Cross-ownership Rules for the Energy Sector

Submission to the Victorian Department of Infrastructure

SUMMARY

The privatisation of the Victorian industry has brought a considerable increase in efficiency, partly as a result of structural re-organisations and ownership changes since the privatisation process commenced.  The electricity industry has certain features not shared by most other industries, including non-storability of its product, but these are not unique and should not be used as justification for enhanced regulatory oversight of mergers within the industry.  There is a danger that inefficient corporate structures will follow from special regulatory measures that hinder corporate strategies within the industry through inhibiting vertical integration.

MARKET POWER AND THE FOUR ELEMENTS
OF ELECTRICITY SUPPLY

Issues of market power have been major motivations of the structural separation of the various elements of the electricity industry in Australia (generation, transmission, distribution and retailing).  The realisation in Australia from the early 1990s that generation and retailing could be competitively supplied gave rise to the acceptance that having rival suppliers would result in greater efficiencies and lower costs in these two areas.

At the same time, recognition that the transmission and distribution were likely to remain monopolistic meant a separation to ensure firms did not favour affiliates in retailing or generation.  The separation took forms ranging from full corporate disaggregation to "ring fencing" areas that might be used to favour affiliated businesses.

The emergence of retailing as an important function in the electricity market was not widely expected at the time of the structural separation of the former integrated monopolies.  Nor was the importance of retailer risk avoidance and control anticipated, partly because maximum prices at the wholesale level were considerably lower than the current cap of $10,000 per MWh.

The need to avoid unnecessary risk has led to retailers and generators contracting on a wide variety of terms with a great many different financial instruments.  Ownership is the ultimate such instrument, and retailer developed and owned new generators are now familiar.  Generators have also forward-integrated into retailing (Snowy/RED, Yallourn/TXU).  An early development along these lines was the TXU contract with Ecogen Energy, which though falling short of ownership, is considered to be similar in effect.

GENERATOR MARKET SHARE IN VICTORIA

The sale of the SECV as six generation businesses (Yallourn, Loy Yang A, Loy Yang B, Hazelwood, Ecogen and Southern Hydro), a transmission business and five retail/distributors has been followed by many secondary sales of these assets and developments of other assets.  The latest ownership re-arrangement is the on-sale of some of the former TXU assets to China Light and Power, the owner of the Yallourn power station.  This means that 80 per cent of the state's generation is owned by three businesses.

Peak and baseload power are not under common ownership at the present time.  Although Valley Power (300 MW) was built by Mission and is now owned by International Power, its output is better described as mid range, as are the TXU/CLP plants at Newport and Jeeralang.

Peak capacity in Victoria comprises the Snowy (1,900 MW deliverable) Southern Hydro (Meridian) (up to 480 MW) and the smaller gas turbine plants of AGL at Somerton (150 MW) and Alinta at Bairnsdale (80 MW).  In addition there is the planned Laverton plant of Snowy.

Once the transmission links are factored in, the market share that the state domiciled generators could command is reduced considerably.  In addition to Snowy, there are the links with South Australia and Basslink from next year.  On this basis the four major suppliers combined have a capacity to supply only three quarters of the market.

In terms of the generation supply to Victoria, the following provides a picture of import capability plus in-state capability once Basslink is completed.  This however is only a short term capability as neither Basslink nor Snowy could provide all their capacity for extended periods (though Snowy could be replaced by NSW supplies where its internal resources are low).

Figure 1

An alternative way of looking at the Victorian market is to consider it as a joint market with South Australia.  NEMMCO often sees this as particularly meaningful for its own analyses.  On that basis, joint supply is as follows.

Figure 2

Peak Power supplies are as in the case of Victoria plus the two Origin CCGT plants at Ladbroke Grove (83 MW) and Quarantine (95 MW).

The baseload supply structure comprises three major suppliers (CLP, Loy Yang Power and International Power) with NRG as a smaller but still substantial baseload supplier.

RETAIL MARKET SHARE

Origin Energy is the closest major retailer to a retail-only business.  It has no generation in Victoria and less than two per cent of the combined Victoria SA supply.  It has the largest market share among Victorian households as illustrated below

Figure 3

Origin also has the largest share of the small business market, into which some smaller retailers like Powerdirect have also made incursions.

Figure 4

JOINT PROVISION OF RETAIL AND GENERATION

The original market design in Victoria and elsewhere envisaged stand-alone businesses concentrating on generation, retail/distribution or transmission.  Retailing and distribution were separated by a required ring fencing arrangement.

While this was considered to be a source of potential fragility, the retail/distribution separation has proved to be enduring permanent.  Origin Energy, operating without any distribution activities and with only minor generation resources, has become the purest example of a stand-alone retailer but both AGL and TXU have clear internal separations between the two business functions.

The first major move by a business upstream or downstream was the foundation by Yallourn of a retail arm, Auspower.  Treated as something of an aberration initially, it has targeted only the largest customers.  Other generators have since established retail arms, while retailers, notably AGL and TXU have moved into generation, in the case of TXU not only through its own company ownership but also through an independent entity which is comprehensively contracted.  Snowy Hydro, as well as commencing building a new gas power station at Laverton, has also bought the startup retailer RED.

At the present time the only entity with a rough correspondence of generation and retail is CLP.

Estimated supply and retail market shares of Victoria are shown below.  (Basslink also gives the Tasmanian retailer Aurora a generation source for Victoria, a market it is targeting).

Table 1: Estimated Victorian Market Share

	Retail Sales	Supply capacity
Origin	36%	0%
TXU/CLP/Auspower	27%	20%
IP	<1%	25%
AGL	22%	1%
Loy Yang	0%	18%
Snowy	<1%	5-18%
Other	15%	18-31%

Hence, competition has led to a variety of market participants.  We neither have the re-aggregation of the SECV, which some feared may be an outcome, nor do we have stand-alone players operating exclusively in one area of supply.  Instead we presently have one firm with a high degree of retail and generation ownership, some with a degree of integration and others concentrating almost exclusively on one or the other.  Such developments are not uncommon in resource intensive industries -- they can, for example, be seen in aluminium and forest products.

ISSUES RAISED IN CROSS OWNERSHIP
RULES FOR THE ENERGY SECTOR

THE ISSUES PAPER'S APPROACH

The Issues Paper includes a comprehensive and well thought through analysis of the matters confronting policy makers.  It pulls together material on recent judicial determinations and market developments that point strongly towards a conclusion that the existing restraints have outlived their usefulness, could be having a detrimental effect on market certainty and could be inappropriately creating some unique regulatory arrangements in Victoria that are inconsistent with a national market.

The Issues Paper correctly notes that market power is only a concern if it is persistent, recognising that nearly all firms in other than totally atomistic supply markets have some ability to influence price in a transient manner.  It accurately describes the issues where market power might be of concern as being excessive concentration or where a firm has control of a monopoly facility -- a transmission or distribution line -- and uses this control to favour an affiliate.

