In the Matter of Fortescue Metals Group Limited

Justice Finkelstein
Mr Grant Latta
Prof David Round

[2010] ACompT 2

Australian Competition Tribunal (first hearing)

Briefly

The Tribunal (1) affirmed the deemed decision of the Treasurer not to declare the Mt Newman line; (2) varied the decision of the Treasurer to declare the Robe line to reduce the access expiry date from 2028 to 2018; (3) set aside the decision of the Treasurer to declare the Hamersley line and (4) affirmed the decision of the Treasurer to declare the Goldsworthy line.

On whether criterion (a) was satisfied - access would promote a material increase in competition in at least one other market:

For 'each service except the Mt Newman service, access would promote a material increase in competition in a rail haulage market' (para 17 summary) but not in the other markets claimed by Fortescue (the Pilbara tenements market and the seaborne iron ore market)

On whether criterion (b) was satisfied (uneconomical to develop another)

Tribunal held that this criterion tests 'whether a facility has natural monopoly characteristics' and held that all lines but the Mt Newman line were natural monopolies. The Tribunal rejected the previously favoured 'net social benefit' test in favour of the 'natural monopoly' test.

On whether criterion (f) was satisfied (not contrary to public interest)

The Tribunal held that in making the public interest assessment it was 'necessary to weigh up the benefits and costs of access to society, going forward.' The key benefits from access included '(1) savings from sharing the existing railways rather than duplicating them; and (2) making rail services available for some mining projects ...' (summary page 19).

There would, however, be significant costs resulting from access. 'Where there was high demand for a line, there would be severe logistical and commercial constraints imposed on third parties to ensure there was no interference with the owners' highly flexible business models. Access would also delay the owners' future expansions plans or changes in operating practice or technology. This could result in billions of dollars of lost export revenues.' (summary page 20)

The balance of cost/benefit varied between lines, largely because of intensity of existing use and potential for additional demand. The costs from access to Mt Newman or Hamersley were likely to be so great that access would be contrary to the public interest. The benefits from access to Goldworthy and Robe would, however, outweigh the costs and so access would not be contrary to the public interests.

Extracts (on the promotion of competition (criterion (a))

Overview

[1007] The objectives of Part IIIA cannot be achieved directly by, for example, an edict that a firm must be efficient or innovative. Instead, the legislation operates indirectly by the regulation of the conduct of firms in a way that will affect how they perform. The implicit assumption is that regulating a firm’s conduct will affect market behaviour in a way that will bring about the stated objectives.

[1008] The principal way it is thought the objectives will be achieved is by promoting competition. Hence criterion (a), which provides that a service should only be declared if access to the service will “promote a material increase in competition in at least one market … other than the market for the service”. This criterion introduces two concepts from industrial organisation: “market” and “competition”. It raises the following questions: (1) What is a market?; (2) What is competition?; and (3) What is required for competition to be materially increased?

17.2 Market definition

[1009] ... to a businessperson, a market is a place or area where goods may be sold or, more broadly, where there are people who are sufficiently aware of a firm’s product to consider buying it. This concept of a market concentrates its attention on buyers rather than sellers.

[1010] We are not here concerned with the businessperson’s understanding of a market but rather with the analytical definitions developed by economists. Several classical economists have offered definitions. Cournot defined a market as: “The entire territory of which parts are so united by the relations of unrestricted commerce that prices there take the same level throughout, with ease and rapidity” ...

[1011] This economic (or relevant) market, then, consists of groups of buyers and groups of sellers in a geographic region who seek each other out as a source of supply of, or as customers for, products. The interaction of the buyers and sellers determines the price for the products.

[1012] We have not referred to a “group” of products because implicit in the classic economists’ definition of a market is the assumption that there is only a single homogeneous product and that the firms in the market produce perfect substitutes.

[1013] In the real world it is not only homogeneous products of rival sellers that affect price; price is also affected by the products of rival sellers that are close substitutes. Hence it is necessary to expand the definition of a market to include not only identical goods but also close substitutes.

[1014] The output of the process of defining the relevant market – the identification of the participating firms, a description of the products exchanged and the borders within which the exchange occurs – is critical to an assessment of the behaviour of firms in the market (ie whether or not they impose competitive constraints upon one another) and, importantly, whether or not a firm has, or a group of firms have, power to control price or reduce competition (ie to shift the price away from that which would be obtained in a competitive market, namely the marginal cost of the product).

[1015] In QCMA (at 517), the Tribunal defined a market to be a "field of rivalry" between firms in which there is "substitution between one product and another, and between one source of supply and another, in response to changing prices."

[1016] Section 4E was introduced in 1977 to give statutory recognition to the concept of substitution. It provides that "for the purposes of this Act, unless the contrary intention appears, 'market' means a market in Australia and, when used in relation to any goods or services, includes a market for those goods or services and other goods or services that are substitutable for, or otherwise competitive with, the first-mentioned goods or services."

[1017] It is often difficult, and sometimes impossible, to define with any precision the relevant dimensions (product, geographic, functional and temporal) of a market. On occasion, it can be particularly difficult to describe the relevant product market and its geographic borders. The process often involves judgments as to matters of degree that can be difficult to measure.

[1018] As regards the product market, the notion of substitution refers on the demand side, to a customer’s practical ability to switch from one product to another and, on the supply side, to the capacity of a supplier to switch production from one product to another. There are various conventional approaches to determining substitutability. [emphasis added]

[1019] The first significant approach developed by the courts and leading economists in the US is the “reasonable interchangeability of use or the cross-[price] elasticity of demand between product itself and substitutes for it”: Brown Shoe Co. v United States 370 US 294 (1962) at [15]. Cross-price elasticity of demand measures the extent to which consumers will change their consumption of a product in response to a price change in another product. A high cross-price elasticity value suggests that products are good substitutes and are probably in the same product market.

[1020] Reasonable interchangeability of use is established by looking at actual and potential buyer substitution patterns. Relevant evidence will include product characteristics (including differences in grade or quality), price differences (including price trends), past buyer responses, the views of firms regarding who their competitors are, and the existence or absence of different distribution channels. [emphasis added]

[1021] On the supply side, cross-price elasticity is also relevant. Products will be in the same market if a firm can readily switch production from one product to another. What is important is the ease with which the switch can take place. It may be immaterial that consumers do not regard the products as substitutes, that a price difference exists, or that the prices are not closely correlated. [emphasis added]

[1022] The geographic market is the area of effective competition in which sellers and buyers operate. What is relevant, as a starting point, are actual sales patterns, the location of customers and the place where sales take place, and any geographical boundaries that limit trade. But it is not sufficient to measure only historical and current market behaviour. It is also necessary to consider whether customers would readily turn to more remote suppliers in response to a price increase by local suppliers or whether remote suppliers would choose to enter the local market.

