Tuesday, 10 December 2013

My Christmas deathwish for TSLRIC

The government is reported to be reviewing "Commerce Commission laws" in the wake of the Chorus debacle and following concerns expressed by a grumpy foreign investor (who, incidentally hasn't been interested in NZ for some time).

This is worrying because it seems rushed. However there definitely are improvements that could be made, so in the spirit of constructive engagement here is what I'd be thinking about. For simplicity I'll refrain from considering the s36 problem and stick with telecommunications.

A good start would be to admit that TSLRIC is a silly concept for pricing access to a monopoly network. Investors and consumers would both be better off if it was scrapped. Here's why.

TSLRIC is a way valuing network assets at their replacement cost. To make it work, you first decide how the network would be rebuilt (architecture, equipment, installation, commissioning etc) if it was destroyed (yes, it really is fictional). Then you estimate the cost of doing that rebuild today.

This is hugely time-consuming and expensive. Last week, the Commission got started on a TSLRIC process for copper network services that "international experience suggests...can take some years".

It's not just slow and costly though: the outcomes are also very uncertain. For example, if the Commission decides to (notionally) rebuild the copper network, it will need to pick a price for copper wire. As the graph shows, copper prices are not exactly stable.

So we have hard-wired into the Act some very significant risks for both investors and consumers. This is a recipe for very big and expensive fights, not to mention political lobbying around the fringes.

Why do we have such a thing embedded in our Act? The best reason is that some of the services being regulated (UBA for example) can be supplied by competitive firms. In that case, regulating at replacement cost preserves an incentive for competitive investment. So it is not always utter madness.

But for most of what Chorus sells, there is a cheaper, less risky and more stable alternative form of regulation. It goes by a few different names (RAB, building blocks, rate of return regulation) but the key point is that the assets are not valued at their new build cost. Instead, we strike an asset value at the start of the regime and stick with it, updating each year in line with extra capital investment and depreciation. Then, when arguments arise, it doesn't take years to estimate the asset's value. And there are no massive risks to consumers or investors from volatility in things like the price of steel, exchange rates and other things that would be needed to build a new network.

This is still regulation and so its still difficult to do it well, but it is a much better approach for monopoly network assets. The Australians saw the light a few years ago, and its about time we admitted they were coughrightcough.

And now I'm really going to tempt fate. There has been a massive regulatory effort going on in NZ to design "input methodologies" for regulating monopolies like electricity power lines, gas pipelines and a few big airports. This seemed like a good idea in 2008, and it probably still is. One of the big changes that the Commission is making in this process is to abandon replacement cost valuations for these monopolies. What I'm suggesting here is simply the extension of that model to telecommunications monopolies. [This is tempting fate because we are still awaiting the High Court's judgement on appeals to these methodologies.]

The only losers would be consulting economists and lawyers who would just have to find something more productive to do :)

I should add that while TSLRIC is a dragon worth slaying, doing so would only be the first step in reform. While we do have a lot of the alternative machinery in place, it would take some time and effort to get it configured properly to apply to Chorus, and there would be plenty of potential for mischief along the way.

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