Electricity privatisation

John Quiggin has written a report into electricity privatisation in Australia – making the argument that privatisation has generally failed.

A couple of thing where we agree:

Economists, at least when they were thinking clearly and speaking honestly, were as one in rejecting the most popular political reasons for privatisation: as source of cash for governments or a way of financing desired public investments without incurring public debt.

I made a similar argument recently in New Zealand.

Then he is critical of Public-Private Partnerships. I am too – albeit for different reasons. All too often, I suspect, they are financing mechanisms looking for infrastructure to finance, as opposed to being a positive NPV infrastructure project looking for financing.

Then a point where we can quibble:

A survey of Australian and international experience yields the following conclusions:

  • Privatisation does not improve, and usually worsens, the fiscal position of the governments that undertake it.
  • Privatisation has always been politically unpopular, and public opposition has hardened with time and experience of private ownership of public infrastructure.
  • Privatisation does not, in general, lead to better outcomes for consumers.
  • Privatisation almost always leads to bad outcomes for employees.

He doesn’t actually provide much a survey or reference such a survey. William Megginson, however, has undertaken a lot of work in this area and his conclusion is:

private ownership must be considered superior to state ownership in all but the most narrowly defined fields or under very special circumstances.

Yes – privatisation is politically unpopular and the evidence on the impact of privatisation on employees is mixed. It may well be the case that electricity privatisation is a “narrowly defined field” where a policy of privatisation is less likely to be successful. That is the argument I expected to see in the paper – but there is no such argument, rather an assertion that electricity privatisation has failed.

I was particularly taken by this statement and graph:

Advocates of privatisation sometimes claim that the increase in prices is due to public ownership and that Victoria, which was the first state to undertake privatisation, has experienced smaller price increases than other states. This claim is often supported by selective reporting of data.

Quiggin - electricity

That is a pretty damning graph – it looks like price increases in Victoria have tracked the rest of the country. So I went to the original ABS data and played around. First I disaggregated “Australia” into the actual other cities and replotted the data.

Quiggin - electricity 1

Okay – looks like Victoria is in the middle of the pack, and on the low side from time to time. To get another perspective I standardised all the series to start at 100 and plotted the data again.

Quiggin - electricity 2

Now it looks like Victorian (Melbourne) prices were on the low side compared to other states until about 2007. Next thing I compared electricity price inflation to general CPI for each state and territory.

Quiggin - electricity Vic

Not bad, but not as good as say Brisbane …

Quiggin - electricity Qld

… but certainly better than the ACT.

Quiggin - electricity ACT

What I do next is show the ratio of the electricity price index to the CPI index for each state and territory. When that number is greater than 1 electricity prices are rising faster than CPI and when less than 1 they are rising slower than CPI.

Quiggin - electricity 3

Perth and Brisbane were the places to be for low electricity prices relative to CPI. Melbourne too. But there is another problem that John Quiggin barely touches on – those massive price spikes after 2007/8. Now he does say:

The design flaws that have led, over 20 years, to the failure of the NEM were not anticipated.

To be fair, however, the rise of the global warming movement and the political response to that movement is not a design flaw in the National Energy Market. Here is how John Quiggin describes the issue:

Efficient investment – the pricing system has not delivered coherent signals for investment. In particular, the existing system has failed to cope with the entry of renewables.

Well actually, no. The pricing mechanism left to its own devices would have provided very effective investment signals – renewables are not price efficient and no or little investment would have been made. Rather it was political intervention in mandating renewable targets and the regime uncertainty associated with the carbon price/tax/mechanism that lead to sub-optimal investment decisions being made.

After all that, where does that leave us? John Quiggin has repeated his long standing criticisms of privatisation.* He has suggested that electricity privatisation has failed – but, in my view, not substantiated that argument. Many of his criticisms of the NEM relate to the process of corporatisation and (in some states) privatisation but to my mind those are public choice problems, not a critique of how actual markets could or should operate. Based on his argument to date, I think it is premature to suggest that there has been a record of failure in privatisation.

* I have other criticisms of his argument (discount rate used for public investment and around perfect v efficient markets) but that’s not important for this discussion. As always this is not an invitation to launch into John Quiggin – please keep your comments on topic and focussed.

Update: The ETU that commissioned John Quiggin’s report also released this clip.

