The NSW government's 10-year march to electricity privatisation is finally under way. The state's retailers and generators are earmarked for sale. But half of the costs of electricity comprise network costs -- poles and wires. Regulatory decisions determine charges for these "natural monopolies".
With network pricing, regulators walk a tightrope between providing the businesses with revenues that prevent system decay while avoiding excessive price allowances. To obtain greater consistency and concentrate expertise, the national Australian Energy Regulator (AER) has been given responsibility.
Until recently, regulatory reviews of networks generally brought lower prices, followed by cacophonic protests from networks claiming the new price would ruin them.
But the businesses usually continued making good profits without damaging the networks' performances. An exception to this was the 2004 blackouts Queensland experienced, due partly to the regulator squeezing the expenditure budgets of the (government-owned) distribution businesses.
Elsewhere, good network performances were achieved alongside healthy profits because private businesses spent less than regulators had allowed them.
Hence, regulators' price determinations have tended to downgrade the networks' stated spending intentions. Regulators have also argued that the stability of the businesses' income streams warrants lower than average profits.
There is, however, a difference in regulatory treatment of private compared with public network businesses. Prices for the privately owned Victorian and South Australian networks have been markedly reduced -- by 35 per cent since 1995 in real terms for Victorian electricity.
This is in contrast to the government-owned NSW and Queensland networks. In NSW, metropolitan area network charges were cut by 10 per cent in real terms between 2000 and 2004 but a recent increase will largely restore allowable real prices by 2009.
Queensland by 2009 will have had a 20 per cent increase in real prices.
Initially, independent regulatory oversight brought with it a very strong case for draconian price cuts. The networks had been highly inefficient. Privatisation, and its poor relation corporatisation, fostered considerable efficiency dividends that could be passed back to consumers.
But the recent NSW decision reversing previous cuts is a reminder that regulatory paring of prices cannot continue indefinitely.
The regulator's nightmare is to make a determination of prices and to watch companies' shares surge.
This happened in Britain 10 years ago and the lesson was not lost in Australia.
Government ownership shelters regulators from scrutiny in NSW and Queensland compared with the privately owned systems in Victoria and South Australia. If the regulators are overgenerous the lack of a share price reaction means this cannot be seen.
But if regulators are relaxed about grant price increases to government firms there is an asymmetry of treatment between them and those under private ownership.
This might pose a greater risk of system degradation in the private sector but it also enhances the reluctance of governments to privatise their networks. A power system failure has political consequences, while few notice the higher costs from continued government ownership stemming from regulatory laxness.
This incentive to continued government ownership means lost productivity of labour and capital. Government companies will automatically spend money once regulators sanction this, while private firms with the option of distributing funds to shareholders will review its necessity.
The inefficiencies locked within electricity networks' structures should be released.
The AER, in taking over price-setting, can assist in this by being more forceful in reviewing the public networks' claimed cost increases. Unfortunately this entails a risk to the regulator of being exposed of making a wrong decision and is a poor substitute for the discipline of profit-oriented businesses.
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