The Carnegie Challenge: Restructuring the Energy Supply Industry of Western Australia

Vol. 5, No. 2

SUMMARY

The Report of the Energy Board of Review -- The Carnegie Report -- entitled The Energy Challenge for the 21st Century and delivered in April 1993, recommends a far-reaching, though phased, restructuring of the State Energy Commission of Western Australia (SECWA).  The emphasis is on the introduction of competition through the creation of new, publicly-owned energy authorities, new opportunities for private participation in energy supply, as well as open access to, and direct purchasing through, the new authorities for energy producers and consumers.

The need for this approach is derived from the apparent paradox that Western Australia has abundant, but high-cost energy.  Institutional factors, as well as geography and geology, are the major explanations for the high energy costs.

This Backgrounder reviews the Carnegie Report and confirms that only a thorough-going process of reform will eliminate the institutional obstacles to an efficient energy supply system in Western Australia.  At the same time it warns that there are substantial obstacles to reform, the major one being the Collie coal-fired proposal for a 600MW station.  Even if this proposal were to proceed as only a 300MW station, as has been suggested, it would still act to blunt the reform process by doing nothing to solve the energy surplus problem or reducing energy costs.  It would also be a signal that the government was willing to pander to the vested interests associated with the status quo.

A high level of political determination and public support will therefore be required for successful reform of SECWA.  Not to proceed with the process of institutional change will hold Western Australia back economically, in the face of far-reaching change in the energy supply industry in the Eastern States of Australia.

INTRODUCTION

The Carnegie Report is the culmination of a number of independent reports into the operations and structure of the State Energy Commission of Western Australia (SECWA) which have highlighted difficulties with, and the need for change in, SECWA. ⁽¹⁾

The most tangible source of concern with SECWA lies in the prices for electricity and gas charged by SECWA.  Electricity prices in Western Australia are some 40 per cent above the Australian average (see Chart) and gas prices are unable to offer a local advantage because of the link with oil and coal prices in the gas supply contracts between SECWA and the North West Shelf Joint Venture Participants (NWSJVP).  Typically, these outcomes have been excused on the grounds of geography, geology or the size of the local market.  The thrust of the reports mentioned above, however, is to suggest that the institutional structure itself is a root cause of the high energy prices.

Average Electricity Prices -- All Customers, 1988 and 1992
(cents per kWh, year ended June)

Source:  Electricity Supply Association of Australia

Note:  *The national figure is a weighted average

The institutional problem derives from SECWA's formation in 1975.  It was created primarily as the economic development arm of the Western Australian Government.  The concentration of market power over all energy markets (other than liquid fuels) in SECWA was an attempt to use that power to supply energy for the further processing of the State's mineral resources.  That approach to the promotion of resource development is now seen to have failed.  The emphasis on controlling the State's energy resources through SECWA came at the cost of a more commercial approach and the outcome has been a high-cost energy system for consumers, with minimal gains in resource development.  The most obvious manifestation of this misplaced approach was the fuel supply contracts with coal and gas producers negotiated by SECWA which gave it an over-supply of high-cost energy.

When public enterprises lack both competition and a direct commercial objective they tend to entrench inefficient labour and management practices into their operations.  SECWA, in particular, has suffered from industrial relations problems associated with the ability of the unions to negotiate directly with the relevant minister, effectively by-passing SECWA management.  The consequence of all this is that, according to one review of state energy authorities, "Western Australia's labour performance has been consistently the worst and contrasts markedly with Queensland's performance which was at a similar level until 1981-82". ⁽²⁾

The Carnegie Report quotes advice to it that labour productivity within SECWA could be improved by about 20 per cent.  The restructuring of SECWA, and the adoption of a commercial focus in a competitive environment, would lift the performance of both labour and management.  They would also eliminate restrictive work practices which add to both labour costs and the overall costs of energy supply.  While labour costs, in themselves, are only a small proportion of total electricity costs, restrictive practices limit the availability ⁽³⁾ of the system's operating plant, thus requiring larger-than-otherwise-necessary investment in plant.

SECWA is not the only publicly owned energy supply authority in Australia to have operated in this way.  But under the prodding of the Commonwealth Government, itself responding to the recommendations of the Industry Commission, authorities in the other States have accepted the path of institutional reform leading to greater efficiency.  Failure to take Western Australia down the same path will result in the State's becoming even less competitive.