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26 Responses to Electricity privatisation

  1. Robert Crew

    As I commented on Adelaidenow when this report was raised a few days ago (regarding the SA section of his report, where he claimed a loss of up to $1 billion to $2 billion due to privatisation):

    “Great methodology: add all the lost benefits, include none of the avoided costs. With a government monopoly, the taxpayer would have borne the cost of Pelican Point, Hallett, all the wind-farms up and down the State, the new interconnectors, etc. I would be surprised if those private investments totalled less than $1 billion to $2 billion.”

  2. Tardell G

    Ha ha! I stopped reading at “John Quiggin”.
    As usual Sinclair is a hostage to the left/marxists, hoping that they’ll give him airplay.

  3. Jim Rose

    My first ever blog posting at another blog that I prefer to not mention was on this very topic.

    I pointed out that government are so bad and politicised at owning business that they cannot even sell them for a good price.

    The most basic and simple task of owning an asset is selling it. Advisors can be hired to run the auction process for you.

    Government is bad owners – so bad that it can even screw up privatisations. What else would you expect? Governments under-price the asset to favour small share buyers, SOE employees and various other special constituencies. Imagine was favours and waster happens in day to day SOE operations far from the public glaze.

  4. entropy

    Well you could look at it this way, Robert.

    Would the SA Government have mandated all that alternative energy infrastructure if it had to pay for it itself? I think that is less likely. So privatisation removed that constraint on government, encouraging poor policy development.

  5. Sinclair Davidson

    As usual Sinclair is a hostage to the left/marxists, hoping that they’ll give him airplay.

    Gee, am I so transparent? :)

  6. entropy

    To clarify, once privatised, it is easier to impose onerous restrictions and renewable targets on the private entity, because hey, it’s Other Peoples’ Money.

  7. blogstrop

    Energy prices are now so political that reason has gone out the window of opportunity.

  8. Walter Plinge

    Those of us who remember the SECV don’t lament it. Gross over-manning, union capture and regular strikes resulting in power outages. Privatisation stopped that dead. What’s not to like?

  9. Robert Crew

    entropy, yes, but the point most South Australian’s forget is that the rationale for privatisation in SA, from the Auditor-General’s report to the announcement by John Olsen, was not to “save consumer’s money”, but to avoid bankrupting the State. The government, on the edge of bankruptcy, could not afford the required investment in generation capacity, and network interconnections, to the point where we were facing daily, rolling blackouts from roughly 2008 onward. There was no way private investors would build capacity for the use of a government monopoly selling electricity at below-market rates. Prices had to rise, and they had to rise in private ownership.

    This is reminiscent of the original nationalisation of the Adelaide Electric Company, 60 some years ago, which was done with the explicit intent of making the cost of electricity more expensive than the private market could bear, because the private market would not invest in mining poor-quality, expensive lignite from Leigh Creek SA, and insisted (how dare they!) on buying cheaper, “greener” coal from Victoria.

    In other words, not only do I agree with you, but so did the governments of the time.

  10. Jock

    Having worked in the energy utility space for over 25 years I would make the following comments:
    1 Whether it was worthwhile privatising the energy assets of the Stats is arguable. However there is little doubt they were inefficiently run prior to their privatisation.
    2 The various generators, distribution companies etc were used as welfare dumps by the states. Compare the numbers working at ANY generator now compared to 15 years ago. Two thirds of the employees were unnecessarily hired by these SOE’s. Who paid for that? The customer.
    3 Returns. Fine for Governments. They can run something and quote the Bond rate, but the private sector needs higher returns given the actual risk of running these plant. However everything is regulated. Particularly the distribution systems which are allowed a fairly low WACC. Effectively price can and is controlled. Most of the price increases can be sheeted home to RETS, Carbon Tax, and over investment in Capex (signed off by regulators). In other words government requirements. Should add that like all other capex, high labor and material prices play into the higher costs and the then higher regulated prices.

    The reality is that prices would be far lower if all green imposts were eliminated, and regulated capex was based on less than >99% target uptime.

  11. Pyrmonter

    @ Robert: how is an internal financing need within generators any different to the external opportunity cost argument (the one on which SD and JQ rightly agree)? A slightly better one – given SA experience – is that SOEs are also very poor risk managers, but that foes back to the fundamentals of private v’s public ownership, and another longstanding Quiggin absurdity, his belief capital has a lower rate of normal return in the public than the private sector

  12. Jim Rose

    is privatisation an example of the romance of reform as per Tollison

    The notion that it is never beneficial to deregulate because the benefits to the public or private monopolist always exceed the social losses to the public is not new.

