An Address to the WA Power and Gas Conference
at Observation City Hotel, Perth, 27 July 1998
The means to a successful economy is small government both in taxation and regulatory dimensions, and businesses that are continuously forced by competition to seek improvements. The difficulties in arranging for the latter in the utility markets is at the heart of many of the CoAG strictures.
In virtually all circumstances, government ownership of a supply business will offer fewer community benefits than private ownership. A case in point in WA is that Western Power is saddled with excessive costs because it is unable to make involuntary redundancies in spite of its over-manning. Even if an entity is corporatised, Government as an owner will eventually tend to pick as directors people who are owed favours. Ministers will be unable to resist seeking special favours from the business and the business itself, because it is takeover proof, will not be subject to the disciplines of a firm where the market for full corporate control is open.
In respect of these matters, reform in Western Australia has lagged that of the eastern states. There are some special reasons why this might be so. These concern the nature of the energy market here. Nonetheless, other states including South Australia and tiny Tasmania, have moved more resolutely on the twin areas of reform: privatisation, and structural reforms to enhance competition.
REGULATORY ARRANGEMENTS
Much ink has been spilled over the issue of establishing a genuinely independent regulatory agency to oversight the "essential facility" features of electricity, gas and other networked services. In WA, it appears that the Government favours the key regulatory agency being established within its own Department. This is criticised, and rightly so, because it may lead to the regulator becoming an instrument of industry policy and favouring certain directions that the Government supports rather than a policeman seeking to promote genuine competition.
That said, the early outcomes from regulatory agencies that are more detached have not been promising. The regulators are becoming a major issue of themselves especially with the draft decisions of the ACCC and Victorian ORG to establish a low pricing structure for gas carriage.
The regulators' role is to prevent possible price gouging by businesses controlling "essential facilities". However, the lines businesses in gas and electricity are not immune from competition.
The potential for this is already evident in Victoria where rival electricity distributors are planning to drive new lines into each others' territory. Further evidence of the potential is observable in the skill that AGL has shown over many years in pricing their NSW pipeline charges at a level that allows them 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 it adopts too hard-nosed an 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. But the control over excess prices that competition brings does not require that a competitor physically emerges. Contestability for the market is quite adequate.
Competition or contestability is much superior to a regulator. Indeed, the regulator's role is to make judgements that, in his view, correspond to those that would emerge in a competitive market.
It might be said that if the price is set low, the customer will obtain benefits. But prices set artificially low will prove self-defeating. Suppliers will incur only minimum expenditures to maintain and expand the facilities, which will eventually become less reliable. Artificially low wire prices also offer unfair advantages to existing generators facing possible competition from co-generators able to locate in areas where they avoid transmission charges. And customers will not have an opportunity to seek out an alternative wire or gas source of supply, because the regulator's decisions ensure such sources will be unprofitable.
Setting a rate of return that assumes market behaviour is impossible will therefore prove self-fulfilling. And the wire or pipeline company would see no merit in spending money to give premium service and reliability to those customers who would pay for it.
If any price cap is to be set, this should apply only to those areas that were connected at a subsidised rate for community service reasons. This CSO could either be funded directly by the Government or, if the business is privatised, made a condition for the new owner (which means a lower price for the privatised entity). For the rest, prices should be established as if contracted at present levels with the discipline on incumbents provided by rival suppliers.
The regulators' role should be to ensure that there is no impediment to rival facilities. Where there is more than one facility or the possibility of more than one facility regulatory action should be a mere formality. Indeed, with an absence of exclusive franchises, there is no case for regulatory control over a new facility. After all a new facility serves a market that by definition was previously unserved. The customers of that facility can only be made better off. And regulating a proposed new line may undermine its profitability and result in fewer pipelines being built or being built at a lower than optimal capacity. The builder may not wish to be hostage in future to regulatory decisions over what is a fair price for carriage. The NCC was not fully impressed with this view in its assessment of the National Gas Access Regime and seems to be arguing that it would abandon regulation only where it duplicated a very extensive range of offtake points. It also makes the point that competition may be hindered by regulatory barriers -- a position which should surely be remedied by the removal of those barriers.
Perhaps the most egregious regulatory analysis presently underway is that being conducted by the Victorian Office of the Regulator-General into a proposal by one distribution business to push new competitive lines into the territory of another. This is surely the most potent discipline on a business to price its services at levels that reflect cost of service. Yet far from automatically allowing such competition, the Victorian regulator is undertaking a hand wringing exercise asking a range of questions like these:
Is the application based on an agreement with the customer(s) which covers the full costs of operating the infrastructure, including the capital costs?
