Sunday, March 29, 1998

No Conspiracy in MAI Plans

The Multilateral Agreement on Investment (MAI) currently being negotiated amongst the OECD countries has the xenophobes -- on the right and left -- in a state of high anxiety.

To them the MAI is the "grand conspiracy". It is a treaty negotiated in secret by faceless men in Switzerland which will override national sovereignty and open the economy and the environment to unfettered exploitation by multinational corporations.

This is, however, a grand delusion.

An efficient, fair and predictable set of rules governing foreign investment is needed, and very much in Australia's interest.

Australia is major player in the global capital markets.  Direct foreign investment into Australia is essential for domestic growth, jobs and rising living standards.  Australian firms are increasingly investing offshore and Australia has the potential to play a much bigger role as a global financial centre.

Trade and investment flows are interdependent and to achieve the benefits of trade liberalisation, investment barriers must be addressed as comprehensively as trade barriers.  Otherwise countries will use investment barriers as a substitute for trade barriers.

The Uruguay Round failed to achieve this and, as a result, foreign investment transactions amongst OECD countries, continue to be governed by an inconsistent and incomplete patchwork of over 1,600 bilateral treaties.

The MAI seeks to address this by giving investors greater protection against expropriation and other arbitrary acts, establishes legally binding procedures for settlement of disputes and creates an uniform set of rules.  It does not seek to give foreign investors special rights or override national legislation.  Under it, foreign investors will be subject to all domestic laws, including laws governing the environment, industrial relations and taxation.

The MAI allows each country to nominate areas to be exempt from the agreement.  And the Howard Government has indicated that all areas, including floats of public corporations, which currently receive special treatment will continue to do so under a MAI.

It is true that for far too long, international treaties have been negotiated and agreed to by Federal Cabinet without adequate public or parliamentary scrutiny.  Ironically this process has been strongly promoted by many of the left-wing opponents of MAI.

However, this has not been the case for the MAI.

The MAI has been subject to an open and thorough public debate.  The OECD has disseminated over 620 articles, reports and documents on the issue.  All countries, including Australia have published fact sheets and position papers.  Over 3000 articles covering every aspect of the subject can be obtained free in any public library via the Internet.  The Australian media -- particularly the ABC -- has been a-buzz on the issue.

Importantly, the Howard Government has already referred a draft of the MAI to the parliamentary Joint Standing Committee on Treaties.  This committee has called for public submissions and an interim report is due by 24 May.  The Government has also stated that if a MAI is signed, it will be resubmitted to the joint Parliamentary committee for another review -- including public submissions -- prior to ratification by Parliament.

Due process and the national interest is driving Australia's participation in the MAI, not the international brotherhood.


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Friday, March 20, 1998

Realism, Human Existence and the Environment

1997 World Meteorological Day Address


Dr Zillman, Senator Macdonald, friends and colleagues:

To say that it is an honour to have been asked to deliver the 1997 World Meteorological Day address understates the pleasure with which I regard this distinction.  It enables me to record the respect I have for the Bureau of Meteorology which has become one of the most esteemed institutions of its kind in the world.  Perhaps my main reason for accepting Dr Zillman's invitation is the opportunity it gives me to highlight some environmental perceptions of the future and to comment on them from a personal perspective.

The Bureau began before the advents of either computers or satellites but not too early to benefit from the scientific objectivity inculcated by the considerable scientific talent infused into the subject during World War 2, 1939-1946.

From these early years, one perception above all others has stayed with the Bureau:  the importance of critical objectivity for genuine progress in understanding.

In this address I attempt to apply such objectivity in the form of realism to the impact of human existence on the environment, and I will begin by commenting critically on conceptions of sustainable development.  Many of these observations are not original, some were featured in the recent ABC Radio National series "Open Learning", in which sustainable development was considered under the title "Chasing the Rainbow", but they are seldom openly discussed.  This will lead naturally to general remarks on population pressures.  To some extent I shall trespass on ground covered by Barry Jones in his 1992 World Meteorological Day address but my review will be from a somewhat different perspective.  Finally, in this context, it will be relevant to comment on two specific topics:  the 1997 World Meteorological Day theme of Weather and Water in Cities, because urbanisation is a characteristic of population increase;  and Global Warming and climate change, because it is strongly related to world population demands and because recent procedural developments are having an impact on the reputation of climate science.


SUSTAINABLE DEVELOPMENT

Pronouncements from government sources in most countries characteristically contain two types of exhortation that sit uneasily together.  On the one hand we are urged to foster increased economic development in order to provide improved employment prospects and the disposable wealth required for social objectives.  On the other hand we are counselled to mend our profligate ways in order to achieve ecological sustainability.  Indeed the use of the word "sustainable" has become rather hackneyed, and with it the appealing ideal of sustainable development.

Throughout modern history people have wanted to believe that a better society and organisation can exist and be created.  Betterment means not only that the socio-economic system could be more equitable in a humanitarian sense but also that it should be able to resolve the problem of a developing society and a deteriorating environment.  Quality of life is what we are all concerned about.  Yet the idea that "all is for the best in the best of all possible worlds" begs the question of what is possible.  As an imprecise ambition sustainable development provides fertile ground for idealists and gives scope to well-meaning evangelists who seek to impose or encourage ethical changes in the way of the world.  Of course it also attracts those who can use the concept to sell their wares or justify their activities.

Over the past two decades an emerging awareness of environmental degradation has placed it high on the political agenda in many countries.  This has had the desirable effect of achieving for the environment a relatively higher priority than before in the allocation of government funding.  Unfortunately it has also sometimes meant that truth, rather than according with fact or a rational analysis of the situation, has become what people can be persuaded to believe by constant repetition from various pressure groups.  One such persuasion is that a clear path to sustainable development exists and is obvious to those with acumen.  Five years ago Barry Jones ended his address by referring to Pascal's wager as an argument for "taking action to avert disaster";  yet he failed to mention the implicit assumption that a solution exists which allows such action with no adverse consequences.  I will argue later that, in the case of global warming, the advocated cure may be worse than the presumed disease.

A major plank in the platforms of those directing us to this path is the Precautionary Principle -- as a means to help stop the rot of environmental degradation.  This principle advocates that, when faced with any agricultural, industrial, mining or tourist development proposal, regulators should anticipate environmental harm and act to ensure that such harm doesn't occur.  Innocuous enough perhaps.  Indeed it looks very much like a moral imperative:  no rational person could advocate deliberate environmental degradation, and ideally we should leave the world a better place for human habitation than when we entered it.  But things are not that simple.  In a highly interactive society there are competing moral imperatives, or at least desired objectives, including issues like the rights to life, food and comfort, maintaining standards of living, and international and intergenerational equity.  While some of these suffer from the perspective of moral values fashioned in a past era when scope for expansion was perceived as infinite, the conflicts are no less real.  Yet, to achieve them, paradoxically boldness has been replaced by timidity.

In his thought provoking monograph "Don't Panic, Panic" subtitled "The use and abuse of science to create fear", the late John Farrands begins "In our time we have created the most unnecessarily fearful generation of humankind ever to have populated the earth".  He didn't cite the Precautionary principle, yet he might have done because it appears to reflect a fear for the future and a timorous view of the relationship between humanity and the environment.  It infers that almost any developmental activity affecting the environment has a latent tendency to do more harm than good and that societal benefit can no longer justify further environmental alteration.  The principle is often associated with the maxim "lack of full scientific certainty should not be used as a reason for taking no action".  Yet this is a redundant statement given the rationally sceptical perspective that certainty of knowledge is unattainable.  Both the principle and the maxim are arguments used to justify the Framework Convention on Climate Change.

It is now well known that the term sustainable development was coined in the 1987 Brundtland Report "Our common future", and defined as "development that meets the needs of the present without compromising the ability of future generations to meet their own needs".  Indeed this term has received ubiquitous usage, often without the user thinking about what it really means or about the viability of that concept.  The possible, even likely, mutual inconsistency of the two parts of the definition certainly seems to have escaped those who drafted it.  But any rational criticism has been swamped by the powerful dawning awareness of an increasingly obvious deterioration in our physical and biological environment and, because people are becoming a little frightened, of the political potency of the concept in terms of votes.  Where the political climate has fostered the profile of special interest groups this has given "the environmental movement" unprecedented influence.

Somewhat improbably it was the 19th Century anarchist Michael Bakunin who expressed concern about "the tyranny of the minority over the majority -- in the name of the many and the supreme wisdom of the few";  yet this is the direction in which unfettered trepidation might take us.  In his 1990 prize-winning Quadrant essay "The class that cried Wolf" Sev Sternhell asserts that "Greenies use scientific data like lawyers, to make a case;  and not like scientists, to discover what is the case";  he decries exaggeration and distortion.  Hard words perhaps, but whether one subscribes to these criticisms or not it is apparent that some components of modern environmental attitudes are characterised by apprehension with which changes associated with any developmental activity are regarded, the fervour with which views are held, and the prediction of a calamitous future -- unless some specified action is undertaken.  Yet these are not new features in intellectual debate.  On apprehension, in 1873 John Stewart Mill, no less, expressed foreboding -- for statistical reasons -- that the world was running out of beautiful melodies, and that Mozart and Weber had skimmed what was left of the cream.  Hardly were the words off his pen than Grieg, Tchaikovsky, Strauss etc. proved him wrong.  Beware of those who stray outside their field!  On fervour, in 1958 Bertrand Russell rather mischievously suggested that an opinion needed to be held fervently only if it were doubtful or demonstrably false.  Beware of ardent rhetoric!  And on prediction, in 1968 Karl Popper, after noting that the general public expect every genuine scholar to be a prophet, somewhat tongue-in-cheek said "Soothsaying should be kept where it belongs -- in the fairground.  Whether a prediction becomes true or not is not a matter of method, wisdom or intuition;  it is purely a matter of chance".  Beware of false prophets!

The sustainable development advocacy is occurring at a time of more rapid escalation in human numbers than ever before, when it is at last being appreciated that there is a limit to many available resources, and when a decline in disposable wealth in most developed countries has been obvious for a decade or more.  Clearly it is relevant to question whether a truly equitable re-adjustment can be achieved without a vast reduction in the quality of life for many and without the emergence of internecine conflict of the type which is now afflicting the republics of the old socialist union and many other locations.  Such a question is generally avoided by social scientists who tend to annex the issue of environmental degradation as part of a moral crusade.

In 1992 "Beyond the limits" was published.  It is the 20 year sequel to "Limits to growth", sponsored by The Club of Rome, and is a document likely to induce mixed feelings in the reader.  No one of us could do other than laud the moral principles upon which its recipe for meeting the needs of the poor, for equity and for sustainable development is based.  But the balance between altruism and selfishness in the statistics of human behaviour, as distinct from individual compassion and personal character, is not likely to change.  One does not have to be a misanthrope to recognise that average human behaviour on a one to one basis accords with a different standard of morality than it does on a tribe to tribe or a nation to nation basis.