[1023] In the United States, geographic markets are occasionally defined based on shipment flows. ...

[1024] A more recent (and increasingly popular) approach is to define a market as a group of products and a corresponding geographic area within which a hypothetical monopolist would be able to raise prices profitably. ...

[1026] The hypothetical monopolist test has been adopted by the ACCC. ...

[1027] The test works this way. One looks at the effect of a price increase on a single product. If so many buyers would shift to alternative products that the monopolist would find the price increase to be unprofitable, the group of products is too narrow to constitute the market. The market should include all those products for which the hypothetical monopolist’s price increase would be profitable.

[1028] The factors that the guidelines use to determine whether the test is satisfied are conventional. The factors include buyers’ perceptions, similarities and differences in price movements between different sets of products over a period of years, similarities or differences in product characteristics and evidence of sellers' perceptions.

[1029] The test for the existence of significant market power is phrased in terms of the magnitude of the price increase that could be imposed by the hypothetical monopolist. It is generally accepted by both US and Australian regulators that a price increase is significant in size and length if it is at least 5% (sometimes 10%) and for at least one year, but there is flexibility in both the magnitude and the time period. It should be noted that these are not tolerance levels for anti-competitive price increases; they are merely a benchmark for assessing substitution. [emphasis added] ...

[1031] Geographic markets are defined in an analogous manner. One identifies tentatively a small geographic area such that a hypothetical firm that is the only present producer of the relevant product or service is not able to profitably impose a price increase. If the product or service could be obtained elsewhere, an attempt to raise the price could not be profitable and the tentative geographic area would be too small. The geographic area is expanded until the hypothetical monopolist’s price increase would be profitable.

[1032] The hypothetical monopolist definition was designed to satisfy three objectives: (1) To connect the relevant market in antitrust case law to economic policy justifications in merger cases; (2) To arrive at a standardised definition of a market; and (3) To develop a test that fell within existing jurisprudence that relied on the product and geographic dimensions of a market.

[1033] The hypothetical monopolist test has its critics. ... The test is, in essence, a "thought experiment". ... But the trend is towards acceptance of the test ... not only in merger cases, but wherever it is necessary for competition purposes to define the boundaries of a relevant market ...

[1034] Notwithstanding the criticisms, or in spite of it, the hypothetical monopolist test has gained currency in Australia ... [emphasis added]

17.3 Vertical integration

[1035] Vertical integration raises difficult issues about market definition and the identification of market participants. ...

[1036] In her important paper, "Market Definition Issues in Australia and New Zealand, Trade Practices Litigation" (1990) 18 Australian Business Law Review 86, Professor Brunt (a former member of the Tribunal) said (at 122) that: "Where there are such efficiencies of vertical integration [within the relevant organisation(s)] … market coordination between buyers and sellers is superseded by in-house coordination. There would, in such a case, be no functional split to create market transactions between stages of production". It is necessary to examine this proposition closely and in different circumstances. In all circumstances, it is assumed that the good or service supplied in-house is a good or service which could, without major adaptation, be sold to a buyer for at least marginal cost.

[1037] First, assume there are existing vertically separated sellers (ie non-in-house sellers) of that good or service. The presence of vertical separation may be sufficient to conclude that there is a separate functional market. Evidence of actual market transactions by vertically separate firms is strong evidence of the existence of separate functional markets. But some care must be taken in reaching that conclusion. There may be unusual circumstances, such as where there are very few market transactions, to negative the conclusion of a separate market.

[1038] Accepting there is a separate functional market, the question that then arises is: Should the in-house producer be included in that market? The in-house producer should be included in the dependent market if a hypothetical monopolist of vertically separated supply could not profitably increase its price. ...

[1039] There is another way in which the vertically integrated producer can be treated. It can be excluded from the market but taken into account when analysing competition in the market because it acts as a constraint on market participants. The better view is that if the vertically integrated producer responds directly or indirectly to a price increase, it should be included in the market because it is in competition (whether directly or indirectly) with the other firms in the market. [emphasis added]

[1040] Another question that arises is: Should two stages of the supply chain be “collapsed” into the same functional market? This question comes up when the constraint is indirect. For example, vertically integrated retail firms may consume only their own wholesaling services, while vertically separated retailers may consume only vertically separated wholesaling services. Although there is no direct competition between vertically integrated and vertically separated wholesalers, they indirectly constrain each other’s behaviour. To explain, if a vertically separated wholesaler increased its prices and the vertically separated retailer passes this price increase on to consumers, the vertically separated retailer would lose market share to the vertically integrated retailer, who would consume more of their in-house wholesale services.

[1041] It is when activity at one functional level (eg retail) constrains activity at another level (eg wholesale) that one may ask whether transactions at the two levels should be treated as being in the same market. Although the approach in merger cases has not been uniform, the answer has generally been in the affirmative. We believe, however, that it is preferable to find there to be separate markets, otherwise the market would consist of some firms that compete with each other (eg the vertically integrated retailer and the vertically separated retailers) and others that do not (eg the vertically separated wholesalers and the vertically separated retailers). This would be at odds with a commercial view of markets, as vertically separated suppliers at the two levels would not see themselves as part of a combined market. It would also be at odds with the approach taken to determining product and geographic markets, where the aim is to include substitution possibilities within the same market and exclude other products and geographic areas. In any event, as the two functions are usually complements and not substitutes, they ought not to be included in the same market. Instead, each functional market should be treated as relevant to the way in which vertically integrated firms constrain the market power of vertically separated firms, and vice versa. [emphasis added]

