Back on the reform horse By Domini Stuart

Back on the reform horse

Energy market reform has had a chequered history in Australia. Now, with Australia’s governments facing a substantial infrastructure investment task, and with growing cost of living pressures, governments will need to get back on the reform horse, writes Domini Stuart.

At the start of the 1990s, Australia’s electricity utilities were largely single, vertically integrated units fully owned by state governments. The 1995 Competition Principles Agreement brought the states together in an undertaking to restructure the sector, apply competitive neutrality and review the regulation that restricts competition. They also agreed to separate transmission from generation activities, and to segregate the retail and distribution businesses. Southern and eastern states established the National Electricity Market (NEM) – a compulsory wholesale pool into which generators sell their electricity. While Western Australia and the Northern Territory are too distant and remote to be part of the network, the NEM remains the largest interconnected power system in the world, with more than $11 billion of electricity traded annually, meeting the needs of around eight million end users.

But while Australia has come a long way since the days of single, vertically integrated utilities under full government ownership, reform momentum has stalled – with significant differences remaining between the states in respect of the ownership, efficiency and overall energy sector performance.

Just two NEM states have delivered on the agreement for wholesale privatisation. Victoria privatised generation, network and retail businesses between 1995 and 1997, while South Australia did the same between 2000 and 2001.

Back on the reform horse

Energy market reform in Australia has stalled, and national productivity is paying the price

In the lead-up to April’s Council of Australian Governments (COAG) meeting, the COAG Reform Council underlined a persistent lack of progress, while the Productivity Commission’s latest working paper on Australia’s utilities brought more bad news.

‘This report confirms our worst fears,’ says Matthew Warren, Chief Executive of the Energy Supply Association of Australia (esaa). ‘Energy market reform in Australia has stalled, and national productivity is paying the price.’

But there are positive signs ahead. Several states have committed to privatising state-owned electricity businesses, or are undertaking independent reviews into future market structures.

The federal government’s draft Energy White Paper (EWP), due for release in October this year, also promises to be a game changer. It is no secret that the report will come out in strong support for a fully private market, and will push for a move away from retail price regulation towards price monitoring across Australia.

Ensuring this momentum is translated into action will require consensus across the major parties, and a shared recognition that privatised retail, wholesale and networks, coupled with retail price deregulation, will deliver meaningful and enduring price reductions.

This article takes stock of current market structures in the unreformed states of New South Wales, Queensland, Tasmania and Western Australia – and the likely pathway towards reform.

New South Wales

Like all states outside Victoria and South Australia, New South Wales’s transmission and distribution networks are publicly owned and operated.

‘The Premier has said that he won’t sell off the poles and wires without a mandate,’ says Jim Miller, Head of Infrastructure, Utilities and Renewables, Australia and New Zealand, Macquarie Capital. ‘But they are very open to the process of engaging on the subject such that if a mandate is granted they will be able to move very quickly.’

Glenn Byres, NSW Executive Director of the Property Council of Australia, said New South Wales needs to move past the ‘false starts and politics’ that have held back any real reform progress.

‘This should be about economics, not ideology – and economics should lead New South Wales to unlock the capital tied up in energy assets for use on infrastructure renewal,’ says Byres.

Meanwhile, electricity prices are continuing to increase faster in New South Wales than in Victoria. A 2011 Ernst & Young study found that the price paid per megawatt-hour of electricity in Victoria increased by just seven per cent in real terms from 1996 to 2010, compared with real increases of 45 per cent in New South Wales.

Dr Peter Boxall, who is Chairman of the Independent Pricing and Regulatory Tribunal (IPART), is concerned about the impact lack of reform is having on cost increases.

‘Around half of the increase in New South Wales’s electricity prices from 1 July is a result of the continuing rise in costs faced by the retailers from the electricity network – or the poles and wires,’ he says.

This concern is well-grounded. In the unreformed states of New South Wales and Queensland, network costs account for a significant proportion of overall price rises. Ernst & Young found that network costs in Victoria decreased by nine per cent in real terms on a per-customer basis between 1996 and 2010. Over the same period, per-customer network costs in New South Wales increased 65 per cent.

Worse still, over the next five years, New South Wales network businesses are expected to spend up to three times the level of capital expenditure per customer compared with their Victorian counterparts.

Queensland

In 2007, the former Beattie Government sold Queensland’s retail electricity business for a total of $3 billion. However, in December last year, the then Energy Minister Stephen Robertson told the ABC that, while he acknowledged that total privatisation had worked in Victoria, that did not mean it would work in Queensland.