- What are the underlying factors which make the inset appointment applicanta more efficient supplier for the area than the incumbent licence holder?
- To what extent, if any, should the Office consider stranded assets? If so, on what basis should compensation be determined?
- How do the proposed tariffs compare?
- Should the Office allow more than one network service provider to distributeelectricity in the Docklands?
- Is the development of dual (or more) networks in the Docklands likelyto be economically efficient?
- How will the granting of Powercor's application or otherwise impacton the interests of existing and future customers in Powercor's and CitiPower's existing licensed areas as well as future customers in the Docklands?
- How can the Office be assured, in granting a distribution licence to Powercor to supply the Docklands area, that the interests of consumers will be protected without knowing Powercor's proposed tariffs?
- How will the approval or otherwise of Powercor's licence variation affect the financial viability of the industry?
Instead, the regulator should be simply saying, "We are in business to promote competition. We are not about protecting one set of shareholders or second guessing whether a by-pass makes economic sense. The ability to offer competition is the ultimate test of whether the regulated price is appropriate and the provider has every opportunity to selectively reduce price to meet competition. An application for a new line is automatically accepted."
Similarly, instead of trying to guess what a reasonable Weighted Cost of Capital should be and specifying prices accordingly, the regulator should take as given the existing implicit transport prices, or a lower price if the Government as owner wishes to specify this. Those prices were evolved as a form of contract between the supplier and the users. The supplier was inhibited from engaging in serious price gouging because its owner periodically faced the judgement of the electorate. The task of the regulator is to ensure these prices, suitably adjusted for inflation, are capped. The regulator should ensure that any other provider is free to offer lower prices for transport and not face monopolistic interference in this from the incumbent business.
With this form of light-handed regulation, I believe we will see rival suppliers, of which there are many in Australia, trying to cherry pick the more lucrative markets. Whether or not they are successful in this the incumbent will be forced to lower prices in the most profitable areas by force of competition. This, after all, is the process that drives efficiency in every other market and what the ornate system of regulatory oversight purports to replicate.
Hopefully, the WA system will adopt these principles and not discourage any power plant or distribution system that sees business opportunities from pursuing these in an unfettered way.
ELECTRICITY
LEVEL OF EFFICIENCY IN WA ELECTRICITY SUPPLY
Efficiency and its improvement has varied markedly both between the states and within the states over time. Western Australia (which refers to the south west interconnected system) has shown considerable improvement in generation over the period but the State still had a labour productivity nearly 50% below that of the Eastern States.
Productivity per employee in generation has improved in all States but Queensland. Queensland was formerly widely acknowledged to be the most efficient state system in Australia, but has experienced stagnant levels of productivity in recent years, a factor behind the Queensland Electricity Industry Structure task Force, Chaired by Professor Anderson. In 1996, Queensland was in fact overhauled by Victoria, easily the most improved system over the 1990s. It is no coincidence that Victoria has also been the state system most radically exposed to competition and to privatisation.
Chart 1 illustrates the comparisons and trends (Tasmania cannot be compared with the other systems because of its hydro-based nature and previous internal construction focus).
Chart 1
Source: Electricity Australia, ESAA.
Total costs per unit of electricity establishes the most accurate indicator of performance. Western Australia's generation costs are the highest among Australian States and costs have tended to rise, unlike in Victoria and South Australia, two systems with comparable costs to those of WA in the early 1990s.
Chart 2 illustrates these trends.
Chart 2
Source: Electricity Australia, ESAA
These generation costs are only part of the story.
Other matters include the quality of fuels. WA is disadvantaged in its electricity generation by having inferior or higher cost coal to that in the eastern states.
In addition, there are the transmission and distribution costs, which account for half of the total costs. Unfortunately the measures of efficiency in distribution and transmission available from the ESAA present less reliable comparative indicators than those for generation.
The bottom line is that electricity is expensive in WA. Prices are 30% higher than the Australian average for household consumers and 40% higher for commercial and industrial customers.
COMPETITION POLICY: PROGRESS IN WA IN RELATION TO OTHER STATES
Competition has been the naked flame that has transformed previously moribund electricity businesses in NSW and Victoria. It has resulted in price reductions for larger customers of at least 12% and up to 50%.
WA is very much behind the eastern states in permitting electricity customers to choose their own suppliers of electricity. In part this follows from the monopoly that Western Power has over generation. Much of the nominally independent generation is tied up by Western Power; thus, the Mission Energy operated BP co-generation plant is a contracting out process rather than a new competitor. Other states are seeking to convert similar contracts into competitive power provision -- Victoria has done so with Mission at Loy Yang B, whilst Queensland is undertaking discussions with Comalco over the Gladstone Power Station.
