29th Septrmber 2006
Water, Ferries, and Exclusivity Provisions
There are strong parallels between the cases of the essential lifeline services of Scottish Water under EC law and the Scottish essential lifeline ferry services under EC law.
First, note the following Commission Decision in 2001 in the case of Trasmed Ferries
"99) In this context, even though no exclusive market access rights have been granted to Trasmed, it is useful to refer to the judgment of the Court of Justice of 19 May 1993 in Case C-320/91 ("Corbeau")(27), in which the Court established that the obligation on the part of the undertaking entrusted with [the] task to perform its services in conditions of economic equilibrium presupposes that it will be possible to offset less profitable sectors against the profitable sectors and hence justifies a restriction of competition from individual undertakings where the economically profitable sectors are
(100) Indeed to authorise individual undertakings to compete with the holder of the exclusive rights in the sectors of their choice corresponding to those rights would make it possible for them to concentrate on the economically profitable operations and to offer more advantageous tariffs than those adopted by the holders of the exclusive rights since, unlike the latter, they are not bound for economic reasons to offset losses in the unprofitable sectors against profits in the more profitable sectors"
Comment from Neil Kay: the Decision itself looked at the principle and application of PSOs (public service obligations) under PSCs (public service contracts). The important aspect is that it recognises that ferry operators pursuing PSOs can cross subsidise loss making operations from profititable operations and that, crucially, an exclusivity provision may be enacted to prevent cherry picking of these profitable operations from entrants - if you do not have that, it is recognised the system could collapse (as happened in the ferry sector in the case of the Northern Isles first tender)
Note the reference above to the Corbeau case. Now look at the following
Note on Application of Competition Law to Scottish Water September 2004,
this published in a Report by Scottish Parliament's Finance Committee,
in which Corbeau is also cited.
"2.1 By refusing to grant third party access to its network, Scottish Water presently faces the risk of competition law challenge.
2.4 By proposing to subject Scottish Water (and its revenues) to more robust, independent regulation, the Bill also contributes to competition law risk mitigation.
4.8 There would appear to be more convincing justifications for refusing access under the SGEI Exclusion, i.e., that Scottish Water requires to maintain exclusive rights over the public networks in order to be able to carry on its public service tasks in economically acceptable conditions.
4.12 In the Corbeau case, an undertaking looking to enter the postal services market in Belgium sought to challenge under Article 82 the exclusive rights conferred on the Belgian Post Office for delivery of all mail. In this case, the BPO had an obligation to collect, carry and distribute mail on behalf of all users throughout Belgian territory, at uniform tariffs and on similar quality conditions, irrespective of the specific situations or the degree of economic profitability of each individual operation.
4.13 The Court then set out the following legal analysis:
The question which falls to be considered is therefore the extent to which a restriction on competition or even the exclusion of all competition from other economic operators is necessary in order to allow the holder of the exclusive right to perform its task of general interest and in particular to have the benefit of economically acceptable conditions.
The starting point of such an examination must be the premise that the obligation on the part of the undertaking entrusted with that task to perform its services in conditions of economic equilibrium presupposes that it will be possible to offset less profitable sectors against the profitable sectors and hence justifies a restriction of competition from individual undertakings where the economically profitable sectors are concerned.
Indeed, to authorize individual undertakings to compete with the holder of the exclusive rights in the sectors of their choice corresponding to those rights would make it possible for them to concentrate on the economically profitable operations and to offer more advantageous tariffs than those adopted by the holders of the exclusive rights since, unlike the latter, they are not bound for economic reasons to offset losses in the unprofitable sectors against profits in the more profitable sectors.
4.14 In other words, as the OFT has put it, the Court's judgment is, "based on the cherry picking or cream skimming argument, i.e. that the introduction of competition in these markets would have resulted in the new entrants targeting the profitable customers/sector and leaving the higher cost customers/sector to be supplied by the incumbent at a prohibitively high price, against the interest of these customers, or would result in the incumbent being made reliant upon state subsidies".
