Privatisation of Queensland Electricity Assets: A Preliminary Evaluation

John Quiggin

School of Economics University of Queensland

Summary
There are two main arguments for privatisation of electricity assets (1) The sale of income generating assets, such as electricity assets, will improve the nancial position of state governments, allowing new investment in assets such as schools and hospitals. (2) The process of electricity market reform associated with the creation of the National Electricity Market requires privatisation to function properly These arguments are assessed and shown to be unsound. Privatisation is unlikely to improve the nancial position of the state. If badly managed, as has been the case in most previous asset sales, it will leave the public worse off. Reforms to the electricity market over the past two decades have resulted in higher prices and a misallocation of investment, which has been made worse by privatisation and corporatisation. The entire process should be reassessed before any change in ownership structures is considered. Analysis undertaken by Queensland Treasury or by the Costello Commission of Audit is purely political, and of no evidentiary value. The weakness of this analysis is demonstrated by the consistent refusal of Treasury and the Commission to respond to criticism by leading economist.

Privatisation of Queensland Electricity Assets: An Economic Evaluation

Since the early 1980s, privatisation of public assets has been demanded by advocates of microeconomic reform and strongly supported by the nancial sector. It has been opposed, equally strongly, by voters, who have rejected privatisation whenever they have been given the chance (Kelley and Sikora 2002). A variety of claims have been made in favour of privatisation (Kay and Thompson 1986), but experience has shown these claims to be false in nearly every case. According to press reports, the Newman LNP government in Queensland is considering the sale of the states electricity assets. The government has indicated that the Queensland Commission of Audit, headed by former Treasurer, has recommended the sale of assets including electricity assets, although the Commissions report has not yet been made public. There are two main arguments for privatisation of electricity assets (1) The sale of income generating assets, such as electricity assets, will improve the nancial position of state governments, allowing new investment in assets such as schools and hospitals. (2) The process of electricity market reform associated with the creation of the National Electricity Market requires privatisation to function properly Neither of these arguments is valid. The rst was comprehensively rejected, both by economists and by the general public, when it was put forward by the Bligh Labor government. The second has been discredited by the failure of electricity market reform to achieve any of the goals originally put forward. In particular, whereas reform was expected to result in lower prices, the actual outcome has been a near-doubling of real prices in most Australian markets. This outcome has occurred regardless of whether electricity assets are publicly or privately owned, but evidence suggests that the outcomes have been worse under privatisation.

Background Before the 1990s, electricity supply infrastructure in Australia was almost entirely owned and operated by statutory authorities, which were obligated to supply electricity at the lowest possible cost consistent with meeting a range of policy objectives. The development of the electricity industry by the public sector was highly successful in delivering cheap and reliable electricity at prices sufcient to service debt associated with the construction of power stations and electricity networks. undertaken by the same authority. The creation of the National Electricity Market has involved the separation of the industry into separate generation, transmission, distribution and retail components. Within this framework, transmission and distribution services are undertaken by regulated monopolies. An electricity pool market operates continuously to match demand from retailers with supply from generators. In addition, generators may make long-term contracts with retailers or consumers. In addition to matching supply and demand, the market is supposed to provide investment signals. Under the corporatisation system, required by National Competition Policy, the boards of statutory authorities, with representation from a range of stakeholders have been replaced by a system mimicking that of a private corporation. The boards of corporatised government business enterprises are appointed by, and have a duciary responsibility to, the shareholding ministers, normally the Treasurer and the minister responsible for energy. The promoters of National Competition Policy and electricity market reform envisaged a fully privatised, competitive market, as the natural outcome of the prices (Quiggin 1996). After twenty years, movement towards privatisation remains limited, and the hoped-for market outcomes have not eventuated. The history of privatisation Privatisation proposals have been advance or implemented in most states. In nearly all cases, these proposals have been both economically unsound and politically disastrous. Here is list of examples from the electricity industry In most, though not all, cases electricity systems were vertically integrated, with generation, transmission, distribution and retail functions being

