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Neither up nor down

March 16th, 2015

I’ve had the unusual experience of being cited as an authoritative expert* by both the Oz and AFR this week. Unfortunately, the Oz got the story wrong, and the AFR report, while correct on a careful reading, is misleading. The issue is the impact of electricity privatisation on power prices.

Direct comparisons suggest that consumer prices don’t differ much between NSW and Queensland (with public ownership) and SA and Vic (with privatisation), though SA is highest.

The advocates of privatisation have focused on distribution charges, showing in the process that they don’t understand the National Electricity Market reforms they and their ideological allies pushed through in the 1990s. Under the system of regulation, distributors are allowed to charge a price sufficient to cover their “efficient costs”, which are determined in large measure by benchmarking against other distributors. So, if private firms are more efficient than public firms, that should have no effect on regulated distribution charges, only on relative profitability. **

As the AFR and Oz both gleefully pointed out, that analysis contradicts what they called Luke Foley’s “great lie”, that prices will rise if privatisation takes place. Unfortunately, it also contradicts the equal and opposite lie, that prices will fall if privatisation takes place. The AFR gives a misleading headline, but is correct in the body of its report, saying “The prices charged by the government-owned NSW network companies will go down – not up – whether or not they are leased out to private operators.” That contradicts Foley’s claims, but also the opposite claims made by the Liberals.

I look forward to the AFR and Oz correcting this error and presenting the correct analysis (only joking!).

More seriously, I’m hoping to do a proper analysis of electricity prices and why they have risen so much under the NEM, contrary to the predictions of the micro reform lobby of which both the Oz and the Fin are part.

* Of course, I was cited in an “even the liberal New Republic …” way. The AFR noted, reasonably enough, that I was opposed to privatisation. The Oz went full-on as only the Oz can do, reprinting some of Michael Stutchbury’s hit piece, written for them before he jumped ship to the Fin. Since this piece earned me a very nice write up in the New York Times, I guess I can’t complain.

** Disclosure: I was for some years, a member of the Queensland Competition Authority, which regulated distribution charges. I’ll write more about this, if I get time.

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  1. Uncle Milton
    March 16th, 2015 at 15:41 | #1

    So, if private firms are more efficient than public firms, that should have no effect on regulated distribution charges, only on relative profitability.

    I thought the regulators made the distributors share the efficiency gains between the customers (because they are supposed to get the benefits) and their shareholders (to give the distributors the incentive to become more efficient).

  2. Hermit
    March 16th, 2015 at 15:52 | #2

    I wondered if Électricité de France the world’s biggest integrated energy company (power stations, poles, wires and retail) had something in its mission statement about providing value to shareholders. Can’t find it eg in
    http://about-us.edf.com/strategy-and-sustainable-development/our-vision/objectives-and-commitments-43682.html
    Key words seem to be community, efficiency, climate protection and so on. Past and future owners of anything linked to NSW Hunter valley assets will struggle to boast about climate protection. Somehow EdF got to be the world’s biggest without an explicit profit maximisation objective. Perhaps though like our Telstra they might need smaller competitors to keep them on their toes.

  3. Uncle Milton
    March 16th, 2015 at 16:06 | #3

    @Hermit

    According to the link, EFD has the objective to “Remain the lowest carbon emitter among the major European energy companies, especially electric utilities.”

    Of course, this might be because 84.7% of their electricity is generated by nuclear power.

  4. paul walter
    March 16th, 2015 at 16:27 | #4

    I am here bit muddled and find Uncle Milton’s first comment answers most of it.

    For the rest, I am inclined to google up the 4 Corners episode on ICAC from last year, involving folk like Obeid and Sinodinos and privatisations, in order to understand better the scrutiny mechanisms, regulatory frame works and criteria for determining costs and pricing.

  5. Ikonoclast
    March 16th, 2015 at 20:18 | #5

    Censure from fools is praise indeed.

  6. Ivor
    March 16th, 2015 at 23:03 | #6

    Of course private companies can provide cheaper electricity – they just cut labour costs per kwhr.

    “Privately owned businesses run at lower cost to the benefit of consumers,” the Grattan ­Institute’s energy director, Tony Wood, said. [Grattan]

    Possibly too, companies may all tender higher when providing materials for government contracts. This creates higher costs for government. Private companies may also benefit from sweat-heart deals from associated entities.

    No wonder they are so coy about what “lower cost” actually means.

