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The Australian Competition and Consumer Commission today accepted court enforceable undertakings from BHP Billiton Petroleum (Bass Strait) Pty Ltd (BHP) and Esso Australia Resources Pty Ltd (Esso) to separately market their share of gas produced under the Gippsland Basin Joint Venture (GBJV) from 1 January 2019. The separate marketing of GBJV gas means buyers will have access to competing offers from Esso and BHP in the future.

The ACCC was investigating the joint marketing arrangements between BHP and Esso as it was concerned that the arrangements were likely to have resulted in a substantial lessening of competition in the market for the supply of gas to buyers in the Southern states.

Frontier Economics provided a report to Esso and BHP on the likely effects of the joint marketing arrangement on competition, which was provided to the ACCC to assist in their inquiry.

Frontier Economics regularly advises clients in a range of competition matters.

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Frontier Economics director Jason Hall is presenting today at the Australasian Finance and Banking Conference in Sydney.  Jason will be explaining some recent work estimating the market value of imputation credits, outlined below.

Imputation tax credits are the credit an investor gets with a dividend for corporate tax already paid in Australia. The imputation system has been around for 30 years and there is still no consensus about how much the credits are worth. This is an issue because credits are not separately traded. You either get a credit with a dividend, or you don't, and only Australian resident investors get a cash flow benefit from the credits. For example, they are not useful for U.S. investors.

This creates a problem. As an Australian you get a large cash flow benefit from receiving a credit and if it was only Australians buying Australian-listed shares, you would pay more for a share that gives you a credit than a share which doesn't. But the international investors don't care about the credits. So when you have a market with Australian and international investors, it is an open question about how much higher the share price is if the company pays dividends that are accompanied by a tax credit.

It is considered important amongst regulators and regulated entities because the regulator makes an estimate about the value of the credits. The higher the assumed value of the credits by the regulator, the lower the revenue stream the regulated entity is allowed to earn. So the estimation of this single parameter affects the aggregate revenue stream of regulated entities by hundreds of millions of dollars.

The paper, co-authored by Stephen Gray, allows us to estimate the market value of imputation credits. We developed a novel technique that allows us to jointly estimate the value of cash dividends and credits (recall that it is hard to separately value them because credits are not traded). Our technique involves making an assumption about the distribution of error terms in regression analysis and then generating thousands of simulated samples in order to estimate confidence intervals.

Further, our research method has applications amongst any empirical analysis in which two of the explanatory variables are correlated. For example, suppose you were measuring the relationship between running times, testosterone and gender. There is correlation between testosterone and gender (if you code males = 1 and females = 0 there will be positive correlation between testosterone and gender); or suppose you were measuring the relationship between consumers' willingness to buy a train ticket as a function of (1) income and (2) distance to the CBD - people living close to the CBD have, on average, higher income so there will be negative correlation between income and distance. Our method has applications to those cases.

Click here to access the PowerPoint presentation (17 mins duration) and a transcript. (Please open the audio PowerPoint presentation as a slide show: the audio should automatically play).

The full research paper is available here.

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Econometrics is the application of statistical methods to the study of economic data and problems. In the area of competition and regulation, econometric analysis is often used to provide justification for regulatory proposals and decisions. Yet figures are not infallible and mistakes can happen for a number of reasons. This can have real ramifications for businesses that are being regulated. This new bulletin from Frontier Economics, Quantitative analysis - quality assured? uses recent actual examples to show the importance of using appropriate methods, and why it is critical to carefully review the analysis before drawing conclusions from the modelling results.

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Econometric modelling can go awry

Econometric analysis is often used to provide justification for regulatory proposals and decisions. Yet figures are not infallible and mistakes can happen for a number of reasons. This bulletin uses recent actual examples to show the importance of using appropriate methods, and why it is critical to carefully review the analysis before drawing conclusions from the modelling results.

The importance of being robust

Econometric analysis is a powerful tool. It can be used to test claims and draw conclusions. It can be used to study the growth of economies, underpin conclusions regarding market power in antitrust cases, and provide estimates of the efficient costs of regulated monopolies. But, like most tools, it must be used correctly to avoid inadvertently causing harm.