MERGERS AND INDUSTRY POLICY IN ELECTRICITY SUPPLY

Mergers that have the capacity to bring excessive market power are controlled under section 50 of the Trade Practices Act, largely administered by the ACCC which has put a number of tests in place that form the basis for examining merger proposals.  The ACCC is a highly professional agency to which the Australian Parliament has extended considerable powers.  The ACCC's powers are circumscribed by the Parliament since it could, under imprudent leadership, involve itself in commercial matters to such a degree that innovation is inhibited and businesses become regulator-oriented rather than customer-oriented.

The current Victorian cross-ownership provisions augment the ACCC's powers for one industry in one state.  This is an inconsistency in both activity and geographic coverage, stemming from the mid 1990s privatisation process.  While "belts and braces" regulation may have had an appropriate role given the experimental nature of the Victorian electricity privatisation, the outcome of the experiment has seen the maturing of a customer responsive industry the efficiency of which surpasses that of other jurisdictions when measured by a range of factors.  Concerns about premature re-aggregation have now diminished and the specific legislation still in place may impede industry restructuring in ways that best take advantage of economies of scale and scope.

In this respect, it is implausible for a government policy organisation, or regulatory agency, to be able to correctly divine the appropriate structure for an industry.  Even the highly regarded Japanese MITI, with its very close ties to industry was recognised to have made a crucial error in strongly discouraging Honda during the 1960s from becoming a motor vehicle manufacturer.  MITI, which was then highly respected for its apparent industry policy acumen, argued that any additions to Nissan and Toyota would eat into the benefits of scale economies in the industry.

A key part of the Victorian industry's present level of efficiency is the dynamic and ceaseless examination by commercial parties of the assets and associated workforces of the industry's component parts with a view to ensuring they are yielding the best value to shareholders.  None of the privatised businesses have their original ownership structure, an indication of the adaptability and value searching features of the industry.

Private ownership within a rivalrous industry environment is a key to creating sustained efficiency and customer value.  Laws that monitor, and where appropriate curb any monopolistic behaviour are important supplements to the natural processes of the marketplace.  However, if there are benefits in strengthening the ACCC's powers so that aspects of its decisions, in this case cross-ownership rules, are not appealable, this should be set at a national level and cover all industries.

In this respect the Issues Paper is compelling in saying,

"Applying quantitative ownership restrictions only with respect to the entities that are licensed within one State (Victoria) may lead to errors -- such as by overstating the market power that may be created by a merger within a State (and potentially precluding a merger that offered substantial benefits but had no effect on competition), but ignoring the market power that may be created by mergers that occur outside of the State (and potentially permitting a merger that may have an adverse effect on competition)."

IS THERE A NEED FOR ADDITIONAL MERGER CONTROLS IN ELECTRICITY SUPPLY?

In examining whether there may be some unique features of the energy industry, the Issues Paper focuses on two matters.  The first of these concerns the inter-dependencies of different firms along the supply chain.  As the paper correctly argues, these are covered by regulatory arrangements (ring fencing, open access, etc.) that are not, by and large, controversial.

The second unique feature to which the Issues Paper draws attention is that the product cannot be stored.  This is not, strictly speaking, a unique feature since electricity shares these attributes with other products like theatre tickets, airline tickets and hotel rooms.  Like electricity, the prices of these commodities tend to be highly volatile to allow for scarce supplies to be rationed and to unload a glut.  The price volatility and high price excursions create opportunities for niche players either in the supply itself or in the process that results in its smoothing.  As with industries like air travel, electricity's non-storable features do not provide a case for additional oversight of mergers.

Where electricity differs from other non-storable goods is:

• nearly all its balancing of supply with demand has to occur on the supply side;  and
• it is not possible for supply shortcomings to be isolated -- either they do not occur or they affect a large number of customers.

These and other features of the electricity industry place it among the most difficult of markets to understand and to manage.  Balancing supply and demand in both the short term and the long term is only possible by leaving the parties considerable flexibility to operate.  In most respects this calls for even less bureaucratic intrusion on the industry's operations than can be accommodated in other industries.

It is sometimes maintained that the lack of consumer response to electricity pricing peaks (which can reach hundreds of fold average price levels) requires additional regulatory intrusion.  Given metering limitations and the relatively small share of electricity within the overall benefits to which it contributes, almost all of the supply/demand adjustment does, indeed, take place on the supply side and this vastly increases the spot price volatility.

Integration is one consequential business strategy, alongside long term contracting, to smooth the costs to the retailer.  Hence retailer-generator combinations, where they occur, are designed to reduce the risks of cost blow-outs resulting from a product sold at a fixed price but with inputs that have a potentially volatile cost.

One fear of the ACCC in seeking to oppose integration is that retailer/generator combinations will have an element of either exclusivity or discriminatory pricing and be able to extract monopoly rents.  This is most unlikely however, since the vulnerabilities are in peak power provision which involves a low cost capital expense and for which there are some demand side alternatives to generator supply.

In terms of concentration of suppliers, the industry needs no further regulatory oversight than that generally applying.  However, like other network industries, electricity supply has a distinct regulatory oversight need to prevent the monopoly line parts of the supply from favouring affiliates upstream or downstream.  Indeed one issue that it is pertinent to examine is whether there should be restraints on mergers between distribution businesses and transmission businesses.  The current cross ownership provisions between transmission and distribution in electricity specify restraints on a distributor owning more than 20 per cent of Transmission.  A question not raised in the Issues Paper is whether a transmission business that serves different distribution businesses could, through overhead allocation for example, favour its affiliate over other distribution businesses.

The Issues Paper asks whether quantitative ownership measures in addition to the TPA are useful and raises the issue of whether the limitations on grid reliability may provide a reason for maintaining greater atomisation in Victoria to prevent rent extraction.

Our answer to these questions is negative.  If some power -- either via an interconnector or from an older facility -- is less reliable than other power and the other power can earn a premium price, this does not represent a deadweight rent loss.  It offers market signals that reward the more reliable sources of power, and if these provide sufficient reward other power sources will be incentivised to enhance their own reliability.  This may be by engaging in contractual arrangements with supplementary power sources, embarking on deals with particular loads or financing a more robust interconnection.  If the government seeks to enforce a more atomistic industry structure it is likely to blunt these incentive mechanisms while raising industry costs.  Rent, in the way that it is described in the Issues Paper is therefore merely a profit for features that are valuable to the consumer.

Of course if the industry were to be heavily concentrated so that, say, only two firms were dominant, there may be concerns about improper exercise of market power.  This is not the case in Victoria, where as illustrated in Figure 1 there are six supply sources with a capability to supply more than 5 per cent of the market.

CONCLUDING COMMENTS:  WHERE WILL
THE MARKET STRUCTURE SETTLE?

The present market structure was not anticipated ten years ago at the time of privatisation.  Not only was it unexpected that retailing would emerge as a separate and powerful activity within the supply chain, but the cross-ownership provisions did not originally contemplate it as a separate activity.  The concerns referred to "distributors".