    The public choice literature on the transitional gains trap suggested that reform does not necessarily make society better off. The rent-seeking costs of the original privileges are capitalised and are lost forever. They are not regained by reform.

    McCormick, Shughart and Tollison (1984) generalised to argue that the initial effort to establish regulation dissipates the monopoly profit, limiting the gain from deregulation to the efficiency cost of monopoly. The resources lost to rent-seeking can never be recovered, which was why there was voter disinterest in deregulation prior to the 1980s. The gains of deregulation were small prior to the 1980s.

    The relevant article by Tollison and Wagner (1990)

    “This paper applies the theory of rent seeking to argue that economic reform, in the sense of correcting past deformities in the economy, does not pay from a social point of view.

    Economic reform, at best, should focus on the prevention of future deformities. The analysis is developed in terms of the example of monopoly, but its applicability extends to any example of economic reform.

    The general principle underlying the analysis is that reform is not a free lunch, all the more so when the costs of the reformer and the resistance of the object of reform are taken into account.”

    Tollison and Wagner concluded that the gains from deregulation are greatest in industries that fight reform the hardest. Their rent-seeking is ongoing rather than sunk costs and this can be recouped by deregulation. Diana Weinert argues that there is deregulation despite the transitional gains trap because innovation expands the opportunity set.

  13. Amused

    2007 – now why is that year so familiar?

    I just can’t put my finger on it…

  14. Milton von Smith

    “I have other criticisms of his argument (discount rate used for public investment…) but that’s not important for this discussion.”

    On the contrary, I would have thought it was highly relevant. Quiggin argues that privatisation worsens the government’s overall fiscal position. But he appears to get this result in part by assuming that the government bond rate is the appropriate discount rate to use when the asset is under public ownership, but not when it is under private ownership.

    What the differences in discount rate actually reflect is the risk that taxpayers are implicitly bearing (involuntarily) when assets are owned by governments, and the implicit, hidden subsidies that are financed by taxpayers when there is government ownership.

  15. Frank Brus

    Electricity is an essential service and no matter what people may say, if the electricity market fails the government of the day will be punished for the failure. So to say that privatisation is appropriate because the government can lay off the risks of running a commercial business does not wash. On failure, the government will have to step in as it has in the past. If that’s the case then why not just pay the government bond rate for electricity investment, currently around 4% rather than the full funding cost that private investors demand. That debt and equity cost would probably be around 10%. Since the capital costs of electricity generation are one of the largest costs the industry faces, the savings to consumers would be enormous. The total value of the electricity capital investment in NSW is probably over $30B. If all of that is privately funded then the return to private investors would be around $3B compared to that faced by the Government of around $1.2B. That’s probably a bigger saving than elimination of the carbon tax!

    By the way, this difference in cost has always been of this order of magnitude. When government bond yields were 8% the Weighted Average Cost of Capital for investors in the power industry would have been around 14%.

  16. john constantine

    victoria privatised electricity when the population of melbourne was two and a bit million. now melbourne is 5 million ish,heading for a big australia 10 million. this hints at funding needs for the demand. [gold plated,or just good enough that people don't die in the australian summers highest demand days.]

  17. entropy

    Victoria was like SA in that it had to sell assets because it had to much debt.

  18. Robbo

    I admit to being amazed that we still have people in this country who think governments should still be running businesses. All the evidence over so many years has shown that when governments monopolise the delivery of services to consumers the end result is gross inefficiency. It is encouraging to note that the majority of those making comments here appear to have the same view as I have. Privatisation may not be perfect but it is a hell of a lot better than retaining what was there before. The only role that governments need to have is a monitoring of service delivery to ensure, as best they can, that consumers are not being dudded. That might be easier said than done but one of the main reasons governments are elected is to ensure that the community is protected.

  19. .

    Privatisation may not be perfect but it is a hell of a lot better than retaining what was there before.

    Exactly.

    …and as for “gold plated infrastrucutre”, a true gem of idiocy that Gillard muttered and for inexplicable reasons, the majority of Australians (who hate her) still mutter, why the fuck do we have blackouts still?

    Gillard deserves a good slap for her bullshit and lies over this which changed the debate into a race towards economic regression, as the misanthropic deep green movement desires.

  20. Bruce of Newcastle

    That ski jump in energy prices is purely wind plus solar.