Just as you would want a qualified medical practitioner performing a routine check-up, econometric analysis should be performed by a knowledgeable practitioner and second opinions may also be valuable. Undertaking quality assurance is important.

Below, we discuss issues that may affect the validity of an econometric analysis, including some examples uncovered by Frontier Economics during recent reviews of work.

Computational errors

The potential for human error means it is possible to make mistakes when typing the commands for the statistical software used in econometric analysis. A missing hyphen led to the destruction of NASA’s Mariner 1 spacecraft; results of econometric analysis can similarly be impacted.

Mistakes like the above examples can be challenging to identify, even with rigorous quality assurance procedures. A culture of transparency can help mitigate risk. If suspicions arise about certain findings, stakeholders should verify the analysis undertaken by examining the code used to perform the analysis. Ultimately, all errors have some ramifications. While some may be purely academic, others may directly impact a business’s bottom line. In regulated industries, erroneous results might make a difference of millions of dollars. A number of regulators in Australia allow for stakeholders to review the code used in the analysis underpinning their findings. This improves accountability, and allows mistakes to be identified and corrected. This in turn improves the quality of decisions made by regulators.

Data Quality/timeliness

Results of econometric analysis are only as reliable as the source data: garbage in, garbage out. The data may not be appropriate for the purpose it is used for, or perhaps there exists a better dataset, one that is likely to provide more reliable information. Stale data may cease to be useful in determining numerical relationships.

This is not to say that imperfect data is uninformative; data sources often fall short of perfection. But it is important to strive to have the most up-to-date and accurate information whenever practicable.

Improper cleaning techniques

Let’s assume the code has been programmed correctly, and the dataset is appropriate for the query at hand. What else is important? In a typical analysis, the data is obtained from a variety of sources. However, the data is often not in an immediately useable format and usually requires “cleaning”. There may be errors that could have a substantial impact on the results if not corrected. Data may have been inputted incorrectly, perhaps missing a digit. Units of measurement may also be inconsistent between observations - petrol prices may be reported in dollars for some observations and cents for others, distance travelled may be reported in kilometres, or thousands of kilometres. Frontier Economics has encountered and corrected for such errors on a number of occasions.

Ensuring that like is compared with like is important. Rigorous cleaning methods will reduce the chance that errors survive the cleaning process. But such mistakes may not be noticed, instead appearing as outliers or influential observations, impacting results.

Statistical misconceptions

Statistics, and by extension econometrics, is often at odds with intuition. People often have cognitive biases which may lead to incorrect conclusions. Patterns may be seen, when in fact there is no pattern. It is for this reason that it is preferable to employ an approach that satisfies statistical rigour—to separate genuine information from ‘noise’.

Careful attention needs to be paid in the prediction methodology to mitigate the impact of any selectivity biases.

Conclusion

Econometric analysis is not a trivial exercise and there are many potential issues that may undermine any conclusions reached. Hence, it is important not to take work performed by others at face value: a surprising finding may be the result of a tiny coding mistake, errors in the data or inappropriate statistical procedures and statistical reasoning. But when done right, econometric analysis can be a very powerful tool for quantifying economic analyses and underpinning economic and regulatory decision-making.

[1]            “(W)e were able to identify the selective exclusion of available data, coding errors and inappropriate methods for weighting summary statistics”, p.261 in Herndon, T., Ash, M., & Pollin, R. (2014). Does high public debt consistently stifle economic growth? A critique of Reinhart and Rogoff. Cambridge Journal of Economics, 38(2), 257-279.

[2]             “Following advice … that they were unable to replicate some of the findings … a review of the computer programs used to produce the table revealed some coding errors”, p.61 in Wilkins, R. (2015). The Household, Income and Labour Dynamics in Australia Survey: Selected Findings from Waves 1 to 12. Melbourne: Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.

[3]             Economics Regulation Authority (2017), Estimating the Utilisation of Franking Credits through the Dividend Drop-Off Method. available at http://www.erawa.com.au/cproot/17208/2/Secretariat Working Paper - Estimating the Utilisation of Franking Credits.PDF

[4]                 AER, Final Decision Ausnet Services Transmission Determination 2017-2022 - Attachment 3 - Rate of Return, April 2017, p. 403.

