Government interference doomed

21:59, Dec 10 2012

The Telecommunications Act allows internet service providers to either buy access to Chorus' copper local loop and put their own equipment in Chorus exchanges to provide bitstream services (known as the unbundled copper local loop or UCLL), or alternatively they may buy a single access and bitstream service (known as unbundled bitstream access or UBA) from Chorus. Bitstream refers to the transmission of data necessary to enable broadband services to be delivered.

The Commerce Commission last week issued its draft determination on the re-pricing of Chorus's UBA service. The 2011 amendments to the Telecommunications Act, which introduced the structural separation of Telecom, changed the wholesale price for UBA from retail-minus to a cost-based formula, from separation day for new wholesale customers, and three years from separation day for existing customers. This change was a necessary consequence of structural separation, as Chorus would not be providing retail services.

The Amendment Act also changed the UCLL price, which is $19.08 for urban customers and $35.20 for non-urban customers (reflecting the higher costs in non-urban areas) to a single geographically averaged price three years from separation day. The Commission has set that price at $23.53.

It was well recognised, as is clear in the submissions made in the Select Committee hearing on the amendment, that these changes would have a significant detrimental impact on the business case for unbundling copper. It was for this reason the changes to the UCLL rates, and UBA rates for existing wholesale customers, were deferred for three years.

On 30 November 2014 the relativity between UCLL and UBA prices that had been a fundamental feature of the 2006 Amendments designed to encourage copper unbundling would disappear, as the UCLL price increased and the UBA price decreased. ISPs who had unbundled were given three years to achieve a return on the investment they had already made in unbundling, but future unbundling would become increasingly uneconomic as November 2014 approached.

Telecom (which at the time included Chorus) supported both the single averaged UCLL price, and the move from retail-minus to a cost based UBA price, in its submissions to the Select Committee. Its public disclosure documents in relation to the de-merger highlighted to investors that both the UCLL and UBA price would change as a result.

The Commission in its draft determination set the UBA price by benchmarking the price of similar services in comparable countries that use a forward looking pricing methodology, as the Act required. The draft determination, which sets the access price for the basic UBA service (excluding the UCLL component) at $8.93 per month, (compared with the existing retail-minus price of $21.46) will be subject to submissions and cross submissions, followed by a conference of interested parties, before a final determination is made. If Chorus is unhappy with the final determination, it has the right to call for a cost-modelled final price.

The draft price would have come as no surprise to anyone who had read the legislation and understood the industry. The existing retail-minus price was set by reference to Telecom's retail price, and bore no relationship to the costs of providing the service. It was common knowledge in the industry that a cost-based UBA price would be substantially lower than the prevailing retail–minus price. This was clear from the experience of those ISPs who took the UCLL service, and provided their own bitstream service. Their costs to provide that service were substantially less than the retail-minus wholesale price, even though they did not have Telecom's economies of scale. Indeed it was these lower costs that made the business case for unbundling so compelling.

Chorus' response to the draft determination (that it could require Chorus to fundamentally rethink its business model, capital structure and approach to dividends) comes as no surprise. It is now commonplace for parties involved in the Commission's processes to use the media to advance their position.

The Government's response, however, is unprecedented. The Telecommunications Minister "signalled immediate disquiet" on release of the draft determination. The Prime Minister said he would not rule out a law change if the final decision was seen as unfavourable. He stated that the decision could prove problematic for the ultrafast broadband network, because consumers could be discouraged from switching from copper to fibre, and it would substantially reduce Chorus's income, "and its capacity around broadband".

The Government's statement was picked up by rating agency Standard &Poor's, which said it expected the draft decision would be "subject to significant political deliberation" as it could affect the take up of fibre services over the Government's ultrafast broadband scheme, and "accordingly, in our view, it is likely the draft UBA decision will be subject to amendment before it becomes final".

It is a fundamental principle of our telecommunications regulatory regime that the regulator is independent, and is left to carry out its statutory role without interference or undue influence from the Government. The Government, by entering into the media debate, and criticising the draft determination in such clear terms that a rating agency has concluded the issue will be resolved politically, has crossed that line. Its position is not helped by its clear conflict of interest as financier of Chorus's UFB roll out, and an investor in the other UFB local fibre companies.

There is no doubt that the migration from copper to fibre is a major challenge facing countries that are rolling out national broadband networks. Singapore and New Zealand decided to leave migration to fibre to market forces, and a similar approach is being adopted in Europe. However, the low uptake of fibre is a major cause of concern – in Singapore it is less than 15 per cent, and the latest figures from Europe show uptake at less than 20 per cent.

Australia, uniquely, recognised that universal take up was critical to the success of NBNCo. and that a copper to fibre migration strategy needed to be part of the national broadband plan. The Australian Government accordingly agreed commercial terms with Telstra for it to decommission its copper network as the fibre passed premises. New Zealand specifically rejected the Australian approach because of its cost.

The New Zealand policy is that copper will be a competitive constraint on fibre, with uptake determined by market forces. If copper prices are set above cost to encourage fibre uptake, they will no longer constrain fibre prices, and uptake will no longer be market driven.

Furthermore, a moment's consideration shows that a policy of artificially increasing the wholesale UBA price to encourage fibre uptake is doomed to fail.

Firstly, if the Government were to change the legislation, what pricing standard would it adopt? How much higher would it need to be to be "favourable" - how high will the price have to be to encourage consumers to switch from copper to fibre, and increase Chorus's capacity around broadband.

Secondly, and somewhat perversely, the greater the increase in the regulated wholesale price, the more the business case for further unbundling improves. As the difference between the unbundlers' cost (which is not affected by the wholesale price of Chorus's UBA service) and the new above cost wholesale price widens, the available market grows. Copper based services from the unbundlers would not increase in price, and the fibre subsidy paid by customers where unbundling was not available would be plain to see.

Thirdly, for many of those customers, fibre based services would not be available for many years, if at all; they would be paying a higher price for copper services for many years to encourage them to take up a fibre service which did not exist.

At the recent ITU Telecom World 2012 conference in Dubai, a panel of investors discussed the preconditions required for telecommunications investment. The first and most important condition they identified was regulatory independence – the highest risk profile was assigned to jurisdictions where the regulator was subject to political direction or influence. Following last week's events, the issue of attempted undue political influence in the context of New Zealand is being discussed for the first time.

Dr Ross Patterson served a five-year term as Telecommunications Commissioner with the New Zealand Commerce Commission, ending in July this year. He is currently chairman of Akhet Consulting in Dubai.