[1042] Why does it matter whether vertically integrated firms are included in the market or whether a functional split is created between two processes in the supply chain? It is true that in merger cases and abuse of market power cases, whichever approach is taken is unlikely to change the result. In Part IIIA cases, however, the distinction is critically important because the promotion of a material increase in competition will only satisfy criterion (a) if it occurs in a market other than the market for the service. We have explained why, in our view, it is preferable to place only “competitors” (ie those who act on and react to a direct or indirect constraint) in the market. While the purposive approach to market definition means that it is possible for divergent tests to be applied to different sections of the Trade Practices Act, the purpose of market definition in Part IIIA, s 46 and s 50 cases is to allow for an analysis of competition. This rather suggests that the approach to market definition should be uniform. [emphasis added]

[1043] The second circumstance in which to consider whether there is a functional split is where there are no existing vertically separated sellers of the good or service. Can it then be said there is a market for that good or service? Economists start with the proposition that without transactions there can be no market. We will in due course show that this proposition, correct though it might be, cannot survive the legal analysis that has been applied under the Trade Practices Act to the theory of a market. Under that theory, if there is evidence that a good or service could profitably be sold, there is a market for that good or service. Thus, there will be a functional split in markets if: (1) there is a demand at a particular functional level; (2) there is a real possibility that the demand can be satisfied; and (3) the supplier is able to recover at least the marginal cost of supply at that functional level. [emphasis added]

[1044] The Tribunal's approach in the past has been to find "no functional split" when vertical integration is "inevitable" or "overwhelmingly efficient". ...

[1045] This approach is consistent with the NCC's view that for a functional split, "vertical integration … [must not be] inevitable" ... and also with the ACCC’s 2008 Merger Guidelines, where it said there will be no functional split if "there are overwhelming efficiencies of vertical integration" [para 22] ...

[1046] It is easy enough to ask whether the in-house provision of a particular good or service is always more profitable than if it is purchased from a third party. ... The problem is that the information required is rarely available.

[1047] For that reason, it may be helpful to examine a number of proxies that can be used to help come to a decision. First, evidence of functional splits in similar situations will be relevant to show that a functional split is possible in some circumstances. Second, examining firms' demand preferences will help to ascertain whether firms believe that it is possible to participate at one level of the supply chain and not the other. As firms are profit-motivated, absent any ulterior motive, firms' intentions are likely to be a reliable proxy.

17.4 Will access promote competition

17.4.1 With or without test

[1048] Criterion (a) is forward looking.  It involves a comparison of the future state of competition in the relevant market with access to the service and the future state of the competition without access ...

17.4.2 Competition

[1049] In considering the meaning of competition it is, we think, necessary to draw a distinction between, on the one hand, the process of competition and, on the other, the extent of competition, which is the outcome of that process.

[1050] In economics, the word “competition” (as a process) has many meanings. Stigler’s well-known definition is “rivalry between individuals (or groups or nations) and it arises whenever two or more parties strive for something that all cannot gain”. Under this definition, competition refers to behaviour, and especially to patterns of business behaviour. Relevantly, it relates to behaviour that may affect the price or quality or conditions of sale of goods exchanged in the relevant market. Hence competition may be described as rivalry that amounts to a process that leads to an increase in economic efficiency.

[1051] The The extent of competition is another matter. Economists describe markets as perfectly competitive, effectively competitive or imperfectly competitive (such as monopolies or oligopolies). ...

[1052] ... Professor Brunt says there is effective competition where "the availability of substitutes, both in demand and supply ... act as constraints on each individual firm's market power." [Brunt, "Market Definition Issues in Australia and New Zealand, Trade Practices Litigation" (1990) 18 Australian Business Law Review 86 at 96]

17.4.3 Access

...

[1058] the Full Court said that the correct comparison is "of the future state of competition in the dependent market with a right or ability to use the service and the future state of competition in the dependent market without any right or ability or with a restricted right or ability to use the service ... [T]he terms of s 44H(4)(a) do not incorporate the requirement for comparison with what is factually the current position in any given circumstances": Sydney Airport (No 2) at [83]-[84].

[1059] Given the Full Court’s approach, "access" in criterion (a) means access simpliciter ie the right or ability to use the service. It does not mean the right or ability to use the service under Part IIIA. ... it would be inappropriate for the Tribunal to surmise what the terms and conditions of access might be as a result of an arbitration under Part IIIA.

17.4.4 Promote competition

[1060] How does an act, for example access to infrastructure, promote an increase or, now more correctly, a material increase in competition? In Sydney Airport (No 1), the Tribunal said (at [107]) that "the promotion of competition involves a consideration that if the conditions or environment for improving competition are enhanced, then there is a likelihood of increased competition that is not trivial" (an approach approved by the Full Federal Court on appeal (at [57]). In Application by Chime Communications Pty Ltd (No 3) [2009] ACompT 4 (at [18]), the Tribunal proceeded on the basis that any increase in competition must be "socially-useful".

[1061] A particular act will have the tendency to promote a material increase in competition in a socially useful way if sellers are given greater freedom to engage in rivalrous behaviour, or if the act will cause an increase in the number of rivals coupled with a move to more independent behaviour. Often the inquiry will come down to this: Will the act (eg an alteration to an aspect of market structure or a change in a firm’s conduct) increase the constraints on the market power of sellers or, more directly, will it increase their rivalry in a way that will produce greater efficiency? If the answer is in the affirmative, the act will promote an increase in competition. [emphasis added]

[1062] What are the practical indicia that would lead to the conclusion that an increase in competition will be promoted? They would include a likely increase in the number of sellers (although that may not necessarily be a sufficient condition), a restraint on anti-competitive conduct such as price fixing or predatory pricing or the creation of incentives for innovation. That is, one is looking for a change that will force sellers to outsell, or attempt to outsell, their rivals in the relevant market, on pain of losing market share if they do not change their competitive strategy. One might also look for a stream of rivalrous initiatives that compel responses. [emphasis added]

[1063] The ability to examine these indicia has been reduced by the Full Court decision. On one view (which is of the NCC’s view), the decision means that satisfaction of criterion (a) is to be determined without regard to factors such as whether access will be taken up; the terms and conditions that might be imposed on the grant of access; and the number of firms that will take up access and the extent to which they will utilise access.