  7. Hermit
    March 17th, 2015 at 08:11 | #7

    I doubt the green cred of NSW Labor if Qld is anything to go by. It looks a new coal fired power station might get the tick of approval. I thought that was never supposed to happen the way federal Labor talked when in power. I wonder if Qld is not bothered then NSW next door won’t be either. That is no pressure on private operators to clean up.

  8. Nevil Kingston-Brown
    March 17th, 2015 at 08:48 | #8

    Typo: “Unfortunately” should be “as usual”

  9. David Irving (no relation)
    March 17th, 2015 at 09:51 | #9

    @Ivor
    Heh. I like “sweat-heart deals.”

  10. totaram
    March 17th, 2015 at 12:39 | #10

    @Ivor
    “Of course private companies can provide cheaper electricity – they just cut labour costs per kwhr.”

    I think there is evidence that actual man-hrs/kwhr has increased after privatisation, possibly because of “marketing”. If this actually costs less, you know what is going on.

  11. John Quiggin
    March 17th, 2015 at 15:32 | #11

    @totaram

    From the available data, that appears to be about right. Technical staff numbers declined, but that was offset by growth in marketing and managerial positions.

  12. John Quiggin
    March 17th, 2015 at 15:33 | #12

    @Hermit

    It’s supposed to have CCS and geosequestration. I’ll be impressed if that works economically, but I can’t see how it fails on the green credentials test.

  13. March 17th, 2015 at 15:45 | #13

    NSW has some of the highest electricity prices in the world.

    In the US electricity prices range from 8c to 12c per Kwh. In NSW they are from 20c to 40c per Kwh.

    Electricity charges in NSW effectively have a 60% stealth tax levied by the state government.

    The whole power sector should be privatised in NSW like they are in the US. This is the only way NSW can revert back and have some of the lowest power prices in the world again.

    In the US their power utilities are regulated private monopolies that restrict the return on capital for investors to a return just over the bond rate. This equates to lower prices for consumers as excess returns are channelled back in the form of lower electricity prices. (instead of to the government as a stealth tax)

    We pay enough taxation in Australia as it is without having to fork out extra 12c a Kwh on top of what electricity should cost, that is effectively a tax.

  14. totaram
    March 17th, 2015 at 19:51 | #14

    @John Quiggin
    I’ll be surprised if that (CCS and geosequestration) works at all ( forget economically). They will probably give up after “trying” and then go back to good old fashioned coal burning. Can’t let the existing investment go to waste etc. It’s just a way to get the foot in the door.

  15. Hermit
    March 18th, 2015 at 06:19 | #15

    @John Quiggin
    It sounds suss because they want to inject the captured CO2 into another part of the basin. Coal basins are shallow (<200m) and leaky compared to oil and gas basins with kilometres of sandstone cap rock. That's even if it is economic. If it goes ahead it will be the first Australian coal fired power station built in the 21st century.

  16. Ikonoclast
    March 18th, 2015 at 08:45 | #16

    We have reached the point, climate-wise, where no new coal power station should be built anywhere on the planet. No new coal mine should dug. No new oil well or gas well should be drilled. Every addition to power and/or every replacement of retired fossil fuel power should come from renewable energy. If this mean living with less energy then we do that with efficiency and frugality measures. Of course the chances we will actually do this are 0%. Thus the chances that we will prevent dangerous climate change by our own actions are 0%. In a nod to Tim Macknay, the chances that climate change will prevented by some adventitious events or phenomena or that the climate scientists are wrong after all, probably add up to 1%.

  17. Ken Fabian
    March 18th, 2015 at 09:41 | #17

    Because it’s essential to maintain reliable electricity supply as well as essential to force and regulate a transition to low or zero emission, maintaining public ownership will be invaluable to shortcircuit much of the obstructionism based on maintaining short to medium term profitablity that is inevitable when sold off.

    Existing fossil fuel plant is headed for intermittency as renewables penetration gathers pace but will remain the principle backup for some time; the means to maintain such plant in a less profitable part time role is probably essential, but clear incentives are needed to reduce their use and encourage their ultimate replacement. Well managed and overseen of course to avoid yet more rent seeking.