For these reasons, even if theoretically possible, there must be some doubt whether the wider concept of sustainable development as defined is achievable.  This may be why the honourable intentions voiced at the 1992 United Nations Conference on Environment and Development (UNCED) in Rio de Janeiro have been echoed by subsequent conferences (on Population in Cairo, 1994;  Women's issues, Beijing, 1995;  Habitat, Istanbul, 1996) and the Social Summit, Copenhagen, 1996 without the ambitious resource transfers from "rich" to "poor" nations outlined in Agenda 21 being effected.  A significant feature of UNCED was a noticeable avoidance of reference to, let alone discussion of, the world population problem.  The difficulties became obvious at Cairo where virtually no headway was made in tackling the ideological impediments to attempts to control the rate of world population increase.


PEOPLE

Since the Essay on Population by the Englishman Thomas Malthus in 1803 the carrying capacity of the planet has at various times been a topic of debate.  The essence of Malthus's notion was that, if population numbers continue to increase geometrically whereas food production increases arithmetically, at some time widespread famine must ensue.  A few years ago Paul Ehrlick and collaborators excited widespread concern with books entitled "The population bomb" (1968) and "The population explosion" (1990).  However, sceptics have delighted in noting the downwardly adjusted population predictions in the second book and between this and recent United Nations estimates of world population (currently nearing 6 billion).  They also criticise the simplicity of some of the modelling assumptions in "Limits to growth" and argue that inadequate allowance was made for technological and agricultural improvements which dramatically increased yields in the so-called "green revolution".  And yet the current world population estimate and the rate of increase of nearly one billion every 10 years are not so far from the estimates made in "Limits to growth" 25 years ago.  The "time of doubling" estimated for 1995 by the World Bank "World Population Projections" is 12 years, and probably at its lowest, but numbers are not expected to stabilise, at between 11 and 12 billion, until well into the 22nd Century.

The deleterious effects of such pressures on the quality of life are to be seen not only in the famines of Ethiopia or Somalia and the endemic water shortages in much of Africa, in the rural saturation of much of China, in the suffocating atmospheres of Mexico City, Sofia, Teheran or Taipei, in the pathetic overcrowding of Calcutta or in the squalor of Sao Paulo.  They are a major component too in events such as traffic jams in London, breakdowns of city services in New York, overloading of the sewerage system in Sydney, the inadequacy of infrastructure in most countries and the increased urbanisation everywhere.

Environmental threats due directly to increasing population and development expectations can be perceived as ranging from the more acute to the more chronic:  from water deficiencies and waste disposal contamination of land, water and air, through decreased biodiversity and perhaps climate change, to reduction in non-renewable resources.  Warfare and disease could be included in this categorisation because they are exacerbated in many parts of the world by too many people for too few desired and available resources.  To many people in developing countries "development" means "catching up with the rich countries";  hence their concerns that international requirements to clean up their environment, prevent further degradation and limit their use of fossil fuels would impose impediments to their growth and prosperity.  The logic seems sound.

Realistic attempts to address national aspects of population increase were considered at the Australian Academy of Science Symposium "Population 2040:  Australia's choice", held in April 1994.  There, particular concern was expressed about the possible doubling or tripling of the size of Melbourne and Sydney, the need to service them and their impact on surrounding regions.  The full complexity was considered in "Australia's population 'carrying capacity' ", the 1994 Report of the House of Representatives Standing Committee for Long Term Strategies.  The political difficulties are indicated by what Doug Cocks in his book "People policy" calls "the Committee's somewhat confused report which manages to avoid making any recommendations".  Cocks himself argues that a much better case exists for a policy aimed at stabilising Australia's population in a generation or so than for the current tacit policy of doubling the size within a few generations.  Urban quality of life emerges from his analysis as the single most important issue in the population debate -- although I suspect this is not as important as the consequences of such a policy on employment and wealth:  commerce and industry on which these depend rely upon the demands of an expanding society.

However desirable ecologically they may be, the prospects of any significant medium term change in population trends are not large.  Nationally this is illustrated by a recent call for action to develop a population policy for Australia, but at the same time the adverse social consequences of containing population are given more weight than the adverse environmental consequences of not doing so.  Internationally it would be naive to believe that carrying capacity is high on the priority list of many underprivileged and warring factions already actively engaged in survival activities that degrade the environment in one way or another.  For such groups, maintaining current existence is more urgent than any thoughts of the viability of future generations.

Realism has been defined as the application of thinking to wishing.  Clearly when planning for the future it is necessary for these plans to be based on realism not wishful thinking.  In any case it would be more honest to admit that until world population and associated expectations stabilise, environmental damage control is a more realistic aim than ecologically sustainable development (ESD).  Indeed, on the national scene, if Australia's population is not to be stabilised in the medium term, environmental damage control together with improved efficiency and conservation of resources, is the main thrust of the principles set out in 1992 by the 9 government sponsored ESD working groups.

Meteorology is involved in many responses to the problem of increasing numbers of people and a decrease in the quality of their environment.  I would like to comment on two such responses:  the first, servicing cities, is based on realism but the second, coping with climate change, is in dire danger of being overwhelmed by wishful thinking.


CITIES

In Australia 60% of people live in the five largest cities, and the 1994 forecast of the Australian Bureau of Statistics is that most future immigrants will settle in capital cities and that the drift away from inland centres will continue.  Such a changing distribution is similar to the world-wide population shift from rural to urban areas.  Recognising the implications of increased urbanisation the World Meteorological Organisation (WMO) has chosen "Weather and Water in Cities" as the theme for the 1997 World Meteorological Day.  Topics that fall under this heading include precision forecasting, extreme weather, the urban heat island and flood forecasting, but two that are particularly relevant to my theme are urban air pollution and water supply.

Perhaps the most widespread problem in urban meteorology concerns the structure and behaviour of the lower atmosphere and its effect on atmospheric pollution.  This has been extensively studied in Australia partly because of the role of this part of the atmosphere in affecting the hydrological cycle and agriculture.  Also, our country has a sparse population and, even in the more densely settled areas, is characterised by relatively discrete areas of industrial development.  This has provided opportunities to study plumes from individual and conglomerate sources.  A third feature of Australia is that most population centres are near the coast, and there has been a particular interest in the fate of waste emissions into the atmosphere under sea breeze conditions.

Meteorological conditions associated with photochemical smog have been studied in most of our major cities, and the success of these studies as a basis for improved regulations and forecasts is due in no small part to strong collaboration between scientists and engineers from Federal and State Governments and Industry.  This collaboration continues in the current National Inquiry into Urban Air Pollution being organised by the Academy of Technological Sciences and Engineering.  The numerical modelling component of this work now has the ability to simulate likely ground level concentrations of pollutants from contemplated emissions sources not yet in existence, incorporating realistic topography.  It has emerged as an invaluable planning facility, has been adopted by many overseas agencies and is a central facet of several overseas consultancies won by Australian consortia.

Regarding fresh water demand, assuming world population figures of 5.3 billion in 1990 and 10.0 billion in 2050 it has been estimated that in 1990 335 million people (6% of world population, in 28 countries) suffered water stress or scarcity, mostly in Arabia and Africa.  In 2050 this will rise to 4,400 million people (44% of world population, in 58 countries), with India and China now in the list.  Despite the drawing down of ground water resources in some countries, including Australia, this worsening is almost entirely due to population increase.  Transporting water more than 100 km is extremely expensive, thus the inexorable urbanisation throughout the world exacerbates the problem.  Ironically water engineers are partly responsible for the problem:  the introduction of water supply and sewage treatment technology in the 19th and 20th centuries accelerated the population increase.


CLIMATE

Although scientific uncertainties remain, the Greenhouse debate has now firmly moved to the response phase.  Indeed this has become obvious from the hectic activity within Government and Industry preparing for the latest in the round of negotiations for the sequence of meetings of the Conference of Parties to the Framework Convention on Climate Change.  I believe that climate scientists need to take a long hard look at just why, internationally, policymaking has so effectively pre-empted science.

In the decade following 1985, with surprising speed catastrophic climate change assertions by the media and those on the periphery of the science became widely accepted.  Where reference was later made to the consensus set out by the Intergovernmental Panel on Climate Change (IPCC), formed by WMO and UNEP in 1987, the focus was always on the upper bounds of possible climate change, and caveats tended to be ignored.  Some 30 years ago the eminent US meteorologist Joe Smagorinsky, unhappy at what he regarded as the precipitate utilisation of numerical weather prediction in operational weather forecasting, coined the phrase "an inadequate framework has been pressed into premature servitude"!  This is a much more relevant lament about global warming than was the case for weather forecasting.

In the 1970s and early 1980s the Joint Organising Committee of the WMO/ICSU Global Atmsopheric Research Programme focussed first on the science of weather and second on the science of climate.  These were exciting times.  Meteorologists had cause to be proud of improvements to numerical weather analysis and prediction that resulted from the combined observational and modelling undertaken in the 1979 Global Weather Experiment.  Equally impressive was the subsequent application of climate models to study the sensitivity of results to variations in some of the controlling influences, notably atmospheric composition.  This paved the way for rapidly organised collaboration between meteorologists, oceanographers, atmospheric chemists, biologists, etc., and the well informed reviews that provided input to the IPCC consensus.  Within a short time initial industry scepticism about aspects of both model results inferring climate change due to increasing levels of Greenhouse gases and observational studies of global surface temperature trends was largely dispelled.

But something has gone wrong.  Whether we like it or not the rapport that many of us have tried to establish between industry and science has been disturbed by the way in which the 1995 up-date of IPCC consensus on climate change was handled.  Background information and the first draft of documentation was provided by hundreds of scientists around the world who had met to contribute the results of their research and their interpretation of it.  An executive group took on the responsibility of editing the detailed material, preparing Summary findings and publishing both.  Unfortunately the end products from this process have been severely criticised from within the ranks of both science and industry.  The seriousness of these criticisms can be gauged from the headline "A major deception on global warming" in the editorial columns of The Wall Street Journal (12 June 1996).  In this, Frederick Seitz, President of the Marshall Institute and a past President of the United States Academy of Science, questioned the objectivity of the IPCC report and in particular its "on balance" attribution that human influence was already evident in the observed small global average temperature trends over the past 50 years.  These concerns were peremptorily rejected as right wing prejudices by the United States delegation at Geneva and of course by the IPCC principals.  But it may have been unwise for them to have been so dismissive.  Alarm bells were ringing while the report was being compiled.  Immediately after a late stage international meeting in Madrid, November 1995, to consider the scientific component of the update, several national delegations specifically expressed misgivings at the way in which the procedures were being used to bypass the background documentation that had already been prepared by grass roots scientists throughout the world.  And later, at conferences in Rome and Geneva, industry was disconcerted at the precedence given to the points of view of the zealous environmental lobby.