[1064] We do not believe that the Full Court intended to ignore any consideration of whether access would be taken up. While the Full Court made clear that the approach to criterion (a) is not to infuse "an overly elaborate body of considerations into that criterion", it could not have intended for the approach to be entirely theoretical. ... Whether or not access will be taken up is also, we think, an essential consideration. [emphasis added]

[1065] ... It is also possible the Full Court proceeded on the basis that the mere possibility of access would be sufficient to promote competition. That approach is not dissimilar to what is known as the "contestable market theory". This theory holds that in certain circumstances, the mere threat of entry will constrain even a monopolist from exercising its market power to the detriment of consumers. The necessary condition for a contestable market is that entry is free and exit is costless (ie no sunk costs). It goes without saying, but say it we must, that the markets with which Part IIIA is concerned are as far removed from being "contestable" as may be. ... [emphasis added]

[1066] ... the Tribunal does not adhere to the view that mere access of itself will promote a material increase in competition. What matters is the likelihood of access, the sufficiency of access and the likely timing of access. For the Full Court to hold that it is impermissible to consider whether, when and to what extent, access will be taken up could easily lead to the result that criterion (a) is not satisfied although a close examination of the facts may show otherwise. This result could hardly have been intended. If it was, it is necessary for Parliament to intervene. That said, we accept that in assessing the extent to which access would be taken up, the Tribunal should assume that access is on reasonable terms and conditions, without speculating about any particular terms that might be imposed by arbitration under Part IIIA. [emphasis added]

[1067] A second issue that arises from the Full Court’s decision is whether access must be "essential" or "necessary" to permit effective competition in a related market for criterion (a) to be satisfied. There are passages in the joint judgment which suggest that this is the approach. For example, the Full Court noted (at [86]) that "the essential precondition discussed [in the enacting history] was that access ... was necessary to permit effective competition in a downstream or upstream market." ...

[1068] ... It is apparent from the passages just cited that the Full Court considers that criterion (a) is concerned with effective competition. To reach this view, the Full Court relied on the legislative background. If anything, the view has been strengthened with the subsequent introduction of s 44AA, which now expressly provides that an object of Part IIIA is to promote "effective competition". The position we take is that if a dependent market is already effectively competitive, intervention is not called for. That is, we read criterion (a) as having no application to a market which is effectively competitive. In any event, even if we are wrong in this approach that the dependent market is already effectively competitive, it would be an important consideration under criterion (f) and the discretion.

[1069] Coming back to the "essentiality" requirement, ... If the state of competition with access is the same as the state of competition without access, access is not essential for promoting competition. In most cases there can be no quarrel with this approach. There will, however, be some situations where the result may be unsatisfactory.

[1070] Assume that a facility is a natural monopoly but not a bottleneck. Assume also that the facility could profitably be duplicated, although that would be highly inefficient. Assume finally that either access to the natural monopoly facility or the construction of a substitute facility would equally promote an increase in competition. ... In the assumed case, criterion (a) would not be satisfied.

[1071] We have some reservations about this outcome. It has the arguably perverse result that a declaration must be refused because a highly inefficient duplication of an existing facility would have the same competitive effect as sharing the facility. It is doubtful whether this is what the legislature intended. But we accept that this result cannot be avoided as criterion (a) is presently worded. Still, we think that this is an issue that warrants parliament’s close attention. [emphasis added]

17.5 Dependent market - global iron ore market

[1072] One dependent market identified by [Fortescue] is the global iron ore market. ... Interestingly, all the economists agreed the market was global in geographic dimension.... [emphasis added]

[1081] The first question we must resolve is whether the global seaborne market is already effectively competitive. The market has three main suppliers, Vale, BHPB and RTIO, which supply approximately 30%, 20% and 15% of the market, respectively. In addition, there are many smaller firms. ...

[1082] ... Dr Williams, an economist, described the global iron ore market (perhaps only slightly tongue-in-cheek) as being as close as can be to perfectly competitive.

[1083] The Tribunal accepts that the market is effectively competitive and is likely to continue to be so. ...

17.6 Dependent market - iron ore tenements market

...

[1108] Does the evidence support the existence of an iron ore tenements market? The sole proponent of the contrary view is Dr Williams. He said that iron ore tenements should only be considered as a separate tenements market from the iron ore market if the activities involved in prospecting, initial exploration and development are undertaken by different firms from those that subsequently mine and market iron ore. ...

[1117] What these dealings in tenements and the statements of the mining companies show is that there is both a demand for tenements and sellers willing to meet that demand, including sellers who do not carry out mining operations. It is difficult in those circumstances to deny that there is a functionally distinct market for iron ore tenements. ...

[1118] The geographic scope of the market must be determined.  ...

[1119] Most of the experts accept that the market for tenements is at least Pilbara-wide.  Dr Fitzgerald supported a global market [but] as Mr Houston pointed out, differences in the scale and quality of resources, and different regulatory requirements and business environments, mean that businesses most likely characterise their operations on a region-by-region basis, rather than a global basis.  We believe that the market is most likely Pilbara wide, and not global ...

[1120] It is now necessary to consider whether the tenements market is already effectively competitive.  We think it clear that this is an effectively competitive market.  ...

[1129] ... when we have regard to what would happen in a future without access, it is not possible to conclude that access to any one line would promote a material increase in competition.  What stands in the way of that conclusion is the lines that will likely be constructed if there be no declaration ...

[1130] ... we are not satisfied that providing these tenements with rail options would promote a material increase in competition in the Pilbara-wide tenements market.  In this regard, we note that (1) the market is already effectively competitive, with levels of activity likely to increase in any event; (2) the majority of tenements in the vicinity of the Robe line and the Hamersley line are likely to have alternative rail options without access; and (3) many of the tenements in the Pilbara-wide market would be too far away from the Hamersley line or the Robe line (as the case may be) to be affected by access to either line. 

...

17.7 Dependent market - rail haulage market

[1132] The third dependent market proposed by [Fortescue] is for rail haulage services for iron ore on each line (the product market), the geographic market being the vicinity of each line.  The existence of a separate product market for rail haulage services immediately gives rise to the question whether, in a vertically integrated operation of which rail services are but one part, that part can be treated as functionally discrete for market analysis purposes.  This also raises the question whether there can be a market when there are no market transactions and, on the supply side, the putative seller is unwilling to enter into any transaction.

[1133] It is convenient to deal first with the second issue:  Can there be a market for a product or service absent any market-based dealings in that product or service?  In QCMA (at 517), the Tribunal accepted that a market was delineated by "the field of both actual and potential transactions between buyers and sellers among whom there can be strong substitution, at least in the long run" (emphasis added).  We think that the statement that market participants include both actual and potential buyers and sellers is uncontroversial.  The existence of potential buyers and sellers can in many cases affect the price and non-price decisions of actual buyers and sellers.  In those cases, it would be wrong to exclude potential buyers and sellers from consideration.

