Defining energy markets and competition: the Santos decision

By Linda Evans.

Key Points:
Two key issues were explored in the ACCC decision: market definition and small players' ability to be significant competitive constraints.

In March this year, the ACCC announced that it would oppose the bid by Santos Limited for Queensland Gas Company Limited ("QGC") because it would be likely to have the effect of substantially lessening competition in the market for the production and supply of wholesale gas in the southern interconnected region of Queensland (including Brisbane, Gladstone and Mt Isa) and in the market for production and supply of wholesale gas in the southern states of Australia. After the ACCC's decision, Santos did not proceed with its bid.

Initially Santos proposed a bid without any concessions to address competition issues. It later put forward a revised bid which involved the creation of a new company, NewCo, as a wholly-owned subsidiary of QGC and the transfer of certain assets, liabilities and obligations to NewCo which would then be demerged from Santos. Santos would own 30 percent of NewCo. This proposal included a number of ongoing arrangements between Santos and NewCo including transitional services arrangements, infrastructure access agreements, a transportation and gas swap agreement and interim funding arrangements.

The key important issues to come out of the ACCC's decision are:

• its approach to market definition
• the difficulties which small producers face in establishing the requisite scale and reliability to become a significant competitive constraint on the major producers.

Market definition

The ACCC found that there was a distinct market for gas (both conventional and coal seam methane gas) and that neither coal nor electricity should be included within the same market.

In considering the geographic scope of the relevant markets the ACCC looked at two geographic markets.

The first identified as the market for the production and supply of wholesale gas in the region of southern Queensland which is interconnected by gas transmission pipelines. It found that the market did not extend to include the Australian eastern seaboards because of:

• either non-existent or inadequate pipeline infrastructure interconnection between southern Queensland and the southern States, which were said to include South Australia, New South Wales and Victoria; and
• the price differential between gas in the southern States and in Queensland.

The ACCC looked at whether gas swap arrangements expanded the geographic scope of the market by constraining gas producers in the southern Queensland region. It found that swaps did not provide a relevant competitive constraint seemingly because of the limited number of participants in southern Queensland likely to participate in swap arrangements.

The second was the market for the production and supply of wholesale gas in the southern States of Australia. This second market focussed on examining the impact that the supply of gas by an independently owned QGC may have on the supply of gas through southern States through two proposed pipelines: the Ballera to Moomba Interconnect and the Queensland Hunter Gas Pipeline.

Factors affecting competition

The ACCC found that small explorers faced significant hurdles to becoming a credible alternative to the major players. These hurdles included:

• have significant levels of proven and probable gas reserves, which requires substantial sunk capital
• establish a reputation as a reliable supplier - described by market participants as the "chicken and egg" barrier
• successful entry requires a long term investment and planning horizon.

QGC had successfully made this transition and has been an aggressive competitor in recent years contributing to lower ex-field prices for gas in Queensland.

QGC was also a key player in the development of several new pipeline projects and as a wholly-owned subsidiary of Santos its incentives to participate in those pipeline projects may be reduced.

For further information, please contact Linda Evans.