Most informed scientists believe that Seitz was wrong to impugn the integrity of certain individuals involved in the final editing of this very large project but many share his irritation at what they see as examples of bias and exaggeration in the final Policymakers' Summaries.  Study of the report by "IPCC watchers" associated with major world industry associations has revealed examples of changes to the earlier wording of the Summary for Policymakers for Working Group I (Science), the effect being, they aver, to "scientifically cleanse" the final report of equivocations and caveats in the background documentation.  The World Energy Council cites evidence also of scientific bias, technical weakness and political influence in the Policymakers' Summaries for Working Groups II (Impacts) and III (Strategies).  The credibility of the IPCC would seem to have suffered.  Perhaps the most potentially damaging and controversial assertion is in the Synthesis of the 1995 IPCC Assessment which states "the risk of aggregate net damage due to climate change, consideration of risk aversion and the precautionary approach provide a rationale for actions beyond 'no regrets' ".  This is an unwise statement when no assessment has been made of the net long term damage from either climate change or, importantly, from major emission reduction strategies.

Action aimed at stifling informed dissent in favour of a cult opinion is bad practice.  Because I am personally worried about what might be regarded as international endeavours to dilute objective criticism and establish a "scientifically correct" view on global warming, I consulted six senior overseas professionals who at one time or another had played a major role in international meteorology.  None of them is closely connected with industry.  Five of the replies expressed equal or greater concern about what one called "first guessing the science" and another called "exaggeration and unjustified alarm".  Only one felt that such criticisms were misplaced -- because, he said, of the political support this had obtained for the science!

Already an enormous amount of time and money has been spent on international policy response negotiations.  Yet it is not generally appreciated that a rational consideration of why we need to reduce Greenhouse gas emissions rests on a sequence of four assumptions:

  • that the greenhouse gas -- climate change scientific theory is valid, and that global warming and other climate changes will be induced by higher gas concentrations,
  • that any such climate change is necessarily a net detriment to our well-being,
  • that realistically we can achieve a sufficient world-wide reduction in greenhouse gas emissions to effect a stabilisation of gas concentrations in the atmosphere and thus limit any climate change that would otherwise occur,
  • that the total cost to society of such a reduction is less than the cost of adapting to the climate change.

If even one of these is untrue then the chain of argument justifying a policy of greenhouse gas emission reduction is broken.  It is not appropriate to consider them here;  although I will say that while, with important qualifications, the first assumption (science) is likely to be broadly correct , the second (impacts) is indeterminate and the third and fourth (strategies to cope) are probably incorrect.

A critical and thorough objective analysis of the need, possibility and effectiveness of major world-wide emission reductions is called for, along the lines of the above analysis -- before we get into more trouble than we are already in.  Well perhaps not we older scientists;  the crunch will come in a decade or so if some of the rashly formed predictions of dramatic climate change are revealed to be flawed.  When scapegoats are sought science will not be ignored.

There is an element of hypocrisy in the current negotiations preparing for Conferences of Parties (COPs) to the FCCC.  National delegations seem to be more concerned with setting new targets at the Kyoto COP in December 1997 than in meeting old ones.  At the Geneva COP in 1996 information gleaned from various sources suggests that far from stabilising concentrations, it is probable that even emissions will not be stabilised by the year 2000, an increase of magnitude 10% above 1990 levels among the developed nations is more likely.  Developing nations will considerably exceed this.  (The net result is a rate of increase similar to that of world population.)  Intentions regarding legally binding targets are hedged by caveats, and while there is much debate about "equitable burden sharing" and "differentiation" (taking into account the different social and economic circumstances of individual nations), few countries regard this as other than a means to reduce their share.

At the most recent meeting in Bonn, March 1997, European Union (EU) environment ministers appear to have agreed to differentiation between European countries but it is nor clear whether this is accepted also for countries outside.  But many inconsistencies exist in the European position, and while a 15% emission reduction target by 2010 is being advanced (already rejected as unrealistic by Australia), one senior official is said to have conceded that agreement at Kyoto of even a 10% target is far from likely at the moment.

Draconian policies of emission reduction are being seriously considered by some countries with scant regard to their effectiveness in retarding climate change and minimal understanding of their total downstream socio-economic consequences.  However, at the Bonn meeting, the United Mine Workers of America declared that such policies would reduce economic growth and impact on rich and poor alike.  The union echoed opinions that without definite emission reduction commitments from non-OECD countries it is impossible to point to any environmental benefit that might result from a one-sided emission reduction agreement covering only a fraction of future Greenhouse gas emitters.  Similar views have been expressed by the Australian Bureau of Agricultural and Resource Economics.

Clearly uncertainties in both the science and impacts of climate change are not being balanced against the full costs of mitigation strategies.  It is not rational to advocate a policy without first obtaining convincing estimates of what its total effect is likely to be.  The objective of the Framework Convention on Climate Change is to reduce Greenhouse gas emissions sufficient to stabilise concentrations or to reduce significantly their rate of increase within a credible time frame.  But there is an obvious possibility that this objective is unnecessary, unachievable and undesirable.  It should be a matter of some concern that these doubts are not openly discussed.

When danger threatens, intelligent people have four possible courses of action:  to ignore it, to prevent it, to ameliorate it and to prepare to adapt to it.  In this case we are not ignoring it, cannot prevent it and our options for the amelioration are severely limited.  It appears therefore that planned adaptation should be the central policy;  for this, science will be even more important because of the requirement to predict what it is we need to adapt to.  An eminently sensible approach appears to have been adopted by the Australian Government:  questioning the feasibility of targets, working to resolve the uncertainties on all fronts and assessing the consequences of policies before adopting them.  It is clearly time to change from wishful thinking to realism when planning for the future.

Sunday, March 15, 1998

Black & White Pay for Land Title Plight

To most Victorians, Native Title is viewed as somebody else's problem and no big deal.  They are, however, wrong.

Currently 53% of the State is subject to land claims.  While this is less than in other states (for example claims currently cover over 80% of the land area of WA), it is, nonetheless, a large area.  Moreover, the areas covered by the claims -- which include water rights over the Murray River and public right-of-ways-are vital to the economy of the State and have a wide impact on property owners.

Although mining is not a major activity and is not greatly effected by land claims in Victoria, Melbourne is the home-base of many of the nation's major mining firms.  We will only keep that home-base while Australia is a major area of mining activity.  If mining firms continue to move exploration and production offshore, as they are currently doing because of land rights, then head-office jobs will soon follow.

More importantly, the Australian economy is still predominantly resource based.  Resources -- rural, mineral and metals -- still represent over 70% of total exports.  Resources dominate our stock market.  Resource projects still are the main drivers of private investment.  In short, if the resource sector suffers, we all suffer.

And there is now no doubt that the Native Title Act (NTA) is hindering the growth of the resource sector and the Australian economy.

According to a recent survey of world miners, Australia is considered to have the most risky land-rights system amongst the major mining nations -- indeed the land-rights regime in Australia is now considered to be more uncertain than the chaos that reigns in New Guinea.

A major accounting firm recently estimated that since December 1993 native title has cost taxpayers $30 billion in lost mining revenue and investment opportunities.

Even ATSIC now agrees that " any argument that the NTA does not need amendment is unsustainable".

There are a number of fundamental faults with the NTA, the most significant being the right it gives to native-title claimants to negotiate with miners and pastoral leaseholders.  The NTA allows any Aboriginal to register a claim -- no matter how tenuous -- and thereby claim the right to negotiate at every stage of development.

This has led to a flood of claims.  For example, the WA gold fields region is currently subject to 90 different claims with some areas being subject to as many as 14 separate claims, some of which are conflicting claims by members of the same family.

These claims have virtually halted the issue of mining titles in WA.  There is currently a backlog 7,400 mining titles in the State which, even without further delay, will take three years to clear.  Only 181 or 86% of the 2094 titles submitted, since March 1995, have been granted-and none have overcome the Native Title Tribunal hurdles.  And things are getting worse, not better.

The debate is not about eliminating native title rights-they are accepted by all parties as a fact.  The debate is about the best way to inject sanity and a degree of certainty back into to property rights system.  Failure to do so will be costly to all Australians -- black and white.


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Paying Cultural Debts

Sixty years ago, an American anthropologist named Ralph Linton published a delightful response to the smug parochialism of his countrymen.  "One Hundred Per Cent American" follows the morning activities of a typical American who wants to preserve the integrity of his national heritage by shunning dangerous foreign ideas.

Linton noted the origin of all the things this hypothetical chauvinist might use and do, from the time he woke in the morning till the time he caught a train for work.  He described the clothes the American might wear, the food he would eat, and the objects he would come into contact with.  Apart from the radiator in the bathroom, everything had been discovered or invented elsewhere;  in Asia, Europe, Africa or Central America.

An updated version of Linton's essay would need to acknowledge a few more items originating in America, given the contemporary importance of plastics and microelectronics.  But the basic point remains.  As is the case with all countries, the subsistence of Americans and their comforts and pleasures are overwhelmingly the outcome of foreign influences;  the creative achievements of usually unknown individuals coming from cultures that many contemporary Americans would regard as inferior.

Australians are more willing than Americans to admit dependence on foreign things and ideas, although this may only be because our much smaller size and economy make it harder to pretend we are the centre of the world.  Nevertheless, we also tend to be unmindful of the debt we owe to people from other cultures.

For instance, it is only in recent years that white Australians have begun to appreciate and acknowledge the important role that Aborigines played in the European exploration and development of the Australian interior.  And there is little realisation of the part played by another once-despised people, the Melanesian islanders, in the early development of two of our most popular recreations, swimming and body surfing, even though the Polynesian origin of surfboard riding is well known.

The Melanesians were brought to Australia as indentured labourers to work in the cane fields from the 1860s on.  Most came voluntarily, although this is often denied by those who like to speak of Australia's own "slave trade".  (The really shameful aspects of Australia's treatment of the Melanesians were the forcible repatriation in the early years of this century of many thousands who wanted to stay here, and the discriminatory legislation directed against the few who were permitted to remain).

The Melanesian islanders usually came from cultures with longstanding maritime traditions and an easy familiarity with the sea.  In the 1890s a lad from Roviana Lagoon in the Solomon Islands named Alick Wickham was working as a "house-boy" in Sydney, and swimming in the sea-baths at Bronte Beach, using a stroke that was widespread in many parts of the Pacific.

One day a leading swimming coach of the day, George Farmer, saw Wickham swimming, and is said to have called out in excitement, "look at that kid crawling over the water".  Other swimmers quickly took up the stroke and developed it, but the "Australian crawl" is clearly a misnomer.  However, in those days of racist nationalism, the "Melanesian" or "Pacific Islands crawl" would have had rather less appeal.