This realisation provoked the then Premier of Western Australia, Dr Carmen Lawrence, to push for institutional reform in 1990.  It was not until the WA Advantage statement of February 1992, however, that there was a decision to establish the Energy Board of Review (the Carnegie Committee).  Three things were noteworthy about this decision.  First, neither SECWA nor the then relevant minister, Geoff Gallop, was consulted over the matter.  Second, the statement endorsed the separation of the Dampier-Perth natural gas pipeline from SECWA and the creation of a separate energy authority in the Pilbara region of Western Australia.  Third, the statement announced that SECWA's regulatory and policy functions were to be moved to the soon-to-be-created Department of Minerals and Energy.

In other words, the process of reform was to have started from February 1992, and was not dependent on the Report of the Carnegie Committee whose recommendations were mainly intended to deal with the separation of the electricity and gas operations into two or more entities.  To date, no action has been taken.

For the membership of the Board of Review, the Premier wanted a high profile team with equally high credibility so that its recommendations would derive sustained momentum from the personal commitment and standing of the Board.  Sir Roderick Carnegie was appointed Chairman because he met these requirements at the national level;  while the other two members of the Board, Stuart Hohnen and Bob Huxtable, also had a high and respected profile in the Western Australian community.  Stuart Hohnen had been the Coordinator of the Department of Resources Development and a member of the SECWA Board, while Bob Huxtable had been a Senior Partner in Price Waterhouse.

Also of interest in the composition of the Board of Review was the role played by Bill Heron, who was the coordinator of a working group responsible for the day-to-day activities of the Board, and at the same time State Deputy-Under Treasurer and a member of the SECWA Board.  Heron had also held a senior management position at SECWA before moving to the Treasury.  Of the working group, two members were seconded from SECWA (Mark Chatfield and Peter Oates) and the other from the Energy Policy and Planning Bureau (Vince Walsh).

Thus, although the Board was independent of SECWA, there were a number of ways, both formal and informal, in which SECWA's views could be made known to the Board.  The reaction of SECWA to the establishment of the Board was nevertheless one of hurt and dismay:  hurt from the perception that the appointment of the Board appeared to be a vote of no confidence in SECWA, and dismay because SECWA had thought it was doing a good job of reducing inefficiency within the existing institutional structure.

OBSERVATIONS AND RECOMMENDATIONS
OF THE CARNEGIE COMMITTEE

The challenge for the Carnegie Committee was the high price of energy delivered by SECWA and the view that the institutional structure bore part of the responsibility for that outcome.  The Committee focused on competition as the mechanism for achieving greater efficiency and lower prices.  Competition was now seen as possible because of technological changes (especially in electricity generation), but also because of the growing number of natural gas producers who could supply gas to the Western Australian market.  With the promotion of competition uppermost in mind, the Committee made the recommendations set out below (and illustrated in Figures 1 and 2 on the following page):

Figure 1:  The Restructured Electricity Industry

Source:  Adapted from Energy Board of Review,
The Energy Challenge for the 21st Century, 1993, page 38.

Note:  The heavy line indicates the "ring fence" separating the transmission and distribution systems

Figure 2:  The Restructured Gas Industry

Source:  Adapted from Energy Board of Review,
The Energy Challenge for the 21st Century, 1993, page 59.

• Separation of SECWA's electricity and gas supply functions into independent authorities;
• Placing the electricity generation function carried out in SECWA's power stations in the hands of a new authority to be known as GENERATION WA;
• Creation of a new authority, to be known as POWERWEST, to handle the activities associated with electricity transmission and distribution;
• The "ring-fencing" of the transmission function within POWERWEST so as to allow the transmission system to be used for the direct supply of electricity to large consumers wishing to bypass the distribution system (an activity known as "power wheeling");
• The establishment of separate business units in POWERWEST, focused on the Pilbara (POWERWEST Pilbara) and the isolated system supply (POWERWEST Isolated), to deal with supply to communities not connected to the south-west interconnected grid;
• Separation of gas transmission from gas distribution, through the creation of WA PIPELINES to handle transmission through the Dampier-Perth natural gas pipeline and GASWEST to handle distribution to consumers;
• Corporatisation of all four new agencies through the introduction of new mechanisms for accountability and control, which have the effect of reducing day-to-day political influence over the authorities and exposing them to constraints equivalent to those faced by private sector firms;
• The exercise of regulatory supervision with respect to disputes over the prices and conditions of supply of services from the authorities through the establishment of a Commissioner of Energy Services.