  18. Ikonoclast
    March 18th, 2015 at 10:20 | #18

    @Ken Fabian

    Agreed. If the democratic state had control of all the key infrastructure it could respond directly to democratic demands to take action on climate change. That is if our major parties were not beholden to private capital for campaign funds and thus enacting policies only for the rich. However, as private capital has bought out our major political parties and has most of the ownership of key productive and distributive apparatus, the command and control of our society belongs to that minority who own most of the the private capital and not to the democratic majority.

    A society cannot become genuinely democratic until ownership and control become democratic.

  19. jungney
    March 18th, 2015 at 10:26 | #19

    Maybe the task of geosequestration of carbon could be assigned to Linc Energy which appears to have some experience of how to cover up a technological fail:

    Mining company Linc Energy allegedly failed to report a series of dangerous gas leaks at its experimental Chinchilla coal gasification plant in Queensland and instead covered them up, according to court documents.

    Search warrants and other documents filed in the Supreme Court in Brisbane allege a series of unreported incidents at the plant, unearthed as part of a major state government investigation after tip-offs from former workers.

    They include a fire that caused Linc to evacuate the site in 2007, persistent leaks of toxic gas into the air and groundwater between 2008 and 2011, and an alleged attempt by management to hide problems at the site from government officials in 2012.

    Workers even had nicknames for some of the gas leaks: “Mr Bubbles” and “Puffing Billy”.

    Underground coal gasification (UCG) is a controversial technique involving the ignition of the coal seam, with oxygen pumped into a well to allow for the combustion of coal, which then produces synthesis gas or syngas.

    The trouble with the entire fossil fuel industry is that BAU always teeters on the edge of criminality at any point in the cycle. There’s a long and gritty history of failure of adequate standards from production to end use, from Deepwater Horizon to leaded fuel, from global warming to toxic diesel exhausts.

  20. Tim Macknay
    March 18th, 2015 at 11:06 | #20

    ‘Green’ credentials or otherwise, what is the likelihood of the Galilee power station project actually going ahead? If my money was tied up in the project, I’d be worried.

  21. Hermit
    March 18th, 2015 at 15:15 | #21

    It used to be said one good deed deserves another now it’s one subsidy necessitates another. Rather than pay dispatchable generators a fee to remain on standby I suggest removing guaranteed market share to their competitors. Wind and solar have huge inbuilt advantages. Solar because it can be installed on the user’s premises thereby eliminating the middle man. Wind has the advantage that it may become cheaper than the variable cost (mainly fuel) of gas generation in a few years. That is put up with the fixed costs of idled gas plant and run it when the wind isn’t blowing.

    The driver should be penalty backed emissions targets, somehow packaged in a more palatable. form than carbon tax. The players can decide for themselves when and how much generation to operate so long as they stay under the annual cap. This removes not one but two subsidies; renewable energy certificates and capacity payments.

  22. Ernestine Gross
    March 18th, 2015 at 15:17 | #22

    So, an investment bank reached a conclusion (on the negative impact of privatisation on future State budgets) which the Premier of NSW didn’t like – according to the smh article referenced below. Then there was a phone call and another report.

    http://www.smh.com.au/nsw/nsw-state-election-2015/nsw-election-2015-premier-mike-bairds-office-sought-to-influence-critical-electricity-privatisation-report-20150318-1m1ni9.html

    JQ, you are having an impact – investment bankers seem to be aware they are not the only ones who can do the sums, using mainstream financial economic analysis.

    I am reposting this from an older thread on the topic of privatisation of poles and wires in NSW.

  23. Ken Fabian
    March 19th, 2015 at 08:30 | #23

    In the absence of real forethought and planning from our governments – lets play hot potato in super slomo – we are going to see a succession of climate and energy policy moves back and forth between inadequate to obstructive; even should the LNP ditch their climate science deniers the shift is likely to only be from fiercely obstructive to minimally compromising, with minimal being the operative word – seeking to do the least and force things in the minimalist, inadequate and stalled direction. I think we’ll get an extended version of what Abbott’s been doing – “We accept that it’s a problem but we oppose every fix on offer… jobs and growth”. But our MSM have never demanded up front and forthcoming honesty on this issue, before or after the election.

    Hermit, in the absence of actual mainstream political commitment – Labor barely better than LNP – every policy is going to be flawed. I don’t think there is any more palatable than carbon pricing option for the big players in this market; they want to keep on burning coal and they will continue to seek that outcome. They will claim every option but the ones that do that are too hard, too expensive and too risky; which is why the power needs to be with the regulator. Selling it off diminishes the options for rapid transition to low emissions.