Alick Wickham went on to become a champion swimmer, and he held a couple of world freestyle records in the years before the First World War.  He may also have played a role in the development of body surfing, as he was one of a group of powerful swimmers who congregated around Manly beach in Sydney and who were keen to foster skills and techniques in the early days of surfing.  Certainly, it would be a lot harder to catch waves using strokes other than the "Australian crawl".

But the honour of introducing body surfing to Australians belongs to another Melanesian, Tommy Tanna, a gardener's assistant who was working at Manly around the turn of the century.  Tanna, whose surname almost certainly identifies him as coming from the island of that name in present-day Vanuatu, spent much of his spare time at Manly beach, where he amazed locals with his ability to catch waves which carried him at great speed into shore.

Tommy Tanna was soon befriended by a young Australian, Freddie Williams.  Through a combination of Tanna's instructions and his own experimentation, Williams learnt to body surf himself, and then taught his mates to "shoot the waves".  From Manly, the new sport quickly spread to other Sydney beaches, and then further afield.

This exciting new way of harnessing the ocean's power attracted greater numbers of people to the surf beaches.  The popularity of surfing increased after Victorian era restrictions on public swimming during daylight hours were abandoned in the early 1900s.  But unfamiliar with the dangers, many people drowned.  At Manly alone, seventeen people had lost their lives by the end of 1902.

At this point, Australians began to make their own innovative contribution to surfing.  Men like Lyster Ormsby devoted their attention to developing rescue equipment and techniques that would be suitable for surf conditions, such as the now superseded reel and line.  In 1906 Australia's first surf life-saving club was formed at Bondi, and similar volunteer clubs were soon set up at other beaches, at least partly stimulated by the unwillingness of local authorities to fund professional lifeguards.

Australia's volunteer surf-life saving movement has now spread to many other countries, and has been nurtured and further developed by the efforts of people from a very wide range of backgrounds.  With 350,000 rescues to its credit in Australia alone, it is a great social achievement, one which exemplifies some of the finest features of our nation's character.

Most of the really worthwhile aspects of any culture have diverse and foreign roots.  So while swimming in the surf, pay some homage to Alick Wickham, Tommy Tanna, and their island ancestors.  Without the creative way they found to express their love of the sea, our own lives wouldn't be quite as much fun.


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Friday, March 13, 1998

Native Title: Six Questions for Labor

also published as "False assumptions:  why Kim Beazley is wrong on Wik" in The Age, 23 March 1998

The Native Title Amendment Bill 1997 will return to the Senate next month with most media and academic opinion against the Government, yet claiming to fear a double dissolution election based on what they have chosen to label, the "race issue".

There is a built-in assumption that the only way to avoid such an election is for the Prime Minister to compromise his Bill.  There is of course another way.  The Labor party can drop its objections to the Bill and allow it to pass.  Kim Beazley could sell this as a magnanimous gesture to save the country from the "race" election, and vow to amend the legislation should he win.  That may not entirely kill the debate, but if the Government pursued the Opposition on the matter during a subsequent election it would prove true the allegation that it wanted a race-based election, and it would be penalised electorally.

However, Beazley has already revealed the weakness in the Labor's position on Native Title by making such a feature of the issue at the ALP National Conference.  Presumably the aim has been to use the weight of Conference to lock in caucus members.

Queensland Labor leader, Peter Beattie was right when he said that Labor was wearing its heart on its sleeve on this one.  Labor has some questions to answer, not to the editorialists, but to the electorate.

1. Does Labor believe, as does former leader Paul Keating, that the Native Title Act 1993 does not have to be amended as a consequence of the High Court's judgement in Wik?

Beazley has stated that regardless of Wik, Labor would have been confronted by the need to amend the Act had it remained in government.  The Wik decision introduced the concept of coexistence by deciding that native title could coexist with some forms of leasehold title.  This new law required a legislative response to confirm the extent of native title rights on different types of lease.

Labor's view in office was that past valid freehold and leasehold grants extinguished native title.  Labor not only said this when it introduced its legislation, and it not only assumed the High Court would confirm this view in Wik, it prayed for that outcome.  When Labor spokesman Daryl Melham recently announced that he had always believed that coexistence would occur on pastoral lease, it served to confirm that no-one else on the Labor side did.

The Act was based on the assumption that native title would exist principally on vacant crown land, where there was no significant grant of private rights.  The assumption was that the rights of native title holders in relation to such vacant crown land could be significant, and could be equated to ownership of the land.  Based on these assumptions the Act provided native title holders with the same protection and the same procedural rights as freeholders, as well as special rights to negotiate in relation to mining and some compulsory acquisitions.

Wik contradicted these assumptions.  At one end of the spectrum, native title could approach the rights of full ownership, but at the other end be no more than an entitlement to come onto the land for ceremonial purposes.  Native title on pastoral lease is nearer the latter, so the Bill had to put in place a regime which recognised that native title is, in these circumstances a coexisting and subordinate right.

Labor's assertion that native title was a "fundamental legal property right" belies the High Court's view in Wik, that these are a bundle of rights that vary considerably dependent on where and under what circumstances they survive.  Labor accepts coexistence, but it does not want to accept that the underlying assumptions that relate to crown land cannot always apply where there are other interests.

2. Should the recipients of a benefit be able to determine the extent of that benefit?

Labor argued that its Act was the result of a deal to give indigenous people, as far as possible what they desired, for instance, the validation of past acts of the grant of land in return for the Land Fund and the right to negotiate (RTN).  This deal was struck so that the whole of the Act could be held to be of net benefit to indigenous people, and arguably safe from constitutional challenge.

In Senate hearings on the constitutionality of the Bill, Senator Bolkus had many witnesses agree with his assertion that the only sure way to avoid a challenge was if the Bill was unambiguously beneficial.  Further it was suggested that the standard the High Court should use in the determination of beneficial was "indigenous consent".  How such consent could ever be gauged is unclear.

In trying to undermine Howard's Bill, which is based on the Race Powers (S.51xxvi) of the Constitution, Labor's assumptions that the High Court will rule that the Commonwealth can only legislate in favour of Aborigines and that the measure of that concept was Aboriginal consent are seriously flawed.

Even if the court accepted the "benefit" line, if a deal by one government is seen as too generous or inappropriate surely the next government has the right and duty, within a very wide discretion to change it.  The High Court has already determined that some elements of the Act contain adverse provisions, but still upheld it.  The court might apply a test along the lines, "could the Parliament reasonably consider the law to be for the benefit of aboriginal people".  This does not require the court to weigh up every provision, but rather to see if the Parliament considered the matter properly.

Beazley has now realised that the court is not likely to decide in the forthcoming Hindmarsh Island case that legislation must be for the benefit of Aboriginal people or that Parliament is not competent to decide this, which is why he is now arguing his stance regardless of the High Court.  The question is why?

3. Should rights be available to one race and not others?

Labor has argued that the RTN provisions of the Act were a special measure and applied to one race alone.  The Bill allows for the RTN to be retained in relation to mining developments where native title may be equivalent to full ownership, for instance on vacant crown land.  However where rights are only coexisting rights, equivalent procedural rights for native title holders are provided.  This is an essential difference, rights based on title, not on race.

Beazley argued that the full RTN should be maintained, noting that West Australian freehold and agricultural leasehold have a veto over other forms of economic activity.  Is Labor arguing that native title claimants should have RTN powers almost equivalent to freeholders in West Australia, the strongest such powers in the country?

Such a stance is directly contrary to the Wik decision which suggests a continuum of rights, with native title diminishing at it confronts more powerful title.  The power of native title in relation to other land holders has to be weighed not just asserted.  Gareth Evans has effectively thrown in the towel on this one by hoping that the RTN is a matter of common law entitlement, preferring to leave it to the courts to decide.

4. Should one industry bear the burden of providing an economic base for Aboriginals?

Labor was passionate about native title holders being given the RTN over mining operations.  The rationale according to Evans was that the RTN amounted to a "legitimate" form of economic empowerment.  The very use of the term legitimate calls into question the truth of this rationale.  Why should the mining industry bear the burden of the economic empowerment of indigenous people?  This is a cargo cult mentality at its worst.

The realpolitik of the RTN of course is that, in conjunction with an easy test for registration, it places a very large lever in the hands of indigenous claimants.  With the flimsiest of evidence claimants can lift the cost to miners of compliance, and can extract rent in the form of royalties, jobs and training from what would otherwise be for them unproductive land.  This Robin Hood mentality perhaps more than anything else shows the flaw in Labor's thinking.  Why should special rights attach to a title held by one race and be used essentially against one industry?  The answer probably lies in the legal reasoning behind the typical negligence action.  In those cases the emphasis is not so much on the apportionment of blame, but in chasing the best source of revenue.

The RTN remains a statutory right, not a common law right and its power derives from the nature of the title not the race of the recipient.  It is to be seen in relation to other users of the land, which has always allowed for mining developments to create benefits for all by means of the crown ownership of minerals and the levying of royalties on behalf of taxpayers.  To allow one group to take their slice is a risky action, to do so with abandon as is the case with the current registration test is asking for trouble.

5. Should beliefs be a part of the registration test of native title claims?

The registration test for claims was always a worry for Labor, which in government was fast coming to the conclusion that the test was too loose.  For instance, when the ATSI Social Justice Commissioner Mick Dodson claimed that the test was too tight after the Native Title Tribunal rejected the Waanyi claim (later restored) the Labor government held the line.

The registration test is much firmer in the Bill, and access to various procedures such as the RTN flow from it.  It is a condition of the proposed test that at least one of the claim group has or had a traditional physical connection with the claimed area.  The Bill also does not allow spiritual matters to prevent the use of the "expedited procedure" for developments, and also attempts to restore the rules of evidence in claims proceedings, which also means that spiritual evidence would be subject to tighter scrutiny.

Do these things amount to an attack on the religious beliefs of indigenous people?  No, rather it is a recognition that in a culture with only an oral history tradition, the deliberate fabrication of belief is a real possibility, and must be subject to close scrutiny.  For example, in the Hindmarsh Island Inquiry the Royal Commission found that beliefs had been fabricated for the purpose of stopping the bridge.

None of this suggests that belief cannot be used as evidence to reinforce claims of physical connection, but to make it a decisive element would invite derision in the claims process.

6. Why should the time allowed to make native title claims be unlimited?

There was a very strong practical argument put to the Labor Caucus in the negotiations over the 1993 Act, that to impose a time limit on claims would create a large number of bogus claims.  Gareth Evans is still using this argument five years later.

The sunset clause in the Bill will not prevent common law native title claims being made, it only prevents the making of native title determination applications after the expiry of the clause.  The vast experience of the last five years suggests that land is so important to indigenous people they will not hesitate to make their applications as soon as possible.