Some opening up of Western Power's transmission system is presently underway. The Government also has a policy of fostering provision of additional capacity by businesses other than Western Power.
In the retail market, the present limit of contestability in WA is the 5 MW market opened this year and the next tranche to be opened in the year 2000. NSW and Victoria opened up the 5 MW 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 | ||||||
| Threshold | Type examples | NSW | Vic | Qld | SA | WA |
| 40 GWh | vast sites | 1996 | 1994 | 1998 | 1998 (>20GWh) | 1998 (5 MW) |
| 4 GWh | large office blocks | 1997 | 1995 | 1999 | 1998 | 2000 (1 MW) |
| 750 MWh | supermarkets | 1997 | 1996 | 2000 | 1999 | |
| 160 MWh | small office blocks | 1998 | 1998 | 2000 | 2000 | |
| remainder | 1999 | 2001 | 2001 | 2001 | ||
| QLD 160 MWh is above 200 MWh | ||||||
There is from January 1 next year also regional deregulation for users taking more than 300 MWh per year. This is intended to pave the way for a more competitive tariff but its success in this is difficult to forecast.
Retail contestability will mean prices become more cost reflective. WA still has to make the hard yards on this matter. Electricity charges are higher for small business than for households, even though the former has a better load profile. In other words, the Government is milking small business to win votes. Not only is this bad for the economy, it is unsustainable once competition gets underway and a reform of tariffs is a first step that is yet to be taken.
Similarly, there are massive cross subsidies to rural from urban customers, totalling some $165 million per annum and an on-going requirement for Western Power to subsidise 80% of the cost of new connections. These measures are incompatible with a free market system. If Western Power is loaded with de facto Community Service Obligations its charges to urban areas will be excessive. It will be ripe for cherry picking and may be left holding only the dogs. If CSOs are what the Government wants, these should be funded explicitly from the budget. The alternative is a crippled Western Power.
OPTIONS FOR REFORM
There is currently some speculation that the Government may be considering an early privatisation of Western Power. This is to be welcomed. In such cases, Governments have options in pursuing their obligations to the community: they can seek the best possible price or they can implement privatisation so that customers obtain dividends in lower prices from a formerly integrated system that has been placed on a competitive basis.
With the sale of the natural gas pipeline, the Government opted for the former. It obstructed the provision of a competitive pipeline and obtained a magnificent price for the existing line. This is not in the best interests of the State's development or of its consumers. It is also at variance with the national competition principles.
In electricity, the national market requires the structural separation of generation and transmission. WA, with Western Power, has one business that is vertically integrated controlling the great bulk of generation, transmission, distribution and retailing.
All three of the eastern states have also divided up their generators and retailer/distributors into competing entities which contend for retail customers.
Continued aggregation is not an acceptable option. An integrated supplier has market power, and an unfair advantage over other providers, an advantage that would ultimately impact adversely on consumers.
Consistent with the national market approaches and contemporary views of how to obtain greater efficiency in the electricity supply industry, WA should consider means of disaggregating its generation industry and arrange for power to be bid by rival firms and be scheduled by an independent systems operator. These firms should have independent boards and should be privatised at an early stage.
This approach presents some difficulties where there are only three main generators, each with a distinct set of costs and known position in the merit order. It would however be possible to split the 1040 MW Muja facilities into competing stations. In addition, the imminent commissioning of the Collie station will allow greater competitive tension.
In addition, there is co-generated power that could be fed into a pool. If the WA Government is to privatise Western Power, it is to be hoped that some means of splitting generation can be arranged so that genuine commercial rivalry is introduced with all the stimulus this brings to lowering costs and increasing efficiency.
GAS
Efficiency of Gas Supply in WA
Gas prices in WA are low by the standards of other states. Table 2 shows that they are comparable to those in South Australia and Victoria and considerably below NSW and Queensland.
| Table 2: Average Price to Commercial and Industrial Customers ($/GJ) | |||||
| 1992 | 1993 | 1994 | 1995 | 1996 | |
| NSW | 5.72 | 5.76 | 5.79 | 5.59 | 5.64 |
| Vic | 4.14 | 4.25 | 4.22 | 4.26 | 4.29 |
| Qld | 7.22 | 7.53 | 7.56 | 7.71 | 7.9 |
| SA | 3.9 | 3.96 | 3.9 | 4.01 | 4.05 |
| WA | 3.93 | 4.22 | 3.89 | 4.08 | n.a |
| Source: AGA | |||||
The low cost of gas in WA has brought it a 57% share of the non transport energy market, a share equal to that of Victoria and far higher than the 17% in NSW and 11% in Victoria.
