Prohibiting Energy Market Misconduct Bill 2019

The Federal Government has revived its ‘big stick’ energy laws by introducing the Treasury Laws Amendment (Prohibiting Energy Market Misconduct) Bill 2019 (Bill) to the House of Representatives.

Background

The Bill was initially introduced in the House of Representatives on 5 December 2018 following recommendations made by the Australian Competition and Consumer Commission (ACCC) in the Retail Electricity Pricing Inquiry.

In early 2019, the Bill was abandoned due to the unlikelihood of it passing without significant amendments. However, following the 2019 election, with a majority in the lower house and newly constituted senate, the Government appears to consider it is in a stronger position to secure passage of the legislation and so has reintroduced it. If passed, the new law will affect retailers, generators and ‘gentailers’ (vertically integrated companies with generation and retail arms).

The Bill introduces three prohibitions on certain types of conduct (called ‘prohibited conduct’) in the electricity supply chain relating to:

• retail prices;
• electricity financial contract market (derivative contracts); and
• wholesale and electricity market (basic and aggravated cases).

A wide range of responses are open to the ACCC if it reasonably believes a corporation has engaged in or is engaging in prohibited conduct.

The most controversial aspects of the Bill, however, are the powers given to the Treasurer to, in certain circumstances, issue a contracting order or apply to the Federal Court for a divestiture order. These new powers have been central to the narrative of the government wielding its ‘big stick’ as part of its energy policy and commitment to lowering power bills for small businesses and consumers.

The prohibited conduct provisions and responses introduced in the Bill are discussed below.

Prohibited conduct

Retail pricing (section 153E)

Proposed section 153E is directed at retailers who supply electricity or offer to supply electricity to small customers and is designed to ensure retailers pass on supply chain savings to those small customers. A small customer includes retail customers and small business customers (customers that purchase, or propose to purchase, electricity less at a rate less than 100 MWh a financial year).

A corporation engages in prohibited conduct in retail pricing if:

• the corporation offers to supply electricity, or supplies electricity, to small customers; and
• the corporation fails to make reasonable adjustments to the price offered or charged to small customers to reflect sustained and substantial reductions in its underlying cost of procuring electricity.

The terms ‘reasonable adjustments’, ‘sustained and substantial’ and ‘underlying cost’ are not defined in the Bill.

According to the Bill’s Explanatory Memorandum, a retailer’s cost of procuring electricity (known as its ‘cost stack’) include the following components:

• wholesale costs – acquiring electricity from the market, contracting costs associated with managing exposure to the wholesale spot price volatility, or direct contracting within an entity in the case of a gentailer;
• network costs – transmission and distribution costs; and
• environmental costs – complying with environmental schemes.

Retail costs and retail margins are not considered costs of procuring electricity and retailers are not required to adjust its price to pass on efficiency gains to customers, for example, where a retailer lowers its operating costs by improving its internal processes and productivity.

Prohibited conduct – electricity financial contract liquidity (section 153F)

A key feature of the electricity market is the use of derivative contracts (called ‘electricity financial contracts’) by market participants to manage the risk of price volatility in the electricity spot market. Examples of derivative contracts include put and call options, electricity futures and power purchase agreements (PPA). A retailer, for instance, may enter into a PPA with a generator effectively setting the price of electricity in advance and providing both parties with price certainty.

A corporation will contravene the new law if:

• the corporation generates electricity, either itself or within its corporate group; and
• the corporation does any of the following:
  • fails to offer electricity financial contracts where it has the ability to do so, but chooses not to; or
  • limits or restricts its offers to enter into electricity financial contracts; or
  • offers to enter into electricity financial contracts in a way that has the effect of limiting or restricting acceptance of those offers; and
• does so for the purpose of substantially lessening competition in any electricity market.

According to the Explanatory Memorandum, proposed section 153F is aimed at ensuring ‘generators, including gentailers, do not unreasonably refuse to offer financial contracts for anti-competitive purposes.’

Prohibited conduct – electricity spot market (sections 153G and 153H)

The third category of prohibited conduct relates to prohibited conduct in the electricity spot market with the Bill providing for basic and aggravated cases.

A corporation will contravene the new law if:

• the corporation bids or offers to supply electricity in relation to an electricity spot market (or fails to do so); and
• does so:
  • fraudulently, dishonestly or in bad faith; or
  • for the purpose of distorting or manipulating prices in that electricity spot market.

An aggravated case is made out where both elements (b)(i) and (b)(ii) are present. A basic case only requires one element of b(i) or b(ii) to be present.

Where a basic case is met, the ACCC (but not the Treasurer) may issue a response. For aggravated cases, the ACCC and Treasurer may issue a response.

Responses to prohibited conduct

ACCC responses

A wide range of responses are open to the ACCC if they have formed a reasonable belief that a corporation has engaged, or is engaging in, prohibited conduct. For example, the ACCC may respond to prohibited conduct through:

• public warning notices;
  • a draft public warning notice is issued to the corporation and the corporation is given 21 days to make representations to the ACCC; and
  • 21 days has passed and final notice
• infringement notices (60 penalty units or up to $128,000);
  • must be issued within 12 months of the alleged contravention;
  • the corporation is given 28 days to pay; and
  • if payment is not made, the ACCC may institute proceedings;
• an application to the court for a pecuniary penalty;
  • where a corporation has been ordered to pay a pecuniary penalty, the ACCC may apply to the court to make an adverse publicity order against the corporation;
• accepting a court enforceable undertaking from a corporation; and
• applying to the court for an injunction to stop (or direct) a corporation that has engaged in or is engaging in prohibited conduct.