* Victoria: The industry was privatised by the Kennett Liberal government in 199,3 The attractiveness of the assets was enhanced by a general increase in prices implemented before the sale. This was arguably the most favourable case for privatisation since it was undertaken at a time of strong demand, and limited supply, for infrastructure assets. As a result, the prices paid by buyers were substantially higher than they were able to realise in subsequent resales. Despite this, the benets to the public were limited. The interest savings realised by using sale proceeds to repay debt were about the same as the earnings foregone as a result of the sale. (Quiggin 2002, Cahill and Beder 2005). The Kennett governments policies were strongly supported by policy elites, but were rejected by the Victorian public. Despite coming into ofce under the most favourable conditions possible, with the previous Labor government seen as responsible for nancial chaos, the Kennett government survived only two terms. The Liberal Party remained in opposition for three terms after Kennetts defeat. * South Australia As in Victoria, a conservative government had been elected in a crisis atmosphere following the failure of the Bank of SA. The electricity industry was privatised by the Olsen Liberal government in 1998, despite a promise to the contrary in the previous election in 1997 (Spoehr 2003). Privatisation produced both an increase in electricity prices and a substantial loss to the public. The conservative government was defeated in the subsequent 2001 elections and has remained in opposition ever since. * Tasmania. The Rundle (Liberal) government proposed the partial privatisation of the HEC in 1998 Analysis showed that the likely sale price would be insufcient to offset the loss of earnings from the HEC. (Quiggin 1998) The Rundle government was defeated in an election in which the privatisation proposal played a substantial role, and the Liberals have remained in opposition ever since. Flows of income to the Tasmanian government from its publicly owned assets have remained substantial. * New South Wales. Privatisation of the electricity industry was proposed by the Liberal Party Opposition, led by Kerry Chikarovski in 1999 In an election fought on this issue, the Liberal party was overwhelmingly defeated. Despite this, successive Labor governments sought to implement privatisation policies, with disastrous political consequences and no

economic benets. This pattern has been continued by the OFarrell Coalition government, which now plans to sell the remaining electricity generators. * Western Australia The Barnett Liberal government is currently proposing privatisation of electricity assets * Queensland The retail sector was privatised by the Beatty government Generation and distribution have remained under public ownership. However, the Bligh government sold a wide range of public assets, on the spurious pretext that this would nance additional investment in schools and hospitals. These claims were widely criticised by economists (Group of 20 Economists 2009, Quiggin 2010, Walker and Walker 2009). Following Blighs catastrophic defeat, the incoming Newman government announced that public sector nances were in a disastrous state, requiring massive cuts in services of all kinds, notably including health and public education. The Queensland Treasury, which endorsed the spurious claims of the Bligh government, is now doing the same for the equally spurious, but contradictory, claims of the Newman government. * ACT The Carnell Liberal government proposed the sale of the electricity supply rm ACTEW in 1998 (Quiggin et al 1998). The proposal was defeated and instead, ACTEW established a joint venture with AGL. The Carnell government was defeated in 2000, and the Liberal party has been in opposition ever since.

At the Commonwealth level, both Labor and Liberal governments undertook privatisation. The most signicant case was that of Telstra, managed by then-Treasurer Peter Costello. The sale was mismanaged in many ways (most notably by selling the business in three parts, with an initial promise to retain public ownership), with the result that the return to the public was greatly reduced. With the exception of the second stage sale, undertaken at the height of the dotcom boom, the sale proceeds were of less value than the earnings foregone through privatisation. Moreover, the privatisation was a disaster for telecommunications policy. Telstra refused to invest in modern broadband, necessitating the re-entry of government into the telecommunications sector through the NBN.

Fiscal arguments for privatisation The Bligh government undertook sales of assets valued at more than $10 billion, based on the claim that such sales were necessary to improve the states scal position. These claims were rejected by the then LNP Opposition. On assuming ofce, the Newman government announced that the states nances were in a dire position, bordering on that of Spain or Greece. At no time has the Newman government given any credence to the claim that the previous governments asset sales improved the states scal position. Such a claim is inconsistent with everything the LNP has said both before and after taking ofce. More relevantly, the Bligh governments claim was rejected by economists representing a wide range of viewpoints regarding the merits of privatisation. Their statement (Group of 20 Economists, 2009) is worth quoting in full

Decisions on the sale or retention of public assets have important implications for competition and public policy, as well as for the scal position of governments. These decisions cannotbe resolved on the basis of general ideological arguments for or against public ownership, and require informed public debate in each case. The normal lines of economic debate include whether a given business is more efciently operated in the private or public sector, the appropriate allocation of risk and the extent to which the enterprise is required to pursue social as well as nancial objectives. The signatories of this statement have a range of views on the appropriate balance between the public and private sectors and on the merits of privatisation in particular cases. However, we share the view that these questions should be resolved on the basis of well-informed discussion of the economic and social costs and benets of privatisation, and not on the basis of spurious claims that asset sales represent a costless source of income to governments.