Limiting the time for claims in all other areas of the law is common practice.  In the case of indigenous land claims it has a much more powerful role.  It will signal the end of a phase of readjustment in peoples thinking about land rights, and allow a new phase to begin where indigenous people no longer regard themselves as mendicants, but as citizens with a stake in the nation.

There are elements in the Howard Bill that could well do with further scrutiny when the matter comes before the Senate, especially the conditions under which the states would establish their regimes for managing the process and the integrity of those procedures that allow for Ministerial discretion.  However neither of these is a reason to deny the Bill its passage, and until Labor answers the above questions to the satisfaction of the widest possible constituency, it stands accused just as Hewson's Liberals in 1993 of dealing itself out of the debate.


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Thursday, March 12, 1998

Unravelling the Regulatory Confusion

Address to the AIC Conference
Regulation and the Regulators,
Sydney, 11 March 1998


INTRODUCTION

The title I have accepted for this address is, of course hopelessly ambitious.  It covers the whole gamut of two very detailed codes, state and federal regulatory bodies, numerous sub-groups and working parties operating within their ambit.  Joe Dimasi has outlined the different roles of the various players and Robert Milliner's thumbnail sketch on the conference brochure offers a summary of this for electricity.

Regulation of the electricity and gas industries covers many different facets.  These include:

  • Market regulation
  • wholesale rules governing bidding, transport, connection
  • prudential requirements
  • retail access and connection
  • retail conditions of supply
  • retail metering
  • different conditions for different fuels
  • Ownership rules for the industry assets
  • government ownership
  • takeovers and amalgamations
  • cross-ownership rules
  • State ownership
  • concentration of industry players
  • Rather than repeating the descriptions that have already been covered, in this address I want to focus on some of the possible outcomes and deficiencies of the structural and regulatory arrangements that governments are introducing.


    DIMENSIONS OF REGULATION

    It is significant that the newly emerging electricity and gas markets have had a different birth from that of any other market structure that has emerged.  In general markets can be categorized in two ways:  commodity markets and those based on direct relationships between buyers and sellers.

    Commodity markets developed from the common interests of buyers and sellers wishing to come together so that they can conveniently compare each others product offerings, assess prices, seek to defray risks by arranging for future delivery.  The coffee houses in which merchants exchanged what we now call derivatives grew gradually and spontaneously.  Other markets developed as sellers, or occasionally buyers, sought out specific opportunities to trade either by establishing contact with customers or suppliers or by setting up shop.

    In both cases the rule of law, known and accepted property rights and mutual trust was essential to the development of the market system.  That is why it grew most fruitfully in Western Europe where there was a system of law and ethical standards that gave people the confidence to specialise and transact rather than remain totally self sufficient.

    Markets that grew autonomously were the key to the growth of the modern economy and present living standards.

    The closest parallels we have to the electricity and, in Australia, gas market structures are those covering sporting associations.  In such cases, the rules are established at the centre.  At least until recently, they were not appealable.

    It is therefore something of a concern that the utility markets have been developed by governments rather than evolving from the voluntary interactions of buyers and sellers.

    It is perhaps partly because of this that we have institutions in gas and electricity with vast rule books.  Of course, the essential facility nature of many of the services in the industry make it different from that of many others.  But the Byzantine structures that Robert Milliner has depicted are testimony to a need to accommodate different political and bureaucratic interests.  The structures are designed to put in place checks and balances but most observers would agree that between State regulatory bodies, the ACCC, the NCC, NECA and NEMMCO there is at least one too many regulatory layers.


    DIFFERENCES BETWEEN THE STATES

    In the retail market, the present limit of contestability in WA is the 5 MW market to be opened by 1999.  NSW and Victoria opened up this tranche in 1994 and 1996 respectively.  By 1999, NSW will have made all customers contestable, while Victoria will have half the load free to choose.  Queensland has a program that is about three years behind the NSW and Victorian timetables.

    Table 1 indicates the timetables.

    Table 1:  Electricity Deregulation Timetables
    ThresholdType examplesNSWVicQldSAWA
    40 GWhvast sites1996199419981998
    (>20GWh)
    1999
    (5MW)
    4 GWhlarge office blocks1997199519991998
    750 MWhsupermarkets1997199620001999
    160 MWhsmall office blocks1998199820002000
    remainder 1999200120012001
    QLD 160 MWh is above 200 MWh


    Different State regulatory authorities have also specified different conditions for retail licences.  In NSW the licences contain some potentially onerous conditions designed to promote the consumption of electricity from greenhouse friendly sources.  South Australia is yet to approve licences from inter state.  Only Queensland has taken the route that is consistent with the various inter-governmental agreements signed since 1991.  These provide for mutual recognition of regulations between states.

    It is not sensible to require a retailer that has been judged acceptable in one jurisdiction to go to the expense of demonstrating those same credentials elsewhere.  Nor is it consistent with sensible federal policy to require, as is the case in Victoria and NSW, that the retailer be located in the State itself.

    NSW has also designed a system of retail and distribution oversight to reduce greenhouse gas emissions.  This is a matter for the Commonwealth rather than State Governments.  At best it will bring a further, superfluous regulatory body, the Licence Compliance Advisory Board and the paperburden costs of suppliers reporting to it.  At worst it will distort the market by favouring certain fuels and injecting an additional risk element to the operations of retailers and distributors.

    The freedom of gas consumers to seek out their own sources of supply also varies considerably between the jurisdictions.  New South Wales is moving most rapidly towards the open market and Western Australia is the slowest.  Table 2 illustrates the timetables:

    Table 2:  Gas Deregulation Timetables
    TimingNSWVicQldWASAACT
    end 1997100 Tj 500 Tj
    end 199810 Tj500 Tj 250 Tj100 Tj10 Tj
    end 1999all100 Tj 10 Tjall
    end 2000 5 TJ 100 Tjall comm.
    end 2001 allall all


    While these regulatory matters on gas and electricity are irritants that might offer incumbents in some States certain advantages, they are not fundamental flaws.  A further potentially vexing issue in gas is the different regulatory bodies.  Although the Code is to be the basis of decisions, its frailty which I will address shortly, can be magnified by the existence of different State regulatory bodies.


    COMPETITION AND MARKET FAILURE

    Market failure is a rather misunderstood term.  It is a precise term in economics that refers to the inability of markets to provide the lowest cost solution because of the occurrence of monopoly.  It is sometimes used by regulators as a term to portray a market outcome that does not accord with what they expect to occur.

    Competition is not valued as an end in itself but as the means of promoting efficiency.  This has two aspects.  First, monopoly is likely to mean a waste of resources because the producer's natural interest in maximising profit can be married with an ability to do so through forcing up the price by restricting supply.  Secondly, commercial rivalry is also superior to other arrangements in driving costs down and ensuring the lower cost outcome is passed on to consumers in lower prices.  Competitive firms must constantly seek cost savings and other ways of maintaining or improving their profits and these cost savings are largely converted into consumer benefits as rival suppliers adopt similar techniques.

    These criteria must be used to assess the merits of the gas and electricity regulatory codes.


    ELECTRICITY

    The events in Auckland and Queensland testify to the deficiencies of the government operated and owned systems.  Governments are likely to overbuild­as they have in the past in NSW and Victoria­or underbuild and stint on maintenance.

    The introduction of a market for electricity is among the most radical changes in economic management.  Not only do we have the wide Government ownership but we have monopoly aspects of the system, a non-storable good and uncertainties about whether free rider aspects of provision might rule out a market free of all intervention.

    While aspects of the provision, the transmission and distribution lines are characteristic natural monopolies, the ability of by-pass and the debate over entrepreneurial links may erode this feature.

    The interventions in the market that have been seen to date do not auger well for a system free of Government intervention.  These include the requirement on behalf of the Victorian Regulator-General that retailers contract for reserve power, the commissioning of QNI as a regulated link and the on-going debate on this issue about Riverlink.

    While such decisions as these doubtless pollute the notion of an electricity market that is no less free than other commodity markets, interventions along these lines may still prove to be inevitable.  Alex Henney in a recent report for the UK Minister for Energy and pool members envisages a major role for a variant of the NEMMCO with powers over spinning reserve, continued (though changed) payments for capacity and possibly some reserve trader powers.

    A key issue highlighted by Henney's report is the need for generators of rarely run plant to receive adequate remuneration.  The UK capacity payments associated with LOLP are not considered a success, but what is to replace them when the system is as Henney defines it is, "The majority of customers buy energy PLUS generation reliability.  Many customers either cannot exercise choice in generation reliability by responding to price and many do not wish to exercise choice because they have bought electricity on fixed price terms and expect a reliable supply."

    This issue is of major importance in the various interventions being made in the Australian market.

    It also needs to be said that government decisions have not been fully supportive of allowing the development of a competitive market.  In this respect we have

  • the reluctance of South Australian Governments to disaggregate ETSA as fully as they could,
  • the NSW decisions to create one or two very large retailer/distributors and portfolio generator businesses
  • and the same criticism of the Queensland assignment of its power stations into three businesses rather than at least six.

  • THE NATURAL GAS PIPELINE CODE

    While the Code purports to be a light handed approach, it is not flexible.  The provisions for pricing and access are in fact highly prescriptive and where there is flexibility it is often in directions that offer too much discretion to the regulator and thereby reduce certainty on the part of the operator.  Such loss of certainty is likely to raise the return needed to justify pipeline operations and reduce activity in the business.

    The Code is concerned to prevent excessive profits on the part of pipeliners.  Such goals have clear merit where a facility is a genuine natural monopoly.  However, the pursuit of "excessive" profits or economic rents is a legitimate business goal and one that almost all firms strive towards.  Suppressing that pursuit will reduce activity and those regulatory measures should therefore be confined to tightly defined and rare circumstances.


    GENERAL ISSUES

    THE ISSUE OF NEW VERSUS EXISTING PIPELINES

    Existing pipelines which serve as non duplicable facilities and which face no competition from other pipelines, present a powerful case for regulation of some sort.  Where no pipeline currently exists the regulation on a new line should be minimal.  Yet, in the draft Code, the onus is reversed.  A new entrepreneurial pipeline is required to prove that it should not be covered, and the Code itself would appear to offer few circumstances when this will be accepted.

    There will inevitably be many voices raised after a pipeline is committed seeking lower haulage charges.  The entrepreneur will wish to avoid being hostage to such pressures.  To this end, the entrepreneur will require assurances from the regulator on prices, in the absence of which many worthwhile projects will not proceed and in other cases new capacity will be restricted to only that amount which is fully committed at the outset.  In the latter case, the decision is likely to be sub-optimal since the capacity of a pipeline is related to the square of its diameter and the costs of building in incremental capacity are, accordingly, relatively low.