Back on the reform horse

‘Queensland is still significantly below the electricity prices paid in Victoria, so if that is what the federal government is hanging [its] hat on as a compelling argument to privatise energy-generating assets, then that’s a curious way of going about it,’ he said.

On taking office, Premier Campbell Newman reaffirmed his pre-election promise not to sell off any public assets in his government’s first term.

Since then, the Commission of Audit appointed to assess Queensland’s finances has produced an interim report suggesting that privatisation is a good way to rein in the Sunshine State’s crippling state debt.

The Commission, chaired by former Federal Treasurer Peter Costello, also identified the capital requirement of big government-owned corporations, such as power generators, as a major drain on the balance sheet. At $3.5 billion, the upgrading and maintenance of electricity infrastructure, including generation, transmission and distribution, was one of the largest items of capital expenditure in 2011–12. Over the next three years, investment is estimated at $8.3 billion – close to a quarter of Queensland’s total public sector capital expenditure.

Reform of the state’s electricity sector has been a central focus for the Minister for Energy and Water Supply, Mark McArdle, who announced the appointment of a three-person Independent Review Panel (IRP) to oversee reform of power delivery by government-owned electricity entities.

The panel, which includes former Ergon Energy Chief Executive Tony Bellas, Ernst & Young’s Matt Rennie, and advisor Alec Faulkner, forms part of an interdepartmental committee tasked with implementing power tariff reforms promised by government.

McArdle says that with the exception of privatisation, ‘nothing is off the table’ in the review, with speculation that the panel could recommend merging Queensland’s two major power distributors, Ergon and Energex.

McArdle described the IRP as critical to the electricity sector reforms promised by the Newman government in order to address spiralling electricity prices.

‘Everything, from corporate structures and executive numbers down to the cost of wires and power poles and other matters that drive prices, will come under the microscope,’ he says.

Everything, that is, except privatisation. In August, McArdle reaffirmed the government’s stance that it would not sell assets without first receiving a mandate from voters.

Tasmania

In Tasmania, where state-owned generators provide close to 100 per cent of the power, the government is embarking on what Premier Lara Giddings describes as ‘major reform’.

This follows a recent independent review of the state’s electricity sector, headed by Dr John Pierce, Chairman of the Australian Energy Market Commission (AEMC).

The government’s reform package includes the sell-off of Aurora Energy’s 260,000 retail customers, to be undertaken in three tranches, as well as the introduction of Full Retail Contestability (FRC) from February 2014.

In a move that is designed to realise operating efficiencies in the monopoly networks sector, the government also intends to merge Aurora Energy’s distribution business with state-owned transmission business Transend.

Giddings says her first priority is to limit anticipated price rises, promising the second-lowest increases in Australia. ‘The government’s action means that an additional $200 every year will not flow through to an average customer’s electricity bill from 1 July this year,’ the Premier stated.

However, in a clear departure from the advice provided by the independent review, the government has ruled out structural reform of the wholesale market, instead opting to regulate the prices that Hydro Tasmania can charge.

Everything, from corporate structures and executive numbers down to the cost of wires and power poles and other matters that drive prices, will come under the microscope

Back on the reform horse

ABOVE: Jim Miller at the IPA Symposium

According to the government’s own estimates, this comes at a cost to taxpayers of $37 million per annum, through reduced returns from the electricity businesses.

‘This will ensure our power generation and distribution remains in public hands and continues to provide significant value to Tasmanians who have invested in these assets over generations,’ Giddings says.

Hydro Tasmania’s considerable latent market power – and the subsequent lack of wholesale competition – was found by the panel to be a major barrier to retail market entry.

‘It is incontrovertible that Hydro Tasmania possesses significant latent market power, and can use this market power to profitably influence the Tasmanian spot price in a far wider range of scenarios than generators in the NEM,’ the panel found.

This is a view widely shared by industry.

‘In particular, the panel has pointed to the critical importance of achieving greater competition in the wholesale energy market,’ says Mark Collette, TRUenergy’s Director, Energy Markets. ‘This will support the entry of new electricity retailers into the market.’

The barrier to retail competition posed by Hydro Tasmania’s effective monopoly was also a central pillar of a research paper delivered by Infrastructure Partnerships Australia (IPA) to the Tasmanian Government in May 2012.

IPA’s advice was that the sale of Hydro Tasmania, as well as state-owned transmission and distribution businesses, could reduce electricity prices by as much as 16 per cent.