The arguments put forward by the Queensland government in its booklet Facts and Myths on Asset Sales do nothing to promote a well-informed debate. Two central claims are particularly, and sadly, noteworthy. In relation to ve public assets proposed for sale, the"Facts and Myths"booklet states Keeping these businesses would cost the Government $12 billion over the next ve years. Thats $12 billion spent on new coal trains and new wharves that cant be spent on roads, schools or hospitals. This claim is economically unsound. Forgoing income generating investments, and borrowing an equal amount to fund investments that return no additional revenue, leaves the government with no ow of income to service the associated debt. The necessary income must be raised by increasing taxes or cutting expenditure. Selling public assets will improve the public sectors scal position only if the price realised for the assets exceeds the value of the income stream that the asset would otherwise generate for the public sector. In this respect, the Facts and Myths booklet states The total return from all ve businesses in 2008-09 was approximately $320 million When the sale process is completed, it is anticipated the Government will save $1.8 billion every year in interest payments. This is an invalid, apples-and-oranges comparison. The $320 million gure consists solely of dividend payouts, excluding retained earnings, tax-equivalent payments and the interest paid by the government business enterprises to service their debts. The $1.8 billion represent the interests that would be saved, at a rate of about 6 per cent, if the state realised $15 billion from the asset sale and avoided $12 billion in new investment. Most of this

interest would be serviced out of the revenues of the GBEs, and can therefore not be compared with dividends derived from earnings after the payment of interest and tax. The people of Queensland deserve a robust and well-informed public debate over the costs and benets of privatisation. So far they have not received it. The spurious claim regarding the costs and benets of public ownership was surreptitiously removed from the Treasury website when its falsity became undeniable. The claim that asset sales could nance new investment in schools and hospitals was maintained until the Bligh governments defeat. However, the Budget papers reveal no apparent increase in investment under the Bligh government. The incoming Newman government claims that there is no possibility of new investment, and that hospital services must be outsourced to the private sector. The case of the electricity assets There has been no attempt to present an assessment of the costs and benets to the state of public ownership of the electricity industry. However, the Newman government has repeatedly made the point that CS Energy has lost money in recent years, requiring injections of public capital as a result. The implication is that the publicly-owned electricity industry is a burden on the Queensland government and public, and that selling assets would relieve us of this burden. This implication is false. The electricity sector as a whole has been, and will remain, consistently protable. However, the structure of the sector, produced by the reforms of the 1990s mean that there is a constant shifting of risk between generators, distributors, retailers and consumers. Recent developers, most importantly the sharp increase in distribution charges arising have imposed costs on generators and consumers while benetting distributors and, to a lesser extent, retailers. For example, Energex expects a record prot of $320 million in 2012-13.

Public ownership of the electricity industry means that the gains and losses from market uctuations wash out. Losses in generation are offset by gains in distribution. More generally what Queenslanders lose as consumers from higher prices, they gain as owners. There is no reason to suppose that the current situation, in which some generators are losing money, while distributors are highly protable, will persist. Indeed, if CS Energy were a consistently lossmaking enterprise, it would be unsalable. The history of privatisation has shown that, despite claims that private sector efciency can outperform the public, changes aimed at enhancing protability (often at the expense of other goals) must typically be undertaken before public enterprises can be sold. It appears that the Newman government is already taking measures of this kind, intervening in the management of public enterprises to demand large-scale layoffs. Summary To sum up, the sale of income-generating public enterprises does not, in general, improve the nancial position of the public sector. There is no reason to think that the sale of Queenslands electricity assets will be an exception to the general pattern. The failure of electricity market reform Pressure to reform1 this system came from a number of sources (1) The proposed development of a National Grid meant that the existing system of statebased networks with limited interconnection required structural changes (2) It was claimed that existing systems were characterised by overstafng (pejoratively referred to as featherbedding) and excessive capital investment (goldplating) resulting in excessively high prices for consumers (3) Returns on publicly-owned assets were seen as insufcient

The term reform is commonly used with the connotation of benecial change. However, there is no guarantee

that policies described as reforms will actually be benecial. In this paper, I will use the term reform in its original sense of a change in form, without any implication that the reforms in question are benecial.