Treasurer responses

Contracting orders

The Treasurer can issue a contracting order where prohibited conduct arises under electricity financial liquidity or aggravated cases of the electricity spot market provisions. A contracting order can be issued if the:

• ACCC have issued a prohibited conduct notice to the corporation or connected body corporate;
• ACCC have made a prohibited conduct recommendation to the Treasurer (ACCC notice and response);
• Treasurer makes the order within 45 days of ACCC’s recommendation; and
• contracting order is a proportionate means of preventing the prohibited conduct in the future.

Contracting orders may specify the type of contract, price or range of prices for electricity covered by the contract, and the minimum number of megawatt hours of electricity that must be offered.

In determining the minimum number of megawatt hours that must be offered under a contracting order, the Treasurer must have regard to the total generation capacity of the generation assets held by the corporate group, the nature and location of those generation assets, existing commitments to supply electricity to the customers of the corporate group and any other relevant matters. The Treasurer is not required to have regard to financial derivative contracts to which an entity is a party in determining the minimum number of megawatt hours to be offered under a contracting order, but these could obviously be considered as a ‘relevant matter’ which the Treasurer must have regard to.

The Bill includes an enforcement provision under which the Treasurer can make an application to the Federal Court in circumstances where a corporation has not complied with a contracting order.

The Australian Energy Regulator is also given authority to gather information and share information with Commonwealth entities, such as the ACCC, enabling those entities to perform or exercise their relevant functions or powers.

Court ordered divestiture

The Treasurer can apply to the Federal Court for a divestiture order to be made against a corporation or related entity for aggravated cases of prohibited behaviour in the electricity spot market. The procedure for applying for an order is largely the same for making a contracting order, with two main exceptions:

• the Treasurer must apply a ‘net public benefit’ test before applying to the Federal Court; and
• the Federal Court makes the order, not the Treasurer.

In applying the ‘net public benefit’ test, the Treasurer must be satisfied that a divestiture order will result, or is likely to result, in a public benefit that outweighs any public detriment. The Explanatory Memorandum describes public benefit and detriment as broad concepts to be assessed on a case-by-case basis. For example, increased competition might be a benefit where an asset can be sold to assist a new entrant and this must be assessed against detriment in the form of investor uncertainty.

The Federal Court can make a divestiture order if it is satisfied the conduct identified in ACCC’s prohibited conduct recommendation is prohibited conduct and the order is a proportionate means of preventing the prohibited conduct in the future. The Federal Court will also have to apply the ‘net public benefit’ test and any order made would be subject to the constitutional requirement that the acquisition (or divestment) of any property be on ‘just terms’.

In the case of a government-owned corporation, a divestiture order can only require divestiture to another government-owned corporation.

Conclusion

If the Bill is passed, the new laws will mark an unprecedented level of intervention into the electricity market by the Government. Permitting the Treasurer to issue contracting orders based on ACCC findings which have not been proven in court raises questions about the appropriateness of such a power resting with the Treasurer that could be characterised as quasi-judicial to the extent that it is a response to an alleged breach of law.

Similarly, while court ordered divestiture orders, which were not supported as an appropriate enforcement mechanism by the ACCC, are available under competition laws in Australia, they are rare. Such orders are generally used as a remedy for unwinding offending mergers and acquisitions to achieve a more competitive market structure and not as a sanction for market behaviour.

The ACCC’s inquiry found that fundamental changes to the electricity generation market, such as the exit of large-coal fired generators, shortage of competitively priced gas, poor policy choices and high concentration in the market were responsible for elevated wholesale prices and not the use or abuse of market power.

Critics of the Bill have pointed to existing competition laws as an adequate means to address anti-competitive market behaviour rather than the need for new laws. In the past, Australian courts and tribunals have wrestled with applying concepts such as ‘market power’ in electricity related markets (which the possession of market power for fairly transitory periods can deliver substantial profit and have a substantial impact on the average electricity price). This suggests the courts may struggle with similar concepts should it be called upon to decide matters under the proposed laws.

It remains to be seen if lower electricity prices for small customers which appear likely to occur are a result of market forces or the Government’s ‘big stick’. Market commentators have pointed to a decade of sustained policy inertia and uncertainty as contributing to investment uncertainty and higher electricity prices. This uncertainty has manifested in investor risk with the bulk of investment being limited to lower risk, shorter life term assets, such as solar farms.

It might be the Federal Government are attempting to take advantage of price projections forecasting reduced electricity prices in the next 12-18 months and, in doing so, take credit for a solution which the market has delivered in in the face of uncertain policy settings.

The Opposition have stated that they will review the Bill. If the Government is unable to secure opposition support, then they will have to rely on the Senate crossbench.