Albion Water v Water Services Regulation Authority (Dwr Cymru Intervening)

23 January 2009

Richard Eccles

On 7 November 2008, in Albion Water Ltd, Albion Water Group Limited v Water Services Regulatory Authority and Dwr Cymru Cyfyngedig, United Utilities Water PLC intervening Case Number 1046/2/4/04 [2008] CAT 31, the Competition Appeal Tribunal (CAT) ruled that the incumbent water supplier Dwr Cymru had abused its dominant position in setting an excessive common carriage or network access price, upholding an appeal made by Albion Water Limited against the decision of Director General of Water Services (now the Water Services Regulation Authority (OFWAT)).

The appeal concerns the price for the partial treatment and transportation of non-potable water through an existing pipeline to Shotton Paper Mill on the North Wales coast.  The CAT case arises from a decision issued by the OFWAT on 26 May 2004 concerning the transport of water by Albion Water Limited along the water pipeline network owned by Dwr Cymru.

The case has involved two main elements, one concerning a margin squeeze by Dwr Cymru in relation to the relationship between the prices charged by Dwr Cymru to Albion Water for the provision of the carriage of water on its network (to enable Albion to supply Shotton Paper Mill) and Dwr Cymru’s own water supply prices, and the second, present aspect of the case, concerning excessive and unfair access pricing i.e. common carriage charges.  The proceedings in the case have been complex and protracted, but in a key judgment of 18 December 2006, the CAT found Dwr Cymru to hold a dominant position in the relevant market and to abuse such dominant position by carrying out a margin squeeze.  (The margin squeeze finding was upheld by the Court of Appeal in a judgment of 22 May 2008.)  On the excessive pricing aspect, the CAT (in its December 2006 judgment) referred the issue back to OFWAT for a further, detailed report on the attributable costs of Dwr Cymru to be taken into account in determining whether its prices were excessive.  The present judgment comprises CAT’s substantive assessment after taking into account OFWAT’s report.

The CAT’s judgment makes clear the distinction between a price which is “excessive” in terms of the distinction between the price of the cost of supply (including the costs of capital), and a price which is “unfair” and thus an abuse of dominant position, in that it bears no reasonable relation to the “economic value” of the product or service to be supplied.  The CAT made clear that in certain cases the economic value may exceed the cost of supply where there are additional benefits not reflected in the cost of supply (as, for example, in the Attheraces v British Horseracing Board [2007] EWCA Civ38).  An excessive price is therefore a necessary but not sufficient condition for an unfairly high price. 

On the question of whether Dwr Cymru’s prices were excessive, OFWAT and the CAT took the Average Accounting Costs plus (“AAC+”) approach supported by a Local Accounting Cost (“LAC”) approach.  The AAC+ methodology is traditionally used in the water sector to set retail prices for different customer classes, and typically used as a “top down” method to establish average accounting costs, starting with average revenues generally and then identifying variations in costs of supplying particular classes of customer.  OFWAT used the AAC+ methodology to calculate the relevant regional average costs of providing a service of the kind required by Albion, identifying the individual cost components associated with common carriage and providing a locally cost-based approach in respect of the specific water treatment works at Ashgrove which were used by Dwr Cymru in providing the service to Albion.  However, the CAT rejected OFWAT’s inclusion of certain cost elements in the AAC+ methodology, in particular the cost of sludge disposal, the cost of distribution pumping and the cost of back-up supply, as being not reasonably attributable to the service of transportation of water through the Ashgrove system.  Subject to the need for these deductions, the CAT upheld OFWAT’s AAC+ calculation. 

The LAC methodology estimated individual local costs for each functional activity and added a contribution to common costs, the cost of back-up supply and the cost of common services.  The CAT upheld OFWAT’s use of the LAC methodology as a cross-check of the results of the AAC+ methodology.  However, the CAT concluded that the Long Run Incremental Costs (“LRIC”) approach was not necessary or appropriate for the determining whether the price was excessive.

The CAT found that the margin of Dwr Cymru’s common carriage price over the AAC+ benchmark was 46.8% for non-potable water users generally and 68.1% for the Ashgrove system in particular (and 70.6% using the LAC approach for the Ashgrove system).  It held these margins to be material and excessive.

On the question of whether such “excessive” prices were unfair and therefore abusive, the CAT needed to assess the relationship between the price and the value of the service in question, and stated that whether a price bears “no reasonable relation” to its “economic value” is a matter of degree, which involves a considerable margin of appreciation, because the concept of “economic value” and reasonableness are matters of judgment.  The CAT observed that the European Commission had found in Deutsche Post AG – Interception of cross-border mail (OJ 2001 L331) that the offending prices charged by Deutsche Post exceeded the average cost of delivering relevant incoming cross-border mail by at least 25% and that such price bore no reasonable relationship to the actual cost or to the real value of the service provided.  However, the CAT said that it would not be appropriate to specify a particular amount by which a price would exceed the economic value in order to be an abuse of dominance in breach of the Chapter II prohibition under the Competition Act 1998.  However, in the present case, the CAT found that the economic value of the water carriage services did equate to the costs reasonably attributable to the transportation and treatment services by Dwr Cymru.  On this basis, it concluded that even allowing for the unavoidable uncertainties in cost calculations, there was a “substantial disparity” between the actual access price offered and the economic value of the service to be supplied. 

The CAT concluded that there was no substitute for the services of transportation and partial treatment of water provided by Dwr Cymru and it would therefore be impossible to compare the level of common carriage prices charged by Dwr Cymru with those of any direct competitors.  Further, the CAT held that the fact that a number of other water undertakers in England and Wales engage in similar acts of pricing strategies to those applied by Dwr Cymru, does not in itself show that Dwr Cymru’s access price was not unfair. 

In summary, the CAT concluded as follows:

  • The price specified by Dwr Cymru in March 2001 materially exceeded the costs reasonably attributable to the service of the transportation and partial treatment of water;

  • The economic value of the service to be supplied, was not more, or not significantly more than the cost reasonably attributable to the service of the transportation and partial treatment of water;

  • The price bore no reasonable relationship to the economic value of the services to be supplied, and had both an exclusionary and exploitative effect; and

  • The price was unfair in itself and therefore an abuse of Dwr Cymru’s dominant position within the meaning of Section 18(2)(a) of the Competition Act 1998.

No arguments were made on the question of remedy, and CAT left it to Dwr Cymru and Albion Water to resolve their dispute, either directly or through mediation. 

This long-running case is interesting in a number of respects.  Not least, it highlights the difficulties faced by a regulatory body, in cases where there is no substitute for the services in question. Here OFWAT could not compare the level of the common carriage price charged by Dwr Cymru with that of any direct competitors and had to rely on different methodologies for cost calculations. 

The judgment helpfully clarifies the relationship between the issues of a cost-price relationship and the economic value of a product of service, in assessing abuse of dominance through excessive pricing, and in this respect upholds the European Court of Justice’s judgment in United Brands and the European Commission’s decision in Scandlines Sverige AB v Port of Helsingborg (COMP/A.36.568/D3)).

The judgment is significant in relation to the principles to be applied in assessing the reasonableness of network access prices under the competition rules on abuse of dominance.  To some extent the use of the AAC+ methodology is specific to the water industry, but the CAT emphasised that there will always be a degree of judgement involved in choosing which cost methodologies to apply when assessing the lawfulness of an access price.  Notably LRIC was not considered appropriate in this case for determining whether the price was excessive.