The scope for competition out of the above arrangements comes from a number of factors:

• Electricity and gas are competing sources of energy for a number of industrial, commercial and domestic uses.
• GENERATION WA will have to compete with other private entrants into the electricity generation business who may be able to supply power competitively to POWERWEST.  Initially this competition will come from cogeneration facilities, but it is possible to see the emergence of competitive dedicated generation facilities, particularly if the Pinjar power station were to be sold as recommended by the Board.
• The electricity generation sector (public and private) will be forced to compete with alternative ways of meeting the needs of electricity consumers if the supply authority, POWERWEST, adopts a "least cost supply" approach to the delivery of energy services.  With this approach, POWERWEST will invest in energy efficient consumption technologies if they are cheaper than purchasing electricity from generators.  (An example would be to supply consumers with high efficiency light bulbs if that was cheaper than buying more electricity.)
• Large consumers will be able to purchase electricity directly from generators rather than from POWERWEST, though a "wheeling fee" would be payable if POWERWEST's transmission system was used to carry direct purchases.  This would put pressure on POWERWEST to maintain efficiency.
• Large gas consumers will also be able to purchase direct from gas producers using WA PIPELINES and the GASWEST distribution system, hence bypassing GASWEST sales if it cannot compete with direct purchases.
• All of the new publicly-owned authorities will be corporatised, which in principle should mean that they are subject to the same regulatory and statutory requirements as a private sector equivalent (including taxation), and are without the legal privileges which attach to crown ownership (for example, land resumption rights).

The above structure is not new:  it is very similar to arrangements being put in place or under active consideration in a number of other States and countries including Victoria, New Zealand and England.  In all these cases the reason for change is to introduce competition wherever possible as a means of achieving improved efficiency and thus lower prices.  Indeed, by the standards of the restructuring taking place elsewhere, the Carnegie recommendations are relatively conservative.  A more radical set of recommendations would have separated completely the electricity transmission and distribution functions, broken the distribution system into a number of separate regional systems, and allowed the regional distributors to undertake a limited amount of electricity generation.

OBSTACLES TO THE REFORM PATH

There are, not surprisingly, a number of problems associated with this proposed switch from a vertically and horizontally integrated monopoly to a competitive model.  These problems, and the relevant recommendations from the Carnegie Report for dealing with them, are discussed below.

Some natural monopolies will still remain in the form of the transmission and distribution systems.  Their monopoly power could be exploited through their sales of electricity and gas to small consumers or through the charges they place on transporting electricity and gas through their system.  The Report has dealt with this problem by recommending the greatest possible transparency in all of the rules and pricing decisions associated with the transmission and distribution system.  There would be no commercial confidentiality associated with these operations.  Monitoring of this full disclosure is proposed to be in the hands of the independent Commissioner for Energy Services, who will also be responsible for the conciliation and arbitration of disputes associated with access and the price of access to transmission and distribution systems.

The existing fuel supply contracts with the Collie coal companies, the NWSJVP and other gas producers have given rise to a contracted primary energy supply to SECWA which is in excess of current and forecast needs.  These contracts effectively shut out new entrants into the energy supply system and hence restrict the possibility of enhanced competition.  The only effective solution to this problem is to delay the proposed private Collie power station and thereby avoid taking on another take-or-pay contract at a time of excess capacity and primary energy oversupply.  Deferment would enable a run-down of existing stocks of coal and gas by using present generating plant at a higher level of capacity operation.

As an immediate measure, the Carnegie Committee suggested that the existing SECWA-NWSJVP gas contract be broken down through allowing direct sales contracts to be negotiated between the NWSJVP and the small number of major gas consumers who currently take the bulk of the gas supplied under the existing contract.  In this way the NWSJVP could maintain their market share, and the problem of the excess gas left with SECWA might be managed through increased use in power generation, possible only if the Collie proposal is deferred.  This would also help to eliminate the existing cross-subsidy which currently supports the gas side of SECWA's operations.

Institutional change may be a difficult process without a sustained and widespread groundswell supporting change, or a determination by key decision-makers to push through with change.  The reason lies in the power of those with a vested interest in the maintenance of the status quo, who can exercise considerable influence in opposing change, particularly where the change involves complex technical and financial matters.  An example may be useful.  In the WA Advantage document in February 1992, the then Premier announced that, quite independently of the Carnegie Committee, a Pipeline Authority would be established to own and operate the Dampier-to-Perth natural gas pipeline.  Over the subsequent year, no useful progress was made on this decision, despite the setting up of an interdepartmental committee to implement it.