[5]                 Stochastic frontier analysis.

[6]                 The specific data requested may not have been recorded for the purposes of regulation in the early years of the sample.

[7]             See Kane and Staiger, The Promise and Pitfalls of Using Imprecise School Accountability Measures, 2002DOWNLOAD FULL PUBLICATION

Infrastructure Australia today released Reforming Urban Water: A national pathway for change outlining advice for governments and regulators around fundamental changes to the governance and regulation of Australia’s urban water markets.

Australia’s urban water sector provides water, wastewater, recycled water and stormwater services to a range of diverse customers across Australia. Each of these services is governed (to some extent) by state and territory based economic, environmental and health regulation, which aim to:

Importantly, these different types of regulation interact when determining the efficient and prudent costs – and ultimately, when determining the prices required to recover the costs of service provision.

However, urban water infrastructure is expensive to build and maintain, and faces a number of challenges over the coming years. In particular, a changing climate and substantial population growth is expected to place significant strain on ageing assets. Reform is required to ensure the sector can continue to provide safe, reliable and affordable services into the future. This will require re-shaping the urban water sector, including the range of institutions, regulatory frameworks and decision-making processes to be more efficient, resilient, transparent and accountable.

Infrastructure Australia engaged Frontier Economics (Asia-Pacific) and Arup to provide advice on the current state of economic, environmental and health regulation in the Australian urban water sector, and the opportunities for regulatory improvement. Our report set out minimum and best practice standards for economic, environmental and health regulation, assessed each Australian jurisdiction against these standards and outlined the pathway for regulatory improvement.

Our analysis and findings informed Infrastructure Australia’s advocacy and reform agenda in the Australian urban water sector and helped identify areas for reform. In particular, highlighting jurisdictions that have advanced with reforming their regulatory structures can help to identify what has worked, barriers to reform and the benefits that these reforms have delivered for operators and customers alike. These lessons can provide vital guidance for states and territories that may be further from best practice in each area of regulation, and establish links across jurisdictional borders to advance important reforms in line with nationally consistent standards.

Frontier Economics regularly advises clients in the water sector, including government, regulators and businesses.

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The Australian Competition and Consumer Commission (ACCC) has cleared the proposed acquisition of OfficeMax Australia by Platinum Equity.

Platinum Equity owns Winc (formerly Staples Australia) and sought to acquire OfficeMax Australia. Both Winc and OfficeMax supply office products to commercial and government customers in Australia. The ACCC issued a Statement of Issues expressing some concerns with the proposed acquisition. Frontier Economics (Asia-Pacific) was retained by lawyers for Platinum Equity to provide economic advice. Frontier Economics provided empirical analysis of demand for product categories and demand by purchaser categories. The ACCC decided that although the merger could lessen competition, it did not meet the threshold of causing a 'substantial lessening of competition'.

Frontier Economics regularly undertakes empirical analysis for clients in competition matters.

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 Will competition be kept in neutral?

The public is increasingly embracing ride sharing. To date, debate has focussed on the implications for the taxi industry. However, ride sharing services, and the technological platforms underpinning them, have the potential to transform public transportation. In this bulletin we explore some coming policy challenges for government.

Most people would now be familiar with ride sharing services such as the smartphone app Uber. At first glance Uber, and its competitors, appear to be a simple variation on a taxi. Passengers select their exact pick-up location, get an indicative price and pick up time and then can track the vehicle once booked. This hides two real innovations. First, these platforms use sophisticated technology to match drivers and passengers which facilitates real time, direct bookings at low cost. Secondly, they use reputational reporting mechanisms to signal quality to passengers. This enables underutilised private cars to provide transport services.

Complements or conflicts?

While ride sharing services clearly compete against taxis their implications for public transport are less clear. Emerging evidence suggests that ride sharing may complement public transport by helping to link passengers to mass transit services. In Australia, most major cities rely heavily on trains to services commuter traffic. But passengers, not within walking distance of a station, typically combine their train journey with a bus trip, taxi trip or driving and parking at the station. These options vary in terms of expedience and cost: bus services can be cheap but infrequent, while taxis and parking are convenient but may be expensive.