    If there is no pipeline serving a place and a new one is proposed, the pipeliner should be free to determine the terms on which it does business.  The community can only gain from the new facility and the pipeliner is constrained in his pricing and other conditions by the ability of rivals to offer a pipeline alternative or by the existence of the pre-existing sources of energy.

    The outcome of an entrepreneurial pipeline is seen in Goldfields where WMC/BHP/Normandy took the risks and built a pipeline to supply their own needs. (1)  Having done so, the consortium is relatively unconstrained in charging others, including Alinta Gas, a price that is close to what the market will bear.  This appears to be unacceptable under the Code.  Thus, under s.3.28, the arrangements are designed to preclude a pipeline from obtaining any greater profits than the regulator anticipated, and this is further amplified in s.3.33(e) which requires a tenderer to produce a policy regarding "additional revenue", a provision that does not seem to have a reciprocal arrangement where there is negative additional revenue.


    COMPETITIVE TENDERS

    The parts of the Code dealing with tenders present difficulties of themselves.  A competitive tender for the construction of a pipeline is an appropriate means of pursuing a development when the Government has determined that there is a market need and there would be many businesses seeking to take up the opportunity.  It is, however, not clear how the Government would have access to that information in advance of profit oriented businesses.  If a profitable opportunity exists to supply an area with a new pipeline, it is most unlikely that the first party to discover this would be a Government agency.

    If a private business were to spot an opportunity and subsequently be required to tender for the right to provide the means to meet it, that business will have incurred costs on which other businesses would free ride.  To require the opportunity to be tendered would be analogous to placing similar requirements on the proposers of a new paper mill or smelter.  It would discourage market searching activity and innovation.

    Tendering is really only appropriate where there are Government or private monopoly restraints, which have impeded developments that offer obvious profit opportunities.  In such circumstances, or where the pipeline needs government assistance to facilitate rights of way, an auction may be the best way of allocating the rights to the pipeline.  However, the best approach is to remove the impediments which prevent worthwhile developments from proceeding.  In any event, where one party is successful in offering the best price, that party should not be sheltered from future competition including from those parties whose bids were rejected.


    WHERE THERE IS PIPELINE ON PIPELINE COMPETITION

    The foregoing highlights a further issue.  Where there is adequate competition, no regulation is necessary­after all, the regulation proposed is nothing other than synthesised competition.

    In this respect, the provisions for revoking coverage are unclear.  Although s.1.30 says revocation must be recommended if it is no longer uneconomical to have another pipeline provide the services, the services are not defined.  Revocation is only unambiguous where another pipeline parallels the existing line and there is surplus capacity.  It would not therefore automatically apply to the BHP/West Coast line which provides competition to the Cooper Basin suppliers for the Sydney market.  It is likely that if the BHP/West Coast line is to be covered under the Code, its design and capacity would be affected.

    If the Code is not to be an impediment to efficiency and to businesses striking their own deals as they do in other areas of commerce, it should ensure that regulatory oversight is confined to the core areas and does not attempt to provide an insurance to "fairness" or some other notion where rival suppliers are in place.  It follows that where there is more than one pipeline serving an area or passing relatively closely to the same area, unless one of the pipelines is unable to provide competition (because its capacity is trivial compared with the other) coverage should automatically be revoked.


    SPECIFIC ISSUES

    There are concerns that gas regulation, in seeking to combat the detrimental effects of monopoly will create its own deficiencies.  These would stem from:

  • insecurities on the part of those whose success may generate increased value in their ability to retain for themselves a large share of that value;  those insecurities may stem from:
  • "free rider" problems whereby innovation is discouraged because there is an imbalanced risk/reward outcome;  the innovator gets slender benefit from success because other parties are given a share of the success by Government, while costs of an unsuccessful venture are sheeted home solely to the firm itself;  and
  • fears that the Government may take a view on the price that can be charged which will offer inadequate compensation for the totality of risk involved.
  • requirements on the part of suppliers to offer more information than they would prefer, thereby revealing profitable opportunities to their competitors or offering their customers excessive bargaining leverage.
  • paperburden costs entailed in submitting applications for approvals to regulatory bodies.
  • an inability to combine different businesses together so that risk is reduced.

  • PRICING POLICIES

    The pricing basis for existing pipelines leaves too much discretion to the regulator and is likely to be over complex in establishing prices for different services.  In terms of the price base, notwithstanding CoAG agreements that optimised deprival value be used there is provision for other approaches.  At the minimum, pricing must be based on replacement costs---the alternative sets the price too low and leads to both excess demand for the service and inadequate incentive to increase capacity or build rival lines.

    Not only is there too much discretion on the part of the regulator in the price setting methodology, but the depreciation schedules under s.8.30 may lead to different rates for different parts of the pipeline depending on its use.  This will give rise to highly complex and somewhat illogical pricing decisions.

    The pricing formula is in general over prescriptive and likely to bring departures from efficiency.  Thus, for example, the discouragement of front ending (s 8.31) is difficult to understand.  Typically, many new firms in a competitive market will introduce low prices when demand is being grown and seek to recoup losses in the mature market that grows.  Many new products are priced low to start with­some are even given away free!.

    The tariffs are set on the basis of the Service Provider earning a reasonable revenue.  But price is also the most efficient means of allocating demand between rival users.  If the price is to be fixed, either usage will be misallocated or the users rather than the pipeliner will receive the incentive to construct new capacity---in other words the incentives are placed with the wrong party.  This is notwithstanding s.8.2 which seeks to offer incentive mechanisms seeking to price so that the market clears.  Use of any depreciation schedule in setting the price is likely to mean the price is too low to attract additional capacity.  Rent controls prevent the building of new houses!

    Other deficiencies include:

  • While some price regulation may be necessary for existing pipelines, new pipelines under s.8.13 are equally targeted.  Yet any possible customers on a new pipeline route can only be better off as a result of the enterprise.
  • The determination of new facility capital bases on which charges can be levied (s8.15 etc) requires the regulator to know as much about the business as the owner.
  • The surcharge for "Speculative Investment" (s8.21) is especially cumbersome as an approach and leaves little scope for a rent-seeking entrepreneur to take risks and obtain commensurate rewards.
  • The prudent discount provisions under s8.40 puts the pricing fully under the control of the regulator.
  • The limit of five years certainty that can be given to the pipeliner in terms of price.
  • Some of these issues assume particular importance in the derivation of reference tariffs.  These tariffs appear to be determined by the pricing principles in section 8.  There is a danger that such prices would become a price floor, not the price cap that might be justified for a presently existing monopoly pipeline.  In the latter case, there would need to be some price shifting among customer classes for the pipeline to recoup its permissible margins.  There may be occasions where this becomes impossible because the customers refuse to pay a surcharge are unable to bear it, while in other occasions the tariff will have forced a re-weighting between customers which is unlikely to represent a shift towards greater efficiency.

    The deficiencies of the present proposals are tacitly acknowledged in the sections of the Code that deal with Queuing policy.  This seems to establish rights to negotiate access to spare or developable capacity based on some time of registering concept.

    The appropriate approach is surely to ensure the parties most anxious to obtain the capacity receive it.  This must entail some form of pricing mechanism, perhaps an auction.  None of this is outlined in the Code.  Indeed, the sections dealing with spare capacity (s.5.4, 5.5, 5.6, and 5.7) are designed to place pressure on the Service Provider to release spare capacity.  The procedures to prevent hoarding should be sufficient for this including the requirement that the Service Provider have at least one totally independent director (s.4.4(b)).


    CONCLUDING COMMENTS

    Australia is not alone in embarking on a Brave New World in electricity and gas marketing.  The design of the market structures has involved considerable expertise and ingenuity on the part of a great many people as we turn the old centrally planning and centrally supplied markets on their heads.  There are clearly vast gains already being reaped in the economy from a market rather than government owned system.

    I am conscious that I have said little about state gas market arrangements and particularly the contrived bidding market proposed for Victoria.  Whether or not such a spot bidding requirement needs to be created remains open.  In many respects its construction is founded upon the monopoly held by Esso/BHP.  The Wagga link may well be sufficient to break that monopoly and create a more spontaneous derivatives market.



    ENDNOTE

    1. In fact, following their original proposal going to tender.

    Wednesday, March 11, 1998

    Stolen Children Report Unworthy

    Letter to the Editor:

    Sir Ronald Wilson's defence of Bringing Them Home, the Human Rights and Equal Opportunity Commission's (HREOC) report on the "stolen generations" (Letters, 7-8 March), demonstrates some of the very faults that led to my criticisms of his report.  Despite his claim, I have never stated that witnesses to the national inquiry may have been "confused".  Rather, I said the report's definition of "stolen children" is "extremely confused".

    Nor have I said witnesses may have been "lacking in credibility".  Again, this was a criticism I made of his report because, among many other failings, it omitted crucial evidence, seriously misrepresented major sources, lacked rigour, and did not demonstrate that witness statements had been subjected to appropriate corroboration.  These charges were carefully documented in my booklet, Betraying the Victims.

    Zita Antonios (Letters, 7-8 March), states that the "misstatements and misrepresentations" of my booklet "are too numerous to catalogue in full".  If she or HREOC provides me with even a sample, I would be very happy to respond.  If she can identify genuine errors or misrepresentations, I am perfectly willing to amend the record as necessary.

    Anyone reading my booklet can have no doubt that I regard the forcible removal of innocent children from caring families as totally indefensible, and that I believe the Aboriginal experience of such removals has contributed to an understandable legacy of bitterness that other Australians need to comprehend.  It is because I believe it is such an important issue that I have condemned HREOC for preparing such an unworthy report.


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    Tuesday, March 10, 1998

    Flaws Remain in Bringing Them Home

    also published as "Genocide:  Truth Stolen" in The Age, 5 March 1998

    For much of Australia's history, the treatment of Aborigines has clashed with cherished moral principles, and some of the most serious breaches involved forcibly removing innocent children from caring families.  Last May's release of Bringing Them Home, the report of the "stolen generations" Inquiry, was hailed as a major advance in acknowledging these wrongs.

    But the praise was unjustified.  Recently, I released my booklet, Betraying the Victims, which critically examines issues covered by Bringing Them Home, such as its comparison between Aboriginal and non-Aboriginal child removals, and its claim that the removal of Aboriginal children constituted "genocide".  Amongst its many defects, Bringing Them Home omits crucial evidence, misrepresents major sources, makes false assertions, and confuses "forced" separations with voluntary separations in order to establish the worst possible case against Australia.

    In his opinion column (2 March), Robert Manne claims my criticisms of the report involve a perceived conflict of interest, receiving funds from mining companies who "have a great deal to lose or gain regarding the thrust of Aboriginal policy".  Apart from the fact that I structure my funding so that I am not dependent on any one company or sector, my strongest personal interest is maintaining my own intellectual credibility.  I would be most foolish to risk this by making an unsustainable attack on a report that has been treated so reverentially.