As well as paving the way for effective retail competition, the sale of Hydro Tasmania and stateowned networks businesses would significantly bolster Tasmania’s fiscal and broader economic position at a time of declining state revenues and reduced GST.

IPA has estimated that full privatisation of Tasmanian electricity assets could unlock between $6.57 billion and $7.9 billion in capital proceeds, including: retail businesses worth between $271.75 million and $326.1 million; generation businesses worth between $3.2 billion and $3.97 billion; and network businesses worth between $3.1 billion and $3.6 billion.

Western Australia

Western Australia is another state in which close to 100 per cent of the generation assets are publicly owned, and it is also another state unlikely to pursue bold structural reform anytime soon.

Responding to the federal government’s draft Energy White Paper (EWP), released last year, Western Australia’s Energy Minister Peter Collier reiterated that his state is not considering selling any of its assets.

‘What we have at the moment is a situation where we have had significant private sector investment, in generation particularly, over the past few years, but that has come at a cost,’ he told the ABC.

‘There will be opportunities for private sector involvement as energy capacity increases over the next decade, but in terms of an overall blanket privatisation, it is not on the agenda.’

In a recent speech to an industry conference, Federal Energy Minister Martin Ferguson singled out Western Australia for its blanket failure to undertake energy market reform.

‘The biggest barrier to greater investment in Western Australia’s energy infrastructure is government ownership. It is crowding out private players who do not have the certainty that government policy won’t change and adversely affect them,’ Ferguson said.

Ferguson went on to state that prices have risen

Back on the reform horse

by 57 per cent – or by $520 per household – under the current government, despite electricity prices being suppressed at a cost to state taxpayers of $367 million last financial year.

The case for reform

The economic case for completing electricity market reforms is clear-cut, but the politics are difficult.

Since privatisation in the 1990s, electricity price rises in Victoria have been consistently lower than in all other states. Victorian consumers also enjoy and actively take advantage of their ability to switch to a retailer of their choice. Retail competition is so advanced that Victoria is now widely recognised as the most competitive electricity market in the world, based on customer switch rates.

Price impacts aside, the privatisation of network businesses also represents the best opportunity Australia has to break the back of its broader infrastructure shortfalls.

Speaking at last year’s Partnerships conference, Macquarie Group and Origin Energy Chairman Kevin McCann hit the nail on the head. ‘At a time of historic shortfalls, Australia simply cannot afford for scarce capital to be allocated to areas where private capital is readily available,’ McCann said.

In states where networks remain publicly owned, electricity investment consumes up to one-quarter of total public infrastructure investment – money that would be much better spent on ailing transport, hospitals and other social infrastructure.

IPA valuations suggest that the sale of network assets in New South Wales would have a $50 billion bottom-line impact, through a mix of capital proceeds and avoided debt.

This would give the cash-strapped New South Wales Treasury the ability to fund the North West Rail Link, the M5 and M4 motorway completions, and the Pacific Highway duplication, as well as the capacity to replace ageing hospitals, schools and community infrastructure.

In Queensland, the sale of electricity businesses would have a similar, game-changing impact on that state’s bottom line.

After years of heavy investment, the combined Regulated Asset Base (RAB) value of Queensland’s electricity networks is pushing $30 billion – more than in any other state. Add to this the roughly 8000 megawatts of state-owned generation capacity.

Opponents to reform are quick to point to the loss of dividends paid to government. But, as Kevin McCann told delegates at last year’s Partnerships conference, this argument has little merit.

‘Victorian Treasury analysis shows that savings from the retirement of debt more than compensated for the loss of dividends,’ he said. ‘The analysis found savings from debt retirement outweighed dividend payments by over $600 million in 1996–97, and by $718 million in 1997–98.’

Jim Miller says that concerns about job losses are similarly unfounded.

‘Historically, these concerns are not borne out by experience,’ he says. ‘In Victoria, for instance, the prospects for generation and hence employment actually improved after the assets were privatised.’

He believes that there is much to be gained by educating the public about the benefits of recycling infrastructure assets.

‘Some people have yet to make the connection between needing new infrastructure and the potential to use the sale of existing infrastructure to fund that.’

But with enormous public appetite for better infrastructure and cost of living pressures looming as major political issues, the stars may well be aligning for the completion of the electricity market. New South Wales is widely tipped to take privatisation of network businesses to the next election; and Queensland has few other options if it’s going to repay its massive debt and fund its capital program. Only time will tell.

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