CUSTOMER CONTESTABILITY
Announced deregulation of customer supply is less complete in gas than in electricity. The following table shows the existing plans.
| Table 3: Gas Deregulation Timetables | ||||||
| Timing | NSW | Vic | Qld | WA | SA | ACT |
| end 1997 | 100 Tj | 250 Tj | ||||
| end 1998 | 10 Tj | 500 Tj | 100 Tj | 10 Tj | ||
| end 1999 | all | 100 Tj | 100 Tj | 10 Tj | all | |
| end 2000 | 5 TJ | all comm. | ||||
| end 2001 | all | all | all | |||
Again WA is behind other states in releasing customers from the monopoly supplier.
THE DBNG PIPELINE
Transport Costs
The DBNG pipeline is the key infrastructure for the transport of gas in WA and has a virtual monopoly on transport to the south west.
WA has relatively cheap gas but its price advantage is reduced by the 1,500 km distance NW shelf gas from the must be transported along the DBNG pipeline to the south west. Moreover, the costs of transport are higher than for comparable systems.
Operational costs can be derived from annual report data. These show the average price of transport, excluding contributions to capital, for the DBNG pipeline is 27.4 cents per GJ, which is more than twice that of Victoria's GTC and 50 per cent above the costs of the NSW and SA transmission systems. This is despite the fact that the DBNG pipeline in 1995/6 was operating at 81 per cent capacity, much closer to its maximum than the other major transmission pipelines in Australia.
Chart 3 illustrates the high cost per GJ kilometre of the DBNG pipeline.
Chart 3
Source: Annual Reports Covering 1994/5 except TPA which is 1993/4
Doubtless, the new owners are already moving to wring out excessive costs, but the most potent stimulus to this is a rival facility, which the WA government has effectively foreclosed for a number of years.
COMPETITION ARRANGEMENTS AND THE DBNG PIPELINE
Detailed decisions were taken on free and fair trade in gas at the February 1994 CoAG meeting in Hobart. Subsequent work has progressed on a National Third Party Access Code, which specifies that:
The Code is now being reviewed by the NCC.
Open access also means exclusive existing distribution franchises must disappear. Victoria has moved to implement this as has NSW.
Acceptance of a proposal for a rival pipeline to be built from the NW Shelf was deferred by the Government. This was notwithstanding that the easement within which the existing pipeline is located belongs to the Government (rather than its pipeline business) and presently has sufficient space to accommodate at least three pipelines.
The Government, in effect, granted a monopoly on the existing state owned pipeline and announced it was to be sold. It granted the monopoly to ensure that it would receive a higher price, a view masked by the usual claim that the market was not sufficiently mature and that WA presents unique circumstances which mean normal market forces will not provide efficient solutions.
By withholding approval for a rival facility, the Government achieved a higher price for the existing pipeline. However, that higher price merely represents a tax imposed on consumers and businesses by Government regulation. The tax is paid by a transfer from businesses and consumers. In the process, the market distortion resulting from the Government enforced monopoly brings about an unambiguous loss of income and development in the State.
Higher energy prices mean a likely choking off some of the potential expansion in energy usage, including thwarting some value adding activities that the Government is seeking to foster in the south west.
All of this reinforces the need for governments to avoid placing impediments in the way of proposed new infrastructure and to allow competitive forces to determine the wisdom of expansions.
CONCLUDING COMMENTS
Inside the Geraldton to Bunbury rectangle, energy policy has progressed only slowly towards competitive provision. Progress has failed to live up to the policy aims and the liberalisation process is lagging other states.
Although WA is not envisaged to be connected to the gas and electricity systems of other states in the foreseeable future, the State has willingly accepted the CoAG reform agenda and is an active participant in developing the national access code for gas. But many developments proceed on the basis of State Agreements and the Government intervenes to require Western Power to offer subsidised rates to some users.
Consistent with its CoAg obligations, the present Government has made some moves towards deregulating energy in the state but these remain tentative and are conducted within a highly prescriptive framework. The disaggregating of the gas contract with the NW Shelf Joint Venture was a useful step. This, the opening up of major Alinta and Western Power customers to competing supplies, the encouragement of new non government owned electricity generation, and the announced expansion and leasing out to private sector operators of the easement from the NW Shelf all set the stage for a liberalisation of the market structure.
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