[1134] Here, the issue comes about because there is no actual buyer or seller of the particular service.  All that exists are potential buyers and sellers.  Is that sufficient to conclude there is a market?  There are many economists (probably most) who would answer this question in the negative. Professor Hausman put the point quite starkly.  He said: "For a market to exist there must be both willing sellers and willing buyers.  If no willing sellers exist, a market does not exist."  ...

[1135] The High Court has laid down that in some circumstances, a relevant market will exist even though there is an absence of transactions between a willing seller and a willing buyer.  In Queensland Wire Industries Proprietary Limited v The Broken Hill Proprietary Company Limited (1988) 167 CLR 177, the question was whether BHPB’s refusal to supply wholesalers with products known as "Y-bars" contravened s 46 of the Trade Practices Act.  That section proscribed a firm from taking advantage of its substantial power in a relevant market.  The Full Federal Court had held that because there never had been a market for Y-bar, it was not possible to attract the operation of s 46.  The High Court disagreed. 

[1136] The consequence of Queensland Wire is that Professor Hausman's position, no doubt correct from an economist's standpoint, cannot survive the established legal framework.

[1138] Turning now to the question whether there is a separate functional market, it is our view that the evidence of a separate haulage market is made out.  First, the various examples of below rail and above rail separation in other regions of Australia demonstrate that a functional separation is possible in some circumstances.

...

[1141] ... once again assuming that it is appropriate to treat a haulage market as functionally separate from the incumbent's other activities, the only element of an economist’s definition of a market that is missing, actual transactions, is missing because the potential supplier, a monopolist, has power to withhold supply.

...

[1143] So far as the product dimension of the haulage market is concerned, we have explained that trucking is not generally an effective substitute for rail haulage ... Whether the product market extends to haulage on other lines will depend on the nature of the other line. Clearly, another haulage service that ends at a different port is unlikely to be a substitute for many miners. On the other hand, haulage services on the Mt Newman line and Chichester lines ... are effective substitutes because both would originate and terminate within close proximity to one another.

[1144] The geographic market for haulage is best described as a corridor around each line which is the subject of an all-points application, and a circumference around the access point of the line the subject of a point-to-point application. ...

[1145] The next question is: Will access to a line promote a material increase in competition? Clearly enough the market is presently not effectively competitive as the only potential provider of haulage services, the incumbent, is able to exert market power by refusing to provide haulage. In Services Sydney (at [135]), the Tribunal said that criterion (a) applied to a market in which there was no competition because of the vertically integrated monopolist.  The Tribunal also said that "the facilitation of any competition in any such market is of significance."  In other words, the facilitation of any competition closer to effective competition will satisfy criterion (a), provided the movement is not trivial. [emphasis added]

[1146] Here access to the lines will enable [Fortescue], and possibly other firms if they choose, to provide a haulage service. ... Under the status quo, they have no such choice. We regard the choice as significant. It constitutes an increase in competition even if the supplier of haulage (eg FMG) is a monopolist. Though it may be a monopolist, it may not be able to exercise monopoly power. Once haulage is provided by a third party, the incumbent may be encouraged also to provide haulage services to junior miners. Even if the incumbent does not provide a service to junior miners, it would constrain the third party haulier because of its potential to provide haulage services.

[1147] Is this any different from the position that would obtain if there were no access to the lines?  The answer is "yes" in respect of three lines, the Goldsworthy, Hamersley and Robe lines, and "no" in respect of one line, the Mt Newman line.

[1148] ... these answers ... are dictated by the effect on the rail haulage market if the likelihood is that a substitute facility will be constructed if there is no acc ...ess to the service. 

On whether it was uneconomical to develop another facility to provide the service (criterion (b))

[805] ... It is difficult to gauge precisely what the criterion means. ...

[806] The service to which access is sought is a “below rail” service. The distinction between below rail and above rail services is well known. By above rail we refer exclusively to train operating activities. Below rail activities are those relating to railway infrastructure, such as tracks, terminals, signals and bridges....

Another facility to provide the service

[808] ... it is necessary ... to consider what is contemplated by an equivalent service. Assume that there is a road and a canal side-by-side a railway. Each is capable of being used for haulage via, respectively, a truck, a barge and a train. Is each providing an equivalent service? At a very general level the answer is in the affirmative. Each is a means by which persons or goods may be transported.

[809] Yet this is too simple an approach. Take the instant case. FMG applies for a declaration in hopes of obtaining access to a below rail service for a particular purpose – to haul iron ore. Not all railway lines are capable of providing that service – they must be specially constructed as heavy haulage lines. Not all roads or canals can be used to haul iron ore. Some roads are in a geographic location where haulage of iron ore is not permitted. In the case of a canal, its physical attributes, especially its depth, may make iron ore haulage impossible. In the Tribunal’s view an equivalent service is one which is capable of satisfying the particular need for which the service is sought. [emphasis added]

[810] ... the Tribunal's position is that an equivalent service must allow for use between the same or similar locations. This was the approach adopted in Duke Eastern. There the ... Tribunal explained that there were two possible approaches: (1) identification of the service by reference to the markets they serve; or (2) identification of the service in terms of both start and end points. The Tribunal favoured the latter approach. That approach applies here, in a case where the start and end points are of real importance. ...

[812] It is clear that iron ore can be transported in a number of ways apart from rail haulage. One way is trucking. ... the incumbents (particularly BHPB) argue that trucking should be considered the same service. The Tribunal does not accept this argument. ...

[813] ... for many mining companies who may seek access or to avail themselves of the service, the use of slurry pipelines or trucking is not a realistic alternative to rail haulage. ... trucking by road is not likely to be viable for transporting iron ore over longer distances and at large volumes. It is true that for some miners, transporting by road or slurry pipelines may substitute for rail. It does not follow that transporting by road or slurry pipelines is providing the same service for purposes of criterion (b). Those facilities do not provide the same service because they are not a substitute for the many mining companies that require haulage by rail as the only practically possible or economically feasible means of hauling their desired throughput of iron ore.

'Uneconomical for anyone ...'

