Bruce Mountain The economic regulation of electricity networks in Australia: commentary on a failed reform Melbourne Economic Forum 20 November 2014

2 Source: ABS, CME analysis

Average household prices are comparable though network/non-network mix differs 3 Source: Published network tariffs, CME analysis

Regulated network charges account for much of the end-user price increase (in states where networks owned by governments) 4 Privately ownedGovernment owned Source: regulatory decisions, CME analysis

5 Source: US (EPRI), GB (Ofgem), EU (Florio, 2014) Australia (gazetted network tariffs, average household consumption data, OECD PPP) Regulated network charges from Govt networks in Australia now much higher than GB, U.S or EU

Many factors, but higher regulated assets of government-owned networks is main explanation … Source: regulatory decisions, CME analysis 6

… and larger asset base has translated into remarkable financial gains for the government owners Pecuniary benefit = Pre-tax attributable profits + income tax (which state government collects) + “guarantee” fees on the debt provided by state governments. Source: Statutory accounts, CME analysis 7

Shareholders in private distributors in Australia have also done well 8 Source: RIN for SAPN, UKPN Holdings Limited Annual Report 2012 for UKPN)

Operating conditions don’t explain govt./private cost differences … No evidence of systematic or enduring quality of supply problems Peak and average demand contracting since 2009, and unremarkable growth before that. Asset age data of government-owned distributors does not support “catch- up” hypothesis. Rationale for “reform” 15 years ago - low capital and labour productivity - does not support claims of historic “under-spending” 9

So what can we conclude from the data? 1.High prices, costs and profits: an unusual (and odious) threesome. 2.Situation much worse for government networks, outcomes from private are better, but hardly stellar. 3.Exogenous factors not significant. 4.Ownership seems to be significant. But why? 10

Impact of ownership - two propositions: Incentives to efficiency: private firms more responsive to capital market pressure. Lots of empirical studies around the world, but difference not large. Conflict of interest: A government, as investor, has a financial interest in limiting the extent of regulatory power and discretion and how this is exercised, especially with respect to the severity of the price control. This might be expected to manifest itself in the design of the regulatory framework. 11

Evidence in support of the propositions 1.Costs, prices and profits of government v private networks. After 15 years and 3 price controls (4 in VIC, 2 in SA) by state and federal regulators, the facts speak for themselves 2.Limitation on regulatory authority: key regulatory variables not the regulator’s to decide – risk free rate, planning standards, government/private differentiation, fundamental regulatory approach. 3.Instruction to regulator to assume government-owned monopolies are privately financed and to ignore state government income tax receipts + debt fees. Arrangement unique to Australia. 4.Bifurcation of regulatory institutions: the AEMC as regulatory designer, AER as implementer, limits regulatory discretion and authority, impedes change, as intended. Again, arrangement unique to Australia. 12

Suggested direction for a new “reform” Privatisation (i.e. transfer of ownership and operation to private sector, not minority private equity participation) eliminates conflict of interest and brings capital market disciplines. If state government owns, state government should oversee (the rights to the profits should go with the obligation to account for them). Need for radical re-think of regulation and governance. Fresh ideas, imagination & willingness to learn from mistakes would be helpful. Much to learn about more successful economic oversight of government-owned utilities in U.S. and Australia (pre “reform”). “How can a government regulate a business that it owns?” (The Economist, 12 November 2012) 13