Ride-sharing could change this dynamic. A recent Choice investigation found that 9 out of 10 times, an UberX was cheaper than a taxi, on average by 40%.[i] Price falls of this magnitude could enable ride sharing to be a realistic alternative for connecting to transport hubs; and indeed there is some evidence to suggest this is happening. Figure 1 below suggests that a significant proportion of Uber routes in Sydney connect riders to train lines.

So far, so good, for train operations! But ride sharing could have a very different effect on bus patronage. The extent to which passengers substitute away from buses, in favour of ride sharing, will depend on whether the higher cost justifies the increased convenience/timeliness. In the last few years there appears to have been a slowdown in the growth of metropolitan bus patronage. For example in the 2016 financial year Melbourne bus patronage fell by 0.9% compared to an average growth rate of 2.6% pa over the period 2000-13[ii]. While the specific cause of this slowdown is unclear a further fall in ridesharing prices may exacerbate this trend.

Figure 1: Uber trips in Sydney from launch to 27/5/15

Uber extends public transport
Uber extends public transport

Source: Uber’s submission to the ACT Taxi Innovation Review

uberPOOL and LYFT Line

There is the potential for the cost of ride sharing to fall even further with the introduction of pooling services, such as uberPOOL and Lyft Line (now operating in various cities including Singapore, San Francisco and New York, but yet to arrive in Australia). Ride-pooling allows users to share a ride with another passenger and split the cost of the trip. In the case of uberPOOL, passengers book their trip on Uber as normal, but if they select uberPOOL the platform will look to match closely located passengers travelling along a similar route. This arrangement typically adds some time to the trip (on average less than 5 minutes) but reduces the cost for passengers. Uber has stated that uberPOOL now accounts for over 20% of all its rides globally[iii].

Dynamic routing may hold particular promise for passengers wishing to depart from, or arrive at, a common location, such as after disembarking a train. More people wanting to depart from the same place at the same time, improves the efficiency of the routes drivers may take. Hence, ride pooling services hold particular promise in densely populated areas where there are greater prospect for trip commonality.

Much like public transport these services also have the potential to result in more efficient use of vehicles and roads.

Figure 2: Example of an uberPOOL ride

Example of an UberPOOL ride
Example of an UberPOOL ride

Source: Uber (https://www.uber.com/en-SG/drive/singapore/resources/uberpool/)

Uber is now reported to be trialling a variation on UberPOOL called Uber Express POOL. In this service, the app generates a good meeting spot for all trip participants, and provides walking directions –potentially allowing the vehicle to smooth out the route between pick-ups and avoid busy spots. In the San Francisco trial, this brought the cost of an Uber below a bus fare.[iv]

Binning the bus timetable?

These developments have the potential to represent both a risk and opportunity for traditional bus services.  While bus services may face future competition the technology underpinning ride pooling could help reform bus service provision.

On-demand buses are one such possibility. The key feature being flexibility — where the timetable, routes, and even stops can vary depending on demand. The Australian state of NSW is taking up the challenge and has just recently begun trialling select on-demand bus services in Sydney. Here the scope of on-demand services will be restricted to a particular zone, corridor or fixed destination or origin point such as a hospital or train station.

On-demand bus services can increase the efficiency of public transport. However, to be effective, three things are required:

On the third point, existing ride sharing platforms tap into private vehicles and drivers with time to spare. If suppliers cannot (due to a lack of vehicles) or will not (due to insufficient price incentive) respond to demand, even access to technology and sufficient demand will not lead to better public transport.

How can governments facilitate competition?

Whenever the prospect of competition emerges in a previously constrained market, existing policies and regulations come under pressure. This has already occurred in the taxi market. However, our view is that the regulatory changes so far are likely to represent only the beginning of ridesharing’s market disruption.

Many, if not most, public transport services are subsidised. This is typically aimed at either increasing access to transport for disadvantaged members of society and/or reducing congestion and pollution. However, in a competitive market, subsidising one provider but not another, will distort market outcomes and potentially stifle competition altogether. And there is no better way to encourage providers to reduce costs, improve their services and innovate than competition. Ideally, we would preserve competitive neutrality in the early phases of the emergence of on-demand services.