    As for renewables, if it’s low emissions and available, especially when intermittently cheaper, it should have the priority. To some extent it’s deal with the intermittency problem or bust, but… forethought and planning again – for something other than the emissions issue fading away in the light of commercial “reality”. Renewables especially should not be locked out just because it’s making it less profitable for fossil fuel plant. If the big players can arrange politically to be buffered against the impacts of renewable intrusion into the market (and with climate science denial at the mainstream level they retain allies for doing so) they will do so, with the “but we are essential” fallback argument.

  24. Ikonoclast
    March 19th, 2015 at 09:55 | #24

    @Ken Fabian

    Short version. Nothing will be done about reducing CO2 emissions in Australia (and coal exports) until a category 6 cyclone (see note) smashes through Sydney and carves a path all the way to Canberra. Of course, by then it will be far too late to stop climate change. And it’s a very low probability event in itself. So short, short answer. Nothing will be done. We’ll be slowly boiled alive like the frog in the pot. Australia will become uninhabitable in a few generations.

    Note: There seems to be a need to create a new cyclone category given increasing intensities.

  25. Hermit
    March 19th, 2015 at 10:52 | #25

    The other big spoiler is that the big coal stations will need replacing 2025-2040. It’s hard to see them being replaced by new coal units even with ruse ‘carbon capture ready’ ie install CCS later when/if it’s cheaper. If I recall last year the electricity sector produced 184 out of 542 Mt national emissions. That’s a third. Then if most cars go electric we’ll need perhaps 50% more power hopefully not coal or gas based.

  26. March 19th, 2015 at 18:49 | #26

    JQ,

    Under the system of regulation, distributors are allowed to charge a price sufficient to cover their “efficient costs”, which are determined in large measure by benchmarking against other distributors. So, if private firms are more efficient than public firms, that should have no effect on regulated distribution charges, only on relative profitability.

    Isn’t the theory that if the private firms lower their costs, they get a short term profit, but that these lower costs eventually causes the benchmark to be lowered? This would mean that profitability is increased only in the short term, and in the long run the charges are lowered. Distributors that fall behind and fail to keep up with efficency improvements eventually start to loose money, or not make sufficient money as to become attractive to buyers who feel they can make the improvements. That is, it’s attempting to simulate the process of the market.

    The real problem I see isn’t so much with the theory, but with the practicalities of the benchmarking process. The benchmarking process is largely a theorical exercise of constructing a hypothetical competitor. This is coupled with the fact that the institutional barriers between distributors and regulators create a bottleneck for information and understanding about the real and current costs of operating a network. The result is a process that is vulnerable to manipulation by the distributors through selective information and accounting tricks. The end result is that distributor profitibility relies at least as much on (collectively) gaming the regulator (and hence overcharging the consumers in its captured market) as it does on efficient network operation.

    In the end it seems like an effort to shoe-horn a market based solution into an economic sector where market solutions really don’t fit (i.e. natural monopolies).

  27. John Turner
    March 24th, 2015 at 18:30 | #27

    @Uncle Milton
    I am a little ignorant of the regulatory system but it was my understanding that the rules provide a massive incentive for investment in the electricity infrastructure because the investors are effectively guaranteed a return, in effect by increasing their investment regardless of actual need they increase their profits and get a return that compares well with other alternative uses for their money. Hence the massive increases in the network costs to the consumer.

    Another point to consider is what we mean by being more efficient. It is not just about costs per KW/hr but also relates to occurrences of outages and how well the community is served in areas of low population density.

    I look forward to JQ’s analysis in the future.

  28. Gabrielle
    March 25th, 2015 at 09:21 | #28

    @Hermit
    That link to the project is dated 8th January 2015, three weeks before the election was held and the LNP was the government. It is better to accuse people of things they have actually done when they’ve done it. Making things up does not help the environment. Cancelling of previous contract can be extremely problematic. Ask the Victorian government.

  29. Ikonoclast
    March 25th, 2015 at 09:57 | #29

    @Gabrielle

    New governments should always be able to cancel contracts entered into by previous governments albeit with just compensation. At the same time, the courts should throw out “onerous and odious contracts” written with undue artifice and the intent to trap future governments and thwart the will of the electorate.

  30. March 26th, 2015 at 00:09 | #30

    This ABC Fact Check report explains some of the issues involved.

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