(4) The rise of market liberal ideology (commonly referred to as economic rationalism) created a broad consensus among policymakers (though not the general public) in favour of market-oriented reform and privatisation of public assets. Reforms were implemented through three main processes (a) Reforms associated with the creation of the National Electricity Market (b) The general process of National Competition Policy which required corporatisation of statutory authorities and the removal of barriers to the entry of private rms (c) Privatisation of public assets proposed or undertaken by state governments The National Electricity Market has been a comprehensive failure In the course of the privatisation debate, it has been claimed that the problems of the National Electricity Market are due to public ownership. In reality, the problems have been as bad or worse in states with partially or fully privatised systems. In South Australia, privatisation was advocated in the 1990s on the basis that it was necessary for participation in the National Electricity Market. Far from reducing prices, the result was to raise them to the highest levels in Australia This was due in part to massively increased distribution charges. As the SA Essential Services Minister, Lew Owens noted in an interview with ABC Stateline (2003): The simple explanation for that is in addition to the wholesale energy price you have to add the network charges for the poles and wire businesses. They are dearer in SA because the assets were revalued back in 1996 prior to privatisation and locked in by legislation. Wholesale prices of $71/MWh, well above the national average were also applied, as a result of the poor performance of the National Electricity Market. In Victoria, prices were increased prior to privatisation and deregulation. In the immediate aftermath of deregulation, there was a glut of electricity, and prices for business users were reduced by around 40 per cent. It was widely forecast that full retail competition would result

in similar benets for households. In reality the opposite happened. Charges for household users increased after deregulation and have continued to do so. For example, between 2005 and 2010, electricity prices rose by 57 per cent in Melbourne http://electricitywizard.com.au/electricity/prices/Comparing-Electricity-Prices Differences in tariff structures and local conditions make exact comparisons difcult. However, two conclusions are evident from the data (i) Prices have increased dramatically as a result of the failure of the NEM (ii) The problems have been at least as severe in states that have undertaken privatisation as in those that have retained public ownership. Governments and public debate on privatisation Bad policy is commonly associated with bad politics, including reversals of electoral commitments, refusal to debate the issues and so on. This has been consistently true in relation to privatisation. In the entire term of the Bligh government, no attempt was made to respond to the criticisms made by economists. The Treasurer, Andrew Fraser, consistently evaded debate on the issue, preferring stage-managed set-piece presentations to friendly audiences. Internal critics in the Labor movement were similarly ignored and marginalised. This pattern of evasion continued until the government faced the one test it could not dodge - the electoral verdict of the people of Queensland, which was damning. Treasury analysis not independent It seems likely that, as with the Bligh governments asset sales, the Newman governments proposals will be supported by an analysis from Queensland Treasury. It is important to observe therefore, that such an analysis has no evidentiary value. Queensland Treasury has consistently endorsed the policy preferences of the government of the day whether these were opposed to privatisation (the Beattie government, and the Bligh government before the 2009 election) or supportive (the Bligh government in its nal term and the Newman LNP government).

Moreover, by endorsing the Facts and Myths propaganda pamphlet and website, Treasury has completely destroyed its credibility on this issue. Not a single serious economist in Australia could be found to publicly endorse the spurious claims made by Facts and Myths. The same will be true of whatever Treasury analysis is produced to support future asset sales. The Commission of Audit Interim Report Exactly the same points are applicable to the Commission of Audit. The appointment of a Commission of Audit is a routine piece of political theatre, almost invariably adopted by newly elected conservative governments. Invariably, such Commissions report massive scal mismanagement by the outgoing Labor government and recommend policies in line with the preferences of the government that appointed them. The Queensland Commission of Audit is a particularly transparent example. Its chair, former Treasurer Peter Costello, appointed his own Commission of Audit which was used to justify the Howard governments abandonment of non-core election promises. In ofce, Costello used asset sales to produce spurious improvements in the governments balance sheet. Although the Howard-Costello government presented itself as a model of scal rectitude, independent evaluations have been far less charitable. An International Monetary Fund assessment (Mauro et al 2013) described the Howard government, in its later terms as scally proigate. The conclusions of the Commission of Audit were entirely predictable. Equally predictable was the Commissions, and the Newman governments, refusal to engage with criticism. Following the pattern set by Anna Bligh and Andrew Fraser, independent analyses of the Commissions interim report were dismissed with contemptuous quips and ad hominem attacks. The Commission of Audit Final Report The recommendations of the Costello Commission have been released, but the report itself remains secret. The only plausible interpretation are (i) the analysis presented in the report is so weak that its release would undermine the political case for the policies being recommended; or

(ii) the analysis is inconsistent with claims made by the Newman government about tax and expenditure policy Summary The sale of Queensland electricity assets has been put forward as a way to reduce electricity prices and improve the states nancial position. In reality, it will achieve neither of these goals.

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