But what does preserving competitive neutrality mean in practice?

First, the most efficient service might not come from an existing bus provider. On demand services involve the provision of transportation services and an intermediary dispatch/booking service which links passengers to the providers. While existing bus providers can procure the technology required to provide the latter, this could result in wasteful duplication of platforms. As an alternative governments could tender out the components of the services separately in order to take advantage of existing platforms and expertise in passenger matching.

Secondly, governments might need to change how they support and procure public transport; from competition “for the market” (via tendered bus contracts) to enabling competition “in the market”. It does not require a big stretch of imagination to see how on-demand buses and ridesharing services may end up competing for passengers. However, the way governments support and provide public transport will have a direct impact on the ability of rideshare services to compete.

For example, instead of subsidising uncommercial routes, to deliver societal goals, governments could introduce:

The effect of this would be that even on uncommercial routes, providers can compete on their merits and consumers can choose between providers.

We understand the majority of the NSW trial on demand bus services will be running by January 2018. It is a bold first step towards a change in the way public transport operates. But given the disruptions likely to be around the corner a bigger shake-up of public transport policies is likely to be necessary. While this is challenging the benefits of getting this right are potentially enormous.

[i]               https://www.choice.com.au/transport/cars/general/articles/uberx-vs-taxi-which-one-is-best. Uber fares can incur price surges in times of high demand for rides.

[ii]               PTV 2016 network statistics and BITRE (2014) Long-term trends in urban public transport

[iii]              As of June 2016 (source: https://www.uber.com/newsroom/upfront-fares-no-math-and-no-surprises/)

[iv]              https://techcrunch.com/2017/11/10/uber-express-pool/DOWNLOAD FULL PUBLICATION

The public is increasingly embracing ride sharing. To date, debate has focussed on the implications for the taxi industry. However, ride sharing services, and the technological platforms underpinning them, have the potential to transform (or disrupt) public transportation. This is due to the innovations delivered by the smartphone apps that ride sharing services use — which facilitate real time, direct bookings at low cost. These apps also enable underutilised private cars to provide transport services. As costs get low enough and are combined with the convenience to passengers, ride sharing will have implications for public transportation, in particular bus services. This new bulletin from Frontier Economics discusses these implications and explores some coming policy challenges for government.

Frontier Economics regularly advises governments and private sector clients regarding policy and regulation in the transport sector.

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For an inquiry by the Australian Competition and Consumer Commission (ACCC) into electricity pricing, Frontier Economics and law firm Herbert Smith Freehills were engaged by AGL Energy to investigate the impact of vertical integration on the bidding behavior of generators in the National Electricity Market. The report is available from the ACCC, referenced in the ACCC’s preliminary report.

The findings support a conclusion that vertical integration is not harmful to supply: vertically integrated generators, those owned by firms that also participate in the retail market, actually bid 4% to 6% more capacity at competitive prices. Moreover, there is no evidence that the market-wide trend towards vertical integration has resulted in bidding at higher prices.

Frontier Economics regularly advises clients in the energy sector in the Asia-Pacific region.

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Since 2008, the Courts have ruled repeatedly that a series of decisions made by the Australian Energy Regulator (AER) have contained material errors that need to be corrected in order to promote the long-term interests of consumers of energy in Australia.

Following a number of recent appeals that once again found the AER had erred in its decisions, the Federal Government has introduced a Bill into Parliament that seeks to abolish limited merits reviews (LMRs) of regulatory decisions made by the AER. The passing of the Bill into law would effectively ban any challenge to the AER acting against the long-term interests of consumers or setting the revenues that regulated energy networks are allowed to earn below their efficient costs. The Turnbull Government’s attempts to remove scrutiny of the AER will increase the chance of political interference in what was designed to be an independent regulatory process.

Frontier Economics’ Managing Director, Danny Price, explains in this submission to the Senate Legislation Committee examining the Bill why abolition of LMR rights would harm, rather than promote, the long-term interest of consumers of energy in Australia.

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