4.15 The Court in Corbeau made clear, however, that the grant of exclusivity had to be closely tailored to those services that comprised the universal postal service, stating that, "the exclusion of competition is not justified as regards specific services dissociable from the service of general interest which meet special needs of economic operators and which call for certain additional services not offered by the traditional postal service, such as collection from the senders' address, greater speed or reliability of distribution or the possibility of changing the destination in the course of transit, in so far as such specific services, by their nature and the conditions in which they are offered, such as the geographical area in which they are provided, do not compromise the economic equilibrium of the service of general economic interest performed by the holder of the exclusive right".
.21 Looking at Scottish Water, there are two key tests which it must satisfy, in our view, in seeking to rely on the SGEI Exclusion to deny third party network access. First, the Scottish Parliament should take the step of formally conferring on it exclusive rights over the network. The present absence of legislative endorsement may undermine Scottish Water's ability to claim that exclusivity is objectively justifiable. Second, the current regulatory status of Scottish Water under the 2002 Act, in terms of which its revenue levels are fixed by its owners (i.e. Scottish Ministers) rather than an independent regulator, should be bolstered in order to support the arguments that exclusivity is being used to protect an efficiently run SGEI .
4.22 Accordingly, as things stand at the moment in relation to Scottish Water and its regulatory status, there is a substantial risk that a court would not be prepared to support use of the SGEI Exclusion to justify a denial of network access.
Impact of enforced third party access
4.23 If Scottish Water is unable to rely on the SGEI Exclusion and third parties are able to enforce their rights to access the network using the Chapter II Prohibition, the adverse consequences for Scottish Water's economic viability and the position of its remaining customers could be severe.
5 Potential impact of the Bill
5.1 The proposal to prohibit third party use of Scottish Water's networks under the Bill would represent an important advance in tackling the competition law risks outlined in the previous section.
5.2 It would certainly provide Scottish Water with the ability to rely for the first time on the Legal Requirements Exclusion (as opposed to the SGEI Exclusion) as a defence to any Chapter II claim arising from refusal to grant access.
5.3 However, if that were as far as the Bill was to go, we doubt whether this ability would provide a complete defence to future competition law challenges.
5.4 This is because, whilst the Chapter II Prohibition can be 'disapplied 'in this manner, its EC counterpart (Article 82 EC) cannot. And, as we have pointed out earlier, there are good grounds to regard Article 82 as applying in this context. It would therefore remain open to an aggrieved third party to invoke (EC) competition law to challenge a refusal to grant network access, with all of the same adverse consequences identified above.
5.5 This means that, in addition to the ban on third party access, it is important that any ban is accompanied by the necessary conditions to allow Scottish Water to rely on the SGEI Exclusion (at both UK and EC level). These would include measures to ensure that the interests of Scottish Water's customers are adequately safeguarded in relation to the raising and spending of its monopoly revenues.
5.6 In our view, the Bill makes several important contributions in this respect by strengthening independent regulatory oversight of Scottish Water and its revenues. In particular, it grants determinative (as opposed to advisory) powers over Scottish Water's charges to the Water Industry Commission, subject to appeal to the Competition Commission.
5.7 Indeed, we take the view that the proposals contained in the Bill, taken as a whole, would substantially eliminate the competition law risks facing Scottish Water in relation to third party network access".
Comment from Neil Kay: as well as the reference to Corbeau again, note the need for (1) statutory framework (2) independent regulator (3) defined (public service) obligations, and exclusivity provision for the network and - crucially - the dangers of cherrypicking which cannot be defended against legally if you do not have these things
The parallels with the CalMac ferry network are virtually one to one. These are exactly the dangers of cherry picking I have been warning about. And the solutions to potential cherry picking can be the same ones that I have recommended for the ferry network.
We have seen what not having these solutitions has led to in the case of Northern Isles where cherrypicking was a contributory factor leading to the collapse of the first tender. We will see that happening over the whole of the Scottish ferry system if the warnings by me in the context of ferries (paralleling those of legal advisers in the case of Scottish Water) are not heeded,
Now read the following exchange taken for the Official Report of the LG and Transport Committee of the Scottish Parliament March 15th last year.