    This is a perfect falsification of Prof Quiggin’s hypothesis since the companies would not have installed any of this (or fostered roof top solar PV) unless they were made to by government.

    The man should hand in his professorship in shame.

  21. manalive

    In most capitals electricity supply was originally started up by private entrepreneurs, except Sydney where the city council, after much dithering, decided to control it (a number of NSW country towns had electric street lighting before Sydney).
    Ironically Adelaide was where council control of lighting was most resisted, described as ‘the Baal of extreme state and municipal socialism’.
    Private ownership ought to be the default position where profits or dividends are put to productive use rather than disappearing into general government revenue.
    With Australian consumers paying for near the most expensive electricity in the world and given our vast cheap fuel resources, what has been the benefit of public ownership?

  22. .

    Electricity is an essential service

    So is food. Nationalise?

    If that’s the case then why not just pay the government bond rate for electricity investment, currently around 4% rather than the full funding cost that private investors demand

    The bond rate has got nothing to do with anything. It is subject to manipulation. Why isn’t this obvious to you?

    That debt and equity cost would probably be around 10%.

    Which would accurately cost projects and see uneconomic projects that are a drain on resources never get up – thereby securing supply by eliminating counterproductive generation sources which create onerous demands on networks – such as wind and solar.

  23. rickw

    “gold plated infrastrucutre”

    I got to have a look at some of this infrastructure in Victoria a couple of years ago. Sub stations consisted of 1950′s – 1960′s Metrovick transformers leaking, yep, that’s gold plated!

    I would say that in Victoria, given the age of much of the infrastructure, and the huge increase in the population of Melbourne, the State Government actually dodged a bullet.

    They managed to sell the asset when it still had some value and avoided having to not only replace it, but to having to massively expand its capacity.

    I would also comment that the greatest barrier to efficient private operation of energy assets is the completely useless nature of the likes of “Energy Safe Victoria”.

    In theory, you would think that they would adjudicate and prioritise potential disputes over access for maintenance of existing infrastructure and allocate space for construction of new infrastructure.

    I have intimate knowledge of one particularly critical piece of energy infrastructure (it helps keep Melbourne Airport running). Over 5 years ago a cafe owner illegally built a structure over it. Despite numerous adjudication meetings, compenstation payouts etc. last I heard was the structure is still there. I also saw several million spent on temporary works because they wouldn’t prioritise shutting a suburban rail line (with only two stations to run) for 24 hours to allow a repair to be carried out at a rail crossing.

    Government can’t even adjudicate on energy infrastructure sensibly, how on earth would you expect them to run an energy business effectively????

  24. Casey

    “As usual Sinclair is a hostage to the left/marxists, hoping that they’ll give him airplay.”

    No! Sinclair’s charm is that he calls them as he sees them.
    An annoying phenomenon on this blog (and it is worse still on John Quiggin’s blog) is the use of the comments section to ascribe motives(you are left Marxist, right/fascist, stupid, etc) to the bloggers themselves and to their commenters.
    These are smart blokes. They have a world view that informs their perspective on economic life. You need not agree with them, and given the sheer volume of their output they are inevitably wrong on some issues, but you always learn something from their insights.
    There are also many instances where the comments come from people with specific detailed knowledge of the blog topic. We all learn a bit along the way.

  25. Rococo Liberal

    Quiggin is not a bright lad, though. That is the problem. On too many occasions he seems to ignore major issues when reaching his conclusions.

  26. Tel

    By the way, this difference in cost has always been of this order of magnitude. When government bond yields were 8% the Weighted Average Cost of Capital for investors in the power industry would have been around 14%.

    There’s a good reason for that. Private investment must price in the full costs of risk, while government can hide this cost by fobbing it onto taxpayers.

    Quiggin makes the same presumption that all Keynesians do: somewhere in government exists a very wise man who knows the future, never makes mistakes, and invests brilliantly every time. Of course, it’s laughable on the face of it, but good enough to fool some of the people most of the time, especially if you dress it up in a bit of economic mumbo jumbo.

    Karl Marx never got around to explaining how a Socialist society would operate. There was some governing council or something and after that everything was fine all the time, providing you can get rid of the unbelievers and naysayers. If only we had a bigger union, with more powers, and no scabs. If only government takes over industry… they would run it right. The mental blank remains… but how will it operate? No problem… some wise man in government just automatically knows how to do it. We ask that guy.

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