Electricity privatisation - the theory and the reality

February 15, 2008

The basic argument in favour of the privatisation of electricity generation and distribution is simple — public ownership allows too much bargaining power to electricity workers and their unions (which they will always use to defend "inefficient practices" and "overstaffing"); it also fosters over-investment in generation capacity by engineers concerned to guarantee service reliability ("gold-plating").

This combination of recalcitrant employees and over-zealous engineers and managers guarantees that, for any level of electricity technology, public ownership will supposedly be less efficient than private ownership.

What's more, the only grounds accepted by mainstream economists for public ownership — that electricity generation and distribution form a "natural monopoly" — no longer holds. Competitive markets can and have been created in both the generation and retail side of the industry, making possible privatisation without the danger of private monopoly replacing public monopoly.

In Australia, the creation of the National Electricity Market in 1998 is held up as marking the introduction of a competitive model. While not requiring privatisation of public electricity authorities to function, the existence of the NEM has bolstered the position of the supporters of electricity privatisation — how can aging public electricity generation infrastructure compete on this "playing field"?

Combine privatisation and competition and, the theory says, prices will fall, service reliability will be improved and governments will be able to use the income from privatisation on education, health and public transport and/or paying off public debt. The income lost to the public purse once privatisation takes place will be more than offset by the lower interest payments on public debt.

Such are the basic arguments being pushed to support the privatisation of the NSW electricity industry. In the words of NSW Labor treasurer Michael Costa, writing in the January 3 Sydney Morning Herald: "Increasing private investment in the electricity sector is the best way to protect the jobs of existing employees and create new jobs as expansion and investment take place, while enabling the government to get on with its core service delivery priorities."

How well does this argument stand up after over two decades of electricity privatisation overseas and in other Australian states?

A good place to start is the 1997 World Bank research note The Restructuring and Privatisation of the UK Electricity Supply — Was it Worth It? Its authors, David Newbery and Michael Pollitt, summarised the winners and losers from 1990 to 1995.

What happened? Privatisation helped accelerate job loss, but the gains in industry productivity that resulted didn't lead to lower prices. Instead, the shareholders (banks, pension funds, etc) made a fortune as share prices rose by as much as 300% and the government picked up a bit in increased company tax receipts. "Power purchasers", they observed, "seem to be paying higher prices than they would have under continued public ownership."

Prices and reliability

Between 1989-91, domestic electricity tariffs in Britain rose 28% (4% above the inflation rate), despite a 27% fall in coal prices to the electricity companies. If that had been translated directly into consumer prices, they too would have fallen by 8%.

The British experience is not unique. In the corporatised New Zealand industry the wholesale price of electricity declined 17% in real terms between 1987 and 1997, but the retail price increased by 20%.

In South Australia, between 1994 and 2002, residential tariffs increased by 40%, with the state's regulator claiming that 20% of the total tariff was due to privatisation. The gap between SA and NSW rates has increased from 10% pre-privatisation to 30% today, even as real average electricity tariffs in Australia have declined slightly over the past 15 years.

Today in NSW about 70% of electricity customers are on contracts regulated by the Independent Pricing and Regulatory Tribunal. In an implicit admission that privatisation will mean higher tariffs (and in order to boost the value of the privatisable assets) IPART is increasing tariffs by 4-5% a year.

What's more, IPART is setting average price hikes for the retailers, who will be free to spread the increases however they see fit. IPART admits that this could "result in above-average price increases for some customers, particularly those on low incomes or who are low consumers of electricity and therefore less 'attractive' to competitors".

At the same time, price increases have gone along with decreased supply reliability — the predictable result of job-shedding. This has not just resulted in some spectacular system collapses (for example, the week-long blackout of Auckland in February 1998) but also to a rise in short-term blackouts. In Victoria, the frequency of blackouts increased by 32% in the four years after privatisation in 1995.

The 1997 World Bank research note showed a net gain for British government income from electricity privatisation for 1990-95. But what happens if we take a longer period? University of South Australia economics Professor Richard Blandy, reported in the February 4, 2002 Australian that, "Revenues earned by the Electricity Trust of South Australia (ETSA) for the South Australian government before it was privatised would match, if not exceed, the interest on South Australian debt retired as a result of ETSA's sale. Hence, South Australians now face historically high electricity prices compared with the rest of Australia for no net benefit to the state government finances."

Australian National University economist John Quiggin not only maintains that privatisation in Victoria resulted in no net gain for the Victorian government, he reported in the December 28 Australian Financial Review that he has calculated that "the rejection of [electricity] privatisation in 1997 saved the NSW public between $5 and $10 billion".

A theory in tatters

So why hasn't privatisation reality confirmed privatisation theory? There are four basic reasons.

Firstly, private capital has to earn a higher rate of return than public investment. Private investors are not interested in electricity generation for the sake of it, but only if it offers a sufficiently high rate of profit, which is determined by other potential investments. According to privatisation consultant KPMG, the rate of return on publicly owned electricity generation capacity is 7.1% in Queensland and 10.6% in NSW, while corporate investors would´t touch electricity generation until the rate was 15%.

Thus, any government that wants to privatise its electricity industry has to allow tariffs to rise until the return on private investment is acceptable to potential buyers. Otherwise it won't sell, or will have to be sold cheap.

Secondly, private debt is more costly than public debt. Dr Sharon Beder, an associate professor in science and technology studies at Wollongong University, comments on the Victorian experience in her June 2007 submission on behalf of Unions NSW to the state government's public inquiry into NSW electricity supply: "Most of the economies that could be achieved by slashing the work force had occurred prior to privatisation. Robert R. Booth [in his book Warring Tribes: The Story of Power Development in Australia] estimates that the cost savings from this could have led to price reductions of 30% and still serviced the previous $9.5 billion government debt [the pretext for Victorian electricity privatisation —DN], but because of the need to service the $23 billion spent by private companies buying the industry, there was pressure to increase prices rather than decrease them."

Thirdly, a purely competitive electricity market is simply not possible. The theory that electricity generation and distribution could be made competitive runs directly against the reality that companies that achieve the greatest economies of scale and degree of "vertical integration" of generation and retailing prevail in the war for market share and profits.

This is already clear in the Australian private electricity industry. Not only are producers like AGL on the look out for retailers with whom to integrate, they are also pressing to merge with other big producers (like Origin Energy). If unhindered, this process will lead to an electricity industry with a few "gentailers", dominated by the big three producers — AGL, Origin and TRU — and thus a greater degree of market concentration than in the "bad old days" of public electricity companies!

Fourthly, the short-run gain to state budgets eventually runs out. If a state enterprise is paying a dividend and this is sold off, this annual dividend (around $1 billion in the case of NSW public electricity assets) is lost forever. Sooner or later, the cumulative value of this loss will exceed the immediate gain from the sell-off of public assets.

Thus the fairy tales of privatisation theory actually leads to the reality of consolidation of private monopoly based on the vandalisation of public assets, loss of jobs and increased cost to the consumer. These are very powerful reasons to reject the NSW government's electricity privatisation proposal outright.

[Dick Nichols is the national coordinator of the Socialist Alliance.]

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