Since privatisation we have seen a whirlwind of corporate and ownership reorganisations in the industry.  These represent attempts by owners to forge associations and synergetic structures that maximise the wealth of the entities concerned.  In the process, efficiency is created.  Regulatory arrangements inhibiting the ownership changes that have taken place would have had adverse effects.

As with other industries, it is unlikely that the structure of the energy market will ever settle down into a stable equilibrium.  If we think of even the most mature markets like motor vehicles, we see permanent change as the assemblers juxtapose their purchasing between in-house and outsourced and as different firms merge and sometimes de-merge.

It is unlikely that there will ever be a blueprint of the ideal corporate structure in electricity supply.  It is now impossible for a business to operate in a totally integrated fashion.  The risks of relying exclusively on in-house generation sources are too great and would not be tolerated by retail risk managers who have to face comparisons with their peers in other businesses.  Once a truly self-contained integrated supply model is abandoned, the competitive structure of the industry will, without any regulatory compulsion, result in the retail and generation functions being separated.  The firms' owners will create such a split of their own volition to avoid mistrust on the part of outside parties.  These parties must be dealt with at arms length so that they are assured their confidential information does not reach other parts of the business with which they compete.  Hence we see, with the major private sector retailers:  AGL, Origin and TXU, a similar business outcome of clear separation from related arms of the business, irrespective of whether the retailing is a totally separate firm.

Such models are commonplace in other industries, including the motor industry and other manufacturing industries that assemble components from a mixture of outside and in-house suppliers.  Similar models of separation are to be seen in service industries - Qantas for example operates with several independent "silos":  aircraft operations, catering, travel services, cleaning and so on.  All of these contract at arms length both with sister businesses and with other firms, many of which provide competitive services to other "silos".

For electricity supply, it seems likely we will see some integrated firms, others concentrating on one function only, others seeking to nimbly pick off niche markets from the bigger suppliers.  However, even if the outcome were to be an industry that is relatively concentrated with say, three major vertically integrated providers and several niche players is there a role for government to impede this?  As long as the industry remains rivalrous, the answer should surely be no.  To act otherwise would be likely to reduce efficiency by having relatively uninformed regulator/bureaucrats making industry structure decisions.

Strengthening ties between Australia and Indonesia

Following the powerful earthquake which struck Indonesia's west coast earlier today, Indonesian President Susilo Bambang Yudhoyono has postponed a visit to Australia this week.  He will go instead to the stricken Nias island, a surfer's haven off Indonesia's Sumatra coast, to assess the damage caused by the earthquake.

The focus of his visit to Australia was to have been on security, investment and trade.  Although no new date has been set for his visit to Australia, it is likely that the trip will take place in the near future, since Dr Yudhoyono reportedly believes that Jakarta has neglected ties with Australia in recent years

For more on the existing links between the two countries, Yvonne Gomez spoke to Mr Richard Wood in Australia.

RICHARD WOOD:  The security relationship between Australia and Indonesia has varied over time.  Under Suharto, in the last few years of Suharto, they were very close.  In fact there were extensive exchanges between the militaries of the two governments and a joint defence pact between the two governments.  With the fall of Suharto and the independence of East Timor, the links, at least unofficially, waned.  In fact, there was significant tension.  Australia played a major role in the peace-keeping movement in East Timor and the relationships between the Indonesian military and to some extent, the government generally and Australian military declined, and tensions rose.  Under Megawati, things did not improve much, but things are improving significantly and indeed, it's a clear and strong policy position of the Howard government to put a large amount of effort to improve both the security and economic links with Indonesia.

YVONNE GOMEZ:  A new bilateral security agreement was to be included in an official statement that would have been signed later this week.  What are some highlights of this agreement, assuming that it will be signed sometime soon?

RICHARD WOOD:  In the past, the agreements have included joint operations, intelligence exchange, sharing and the linking of infrastructure facilities, making sure they can communicate with each other.  But I imagine a couple of new links will come in.  first and foremost will be terrorism and also the funding and the inter-relationships between them, and also some of the regional defence issues, in terms of Australia's involvement or otherwise, in some of the more populist independence movements around Indonesia.  Australia has a clear and emphatic goal of supporting the continuation of Indonesia as a whole.  However, there are tensions there and there are issues to deal with between the two militaries that need to be ironed out.  I think another one, a fading one, will be Australia's military involvement in the Aceh area following the Boxing Day tsunami, but those will be fading.

YVONNE GOMEZ:  You've mentioned Australia's involvement in Aceh following the tsunami disaster.  There's also an Australia-funded 1-billion dollar partnership to rebuild Aceh, which was devastated by the Boxing Day tsunamis.  Can you elaborate on this?

RICHARD WOOD:  There are two aspects of it.  The Australian military, as well as the Singapore, Malaysian and other militaries, played a major initial role in assessing the damage in Aceh.  Most of the militaries have pulled out, as agreed.  The Australian government did commit to a very large $1 billion fund for redevelopment, largely in Aceh.  It comes in two parts -- one is loans and the other is in grants, it's focusing largely on infrastructure priorities that will be agreed between the Indonesian and Australian governments.  The military itself will play a minor role in that fund, as I understand it.  It is a very important one and is also an indication of the importance Australia puts into it.  Indonesia has been, for a number of years, Australia's largest aid recipient.  It receives about $120 million a year, and therefore a billion-dollar fund is a very substantial one, more than double Australia's aid to Indonesia.  So it's definitely a significant move.

YVONNE GOMEZ:  Australia's involvement in East Timor in 1999 has been a thorn in bilateral relations but Dr Yudhoyono was reportedly hoping to put an end the any residual bitterness over the issue and wanted to revive ties with Australia.  How do you see the long-term relationship between the two countries unfolding?

RICHARD WOOD:  Yes, that's a statement of fact.  There is still a lot of tension, particularly in Indonesia about Australia's involvement, and also in East Timor and in the Australian public.  Prime Minister Howard has tried to address that.  He's been to Indonesia to visit their respective Prime Ministers eleven times in the last nine years, more so than any other country.  But [the issue] is one that you have to live down and work through and it'll take some time.  But we're neighbours and our trade links are strong and the investment links have been strong and those will overcome tensions from the past.

How many koalas are there, really?

How many koalas are there, really?

A friend recently told me that koala numbers are on the decline.  When the wine and conversation ran out I went home and spent hours on the Internet trying to find out how many koalas there actually are in Australia.

When I want to know how many sheep there are, I just look up the Australia Commodity Statistics.

There were 174.3 million sheep in 1970, 132.7 million sheep in 1980, 118.6 million at the turn of the century (year 2000) and 99.3 million in 2003 -- obviously a species in decline.

But it is never so easy when I want to know how many native animals there are.

The best advice on Koalas seems to be that there are somewhere between 100,000 and one million in Australia.  That's an order of magnitude difference of 1,000 percent and extracted from a published paper in a reputable journal.

So how many koalas are there really in Australia?  If anybody knows, I would really appreciate an email with a link or reference to some hard data.

The research paper on koalas acknowledged the lack of consensus regarding the size and viability of "remaining populations" and "reasons for decline or overabundance".