The reality is that the concentration of considerable power over energy markets in the hands of SECWA has given rise to an equivalent power over decision-making within the State government bureaucracy and Cabinet.  The Carnegie Report put it this way:

As the dominant business in the electricity and gas industries, SECWA has a monopoly on information.  In particular, it does not make public its load forecasts and its long range plans.  This places SECWA in a position of influence when offering policy advice to Government, and enables it to resist the oversight of other government agencies. ⁽⁴⁾

Thus, on the grounds of bureaucratic politics -- and the public interest -- the splitting of SECWA into a number of independent and competing agencies would open up both the information and the debate about government policies towards the energy supply industry overall.

There is a well-founded fear that if restructuring is to be left to the organisation that is to be restructured, it may not happen.  For this reason the Carnegie Report recommended the establishment of an Implementation Board under legislation giving it the responsibility and powers to implement the recommendations.  The commitment of this Board to the reform process will determine the speed and nature of the process.  The Report made no recommendation about the composition of the Implementation Board.  But it is essential that implementation not be controlled by existing SECWA Board members or SECWA senior management.  Ideally, the Implementation Board should consist of persons who have no personal or institutional vested interest in the outcome, and whose objective is to see an efficient energy supply system introduced as quickly as possible in a fair, open and competent manner.  The Board should also enjoy the active support of the relevant Ministers.

The industrial relations aspects of the reform process will be a major task for the Implementation Board.  Unless the workforce can be persuaded of the merits of change and shown that change is in the community's interest as well as its own, then obstacles will arise.  Clearly, the development of enterprise agreements in each of the new authorities will be at the top of the agenda, and these agreements will have to reflect an equitable and mutually-acceptable revision to existing pay and conditions for the workforce.

Community service obligations, particularly in the form of the uniform tariff policy, will be an obstacle to change.  The Report suggests that the uniform tariff policy should only apply up to reasonable consumption levels, with full cost applying thereafter.  Further, the cost of the more limited uniform tariff policy, as well as any other community service obligations, should be met by the government from its own budget.

There is also the reasonable argument against the creation of additional authorities.  This points to the increased administrative costs associated with a new chief executive officer, a new board and new units to handle internal administration in each of the four new authorities.  This argument is based on the notion that economies of scale exist when all these functions exist in a large organisation, and these economies are lost when separate organisations are created.  This is a perfectly legitimate concern, but the gains made possible because the whole industry operates more efficiently will more than offset possible higher increased administrative costs.  Further, it is possible that economies of scale would not be lost if certain administrative functions such as payrolls, human resources, and inventory management, were contracted out to specialists in the area, either in the public or private sectors.  (The contracting-out of garbage collection by local authorities to specialist waste management companies is a clear example of how economies of scale can be captured by small agencies.) Explaining the benefits of reform is an important educative task for the Implementation Board (dealt with further below).

But by far the biggest obstacle to reform is the Collie private power station proposal.  Even if all of the obstacles discussed above were overcome, no reform could occur if the Collie proposal were to proceed.  The State can have a Collie power station or industry restructuring, but not both.  The reason is that to take on the Collie proposal would, because of its size, eliminate the opportunity for a competitive electricity generation industry by removing all scope for cogeneration and the entry of competitive, dedicated but smaller-scale generators, and impose on SECWA another take-or-pay contract.  The Collie proposal would also extinguish the possibility of solving the problems of the existing take-or-pay contracts, which are themselves an obstacle to change because they restrict the development of gas-to-gas competition among producers.  There has, however, been a considerable exercise of pressure-group power and political self-interest in seeing the coal-fired station going ahead, despite the fact that there is no economic basis for it.

The forces at work supporting the Collie proposal include:

• The momentum generated by the 1989 SECWA decision to seek expressions of interest in a coal-fired station, and the receipt by ABB in November 1992 of a mandate, though not a contract, to build a coal-fired station;
• The National Party, which gave an unequivocal commitment to the project before the February 1993 election;
• The ongoing support for the project given by the former Minister for Fuel and Energy, Geoff Gallop, who was responsible for the process to put a coal-fired power station in place;
• South West region politicians, including David Smith and Doug Wenn from the ALP, Hilda Turnbull and Murray Montgomery form the National Party, as well as the State Government's South West Development Authority, together with the Mayor of Bunbury and the Collie Shire President;
• Pressure by the union movement, particularly the Coal Miners' Union;
• The natural self-interest of the Collie coal companies;
• Support by construction and equipment supply companies, particularly in the Bunbury-Collie region;  and
• The support of senior SECWA management and the SECWA Board members for the project.