[815] ... The competing views are that “uneconomical” means that: (1) it would not be profitable for anyone to develop the facility (the “privately profitable” test); (2) the total net costs (including social costs) exceed the total net benefits (including social benefits) of developing another facility (the “net social benefit” test); or (3) a single facility can meet market demand at less total cost than two or more facilities (a “natural monopoly test”). [emphasis added]

[816] ... the existence of a natural monopoly does not necessarily preclude the profitable development of a second facility. ... it may be profitable for a second facility to be built, notwithstanding that it would be more efficient to share an existing facility.

[817] The question is whether Part IIIA is intended to apply in circumstances where it is profitable - albeit less profitable, and potentially less efficient from society’s perspective - for a second line to be built. The incumbents say Part IIIA is not intended to apply in those circumstances, because it is concerned with removing “bottlenecks” and criterion (b) should be seen as a bottleneck test. In contrast, FMG and the NCC argue that while bottleneck considerations may be relevant to criterion (a), criterion (b) is concerned with efficiency.

[818] ... the place to begin is with the objects of Part IIIA. There are a number of features of the objects clause which should be noted. First, it refers to "effective competition" rather than competition per se. This is to be contrasted with s 2 ... which relevantly provides that the object of the Act generally is to enhance the welfare of Australians through the promotion of competition. A very useful shorthand description of effective competition is proffered by Professor Hausman. He said: "By "effectively competitive" economists mean that no individual firm (or group of firms) is exercising significant market power nor is the price above the competitive price." A privately profitable test does not sit easily with the object of achieving effective competition. If viewed as a “bottleneck” test, as the incumbents would have it, then it simply tests whether a person could compete in a related market without access. It does not ask whether that person could compete effectively....

[819] Another feature of s 44AA is that it is concerned with two distinct but related concepts – efficiency and effective competition. The references to efficiencies in "operating", "using" and "investment" in infrastructure connote concepts of productive, allocative and dynamic efficiencies. On any view, the scope of criterion (b) must take into account both effective competition and the efficiencies contemplated by s 44AA(1).

[820] One issue raised by the privately profitable test is whether it ignores efficiency considerations, in particular, the allocative efficiency associated with the use of a natural monopoly facility. The proponents of the privately profitable test contend that if it is privately profitable to develop an alternative facility, there is a strong incentive for the access seeker and facility owner to voluntarily implement a socially efficient sharing arrangement. ...

[823] In essence, the economists supporting the privately profitable test assert that where an alternative facility can credibly be built, private negotiations will necessarily result in efficient outcomes or, at least, will achieve efficient outcomes more readily than regulation. There are several problems with this assertion. First, it assumes that firms always, or usually, behave in an economically rational manner ... Second, there are often reasons for an incumbent owner who is behaving rationally to deny access to a potential competitor even when sharing would be socially optimal. Forcing the competitor to use a less profitable alternative facility may harm that competitor. The incumbent may seek to exploit the fact that it will take some time to build the alternative facility. It may be that it is only profitable to build an alternative facility with limited capacity (which is lower than the spare capacity on the existing facility which would otherwise be available). The incumbent may be mindful of not giving a fledgling competitor a “leg-up” to facilitate its growth into a larger player. Third, given the potential for market failure, it is far from clear that market forces achieve a better result than regulation as a general rule. In any event, it is doubtful that the Tribunal is entitled to assume that the decision-makers regulating Part IIIA will make errors.

[824] There is another reason why a privately profitable test may not lead to the efficient use and operation of a facility. Suppose that an existing facility is a natural monopoly, ie it can satisfy society’s total demand at a lower cost than two or more facilities. Suppose also that it is privately profitable to build an alternative facility which can only satisfy some, but not all, potential demand. On a privately profitable test, a declaration could not be made, even though many potential users would not be able to use the second facility, but could use (and use more efficiently) the incumbent’s facility. It is difficult to see how such an outcome is consistent with the efficient use and operation of infrastructure – and for that matter, the achievement of effective competition – contemplated by s 44AA.

[825] Another factor which tells against a privately profitable test is the emphasis on natural monopolies in the background materials to Part IIIA: ... the two consistent themes which emerge from this material are that: (1) facilities requiring access exhibit natural monopoly characteristics; and (2) the notion of being “uneconomical” has been linked to the definition of natural monopoly. ...

[826] ... In the second reading speeches for the Competition Policy Reform Bill in the House of Representatives (Commonwealth, Debates, House of Representatives (1995) Vol HR202, p 2799) and in the Senate (Commonwealth, Debates, Senate (1995) Vol S170, p 2438), it was said that the notion underlying the proposed Part IIIA regime is that access to certain facilities with natural monopoly characteristics is needed to encourage competition in related markets.

[827] ... Nonetheless, the incumbents argue that the Hilmer Committee was principally concerned with bottlenecks, rather than natural monopolies. ...

[829] Another point against the privately profitable test is that it would lead to a significant degree of overlap between criterion (a) and criterion (b).  All parties accept that whether or not it is privately profitable to build an alternative facility would be a relevant consideration for criterion (a).  This is not to suggest that there is complete overlap between criterion (a) and a privately profitable test under criterion (b). ... the existence of a bottleneck (or whether it is privately profitable to build an alternative facility) is not in itself determinative of whether access would promote effective competition and, for that matter, whether access is socially efficient. It is, therefore, unclear why criterion (b) should separately test for a bottleneck on a stand-alone basis. An alternative approach is that criterion (b) is concerned with efficiency (ie the efficient use of existing infrastructure) and criterion (a) considers effective competition. This approach has the merit of avoiding overlap between criteria (a) and (b) and, more importantly, directly addresses the objects in s 44AA(1).

[830] Were the interpretation of criterion (b) governed solely by the forgoing considerations, the Tribunal would have no doubt in concluding that the privately profitable test should be rejected. There are, however, other considerations which muddy the waters. The first is criterion (e), which is whether access to the service is already the subject of an "effective access regime". When considering this criterion, s 44H(5) provides that the minister must have regard to the Competition Principles Agreement. Clause 6(1)(a) of that agreement refers to whether it is "economically feasible to duplicate the facility." Putting these points together, the incumbents argue that the reference to "economically feasible" indicates a privately profitable test. They then argue that criterion (b) must be interpreted consistently with clause 6(1)(a), or otherwise different results may emerge, depending on whether one is assessing an application under a State access regime or under Part IIIA.