Koala numbers were apparently increasing to such an extent in Victoria that the state government introduced a hormone contraceptive plan to curb numbers -- but that was a few years ago.

I wonder how many koalas were incinerated in the January, 2003, bushfires?

Are these koala populations now recovering?  A lot more of New South Wales is National Park -- so are koala numbers increasing?

Given we spend so much money on state of the environment-type reports and we are always being told species are on the verge of extinction, I find it increasingly difficult to accept that we don't have better information on numbers and trends in native animal populations.

After all, what is more basic to a conservation program than knowing whether numbers are generally trending up or down?

It was in 1998 that I first became aware of how poor our environmental statistics are.

Cane farmers were being publicly accused of killing dugongs.  Dugongs are large aquatic mammals closely related to elephants that feed on sea-grass.

The allegation was that a dioxin by-product of sugar cane production was killing dugongs.  It was later established that the dioxin is naturally occurring, has nothing what-so-ever to do with sugarcane farming and was not killing dugongs.

I am still unclear whether dugong populations are on the increase or decline, but I do know that there are harvest quotas based on indigenous communities wanting to eat dugongs at special ceremonial occasions such as weddings.

What would others think if people wanted roasted koala served up at their wedding?

I am not only interested in how Koala populations are trending, but also populations of other native animals like quolls, wombats, dugongs, mallee fowls and mahogany gliders.

There is only so much money for saving the environment.

I would like to know that the money that is currently being spent on environmental protection is achieving tangible environmental benefits measured, at least in part, by how our rare and endangered native animals are really faring -- including our koalas.

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Reform? Just go back to basics

The 300th anniversary of the death of the English philosopher John Locke last year passed in Australia without much comment.  Few would have noticed the one or two academic symposiums that were held to commemorate the work of the single most important theorist of liberalism.

The 150th anniversary of the Eureka Stockade also occurred last year.  The fact that the actions of a few inebriated miners who burned down a hotel and then barricaded themselves in a stockade to avoid being arrested were celebrated with an extravaganza of government-funded parades and public lectures says much about the nation.

Over the last few months many federal coalition MPs have been privately (and publicly) pondering reform to a number of policy areas, including tax and industrial relations.  In the coming days they will also be thinking about what book to read over their Easter holidays.  Hopefully, in addition to packing away their obligatory copy of The Da Vinci Code, at the same time some MPs will put into their suitcase Locke's Second Treatise of Government.  Written in the 1680s, Locke's classic work remains absolutely relevant and it sets out a number of the key principles that should guide the government's reform program during its fourth term.

In his First Treatise of Government Locke demolished the notion that rulers had a God-given divine right to do as they wished, and in the Second Treatise he established a framework for a government that would operate with the consent of the people.

According to Locke, few people would willingly consent to a law that applied differently according to an individual's status, and therefore there should be one rule for the "rich and poor, for the favourite at court, and the countryman at plough".  Similarly, citizens could hardly be expected to consent to laws that they couldn't easily understand.  He remarked that simple laws not only encouraged greater compliance, they also allowed citizens a greater oversight of government activities.  The knowledge that the people were watching them ensured that rulers were not tempted "by the power they have in their hands".

On almost any measure Australia's current tax system (and our superannuation system) fail John Locke's test of good law.  As commentator Geoffrey de Q. Walker has identified, in the 1940s Australia's federal income tax legislation was 81 pages.  Today it numbers 13,500 pages.  It is beyond the capacity of any taxpayer to comprehend the laws which by which they are expected to be bound.

Simplifying the administration of our tax and superannuation systems must be a priority of the coalition.  At least some of the motivation for the push to reduce personal income tax arises from the frustration that there hasn't been a serious attempt to improve the intelligibility of the existing system.  Paradoxically, it appears that it is easier to cut taxes than it is to cut the regulations governing their collection.

A central concern of Locke was to explain why private property should be protected.  What was revolutionary about Locke's position was his claim that "every man has a property in his own person".  Individuals had the right to the product of their own labour and had the right to dispose of their own labour as they saw fit.  The alternative to this, as Locke didn't hesitate to point out, was slavery.  These are principles we've managed to lose sight of.  Part of the reason that industrial relations legislation has become so complicated is because for nearly a decade successive coalition ministers have tried to amend a century-old system that was not based on protecting the rights of individual workers (and those wanting to work), but that instead was created to ensure the convenience and privilege of union and employer collectives.  The best way of ensuring that workers have property in their own labour is by allowing them to determine the conditions under which they sell their own labour.  And the way to implement this is through a common-law contract of employment that embodies the agreement of two parties free from the interference of others.

If over Easter this year a few coalition MPs were to read the Second Treatise, and if in the coming years some of the ideas it contained were put into practice, then in 27 years' time we could all properly celebrate the 400th anniversary of John Locke's birth.

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Power market works: don't fix it

Anyone who normally books hotels through on-line agencies like needitnow.com, would have observed the price oscillations in hotel room rates.  The cheapest rooms at premium hotels during Melbourne's Grand Prix were four times the price commonly on offer.  Airline seats see similar price swings.

These prices act to choke off demand by persuading people with greater discretionary needs to forego or defer the use of the rooms or travel when pressure is on supply.  Setting prices in the face of volatile demand clearly involves considerable judgement to avoid foregoing profits, while filling the rooms or seats.

Like airline seats and hotel rooms, electricity supply has a low marginal cost, and is non-storable.  However, unlike other commodities, electricity cannot experience a selective shortage.  It is either available to all those who turn on the switch or unavailable to a great many.

Moreover, electricity has a very minor market response to short run price changes.  Few people are able or willing to fine-tune their electricity consumption.  They seldom have the metering information to do so, and in many cases it would take a massive temporary price hike for consumers to respond.  After all, someone who invested thousands of dollars in air conditioning would want to use it in the dozen hours per year when it is especially hot and humid -- the precise times when spot wholesale prices are high.  And a manufacturer would tolerate very high temporary prices to prevent stop-start work disruption to avoid a short price peak if electricity represents only five per cent of costs.  This means suppliers must provide virtually all the adjustment.

Very high price peaks are required in order to attract plant that will run only occasionally and otherwise lie unused but ready for action.  In Australia, a peak of up to $10,000 per megawatt hour may be reached -- three thousand times its normal price.  While such prices are reflected in consumers' bills, they are not explicit because they are incorporated within retailers' smoothed tariffs.  Retailers themselves largely avoid these peak prices by writing forward contracts.

In Australia therefore, a single price signals both long term and short term market scarcities.  An alternative approach is to lower maximum prices but to pay firms for capacity.  This is rather like having a levy on everyone who may use airlines or hotel rooms and using it to ensure there is some spare capacity to meet the peaks.

Capacity charges mean regulators determining what the right capacity is, who has capacity and how much they should be paid for it.  In practice its main use is to provide a signal some years into the future to allow new plant to be installed but designing this is especially difficult.

In Australia we have shown that an energy only market allows capacity to be created without such interventions and supply and, as illustrated below, demand has been fairly well synchronised over the past six or seven years.  Peak Demand and Capacity in the NEM

The National Electricity Market has proven to be highly resilient.  It has brought adequate margins of supply and low prices for the fifth year in succession.  It is not and should not be engineered to withstand all contingencies.