All the above are in powerful positions to push for the Collie proposal to be accepted and as a result for the reform process to be halted.  Their motivations may be understandable on this point but their willingness to pursue the Collie proposal presents a major obstacle to industry restructuring and lower energy prices.  These forces have been sufficiently powerful to counter the advice given to the government by State Treasury, the former Department of State Development, and the Energy Policy and Planning Bureau to defer the Collie proposal.

THE REFORM VISION BEHIND CARNEGIE

Superficially, the restructuring programme appears to be a conservative one.  The initial division of SECWA into separate electricity and gas agencies only takes Western Australia to the same structure as already prevails in the other Australian States where electricity and gas supplies are in different hands.  To proceed only that far does nothing to improve Western Australia's position relative to the Eastern States.  Indeed the Eastern States have already embarked on further separation of their electricity and gas supply systems with, for example, Victoria proposing to divide the Gas and Fuel Corporation into a transmission activity and a separate distribution activity.  The State Electricity Commission of Victoria is to be restructured to allow a competitive generation section, a transmission business and a competitive distribution system.

The Industry Commission went further than Carnegie:  it recommended that transmission and distribution in Western Australia be separated, and that the distribution system be split up into separate regional franchises.  A similar recommendation was made with respect to the gas distribution system.

The spirit of Carnegie is, however, to be found in more than the specific institutional recommendations.  The overall thrust of the Report is that barriers to competition should be removed wherever possible, and positive support given to measures which will improve competition, some of which form part of the Report's recommendations.  Carnegie has not laid down a reform route in the nature of a tram track, with all the elements specified in particular detail well into the future.  What is essentially suggested is a reform process which has flexibility as a key characteristic, that is, flexibility to change as economic conditions, technology and institutions change.  Anyone expecting Carnegie to spell out exactly what the energy supply system will look like in 20 years' time will not find it in the Report.  Nor should they, because it is not possible to be precise about ail of the factors that will prevail at that time.  What Carnegie does offer, though, is that in 20 years' time, whatever the conditions, the energy supply industry can be appropriate for them.  This will be a situation quite unlike the present where it is very clear that the energy supply system is totally inappropriate for both the present and the future.

The other important aspect of the Carnegie vision is its move away from public enterprises as explicit instruments of economic control and development in Western Australia.  This may appear paradoxical in the light of recommendations to create four new public enterprises where there is currently only one, and with only a modest proposal to privatise the Pinjar power station.  The differences are, first, that the political relationship between the public enterprises and the government of the day will be one based on sound principles of corporatisation;  and second, that these public enterprises will not have the monopoly powers now exercised by SECWA -- even if some of them are monopolies, as may be the case with electricity transmission and gas transmission.  Their ability to exploit a monopoly position will be limited by the transparency with respect to their operations, and by the role of economic regulation in the form of the Trade Practices Commission, the Prices Surveillance Authority or the Commissioner for Energy Services, safeguards which do not exist with the present SECWA operations.

Future governments will have a limited ability to use these public enterprises to achieve policy objectives through the manipulation of energy prices or the use of energy supply contracts as is the case today.  The Royal Commission into WA Inc. drew attention to the cases where SECWA had been used to pursue political objectives on behalf of government which were inconsistent with a commercial orientation.  In a competitive environment the creditworthiness of the public enterprises, and of the government itself, will be adversely affected by such moves.

IMPLEMENTING REFORM

The Carnegie Report recommended that management of reform should fall to an Implementation Board, responsible for settling such details as allocating debt, assets, contracts and employment conditions, etc., to the new authorities.  It appears that the existing SECWA Board would continue to function until such time as further Acts of Parliament created new authorities.

Unless the existing SECWA Board makes an unconditional commitment to the reform process and provides all the information required by the Implementation Board on an open access basis, the scope for stalling the reform process is substantial.  Incentives exist within SECWA to stall the process because of what it will mean to the position and responsibilities of present personnel and their prospects in a new framework.  The whole of the Carnegie Report represents a comprehensive statement of the failure of SECWA.  There will, therefore, be incentives not to give complete support to the reform process.  Moreover, the backing given to the Collie proposal by SECWA puts it at odds with the need for deferral of the proposal if the reform process is to proceed.

