The Competition Appeal Tribunal (CAT) has issued an interim judgement in Albion Water Limited's appeal against the Director General of Water Services' decision to reject its complaint under Chapter II of the Competition Act 1998, setting out the framework within which it anticipates finally resolving the appeal.

Introduction

Albion Water Limited (Albion) complained to the Director General of Water Services (the Director) that Dŵr Cymru Cyfyngedig (Dŵr Cymru) had infringed the Chapter II Prohibition in relation to the price offered by Dŵr Cymru to Albion for the "common carriage" of non-potable water across a part of Dŵr Cymru’s water transportation network known as the Ashgrove system. The Ashgrove system serves Albion’s only customer, Shotton Paper Mill (Shotton Paper) as well as Corus Group, which is a customer of Dŵr Cymru.

The Director rejected the complaint and Albion appealed to the CAT. The CAT issued an interim judgement on 22 December 2005, setting out a framework within which it anticipates finally resolving the appeal. The CAT did not consider it possible to reach a final judgement at this stage pending clarification of certain further factual/economic issues.

Background

At present, Albion (which has an inset appointment at the Shotton Paper site) purchases bulk water from Dŵr Cymru at the boundary of Albion’s inset appointment area. Dŵr Cymru, in turn, purchases raw water from United Utilities (UU) (which operates an adjoining water network), transports this water into the Dŵr Cymru network, treats the raw water in its own water treatment works and then transports it on to Albion via the Ashgrove system.

Albion wishes to acquire the water in question directly from United Utilities and then resell the water to Shotton Paper, paying a common carriage charge to Dŵr Cymru for the transport of the water to Shotton Paper via the Ashgrove system (in effect, replacing Dŵr Cymru as the intermediate supplier between United Utilities and Shotton Paper). The viability of Albion’s proposal is highly dependent on the level of the common carriage price charged by Dŵr Cymru for the transport of the water in question. Albion's complaint to the Director arises out of the concern that the price offered by Dŵr Cymru is unreasonable and, thus, abusive within the meaning of the Competition Act 1998.

The de facto retail price offered by Dŵr Cymru to Shotton Paper was 26p/m3. Albion had negotiated a price of 9p/m3 for water from UU. Albion had initially been offered a common carriage price of 23.2p/m3 by Dŵr Cymru. This would have resulted in a total cost to Albion of 32.2p/m3, effectively leaving no room for any margin to be charged to Shotton Paper. This, in Albion's submission, amounted to an abusive 'margin squeeze'.

The Director's rejection of the complaint

In his decision rejecting the complaint, the Director took the view that Dŵr Cymru was, amongst other things, not guilty of a margin squeeze. In reaching this conclusion, the Director observed that the common carriage price offered by Dŵr Cymru was very similar to that (22.5p/m3) which would have been justified under a form of 'retail minus' approach to abusive pricing known as the 'efficient component pricing rule' (ECPR).

The CAT's interim judgement

In its interim judgement, the CAT made a number of observations regarding both the Director's use of an 'average accounting costs' (AAC) approach and his use of an ECPR approach in analysing the abusive potential of the common carriage price offered by Dŵr Cymru. The observations with respect to ECPR are perhaps the most interesting.

The CAT considered that it required to hear further evidence on the operation and impact of this principle before reaching a final view on the compatibility of the Director's use of the ECPR approach with the Chapter II Prohibition.

However, in its interim judgement, the CAT cast significant doubt on the approach taken by the Director – and the appropriateness of the ECPR in assessing the alleged margin squeeze. In particular, the Tribunal considered that the use of such a rule was inconsistent with the governing Community law decision-making in this context.

According to the CAT:

"It appears to us that there is a clear potential conflict between the approach of the Commission […], on the one hand, and the ECPR approach used by the Director in the Decision on the other hand. The European Commission’s approach looks at the difference between the price charged for the upstream input (common carriage) and the downstream retail price in order to determine whether an equally efficient competitor could compete with the dominant firm in the downstream market. If there is insufficient margin between the downstream and upstream prices, then at first sight this may constitute an abuse unless it can be justified on efficiency or other grounds. The ECPR rule, however, looks at the avoided costs of the dominant firm, and prescribes that entry can take place only if the entrant is more efficient than the dominant firm to the extent that it can fund the full cost of entry out of a margin calculated by reference to the dominant firm’s avoided marginal costs" (para. 395).

Moreover, the CAT took the view that, whilst the ECPR was of value in ensuring that incumbents’ common costs are fully funded and that stranded assets are avoided, there remained a number of concerns as to whether – leaving aside the apparent inconsistency with Community law – an ECPR approach is compatible with the introduction of effective competition, viz: (i) the risk of entrenching monopoly rents or inefficiencies in the retail price; (ii) the possible lack of the dynamic effect of competition, resulting from the fact that the incumbent is indifferent as to who supplies the customer; (iii) the raising of barriers to entry; (iv) the risk of a price squeeze; and (v) difficulties in identifying the “minus” element in the retail-minus calculation.

Looking ahead

The CAT noted in its interim judgement that, in reaching a final decision in the appeal, it would need to consider not only the further submissions of the parties on the ECPR, but also the interaction of the Chapter II Prohibition and the 'costs principle' enshrined in section 66E of the Water Industry Act 1991.

According to section 66D(3) of the 1991 Act, the common carriage charges levied on water supply licensees in England & Wales must be set in accordance with this costs principle. Crucially, the costs principle essentially reflects an ECPR approach.

It will be for the CAT to decide, in its final judgement, whether and to what extent, section 66D (and the costs principle) may 'trump' the requirements of the Chapter II Prohibition.

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