    Furthermore, Manne is naïve to think that allowing a shoddy report to remain unchallenged actually furthers Aboriginal interests.  The only proper response to injustice is a passionate commitment to presenting an account that cannot be dismissed.  The truth is bad enough, and exaggerating it, or suppressing details which might embarrass today's activists, or making outrageous charges about "genocide", feeds public distrust and encourages indifference or worse.

    Manne says the structure of my argument is "peculiar", because I have supposedly discovered terrible truths from the very report I described as "intellectually and morally irresponsible".  Manne's statement reveals a strange narcissism, because it implies that because he first learnt about the child separations from Bringing Them Home, the same is true of nearly everyone else.  I learned about the separations over a long period from many sources, including the writings of historians and affected Aborigines, conversations with Aboriginal friends, and cases examined by the Royal Commission into Aboriginal Deaths in Custody.

    As my booklet explains, the Royal Commission's findings suggest a much more complex picture of Aboriginal child removals than the one presented by Bringing Them Home.  This is one of four grounds I give for suggesting the report may not have faithfully represented the testimony before it.  Manne falsely states my suspicions were "based entirely on a single piece of evidence".

    Another basis of my suspicions was the failure of Bringing Them Home to present essential summary data about the witnesses who appeared before the inquiry, such as the official reason for removal, or the extent to which family contacts were maintained after separation.  The extracts from testimony included in the report came from less than 40 per cent of the witnesses, and it is therefore fair to say the experiences of over 60 per cent were very largely ignored.

    The bias of Bringing Them Home is also obvious from its complete failure to record that when the assimilation policy was first formulated in the 1930s, the common strand in the views of all Aboriginal spokespersons in the south was the desire for incorporation into white society.  The point is crucial, because the "genocide" charge hinges on the assimilation objective of the child removals.

    Manne claims that my case against the bias of Bringing Them Home "collapses" because the most significant and passionate Aboriginal advocacy of absorption, the pamphlet written to publicise the 1938 "Day of Mourning", was really written by a white fascist, "Inky" Stephenson.  In the true spirit of Bringing Them Home he has misrepresented his source -- Craig Munro's biography of Stephenson -- and ignored all the other evidence of initial Aboriginal support for assimilation.  Worse, he seems to have joined the ranks of those who believe Aborigines cannot think for themselves, and that there is always a white man behind their protests.


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    Monday, March 09, 1998

    Access Arrangements by Transmission Pipelines Australia

    Submission to the ACCC


    INTRODUCTION AND SUMMARY

    The previously planned and integrated gas and electricity systems are now things of the past.  The systems no longer operate as legislatively protected monopolies.  Rival suppliers of lines and pipes are now permitted in Victoria.

    The draft decisions of the ACCC and Victorian ORG on the Victorian gas pipelines are part of the new market arrangements.  Importantly, they propose a much lower pricing structure for gas carriage than that offered by the Victorian Government.  Those draft decisions have implications for all gas and electricity carriage businesses and potentially for other network providers like telecommunications and water.

    A test in determining whether a regulated price for a sunk asset provides the correct incentives is to ask whether that price would have been sufficient to justify the investment had it been stipulated prior to the system being built.  The draft decisions would fail this test.  Had the proposed price regime been in place when the TPA pipeline was being planned, no commercial organisation would have considered the return sufficient to justify the risks of building it.

    This however is not the most fundamental reason for seeking a review of the decisions by the regulatory authorities.  More important is the impact on the future competitive process.  In imposing a very low price for carriage through existing gas pipelines, the draft decisions will make it unprofitable for rival suppliers to emerge.  One irony therefore, of the decisions if they stand, is that the competition "watchdogs" will have done much to reduce the possibility of competition.  Competition or contestability is much superior to a regulator in bringing about efficient provision.  Indeed, the regulators' function is to make judgements that, in their view, correspond to those that would emerge in a competitive market.

    The regulators see a major role for themselves in preventing possible price gouging by businesses controlling "essential facilities".  However, the Draft Decisions adopt mistaken premises that reticulated natural gas is not subject to competition and that competition for gas carriage is not possible.  Regulatory distortion of commercial decisions will follow from the application of these premises.

    The adverse consequences of regulatory distortions are compounded if the decision is to apply to new pipeline extensions into areas not presently served.  Such an application operates from the incorrect assumption that extensions are inevitable and therefore can have a low price enforced upon them.

    Setting a rate of return that assumes competitive market behaviour is impossible will therefore prove self-fulfilling.

    With both existing and new pipelines, the Draft Decisions will bring inefficiencies and the total philosophy behind them should be reconsidered.  The potential for competition in network facilities is already evident in Victoria where rival electricity distributors are planning to drive new lines into each others' territories.

    Further evidence of the potential is observable in the skill that AGL has shown over many years in pricing NSW pipeline charges at a level that allows the firm to profitably ward off rival facilities.  AGL has responded to competitive threats by reducing prices in areas where those threats have greatest potential.  The nightmare for a utility business is that if they adopt a hard-nosed approach to pricing and service this will call forth competition and leave the existing asset "stranded".  Fear of having "stranded" assets means that little by-pass is actually likely to eventuate.  But the control over excess prices that competition brings does not require that a competitor physically emerges.  Contestability for the market is quite adequate.

    It might be said that if the price is set low, the customer would obtain benefits.  But, aside from pre-empting the possibility of competition and foreclosing many network extensions, prices set artificially low will prove inimical to customers' interests even with the existing built networks.  With low prices enforced, network suppliers will seek to incur only minimum expenditures to maintain and expand the facilities, which will eventually become less reliable.  And the wire or pipeline business will see no merit in spending money to give premium service and reliability to those customers who would pay for it.

    A well structured competitive regime on wires and pipes would ensure all barriers to entry were removed and that the incumbent businesses are unable to block new rivals.  The New Zealand regime operates very successfully in this way without any price regulation (the events in Auckland are unrelated to this feature).

    Some measure of control may be justified in moving from a system where the service provision and prices were set by Government direction to one that allows competitive provision.  Under the government monopoly, users incurred investments on the basis that the political process would prevent prices rising unpredictably.  This constituted a form of contract.  Price caps should be set consistent with this -- that is at the lower of the level presently prevailing and that nominated by the Government as owner of the facilities.  New providers should be free to offer lower prices and incumbents free to meet the competition wherever it emerges.


    THE DRAFT DECISION OF THE ACCC

    The decision covering the pricing of Transmission Pipelines of Australia (TPA) operating in Victoria essentially:

    • accepted the proposed market structure based on market carriage rather than the more conventional contract carriage regime;
    • reserved its position on whether or not the interconnect between EAPL and TPA should be regulated;
    • broadly endorsed the proposal for a queuing arrangement to allocate spare capacity, though expressing preference for spare capacity to be auctioned;
    • allowed augmentations to be treated as stand alone expenditures or rolled in with the other facilities:
      • all extensions and expansions are within the service envelope unless the Commission determines otherwise;
      • rolled in augmentations must obtain approval for their pricing and access;
      • other extensions should also be subject to an access arrangement and those that are excluded services remain subject to regulation to the extent the Commission considers their prices to be "fair and reasonable";
    • set reference tariffs and overall revenue levels on the TPA based on:
      • a DORC valuation for the existing assets with optimisation bringing the value of those assets down by 9%;
      • consistent with the Victorian Access Code, a DAC valuation adjusted for inflation for new facilities and for future reviews;
      • O&M costs are to be reduced by 2.3% per annum over the next five years (the Government proposal was for a real annual reduction of 1.5%);
      • a WACC at 7% compared to the value of 9.73% proposed by the Government;  this level is designed to apply both to the existing network and extensions;
      • an X factor defining the increase in productivity required year by year and consequent price reduction of 3.7% (compared to the Government proposal of 3.4%, with the differences attributable to different inflation forecasts).

    The ACCC estimates are that this will bring a price reduction of 17% on the proposal of the Victorian Government which itself was for a substantial price reduction.

    The rates specified apply both to the existing pipes and to new connections and augmentations.


    THE PREFERRED APPROACH TO REGULATING NETWORK FACILITIES

    REGULATION AND MARKETS AS MEANS OF ENSURING EFFICIENCY

    The Main Goal of Regulation

    The main goal of regulation is to provide an outcome similar to that which would emerge from a competitive market but where natural monopoly prevents this occurring automatically.  Competition is not valued as an end in itself but as the means of promoting efficiency.  Competition prevents the waste inherent in sellers deliberately withholding supplies in order to allow higher prices and higher profits.  Commercial rivalry is also superior to other arrangements in driving costs down and ensuring the lower cost outcome is passed on to consumers in lower prices.  Competitive firms must constantly seek cost savings, and other ways of maintaining or improving their profits;  these cost savings are largely converted into consumer benefits as rival suppliers adopt similar techniques.

    Competition is best regarded as having two functions of competition, one generating "dynamic" gains and the other "static" gains.

    The "dynamic" gains from competition themselves have different facets.  Some stem from constant vigilance of many suppliers who need to cut costs and meet shifting market demands;  these actions prevent sloth and promote a multitude of incremental savings.  Other gains stem from what the Austrian economist, Schumpeter, referred to as "from the new commodity, new technology, new source of supply that strikes not at the margins of profits and the output of existing firms but at their foundations and very lives." These gains, according to many, are an order of magnitude more important to society's prosperity than the vast number of incremental savings.

    Many transmission pipelines would fall into the category of new sources that radically transform markets, sources that usually involve considerable business risk and great skills to manage.

    The dangers are that, in seeking to redistribute the "static" gains, regulators and policy makers will close off opportunities for the more radical "dynamic" gains.  For the latter gains to be achieved, the innovator must be confident that government action will not deprive him of the profits of success.  This means having secure property rights.  If policy and regulation results in property rights being impaired, this compromises a fundamental plank on which competitive efficiency is generated.  For this reason, one of Government's most important role is ensuring the certainty that property will not be taken from individuals.

    Requiring a low price for supplying a service where the supplier has previously sunk its main costs can be, in US terminology, a regulatory "taking".  It markedly reduces the value and security of property rights.  The initial adverse effects of this are felt on the firm whose value is partly expropriated but wider effects follow in deterring other firms contemplating similar activities.


    Models of Different Regulatory Approaches

    There are three models under which network facilities might operate:

    • the no-regulation option where market forces are left to determine price and service levels;
    • the incentive based model under which some standard overall level of productivity is expected and price caps are set to allow any profits over and above this for the line business;
    • a model where the regulator carefully examines all required expenditures of each line business and determines the necessary expenditure and, in effect, profit levels.