One solution to this problem would be to use the legislation setting up the Implementation Board to create a new interim board for SECWA which, while maintaining the ongoing operational requirements of the organisation, would be at the same time fully devoted to the reform process and which could lead the rest of the organisation by example.

To generate public support for the reform process the Implementation Board should, at the same time, give resources to a public education programme which quite explicitly identifies the overall gains to Western Australians from the reform process.

One of the lessons from experience with reform elsewhere is that where far-reaching change is proposed, governments should move quickly to implement the reform.  Otherwise, the forces opposed to change will have time to mobilise both themselves and public opinion against change.  The government should move with all speed to implement the basic structural change proposed by Carnegie, and then allow evolutionary changes in response to the new opportunities that will flow from structural change.

MAKING THE VISION OPERATIONAL

The creation of four independent energy businesses, where there was only one, will change the way in which energy activity is carried out.  A horizontally and vertically integrated monopoly business is governed through internal administration emanating from decisions of the Board and senior management.  In a disaggregated framework, market relations between businesses will play a larger role.  In the Carnegie programme, the most marked change of this nature will be in the relationship between POWERWEST and the generators of electricity, including GENERATION WA.  The way in which POWERWEST purchases electricity from generators will be subject to contracts with generators which will have to cover, given the nature of the industry, purchases of power throughout the day and the year, as well as the purchase of standby capacity and other contingencies.  The negotiation and enforcement of these contracts will represent a completely new sphere of operations.  There is some risk that such contracts will not be complete, in that not all eventualities will be covered.  Their first characteristic, therefore, should be mutually-agreed flexibility and a limitation on the ability of one party to exploit the other in a situation where large, long-term capital outlays are involved.  Given that POWERWEST will not be the only purchaser of electricity from generators, the scope for exploitative behaviour by POWERWEST towards electricity generators is reduced.

On the other hand, the scope for collusion by generators may be a concern.  With only a limited number of generators possible in the small Western Australian system, the incentive to collude over prices and other supply conditions offers a potentially serious threat to the implementation of the Carnegie vision. ⁽⁵⁾  The solution lies in ensuring that entry into the industry is unrestricted, and that existing generators do not install excess capacity to be used as a deterrent to the entry of new firms.  In addition, the various regulatory authorities would need to keep close scrutiny over the conduct of the industry.  Maximum contestability of the generation industry will be maintained by minimising the sunk costs of entry and exit.  This could go so far as POWERWEST's actually identifying power station sites and installing the associated transmission facilities, while tenders were called for the supply of electricity from plant to be established on the indicated site.

Corporatisation has been recommended by Carnegie for each of the new energy businesses.  The processes of corporatisation and commercialisation are often confused in public debate, but are distinct in principle.  Commercialisation is the process of setting clear commercial objectives for a public enterprise and at the same time ensuring that it is not in a privileged position relative to its private sector competitors for the achievement of its commercial performance indicators.  In contrast, corporatisation is the process which seeks to establish only broad controls consistent with the long-run interests of the State, while leaving day-to-day management free of short-run political influence.  Thus corporatisation should increase managerial autonomy and responsibility, but at the same time the public interest is preserved through the agreement of the relevant Minister or Cabinet with the corporate plan of the business.  Corporatisation also involves a direct accountability to the Parliament through the tabling of an Annual Report and openness to parliamentary inquiries.

Corporatisation cannot be seen as a magic solution to the problems of control and accountability in government business enterprises.  Corporatisation with competition is a better outcome than corporatisation alone.  Indeed, there is a real fear that corporatisation and the preservation of monopoly status would only heighten the inefficiency associated with monopoly status.  This is because a politically-strong public monopoly facing a weak minister or Cabinet would be a public monopoly without any genuine public control or accountability.  To avoid such possibilities, all corporatisation must take place in the context not only of the appropriate measures of direct government accountability and control, but also of full openness to the other instruments of business regulation such as the Trade Practices Commission, the Prices Surveillance Authority and the Corporations law.

The Carnegie Report made no recommendation for privatisation of any of the existing SECWA assets, other than the Pinjar power station.  Its view was that the institutional structure at this stage was more important than the question of ownership.  If, in the future, the institutional structure functions as intended, it should be possible to contemplate privatisation.  (By contrast, the privatisation of British Gas, which resulted in the conversion of a public monopoly to a private monopoly, is an example of hasty and poorly structured privatisation which, while it may have generated considerable sale revenues, has not contributed to the development of a competitive and efficient gas supply industry in Britain.)