"Tommy Sheridan: Do you accept that the evidence that Neil Kay gave to the Transport and the Environment Committee back in 2001 about the tendering exercise for the northern isles contract hasunfortunatelyproved relevant, given the disastrous collapse of that tender?
Nicol Stephen: There are lessons to learn
from the northern isles tender.
Nicol Stephen David Hart might want to add something about the potential for a commercial operator to start to operate a service on the existing routes, but one of the reasons for going for a public service contract approach is to ensure that we provide a subsidy for elements of service. Other operators are then unable to come on to the route. That is an important element of the process of applying a public service contract in such circumstances.
David Hart: We are certainly considering the contract procedures that are in place following the situation in the northern isles that George Lyon described; we want to find out whether we can make the contract's ability to withstand the sort of competition that has been mentioned more robust. The other possible approach is to explore, as we have done to some extent, whether there is any scope for a licensing system that would limit access to certain routes. That would be a pretty draconian measure, given the presumption that the freedom to operate maritime services would generally be seen as a good thing. However, we are at least investigating the option to see whether there is any scope for a licensing system.
The Convener: I thought that the minister was suggesting that the tender would protect against someone coming in and operating in competition with CalMac, but it is clear from David Hart's answer that the tender would not prevent someone from coming in and competing, although that could be achieved with some sort of licensing scheme. Is my understanding correct?
Nicol Stephen: Yes."
Comment from Neil Kay: on the exclusivity aspect, the minister apparently first thought (1) that a PSC was a sufficient for subsidy (which it is not - you need a PS0 as I discused in detail elswhere) and (2) that having a PSC would in itself guarantee exclusivity meaning other operators would then be unable to come on to the route (which it would not - you need the legal safeguards that was described in the Scottish Water legal advice above). He had to be contradicted in committee on that point by his own civil servant. The civil servant then described exclusivity as a "pretty draconian measure, given the presumption that the freedom to operate maritime services would generally be seen as a good thing" - with no apparent recognition of, or reference to, the fact that the Commission itself had explicitly recognised that there were genuine public interest circumstances in the case of ferry services in which exclusivity provision was itself the "good thing".
The committee meeting continued .....
"Nicol Stephen: I genuinely do not want to get into the detail of the individual representations this afternoon. I mentioned to Fergus Ewing some of the potential issues that could arise if we go in the direction of the independent regulator that Professor Kay has suggested ....However, I give a guarantee to Tommy Sheridan that there will be a full ministerial assessment of the different options and a full evaluation will be carried out. If they are willing, we will make contact with the individuals who obviously have worked so hard on these complicated issues over the past weeks and months. We will try to get clarification from them where that is important."
Comment from Neil Kay: That "contact" never happened, the minister was referring to Bennett, Findlay and me, and none of us were contacted. Instead, just before the crucial CalMac debate in September 2005, without any warning certainly to me, there was a critique of all our work released for MSPs which in many respects was biased, poorly formulated, inaccurate and misleading. We were not given a chance to respond. In the debate itself, arguments were attributed to me that I never held, and indeed which I had repudiated several months earlier whan I heard an MSP associating me with them. My repudiation was a matter of record in my submission to the CalMac consultation, March 2005 - see page 55 especially. I wrote to the minister and members of LG and Transport Committee afterwards protesting that I never held the views attributed to me in the paliamentary debate by proponents of the tendering option. None of this made any difference. Was Parliament misled? Yes. Was the Executive handling these matters competently? No. Was there a deliberate attempt to impede proper debate on these matters in Parliament? Judge for yourself.
One of the more disgraceful comments out of many disgraceful comments in that parliamentary debate September 2005 was by an MSP who said "(Professor Kay) ... is still trotting out the same old arguments". Yes, I was. And it definitely was not me that should be ashamed at having to do so. The shame is that four years later after making submissions along the same lines to that same MSP's Inquiry 18th June 2001, I should still have had to make them once again in 2005, have to do so again now, and fully expect to have to do so once again in the future, until some adminstration, some time, comes to terms with the sheer waste and folly of what has been happening here over the past several years, and recognises what can and should be done to protect and enhance the public interest in this context under EC law.