[831] The Tribunal acknowledges that this argument has force. Perhaps the most natural meaning of the phrase "economically feasible" connotes private profitability. However, it is not too strained to read "economically feasible" as economically efficient, in the sense that something that is inefficient may be economically unfeasible when looked at from society’s perspective.

[832] Another feature supporting the privately profitable test is the reference in criterion (b) to it being uneconomical "for anyone" to develop another facility. ...

[833] There is also force in this argument. But, equally, the application of the phrase to the privately profitable test creates difficulties. ...

[835] In the end, the Tribunal does not consider that criterion (b) should be interpreted as a privately profitable test.  That test is inconsistent with the enacting history and does not adequately meet the objectives of Part IIIA. ...

A net benefit or natural monopoly test

[836] Having rejected the privately profitable approach, it is necessary to consider whether a natural monopoly approach or net social benefit approach is to be adopted.  The Tribunal has in the past favoured the net social benefit approach.  ...

[838] ... we consider that a natural monopoly approach is preferable to a net social benefit approach adopted in previous Tribunal decisions for several reasons. First, the background material to criterion (b) consistently links the term "uneconomic" to the notion of a facility exhibiting natural monopoly characteristics.  Natural monopoly rests upon a production cost function which does not take into account social benefits or net social benefits.  Second, natural monopoly characteristics are concerned with the costs of production based on the available technology.  Third, a net social benefit test gives criterion (b) a role which overlaps substantially, and perhaps usurps, the role of criterion (f).  Both would involve a weighing up of many of the same social costs and social benefits.  Importantly, in weighing up those costs and benefits, the criteria might arrive at different results.  It must be borne in mind that many social costs and benefits are necessarily difficult, and sometimes impossible, to quantify.  Accordingly, it may be difficult to conclude, at least in quantifiable terms, that there is or is not a "net social benefit".  A requirement to be positively satisfied of such a matter - which would be a requirement if criterion (b) were a net social benefit test - would create a threshold which may, in practical terms alone, be difficult to satisfy.  This is to be contrasted with criterion (f), which is framed in the negative. [emphasis added]

[839] Moreover, criterion (f) looks at the issue in a different setting. For criterion (f) to be satisfied (although it is expressed as a negative), it is not sufficient for the net costs of access to exceed net benefits, ie even if that is the result of the inquiry, the making of a declaration may yet not be contrary to the public interest. Other factors might carry the day. ...

How to test for a natural monopoly

... [841] ... Whether a firm's facility has natural monopoly characteristics involves determining whether the firm's cost function in relation to that facility is subadditive at all levels of output.  This is a purely technical inquiry which looks at a firm’s production costs.

[842] The expert economists put a different proposition. Most supported the position that “costs” are not confined to costs of inputs but should include all social costs. ...

[843] The Tribunal has given careful consideration to the views of the experts but is of the firm view that a natural monopoly test under criterion (b) should not take into account all social costs, for three reasons. First, almost all of the extensive literature on natural monopolies and the extensive works that consider whether particular railways exhibit the characteristics of a natural monopoly suggest that social costs should not be taken into account. The literature shows that economists have tested for natural monopoly by only taking into account costs of production: ... [emphasis added]

[844] The second reason why a natural monopoly test should not take into account all social costs is that, by the nature of the inquiry, many of those costs would not be taken into account even if known.  A natural monopoly test is a static test.  It assesses the state of an industry at a given point in time by taking a set level of demand and technology. ... Many of the social costs which the incumbents say will be caused by access are dynamic in nature ... 

[845] The third reason is that, in this case, the social costs which the incumbents urge should be taken into account are, speaking rather loosely, the cost of the diseconomies and the inefficiencies that are said would result from access, those costs being largely in the form of lost production associated with activities in a downstream market. In the Tribunal’s view, this confuses the cost of production of the service with the cost of providing access.

[846] It should be stressed that just because a natural monopoly test does not take into account social costs does not mean that those costs are irrelevant. The costs are clearly relevant to criterion (f) and, perhaps, as discretionary factors. It is just that they are not relevant to criterion (b).

[848] There are three main ways to test for natural monopoly: engineering cost analysis, survivor analysis and econometric analysis.  The first involves analysis of firm-level data.  Survivor studies involve examining data on the growth of industries to determine those firms, assumed to be efficient, which increase market share over time and those firms, assumed inefficient, which decrease market share over time.  Econometric studies involve examining cost and output data on firms in a particular industry over a period of time and applying statistical techniques to estimate the cost function for the industry.

[849] Testing for a natural monopoly is notoriously difficult.  ...

[850] In the present context, the question comes down to this:  Can each line provide society’s reasonably foreseeable demand for the below rail service at a lower total cost than if provided by two or more lines?  The relevant costs are, as we have said, the costs of producing the below rail service. 

[851] An important assumption of this enquiry is that an existing line can, if necessary, be expanded to meet the reasonable foreseeable demand for the service.  This is consistent with the economic theory of a natural monopoly, which takes into account the ability of the facility (or, more classically, the firm) to expand the relevant output ...

[852] ... Provided the future is predictable with some measure of confidence, that future should be taken into account.

...

[855] In summary, to determine whether a facility is a natural monopoly, it is necessary, first, to determine the reasonably foreseeable potential demand for the facility (strictly the service provided by the facility), and then compare the capital and operating costs of a shared facility to the sum of the capital and operating costs of an existing facility (or an expanded existing facility) and a new facility.

...

[The Tribunal went on to apply the test to the facts in this case]

Application of private profitability test

[at para's 952 - 965 the Tribunal, despite rejecting application of this test to criterion (b), expressed its views on how such a test should be applied and how it would be applied on the facts in this case]

16 Savings

Quantifying capital savings

[966] We have concluded that all of the lines except for the Mt Newman line are natural monopolies.  One of the key benefits of access is the capital savings of not having to construct an alternative facility for these lines.  That benefit must be taken into account when weighing up costs and benefits of access for the purposes of considering the public interest under criterion (f).  It is therefore useful to try to quantify those savings

...

On whether access would be contrary to the public interest (criterion (f)

18.1 Overview

[1160] Criterion (f) requires the Tribunal to be satisfied that "access (or increased access) is not contrary to the public interest". The criterion is expressed in the negative, ie it is not necessary for the Tribunal to positively be satisfied that access is in the public interest.