The Report does not come to terms with the politically-sensitive problem of prices to final consumers.  This is not a problem for large consumers of electricity and gas who, in a competitive environment, will be able to shop around among electricity generators and gas suppliers.  Small-to-medium industrial consumers and domestic consumers will be purchasing from monopoly suppliers of electricity and gas.  Judging by their comment on page 77 -- "Since they will not initially be free to set tariffs and are not to cross subsidise" -- the Board had in mind, initially at least, some method of price-fixing independent of the businesses.  This is, of course, the current practice:  SECWA's tariffs are determined by Cabinet on the advice of SECWA.  Cabinet is, however, reluctant to modify any SECWA recommendations, having neither the expertise nor the independent sources of advice to do so.

This situation is unsatisfactory because of the political second-guessing involved and the absence of any systematic and rational basis for tariff evaluation.  One solution may be to go further than recommended by Carnegie, and to split the electricity and gas distribution systems into a system of regional franchises allocated to competitors by competitive auction.  This is the method recommended by the Industry Commission.  Until that happens it may be appropriate to establish a government enterprises pricing tribunal along the lines of the NSW Government Pricing Tribunal (GPT) to determine base prices and price increases for POWERWEST and GASWEST.  The New South Wales tribunal:

is responsible for regulating the prices of all PTEs which may have a monopoly market position.  The objectives of the tribunal are to depoliticise the process of price-setting in the PTEs, and to achieve a balance among the interested parties:  the shareholders (namely, the State government), the PTE managements, and the PTEs' customers.  More specifically, the tribunal acts to determine the maximum price for monopoly services supplied by the agencies ... and to report on the pricing policies of those agencies. ⁽⁶⁾

Another issue with the potential to go beyond the original Carnegie recommendations is the structure for the Pilbara and the isolated systems.  The Pilbara is unique;  and even though Carnegie suggests a separate business unit, it may happen that the aspirations for major industrial development held for the Pilbara cannot be met by that structure.  This may lead to the creation of an independent Pilbara Authority as originally planned by the Lawrence Government.  Similar considerations apply to the isolated systems.  Each of the systems is different in terms of location, need, and the possibility of sources of supply for electricity or the services electricity can supply.  There may well be local forces wishing to bring about the separation of the isolated system from POWERWEST.

THE FUTURE

The Carnegie Report is the most important report the State Government has received on the operation of its largest business enterprise.  The evidence in the Report clearly shows that the future cannot be allowed to resemble the past.  The institutional framework put in place in 1975 has failed.  New technologies and resource endowments, as well as the gains from competition, now make it obsolete.  A new structure for energy supply is an urgent requirement for the economic health and the social well being of Western Australia.

The path of economic development for the State through energy-based resource processing has not been helped by the existing structure.  The location of resource-processing facilities is an internationally competitive one, and the best recipe for success internationally is competition in the domestic supply of energy.  The monopoly model was appealing to the planners in 1975 because they thought it gave them the control to carry out policy.  But control came at such a high cost that the ultimate objectives could not be achieved, and instead powerful interest groups were entrenched in privileged positions.

The best utilisation of the State's resources requires the combination of an efficient energy supply system with the flexibility to cope with rapid change in all areas of energy supply.  Failure to take the path recommended by Carnegie will deny Western Australians the benefits of our unique energy endowments and will needlessly pander to the short term interests of the status quo and those who hide behind it.