But there is no room for complacency.  Electricity supply remains vulnerable to government interventions that might undermine the commercial principles on which stable supply has been ensured.

Its government induced vulnerabilities include:

• Retail price caps being kept below market levels in NSW and Queensland, which seriously restricts competition.
• Low cost recovery allowed on monopoly electricity lines -- this was one cause of last year's Queensland outages, though it did not contribute to the loss of the Victoria/ SA link that triggered this week's outages in SA, where the issue is why reserve power was not immediately available.
• Government subsidised investments that undermine the incentives for new private capacity.  New Queensland government owned plant may fall within this category. 

The green power measures introduced by some state governments and the Commonwealth can also suppress incentives for efficient new plant as can the environmental barriers put in the way of the most efficient new generators (those fuelled by coal) in NSW and Victoria.

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Self-Reliance and the Self-Employment Revolution

THE OLD INDUSTRIAL RELATIONS SYSTEM

The condition of Australia's old industrial relations system has dominated the policy debate following the 2004 federal election.  There has been argument about such things as setting the minimum wage, the role of the AIRC, and the number of allowable matters in industrial awards.

The discussion, however, has largely missed the point.  Most of the players in the industrial relations system have been so caught up in the old way of doing things that the transformation of work in Australia has been ignored.  The "industrial relations club" remains fixated on models of the employment relationship that are out-of-date.

Our current structure of industrial relations -- relying on awards, arbitration and conciliation -- is literally a product of the nineteenth century.  The central assumption of that structure -- that the interests of employers and employees are fundamentally different -- is also a basic assumption of Karl Marx, another long-discredited product of the nineteenth century.

To ensure Australia's continued prosperity into the twenty-first century, we require a system which encourages creativity, rewards initiative, and responds to the needs of individuals and families.  The existing system meets none of these criteria.

What is occurring in Australia is nothing less than a transformation of how we work.  The traditional employer/ employee relationship is becoming less relevant as an increasing number of individuals are rejecting the restrictions of an inappropriate industrial relations system.  Individuals are choosing to work for themselves to gain the benefits of the choice and flexibility that self-employment provides.  The consequences of this transformation for the economy, for society, and for our political parties will be dramatic.

HOW THE WORLD HAS CHANGED

The trend to self-employment will accelerate in coming decades.  Five major reasons explain this change.

First, the nature of the Australian economy will continue to develop with knowledge-intensive and service industries assuming a more important position.  These industries already have a high proportion of self-employed workers.

Second, as the population gains the higher levels of education required for the jobs of the future, the number of self-employed will increase, as better educated workers are more likely to choose self-employment.

Third, older workers are more comfortable becoming self-employed than are younger workers, and the effects of this will become apparent as the population ages.

Fourth, individuals are demanding choice over their working arrangements, as they are in every other aspect of their lives, and self-employment provides this.

Fifth, individuals are more willing to assume responsibility for the decisions that affect their lives and their families.  Outside the family, deciding the course of his employment is perhaps the biggest decision an individual can make.

The phenomena just described raise issues beyond the scope of industrial relations, and they are the focus of a new research project of mine entitled A Self-Reliant Society.  Other issues to be considered during the project include such matters as the extent to which individuals and families are seeking greater control over their financial assets, and what the consequences of this might be.

This article is one of the first outcomes of the A Self-Reliant Society project.  Specifically this article examines:

• the number of people self-employed;
• the growth of self-employment;  and
• the political consequences of self-employment.

HOW MANY PEOPLE ARE SELF-EMPLOYED?

There is no simple answer to this question.  The idea that people might not be either "employees" or "employers", but could be "self-employed" is relatively new.  The development of measures of self-employment, therefore, have lagged behind traditional indicators such as the number of people who are unemployed, or who are union members, or who are not in workforce at all.

There are actually at least three different measures of the number of self-employed.  The census conducted by the Australian Bureau of Statistics (ABS) every five years asks people to identify their employment status.  The ABS also conducts a monthly labour force survey (from which the unemployment statistics are derived).  The figures for the self-employed vary between the census and the survey because one attempts to be comprehensive while the other is only a sample of the population.  A significant problem with both the census and the survey is that people who work as owner-managers of incorporated enterprises and who would regard themselves as self-employed, are classed as employees because they are employed by the business, even though they would regard themselves as self-employed.

To overcome these issues, in 1998 in a separate survey, the ABS started counting owner-managers as self-employed.  This survey is held every three years and the most recent data available are from 2001.  In that year, there were at least 1.75 million Australians who were self-employed.  This compares with the figure of 1.67 million self-employed recorded in 1998.  (The results of the 2004 survey will be released later this year).

Although census and survey data from the ABS underestimate the extent of self-employment, they are useful.  This is because they allow trends to be measured over time, and because the census records information, including data about where individuals live and differences between electorates, can be analysed.

THE GROWTH OF SELF-EMPLOYMENT

The attention that trade unions and their leaders receive from the media and governments (both Coalition and Labor) is not reflected in the size of their membership.  By contrast, the self-employed are a silent but growing group getting on with the job.  As has been known since at least the 1990s, the proportion of union members in the workforce has been steadily declining, but the related phenomenon of the growth of self-employment has been practically ignored.

When the number of trade union members in the private sector is compared with the number of self-employed, what is occurring is made very obvious.  And when it is remembered that the figures for the self-employed, (Chart 1) are taken from an ABS survey that underestimates self-employment, the effect is even more striking.

The political consequences of self-employment

While the ALP remains wedded to the union movement and the old industrial relations system, the nature of work in its own electorates is changing to embrace self-employment.  Using data from the ABS censuses conducted in 1981 and the most recent census of 2001 and breaking down the rate of self-employment to individual electorates, it can be easily seen that the rate of self-employment grew most in ALP electorates.  In 1981, 10.1 per cent of workers in ALP electorates were self-employed, and in 2001 this figure was 14.3 per cent, an increase of over 40 per cent.  By contrast, in Coalition electorates, where the percentage of self-employed is higher, the rate of growth of self-employment was not as great, rising from 18.6 per cent to 20.3 per cent, which is a change of around 10 per cent (Chart 2).  (As mentioned, ABS census figures understate the extent of self-employment and the actual incidence of self-employment in both ALP and Coalition electorates is much higher).

What this means is that there are now many ALP electorates in which self-employed workers outnumber union members.  As yet, the Labor Party has not woken up to the fact that if it is to regain government, it must at the very least consider the needs of this growing constituency.

Chart 3 shows the percentage of self-employed workers across all types of ALP and Coalition electorates in 2001.  An analysis of individual electorates reveals that there are many electorates which have a much higher percentage of self-employed workers than the average.  More than one-third of ALP electorates had a workforce in which 15 per cent or more of those working were self-employed, and in some electorates this percentage rose to around 20 per cent.

