Government intervention on copper prices hands Chorus 'windfall gains', Vector says

Thursday 17th October 2013

The government's proposed intervention limiting the cut in wholesale prices on Chorus's copper network will grant the telecommunications company "windfall gains", according to fellow regulated monopoly network operator Vector.

In a submission on law governing the telecommunications sector, Vector says the government's proposal to set copper access prices would let Chorus extract a return on investment of 20 percent in the 2014/15 financial year, rising to 25 percent by 2019/20. Vector has based that figure on publicly available information using the Commerce Commission's Part 4 price determination models, the structure it uses to set pricing for airports and electricity and gas distribution firms.

That compares to permitted returns of 8.8 percent for electricity lines companies, 7.4 percent for gas distribution operators, and between 7.1 percent and 8 percent for airports.

"If the government sets Chorus' copper access prices at above cost levels (equal to the agree price for roll-out of a fibre network), Chorus would receive windfall gains," Vector said in its submission. "This would heighten the value of its copper access network."

Chorus would have more incentive to keep customers on its copper services rather than switching them on to the fibre network, the opposite of the government's intention to intervene, it said.

"If the government overrules the Commerce Commission copper access price determinations, it should consider mechanisms to remedy this incentive problem such as tying higher copper access prices with more aggressive UFB roll-out KPIs," Vector said.

Communications Minister Amy Adams sought a review of law governing the sector after Telecommunications Commissioner Stephen Gale proposed sharp cuts to the regulated price of unbundled bitstream access, a copper-based service, something the government viewed as undermining the economics of the fibre network it is bankrolling.

The proposed cuts to UBA pricing came after a three-year freeze and were seen as a way to offset the national averaging of the price of unbundled copper local loop access, which effectively increased prices for urban customers, accounting for about 70 percent of users as part of a proposed transition period.

In an August report, brokerage Craigs Investment Partners said the review was a positive for Chorus, whose share price plunged on the regulator's proposed price cut path, though wouldn't necessarily let the network operator retain its dividend at 25 cents per share.

Chorus shares fell 0.8 percent to $2.57 today, having dropped 12 percent this year. The stock is rated an average 'hold' based on nine analyst recommendations compiled by Reuters, with a median target price of $3.05.

Vector opposes government intervention for regulated copper network wholesale prices, which it claims would harm regulatory certainty and set a "dangerous precedent."

"Transparent criteria for government intervention is needed for stability, transparency and certainty," Vector said. "The proposal for government intervention is not based on any evidence of a problem."

If the government persists with its course to intervene, Vector says a better option would be to impose a levy on top of the prices set by the regulator to prevent a "hidden wealth transfer to Chorus."

Vector rejected Ministry of Business, Innovation and Employment assertions that the proposed regulated price cut would create uncertainty and destabilise the migration to fibre, saying there was no proof of any of those problems in the discussion document.

Chorus entered into the contract to build the fibre network with Crown Fibre Holdings willingly and "must have been well aware that the Commerce Commission copper access pricing determinations could result in significant price reductions when it entered into the UFB bid process," Vector said.

That risk was highlighted to investors in the 2011 scheme of arrangement document outlining the carve-out of Chorus from Telecom Corp for investors.

Regulation of copper pricing was cited as a risk which would prevent the network operator making "an adequate return on its assets" and if they were set "significantly below the prices for comparable fibre-based services, fibre uptake may be negatively affected," the document said.

BusinessDesk.co.nz

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