[1161] The TPA provides no definition of the expression "public interest". Dr Fitzgerald says that what must be considered is the welfare, particularly the economic welfare, of the Australian community as a whole. This is in line with the views of the NCC. Professor Fels put it that the Tribunal should consider whether the costs of access do not outweigh the benefits, though it must be borne in mind that, apart from the fact that the assessment may at best be robust, the object is to achieve not a state of perfection but a better outcome. We are in broad agreement with these views, but with one important qualification. On close analysis it may be that access will be manifestly unjust to a section of the community while, at the same time, benefiting the community as a whole. In that circumstance access may nevertheless be contrary to the public interest. [emphasis added]

[1162] In the past the Tribunal has emphasised that criterion (f) should not be used to call into question the results obtained by the application of the earlier criteria. ... While the results of earlier criteria cannot be questioned, they are not to be ignored. The satisfaction of criteria (a) and (b) indicates that benefits will occur from access. Those benefits, and other benefits not considered under earlier criteria, as well as the costs of access, must be taken into account under criterion (f). [emphasis added]

[1163] The Tribunal also has a discretion whether or not to declare a service. In the past the Tribunal has said that, in light of the detailed considerations required to be undertaken to determine whether the statutory criteria have been satisfied, the discretion is extremely limited. This is not consistent with Sydney Airport (No 2). There the Full Court observed the discretion "may be affected by a wide range of considerations of a commercial, economic or other character not squarely raised by, nor falling within, the necessary preconditions in s 44H(4)": 155 FCR at 137. That is to say, the discretion is a very broad one. [emphasis added]

[1164] The relationship between criterion (f) and the discretion is important. Criterion (f) requires the Tribunal to consider whether "access" is contrary to the public interest. ... The NCC says (and no party disagrees) that it is necessary for there to be a more detailed inquiry to appreciate the effect on public welfare of both a declaration and access under Part IIIA, but that inquiry is only relevant to the Tribunal’s discretion.

[1165] It is, we think, impossible to disagree with the NCC. The result, however, is problematic. Mere access to the service may, in theory, have some consequences, albeit their measurement is impossible. In the real world many consequences will only arise if access is actually taken up. And the nature and extent of those consequences will depend upon the extent to which access is taken up. Moreover, whether, and the extent to which, access is taken up will be a reflection of the terms upon which access is obtained.

[1166] The Sydney Airport (No 2) approach does not permit a detailed consideration of the likely terms of access that might be imposed under Part IIIA. It does allow for the assumption that access will be on reasonable terms. ... Issues which arise because of the specific operation of Part IIIA will be considered under the discretion.

[1167] Our approach could have this consequence. There may be a finding that access simpliciter is in the public interest (or, more correctly, that access is not contrary to the public interest), but taking into account the effects of both a declaration and access under Part IIIA, a different conclusion might be reached. ...

[1168] The factors which the Tribunal proposes to take into account will not be confined to strict cost-benefit issues.  The Tribunal will also have regard to broader issues concerning social welfare and equity, and the interests of consumers. ... 

[1170] In weighing up the costs and benefits, and in the exercise of its discretion, the Tribunal will keep in mind that Pt IIIA was intended by the Hilmer Committee to protect "the legitimate interests of the owner of the facility" ...

[1171] This brings us to a point already mentioned in these reasons, namely, what issues may properly be taken into account at the declaration stage of the two-stage process.  ...

[1172] ... The better view, we think, is that the Tribunal should consider consequences that are likely to arise as a result of access, giving them a weight that pays regard to their degree of likelihood.

[1173] As regards the proposition that Part IIIA provides some protection for the legitimate interests of the incumbent, the Tribunal makes two observations. First, there may be costs which will be borne by an access seeker in order to protect the incumbent’s legitimate interests.  That the incumbent does not bear those costs does not make them irrelevant to the declaration decision. We are, after all, concerned with costs from society’s perspective.  The second observation is that Part IIIA does not provide the incumbent with certainty that its legitimate business interests will be protected ... We think this is relevant both to the public interest criterion and to discretion.

[1174] The final introductory comment we wish to make is that, as regards criterion (f) and the discretion, the Tribunal considers that its role at the declaration stage is to be concerned with the "big picture". At stage two the minutiae of terms of access will be dealt with. When considering the public interest and exercising its discretion at the declaration stage, the Tribunal is, to a significant extent, concerned with broad issues of policy that are unlikely to be dealt with at stage two

20. Concluding remarks

[1348] ... the mechanism to promote community welfare identified by the Hilmer Committee - competition - is as vital today as it was in 1993 when the Committee published its report. Part IIIA is an important means of achieving community welfare. Yet the Part does require reform, and we think the following issues should be investigated:

• The possibility of compelling inefficient investment

• The desirability, and mechanics, of an expansion power

• Whether access on a first-come, first-served basis is inequitable

[1349] These are just some of the important issues which the legislation does not deal with adequately. ...

[1350] Third, one matter of procedure should be considered, namely whether it is appropriate to collapse a rather complicated process. The multitude of steps included in a Part IIIA application for access are: (1) NCC recommendation; (2) Ministerial declaration; (3) Tribunal review; (4) Appeals to the court; (5) Possible remitter; (6) Negotiations for access; (7) Arbitration; (8) Further Tribunal review; (9) Possibly more appeals to court. Getting through this process will inevitably take years: If a complex case was run in the fast lane, the earliest it will still take is 4 to 5 years to complete. ...

Tribunal 2010 decision

Jo Daniels, 'Part IIIA of the Trade Practices Act: Reflections after Fortescue' (2010) 18 Competition and Consumer Law Journal 165

High Court decision

Matthew Ball, 'Pilbara rail access cases keep rolling' (Freehills, 17 September 2012) [alternative source]

Luke Woodward, Simon Muys, Catherine Dermody, 'Twenty years after Hilmer, the High Court sets Part IIIA on a different track' (Gilbert + Tobin update, 17 September 2012) (also published at Lexology)

Tribunal 2013 decision

Julie Clarke, 'The Australian Competition Tribunal ‘undeclares' third party access for rail lines company applying ‘private profitability' test to 44H(4)(b) (The Pilbara Infrastructure Pty)' (8 February 2013, e-Competitions, N°51089, www.concurrences.com)