GLOSSARY OF TERMS

Availability	Measure of the capability of generating plant for energy production during a period compared with the total energy production if the plant had operated continuously at full output during the period.
Cogeneration	The generation of electricity as part of some other process such as the supply of low pressure steam or the recovery of waste heat and gases from an industrial process.
Common Carriage	A requirement imposed on transmission or distribution system owners to carry third party electricity or gas.
Conservation	The efficient use of energy, by forsaking energy needs or by using more efficient systems or appliances.
Demand Side Management	Commonly defined as the systematic planning and implementation of energy utility services designed to influence customer use of energy in ways that will produce desired changes in the utility's load.  It is also known as demand management and encompasses both load management and energy conservation.
Open Access	Similar to common carriage, but with access subject to the availability of capacity.
Power	A measure of the instantaneous demand for electricity.  Units used are gigawatts (GW), megawatts (MW) or kilowatts (kW), depending on the scale involved.
Reliability	The ability of the system to meet the demand imposed by users.
Ring Fencing	The process of separating some activities from others within an overall business operation.  This allows for the separate evaluation and operation of the ring fenced activity and a measure of relative autonomy.
Natural Monopoly	In an industry characterised by falling average costs as the scale of a firm increases, the outcome is that production will take place at the lowest average cost only if there is one firm in the industry.  The introduction of another firm represents a misuse of society's resources because two firms will both have to produce at a high cost level because economies of scale will be lost when the market is divided between them.
Isolated Systems	In Western Australia some 28 rural towns have their electricity supplied by local generation units, usually diesel powered.  These isolated systems supply approximately 7 per cent of the electricity supplied by SECWA, but at a considerably higher cost than electricity supplied by large power stations within the south west interconnected system.
Wheeling	The process of using the transmission system, and possibly the distribution system, to transfer power directly from a generation source to a consumer.  This comes about as a result of a direct purchase arrangement between the generator and the consumer, and the payment of a fee to the transmission system for the transport of the electricity.  When wheeling occurs the transmission system is being used on a common carriage or open access basis.
Transmission System	The high voltage power lines used to carry electricity to the distribution system and high voltage customers.  The transmission system has the characteristics of a natural monopoly which justifies only one system, usually in public ownership and subject to external regulation to avoid any misuse of monopoly power.  It is also capable of being operated on a common carriage or open access basis, and regulation is then also required to ensure fair treatment of consumers seeking access to the transmission system.  Equivalent notions apply in the case of gas transmission through high pressure gas pipelines.
Distribution system	The low voltage power lines which carry power from a terminal with the transmission system to consumers.  The distribution system has the characteristics of a natural monopoly but distribution systems have been separated into regionally based systems which offer a measure of competition between each other even though they may be a monopoly within their own region.  The allocation of regional distribution systems may be done on the basis of auctions.  Similar notions apply to the low pressure gas distribution system.
Regulation	The set of statutory controls exercised over an industry.  In the energy supply industry regulation takes two forms, technical and economic.  Technical regulation fixes the physical terms and conditions under which the system operates in terms of voltage, electrical stability, load, and safety features.  Economic regulation refers to the controls over price and behaviour in conditions of natural monopoly and the maintenance of competition in circumstances where competitive firms (as in electricity generation) might seek to collude over price and output.
Corporatisation	The process of clearly identifying the accountability of and control over a publicly-owned enterprise.  In general corporatisation seeks to establish only broad controls consistent with the shareholder's (the State's) interests while leaving day-to-day management free of political influence.
Commercialisation	The process of replacing varied and often contradictory objectives for public enterprises with a single commercial objective subject to the constraints of a competitive industry or, in the case of a natural monopoly, the constraints (usually a limit on price increases) imposed to avoid monopoly exploitation.

Compiled with the assistance of glossaries from Industry Commission, Energy Generation and Distribution, Volume II, AGPS, May 1991;  and Bureau of Industry Economics, International Performance Indicators -- Electricity, AGPS, February 1992.

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ENDNOTES

1.  The major reports are:  SRI International (1983), The Long-Term Management of Energy Resources in Western Australia;  Harman, F. and P. Newman (1984) Energy Policy in Western Australia;  Final Report of the Committee of Inquiry into Gas and Electricity Tariffs in Western Australia (1985);  Green Paper on Energy Policy Options for Western Australia (1989);  Report of the Review Committee on Power Options for Western Australia (1990);  Industries Assistance Commission (1989) Government (Non-Tax) Charges, Report No. 422;  Industry Commission (1991), Energy Generation and Distribution, Report No. 11.

2.  Lawrence, D, et al. "The Comparative Efficiency of State Electricity Authorities", in Johnson, M.R. et al., 1991, Contemporary Issues in Australian Economics, Macmillan, Melbourne, page 189.

3.  A glossary at the end of the paper explains the technical or unique terms used in this Backgrounder.

4.  The Energy Board of Review, The Energy Challenge for the 21st Century, Perth, April 1993, page 19.

5.  These issues are more fully developed by K.D. Cole, 1993, "Vertical integration vs competitive markets:  a study of the proposals to restructure SECWA", Murdoch University Economics Department, Working Paper No. 91, (forthcoming).

6.  Cited in Richard J. Wood (ed), Reform and Recovery:  An Agenda for the New Western Australian Government, Perth, Wood & Associates, March 1993, page 103.