As ALP electorates become more marginal, the percentage of self-employed workers increases.  Similarly, the safer Coalition seats tend to have a higher percentage of self-employed.

Conclusion

The relationship between self-employment and voting intention is, of course, not simple, and many other factors determine an individual's political choice at elections.  But what this analysis does show is that neither side of politics can afford to ignore the growing number of self-employed.  Because the self-employed are by their nature independent, they haven't been collectively represented -- nor have they sought to be.  They have stood aside from the battles between employers and employees because they are neither.

At the level of national policy, the full impact of the self-employment revolution has yet to be recognised.  To an increasing number of Australian workers the "old-speak" of industrial relations is irrelevant.  The challenge for all governments and political parties is to think in new ways about employment and recognise that the growth in self-employment is the inevitable consequence of the economic and social conditions of the late twentieth century.  There is no likelihood of the trend being reversed.

Nuclear on the agenda

Nuclear energy is set for a come back as the world's "green" energy source.  It also likely to force many green groups to decide what they really stand for:  protection of the environment or anti-economic growth.

Forty years ago nuclear was seen as the energy of the future.  Its fuel source is plentiful, it is pollution-free, and the generation plant doesn't need to be close to the fuel source.  For these reasons, nuclear power stations were planned in several Australian states in the 1970s.

Things changed in the mid-1970's.  The anti-war movement focused on banning the extraction and export of uranium as means of limiting the spread of nuclear weapons.  The anti-nuclear bomb stance of the political left mutated to a hatred of all things nuclear including nuclear power.  The many environment groups born during this era, such as Greenpeace and Australian Conservation Foundation (ACF), spearheaded this anti-nuclear stance.

While competition from other sources of power proved too strong for nuclear power in Australia, the protest movement did the job overseas.  In the US, the construction of new plant came to a halt by the late 1980's, not because of faulty technology or competition from other fuels, but from costly protestor induced planning delays.  With the exception of France the same process spread to Europe.  Outside the West, where the protest movement has little support, construction of nuclear plant continued albeit at a limited pace.

Notwithstanding the backlash, over 440 nuclear power plants currently operate around the world.  In truth, the industry has had a very good track record in terms of safety -- better than other electricity generation if mining and pollution is taking into consideration.  Yes, the reactor in Chernobyl failed resulting in the deaths of about 50 people.  However, Chernobyl as a Soviet era Ukrainian plant is hardly a benchmark for the rest of the world.

Disposal of nuclear waste remains an issue, but there are a number of very safe options.  Indeed the main impediment to effective storage is not the technology or possible sites, but the engrained fear and hatred of all things nuclear.

Enter the greenhouse effect.  The environmental movement, many scientist and many governments are convinced that the world is facing human induced global warming with undesirable long term effects.  They argue for sharp cuts in the prime source of greenhouse gases, the consumption of fossil fuel.  Greenpeace and ACF for example argue for a phased-out fossil fuel use within 45 years.

The only alternative source of electricity available within this time frame is nuclear.  Wind and solar are currently the technologies of choice for the green movement but these are costly and dependent on the weather.  They can never provide energy to power the modern consumer's needs

The green groups are therefore in a bind.  They are against nuclear, which is the only alternative to a back-to-the-cave policy that would result from huge cuts in fossil fuels.

Recognising this, some environmentalists and governments are now re-examining the nuclear option.  Others cannot jettison thirty years of blind rhetoric.

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Meeting Gas and Power Infrastructure Needs

Address to the Australian Energy Summit
17 March 2005

INFRASTRUCTURE AND ITS RELIABILITY

The issue of infrastructure needs and reliability can be addressed in two ways.  The first is to estimate how the market is developing;  what sort of new investments are being made;  how do consumers value different grades of reliability;  where prices and generator reliability trends are heading;  the likely location of new gas discoveries and the competitive environment for Australian gas here and overseas;  the issues surrounding wind and other forms of generation;  peak versus off peak.  The list goes on.  From this amalgam of needs and costs the authorities can devise the appropriate investment and other needs.

The other alternative is to ensure that we have competitive markets with secure property rights and predictably minor regulatory intrusion that allows these matters to be determined by commercial parties.

In principal, the second option is what everyone with any credibility maintains is the correct approach.  We spent half a century of government intervention overinvesting in power stations, over-manning all parts of gas and electricity supply and observing a dismal outcome in terms of reliability by selecting the first option.  And with the generation half of the industry, where there are multiple rival suppliers, it is self-evident that a competitive environment can prevail.

NEED FOR NEW INVESTMENT

When officials consider future investment needs in Australia, the first port of call is the NEMMCO Statement of Opportunities.  Now NEMMCO is a very fine and well organised body.  But it is not and does not claim to be the sort of body that will look at issues examine the various options on costs, competitive conditions and alternative approaches, line up finance and conduct feasibility studies.  It is not, in short, an entrepreneur.  Indeed, perhaps reflecting a public reaction to a rather alarmist SOO issued in 2003 the 2004 SOO states categorically that those looking to invest should use the SOO as nothing more than a guide.

Examining current capacity, what it is obliged to regard as the minimum level of reserves, the likely growth rates and peak levels driven by temperature ranges, demand side participation of which it is aware, the 2004 SOO arrives at the following estimates of the timing of low reserves by state.

	LRC Point	Reserve Deficit
Queensland	2009/10	132 MW
New South Wales	1008/09	157 MW
Victoria/South Australia	2004/05	356 MW
(combined)	2006/07	321 MW
Tasmania	Beyond 2013/14	-

This says that toward the end of this decade we may need new capacity in NSW and we may need new capacity a bit before that in Victoria.

From this a more ornate demand projection is drawn.  The Blue line is the median forecast at 50 per cent likelihood while the Red line is the reliability forecast, ostensibly based on a 0.002 per cent availability (that is under 10.5 minutes per year of customer interruption on average).  The Green bars represent forecast extra capacity for reliability.

The most obvious question to ask about such projections is why are they made at all?  Nobody has a Statement of Opportunities for bakeries, or salt mines;  still less do we have them for less essential goods and services.

Of course, the answers revolve around several factors, including the long lead times for new capacity and lack of storage.  Yet these are features seen with other services like telephony, air travel etc.  More pertinent is whether the shared nature of electricity supply creates a situation where there is market failure.  This hinges on the "free-rider" notion.  It might be argued that since everyone shares in the supply availability because lines are not discriminatory between different suppliers and customers, there is a sub-optimal incentive to ensure supply is available.

Yet these externality issues are all around us within society.  The economist Ronald Coase examined a great many historical examples of public goods -- those that once supplied are automatically available to all -- that are said to make it essential for government provision.  He found many of them had been supplied in the past by individual enterprises.  One case was the lighthouse which was seen as the archetypical type of government facility.  In fact historically it was found that lighthouses were built by entrepreneurs who received payment from charges levied on ships at nearby ports.  Striking and levying the perfect fee on all users was not possible, but adequate incentives to invest were in place.