    In adopting one of these models, assessments are necessary to determine the degree to which the service is contestable.  Clearly, wherever gas is reticulated it already competes with other fuels, especially electricity.  In addition it competes with LPG, the price of which is closely aligned to world prices.  Moreover, wherever more than one pipeline serves an area, there is competition even in the narrowest sense and no regulation is necessary.

    If it is determined that an absence of competition warrants control, some form of incentive-based regulation is preferred over profit controls.  This allows the network provider the possibility of using entrepreneurial and other management skills profitably to reduce costs and increase its business.  Although the Draft Decisions purport to adopt incentive based regulation, in effect they apply profit control, which is the least acceptable form of regulation.


    Inherent Deficiencies of Regulation

    In general regulation is a poor substitute for market disciplines on efficiency because regulators are:

    • ill-placed to determine the price and service levels that the market would prefer;
    • call for vast amounts of information in an attempt to reconstruct the costs of provision and in doing so divert the most capable resources in the businesses from meeting consumer needs towards meeting their needs of regulators and seeking to outmanoeuvre them;  and
    • become captive either of the businesses they regulate or of politico/consumer interests rather than those of overall economic efficiency.

    For these reasons the no regulation model is the preferred approach but the issue is how practicable is it?  How much is the provision of gas services open to competition or contestable?

    The following addresses these issues and the application of the above principles and the different regulatory models to the Draft Decisions.


    APPLICATION TO DIFFERENT NETWORK SYSTEMS

    Different Types of Network Systems

    Pipes and wires are usually thought of as falling either within high pressure/high voltage transmission networks or low pressure/low voltage distribution networks.  In general the former are considered more difficult to duplicate at least in their entirety.  Even so, the fact is that transmission systems can be and are duplicated, or subject to competition from supplies of gas and electricity other than those they directly serve.

    The most useful analytical framework for examining competitive potential and determining regulatory rules is by considering network systems from the perspective of those that already exist versus those that are being proposed.


    Regulation of Existing Networks

    For the existing systems, customer commitments were made on the basis of some predictable level of price trends that were controlled by political decisions.  These offered assurances that the network service provider (NSP) would not embark upon a process of raising prices once customers were captive.  An implicit contract was in place.  In spite of the fact that the networks themselves are now duplicable, this could justify a regulatory regime to restrain existing network owners' abilities to extract excessive profits.  In formalising that contract, the regulatory regime has to be devised so that the incumbent NSP is not vulnerable to "cherry picking" by a rival and left servicing only the least profitable customers and areas at price levels that are unsustainable.

    Requiring lower prices than those set under the implicit regulatory contract of government ownership (or some lower level specified by the government-owner) is a distortion of the arrangements that have been established.  If the regulator requires such pricing action, he is seeking to redistribute the respective parties' long standing shares in the gains from trade.  This is not an appropriate role for regulators.  The distortions that follow from it will rebound on the overall levels of efficiency.

    The approach proposed is a major departure from the much-vaunted "light handed" approach.  This would remove barriers to rival suppliers wishing to contest the market and offer incentives to NSPs to operate efficiently by lowering costs and winning new business.  The regulators' most appropriate role is to set rules that prevent a monopolist from unfairly preventing competitive entry.  Such rules would, for example, forbid the incumbent from combating potential new competitive threats by refusing to allow a connection or pricing a competitive connection at a level that effectively denies it.

    Regulation beyond that is likely to have several adverse effects.  If the regulator attempts to control price to reduce the returns beyond a level that the incumbent considers appropriate, several adverse effects are likely to follow:

    • the network provider will see little merit in maintaining the network to standards expected and the network reliability will progressively decline;
    • the prices will be set so low as to prevent profitable by-pass and therefore competitive provision.

    The ACCC was concerned to prevent uneconomic by-pass in its reasoning behind its decision.  Thus page 26 of the draft says,

    "any value that is in excess of DORC may produce reference tariffs that will expose the service provider to being bypassed.  Moreover, to the extent that parts of the system are bypassed, some of this cost inevitably gets absorbed by the remaining customers who have no bypass option".

    This statement mistakenly assumes the price allowed by the regulator is the minimum price.  In fact networks are at liberty to charge less to meet competitive pressures.  While exposure to by-pass may be the outcome of excessive prices, actual by-pass assumes a lack of business acumen on the part of the network owner.  As has been seen in the AGL system in NSW, the possibility of by-pass has been countered by lowering the price to the vulnerable customer base.  And, even if prices were to be subsequently loaded on to the remaining customer base, that too would be more vulnerable to by-pass.

    The regulatory authorities should take steps to encourage rather than discourage competition in network services.  The present proposals do the opposite and will rebound on consumer welfare by reducing investment and maintenance of the existing network.


    RECOMMENDATION

    • The prices for the use of the existing network should be based on the lower of the level the Government has specified or its present level.
    • If by-pass occurs and existing lines become stranded investments, some arbitration system could be developed to allow increased prices to the remaining customers who might otherwise cease to have access.

    In adopting this approach, it is recognised that by-pass in practice may be difficult.  NIMMBY problems might prevent new easements and use of existing easements might have adverse impacts on the existing lines.


    New Pipelines

    The owners of the systems developed under Government franchise have the advantage of incumbency over other providers but they have no such advantage with augmentations.  The latter are totally open to competitive provision.  There are several businesses operating in Australia with the capability to develop new links even in areas that might have previously been regarded as the territory of one particular business.  In Victoria, the rivalry of Gascor and AGL to link the Murray Valley towns was one manifestation of this.

    Concerns that regulation, in seeking to combat the detrimental effects of monopoly will create its own deficiencies are even greater with the regulation of new pipelines which are, by definition, contestable at the time of their being built.  Regulation of these facilities to reduce prices or enforce access terms that are against the wishes of the supplier will prove self defeating unless the regulator assumes total control of the networks -- an outcome that the competition reforms were designed to avoid.  Price regulation is likely to diminish providers' incentives to seek out new markets;  access regulation is likely to bring them to adopt over-cautious approaches to any expansions they may contemplate.  Both price and access regulation will also create disincentives that will foreclose opportunities for extensions.

    For new proposals, regulation is likely to mean insecurities on the part of their sponsors that the authorities will prevent them making adequate returns.  Innovation is discouraged.  The level of innovation is distorted because there is an imbalanced risk/reward outcome;  the innovator gets slender benefit from success because other parties are given a share of the success by Government, while costs of an unsuccessful venture are sheeted home solely to the firm itself.  The Draft Decisions will have increased these fears and insecurities on the part of suppliers of potential new networks.

    Yet, a new pipeline can only bring mutual gain to both the buyers and sellers of gas.  The pipeline owner has no monopoly and attempting to constrain the conditions under which he conducts business must reduce the amount of new building, thereby denying benefits to producer and consumer.

    Regulation may also reduce efficiency if it prevents backward and forward linkages by requiring common carriage when risks may be reduced by integration.  Risk is the most important feature of major capital investments and can be reduced by forward and backward linkages as follows:

    A Gas Producer Building a Pipeline

    The gas producer will have good information that the size of his reserves is adequate to provide the necessary product stream.

    If required to allocate "spare capacity" to competitors, the producer has every incentive to minimise the extent of that capacity and the facility is likely to be constructed with a sub-optimal capacity.  This will be all the more so to the degree that the producer-builder is required to offer capacity to a competitor at a price that he regards as likely to offer inadequate recompense.  And the deterrence factor in building a new pipeline would be further increased if a regulatory regime were introduced obliging him to displace his own product in order to carry that of his competitor.

    The community is worse off if the producer is prevented from building such a pipeline for his exclusive use.


    A Gas Retailer Building a Pipeline

    A retailer may have greater certainty about the market size but have less knowledge than a producer about the extent of available supplies.

    A retailer would have a natural incentive to operate a transmission pipeline with open access to producers as this puts downward pressure on the price he can negotiate.  Because no retailer now has a monopoly franchise, he too will be deterred from investing or will build a sub-optimal pipeline if this requires carriage, on terms not of his choosing, of rival retailers' product.

    Again requiring common carriage at a regulated price is likely to prevent efficient new investment.

    The Draft Decision is concerned to prevent excessive profits on the part of pipeliners.  The regulatory authorities do not deny that the pursuit of "excessive" profits or economic rents is a legitimate business goal that all firms strive towards.  It is the existence or possibility of competition that constrains this.  Having a regulator combat the pursuit of "excessive" profit may have merit where a facility is a genuine natural monopoly.  But there is no monopoly on a pipeline connection that does not yet exist.  This is one of many circumstances where the incentive of earning high rewards leads to efficiency inducing risk taking.  Suppressing the pursuit of high rewards will reduce worthwhile investment activity and such regulatory measures should therefore be confined to tightly defined and rare circumstances.

    It follows that where no pipeline currently exists the regulation on a new line should be minimal.  There should be no specification of prices by the regulatory authorities.  The community can only gain from the new facility and the pipeliner is constrained in his pricing and other conditions by the ability of rivals to offer an alternative pipeline and by the pre-existing sources of energy.

    In the absence of this approach, any new pipeline that might be built would not be built to maximise economic efficiency.  Thus, if the new pipeline is built on the basis of a significant contractual load, the owner entrepreneur will wish to avoid being hostage to prices determined by a regulatory agency, all the more so in view of the Draft Decisions.  If the price for the additional energy is to be regulated, the pipeliner faces a risk that the price will be inadequate and that the additional energy might even undercut the supplies of the contracted energy.  The contractee is particularly likely to seek to ensure that the capacity of the pipe does not allow such competition.  Accordingly, pipelines are likely to be built that have less than optimal capacity, especially since the capacity of a pipeline is related to the square of its diameter and the costs of building in incremental capacity are relatively low.

    Many augmentations are committed in the context of a great deal of risk that the planned utilisation will not be achieved.  In such cases, the level of return for success is required to be correspondingly high.  The regulatory risk that the high returns for success in a risky venture will not be allowed means the more speculative projects will not proceed.

    This highlights the fact that the notion of "excessive" profit is misplaced.  The high returns obtained by a successful private sector owner are no more than "normal" profits.  There is no monopoly on owning a pipeline (nor on duplicating it).  The various entrepreneurs weigh the different likelihoods of success and failure and, implicitly or explicitly, develop an array of possible profit outcomes.  An amalgam that yields an acceptable return allows the project to proceed.  Typically the array of possible profit outcomes will include very high returns as well as near total loss.  Ruling out the possibility of making very high returns by insisting upon a price cap/access regime will reduce the prior estimates of the project's viability.


    RECOMMENDATION

    • The regime covering pipelines should not normally be extended to new pipelines.
    • Regulatory coverage should be withdrawn from all pipelines that are in competition with each other.
    • There should be no strictures against pricing approaches like "front-ending" or preferred prices to "establishment customers", nor should the pricing horizon be limited to the five years presently stipulated.
    • New pipelines should not be required to be common carriage and ownership by retailers or producers should be permitted.