore Wholesale Electricity Market (SWEM), including:

Frontier’s draft report Review of the Vesting Contracts Regime (the draft report) was released on May 16, 2016. EMA received submissions commenting on the draft report from a range of interested parties. The revised report was released on August 31, 2016 in conjunction with the EMA’s draft determination. A second round of submissions were made in response to the revised report.

The final report discusses the comments raised in both rounds of submissions and Frontier's response to the comments. Frontier's recommendation to phase out vesting contracts in several stages was adopted by EMA.

Frontier regularly advises clients, including regulators, on market modelling and market arrangements in the electricity sector across the Asia-Pacific.

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The New South Wales Independent Pricing and Regulatory Tribunal (IPART) has released the results of its 2015 Household Survey. This was the seventh household survey since 1993 about energy and water consumption across 4,000 houses in New South Wales. The survey was undertaken by Roy Morgan Research in the Sydney, Gosford, Hunter, the Riverina, and the North Coast regions. It obtained information regarding each household’s demographics, appliance stock, how they used energy and water, and a number of other characteristics related to energy and water consumption. Roy Morgan also collected information from network providers on the household’s electricity, gas and water consumption.

IPART regulates aspects of the water and energy sector across NSW. For example, it determines the maximum prices that can be charged for bulk and retail water services provided by major water utilities across NSW and sets the maximum prices gas retailers can charge customers who have not signed a market contact. It also recommends a benchmark range for unsubsidised solar feed-in tariffs that retailers may voluntarily offer customers, and has a role in monitoring competition in the retail electricity market. A sound understanding of the nature of water and energy usage across different households helps to provide a context for its decisions.

Frontier (Asia-Pacific) was engaged by IPART to use the survey data to investigate the determinants of the levels and patterns of household energy and water consumption in NSW.  Frontier used a range of analytical tools, including econometric regression analysis and behavioural insights, to investigate the drivers of energy and water consumption, as well as the underlying relationships between total energy consumption and a range of social and economic characteristics. Understanding these relationships  is critical in informing energy decision-making.

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