So it is with electricity and gas.  In the case of gas, there are well established means by which measurements of inputs and outputs can be made and the contract carriage market is the world norm.  Gas has many advantages in its flexibility and we have an abundance of reserves.  Unfortunately these are in the wrong place in the case of natural gas.  We also have coal seem methane which is interchangeable with natural gas and which is plentiful in coastal NSW and Queensland but this is likely to remain somewhat more expensive than natural gas and will not undermine the competitiveness of coal.  The key deficiencies in the present regime is the enforced open access of new gas pipelines, a regulatory requirement that almost certainly has resulted in sub-optimal new construction since it imposes greater risk on the developer than on those making use of the facility.  Even so, new pipelines have been built.

For electricity, retailers need to balance their demand and supplies and act as the agent of the final consumer.  They pick up the tab when the price spirals out of control and this gives them a great incentive to ensure they measure their sales correctly and contract for supplies appropriately.  They perform the same essential function in the energy market as elsewhere -- they look to demand, seek to attract customers who they can profitably supply and package supply to meet their customers' needs.  The outcome is signals that drive efficient market activity.  These signals include the prices that attract the right form of new supply (peak, off peak etc.)  They also develop prices that choke off or encourage increased demand.

Of course, all this is made more difficult in the electricity supply industry.  The absence of half hourly metering at the domestic level and the price cap are among the market realities that prevent this from operating with full effect.  But the question is not whether there is perfection but is their adequacy in market signalling?

One test is the outcome that has been observed.  And in fact the market has kept supply and demand fairly well synchronised over the past six or seven years.

Some of this felicitous outcome might be due to government investment on noncommercial terms.  But the only plausible cases of this are in Queensland and Tasmania;  elsewhere we have seen market responses ensuring the gaps are filled and filled with the sort of capacity that most people thought most appropriate.

Given this history and the very prominent role of retailers who stand to lose considerably from being short where prices are rising, if the NEMMCO SOO figures are a guide we would expect to see this reflected in forward markets.  NECA constructs a synthetic forward market based on the supposed actions of traders.  Though the forward market shows some tightness in South Australia in the first quarters of 2005 and 2006, there is no upwards prices trend.  In other words, the activities of those in the market demonstrate no urgency for major new capacity.  I would maintain that NSW faces unique difficulties in attracting new investment as a result of its ideological resistance to privatisation, its government's demonstrated willingness (illustrated in the Redbank case) to tear up unwelcome contracts and its deep green anti-coal perspective.  However even in NSW, there is no apparent sign of panic buying to cover positions prior to 2008.

Retailers and generators are taking the view that demand and supply are more or less in balance.  And it is these commercial parties -- retailers and generators -- rather than the central agencies that are the best judges of this since it is they who have most to lose or gain if they forecast incorrectly.

REGULATORY FAILURE

The 2003 SOO was widely interpreted as heralding a series of imminent problems.  These were fantasy, they stemmed from the highly conservative approach taken by NEMMCO and the agencies in each of the states to estimating demand.  Unfortunately NEMMCO itself faces asymmetric incentives.  It pays nothing for attempting to acquire supply over and above those available to the market but faces censure if it fails to alert jurisdictions to an impending major shortfall.

NEMMCO's track record would seem to add support to the hypothesis that it is somewhat pessimistic in its projections of supply and demand balances.

SA demand forecasts as provided to NEMMCO by the Electricity Supply Industry Planning Council of SA are as follows:

The shortfall in 1999/2000 may be attributable to some inexperience in forecasting.  2000/1 was a 1/100 year temperature peak (which the reliability standard does not seek to cover) but was met thanks to the timely arrival of Pelican Point.  It is noteworthy that the level has not been reached again in the following four years.  And the SOO forecast has exceeded the actual at the 90 per cent level in four successive summers.  Aside from flying in the face of global warming scares, the chances of this occurring at random are 10,000 to one!

The NSW forecast has been closer to actual.

But again, Victoria has been considerably below the 10 per cent risk level and has more closely tracked the 90 per cent level.

Queensland forecasts have been more accurate.

If Ministers are confronted with publicity that a failure in the electricity supply is a strong possibility, they are likely to act in manner that could backfire on long term market stability.  A danger is that governments will be panicked into taking precipitate action that will undermine the markets.

Such action can take many forms:

• At its mildest it is jawboning and undertaking pre-feasibility studies at below real cost as the NSW Government is already doing

• At one extreme it might entail the government building new government plant or requiring one of its retailers to sign a long term contract for new capacity.  But in hiving off a part of the demand in this way, the viability of the non-contracted suppliers is reduced -- they face a lower price for their product and this can set in train a vicious circle whereby no new plant is introduced unless it receives privileged prices.  The outcome is a return to central planning.

• Other measures involve different types of capacity charge, which are attractive to Ministers who focus on the public goods nature of electricity but which do not appear to be as low cost as the energy only market we presently have.  The pre-NETA UK system had a payment based on Loss of Load Probability times VoLL.  Capacity markets mean a regulator determining what the right capacity is and who has capacity and how much they should be paid for it.  It is only conceivably useful if it provides a signal some years out rather than in near time periods and designing this is especially difficult.  It comprises a series of interventions in commercial parties' decision frameworks.  Among the deficiencies of this is a muting of the market for reliability -- for example in the demand side bidding.  It also leads to pressures to cap energy bids in ways that prevent prices from providing commercial returns.  We have shown that an energy only market allows capacity to be created without such interventions while those markets that have had a separate capacity payment have often found this to be unsatisfactory (it reached almost one quarter of returns in the England and Wales markets but in New England was almost always valued at zero).

• A less costly outcome of over-forecasting demand is the activation of the Reserve Trader to supplement supply.  As NEMMCO has no facilities, to do this it must use plant that is already available, if mothballed.  To the degree that such plant is needed, we are likely to see higher prices on both spot and contract markets and it would, if the market shares the NEMMCO view of the future, be made available in any event.  On this line of reasoning, the Reserve Trader provisions are irrelevant since the capacity made available is phantom capacity that would have otherwise been contracted or made available for trading on the spot market.

  However, there is a likelihood that the price would be higher from the contracting (otherwise the suppliers would have preferred to have left the capacity available for spot trading or contracted with genuine customers at a lower price) and there is strong evidence that at least some of the capacity made available would not have been had the Reserve Trader not been activated.  This appears to have been the case with the Ecogen facilities in 1997.  In such cases, unless the market is failing in some way, the costs are higher -- eventually to customers.

  Operating the Reserve Trader last year sought an additional 300 MW capacity for Victoria/South Australia but only managed to contract about 80 MW on terms that it considered to be acceptable.  All of that might have been available in any case, and the contracts represented therefore people who would otherwise have been operating in the spot market, as the Smelter Trader does when it plays with about 200 MW.  With the delay in Basslink, NEMMCO might once more seek additional supplies for 2005/6.

Following the 2003 SOO where considerable publicity was given to a NEMMCO picture widely interpreted to offer cause for concern, the National Generators' Forum contracted ROAM to undertake a modelling of the situation using the NEMMCO "reserve margin" against the Reliability panel's "unserved energy approach".  Roam came up with the following, which might bear out the suggestion that NEMMCO is overconservative.  In fact, NEMMCO has since moved to apply a less stringent interpretation of its required approach which can be seen in some closer correspondence with the ROAM analysis for 2004.  In some cases this is also caused by new plant being committed.

First Season Where Reserve Standard is Breached

	SOO 2003	ROAM Modelling of NECA methodology	SOO 2004
Queensland	Summer 2005/6	Summer 2007/8	2009/10
NSW	Summer 2005/6	Summer 2008/9	2008/9
Victoria	Summer 2003/4	Summer 2009/10	2006/7 (1)
SA	Summer 2003/4	Summer 2008/9	2006/7

RISKS OF INADEQUATE SUPPLY AND NETWORK EXPANSIONS

As far as generation is concerned the key risks are that government action will mask the signals and eventually result in a supply shortfall.

• One of these I have already mentioned in passing stems from the NSW Government's actions in discouraging private sector new generation.  Creating sovereign risk through welching on contracts by arranging for a gaggle of green activists to protest is no way to encourage new private sector investment.  And that Government in its Green Paper maintains that it would be most reluctant to have new capacity built other than by private sector participants.  Certainly in the case of coal power stations -- and it is unlikely that other forms would prove as competitive -- some form of sovereign guarantee would be necessary before a firm or its bankers were to embark on a new facility.
• Staying with NSW, the mandatory insurance system or ETEF, provides a weaker incentive for retailers to ensure that they are forecasting market demand accurately since the government has eliminated risks of failing to do so accurately.  This may bring mistakes and unexpected demand shifts.
• Similar threats can emerge in other states if the retail price caps are kept below market levels.  This is however an area where governments in Victoria and SA have managed to control their propensities to intervene and are allowing prices to shift market levels.  NSW however retains very low allowable retail margins which seriously restrict competition.
• Another risk, very much in the spotlight at present, is that regulators will offer inadequate incentives for expansions and optimal maintenance.  This may have been a feature of the fragility of distribution networks, especially in Queensland where the regulator demanded a 17 per cent cost saving of Energex.  It is doubtful that it was a feature of the 14 March 2005 failure of the line through Heywood to South Australia which operates to a high degree of reliability but is not designed to be 100 per cent available.
• Interventions favouring subsidised and uneconomic generation can suppress demand which means reduced new investment especially in the sort of energy intensive industries that Australia is well placed to win.  The various schemes like MRET and NGAC add costs to industry and in the case of NSW, mean that some 23 per cent of electricity is now slated to be subsidised ⁽²⁾;  this probably rules the state out of consideration for major new energy intensive industry.  Less draconian measures are in place in other states -- Queensland has its 13 per cent gas requirement and Victoria was less than firm in controlling its state financed green groups who campaigned to prevent the Hazelwood expansion;  nor has the state made a wise choice in its appointment of a relatively activist Presiding Judge to the Land and Environment Court whose legal interpretations prolonged the case and added expenses.
• Some private sector generation businesses claim that the new capacity building by the Queensland government is not based on commercial principles but are being subsidised indirectly by a government intent on using its cheap coal as an industry development tool.  Though subsidised plant adds to capacity in the first instance, each new tranche of it considerably reduces the incentive of commercial parties to seek out opportunities to build plant in line with market requirements.  Subsidised plant puts us on the slippery slide to total government ownership or control of the industry.
• Much the same risk has in the past been offered by subsidised transmission.  If a power station is stranded by low cost power being brought in from elsewhere it suffers lower than expected returns.  If this is due to it being stranded as a result of government regulations that effectively subsidise costs, damage is done to the market's automatic ability to supply demand.
• Finally, there remains the risk of other interventions.  I think we have finally thwarted the rebidding demon which, by requiring generators to bid "ethically" and constraining their abilities to respond to sudden emergency issues, would have gummed up the bidding system and created costs and uncertainties.  Price suppressing mechanisms like those proposed tend to blunt the signals about scarcity and they reduce the abilities of investors to obtain recompense on their outlays.  Market power is a transitory phenomenon in the NEM and preventing any attempts to exercise it means reduced revenues and dangers to the investment incentive.

The message is that the real dangers to the supply industry in both gas and electricity in Australia are those stemming not from too little government but from too much.  The industry has expanded and maintained low costs in the six years it has been operating.  The price levels in Victoria compared to those expected at privatisation are shown below.

Where issues have arisen, government has often exacerbated them, as with the excessive level of enforced rationing in Victoria in 2000 following industrial relations problems.  Similarly, the competing commercial parties managed the South Australian gas crisis of January 2004 following the loss of the Moomba pipeline and government intervention that mandated particular outages in particular plants probably meant the available gas was used sub-economically.

The recent loss of the main Heywood link to South Australia has brought calls for additional infrastructure spending to provide absolute reliability.  There may be a case for this but governments also need to be made aware of the second and third round effects of actions that in the first instance seem to shore up and to cheapen supply.

Governments have a tremendous capacity to cause major disruptions in the market and add major costs to customers.  In many ways the longer we have the present period of policy drift with the MCE, the less likely are we to see poor regulatory interventions.

---

ENDNOTES

1.  SOO 2004 predicted reserve shortfalls from 2004/5 in SA & Vic, triggering Reserve Trading.  Basslink was expected to shore up reserves in 2005/6, with a reserve deficit returning in 2006/07.

2.  This is based on the NGAC requirements of a maximum of 52,000 kilotonnes of CO2 emissions by 2010 and business-as-usual emissions assuming 2% annual growth at 68,400 kilotonnes in that year.

No wind of change

What if Cyclone Ingrid, as powerful as Cyclone Tracy, had turned south and hit Cairns?  Brick-veneer homes built at the northern beach suburbs might have been turned into roofless swimming pools.  Would north Queenslanders have blamed global warming, or are severe cyclones a risk we should all plan for more seriously?

Across the world there has been concern that global warming is resulting in more extreme weather events including more cyclones.

For example, as Cyclone Olaf battered the Cook Islands in mid-February, Greenpeace issued a statement asking the global community to "deal with climate change" so Pacific Islanders wouldn't have to suffer increasingly extreme and devastating weather events.

However, the evidence for an increase in extreme weather events globally, including more cyclones, is far from compelling.

Some environmentalists argue this way:  Carbon dioxide levels have increased dramatically over the past 40 years as a result of the burning of fossil fuels;  this has caused the Earth to warm up;  there is thus more energy in the atmosphere, and thus there are more extreme weather events.

This argument is flawed.  The overall increase in global temperature of 0.6°C over the past century is mostly the result of warming over middle and high latitudes, particularly in winter.

There has been only slight warming in tropical sea surface temperatures and no general or sustained trend of warming over the western tropical Pacific Ocean.

This is the region where tropical cyclones that affect eastern Australia are formed and intensify and where earlier this week Cyclone Ingrid was born.

Cyclone Ingrid formed during an El Nino event at a time when there have been above-average sea-surface temperatures over the tropical western Pacific Ocean.  However, there is no general trend of warming in this area.

El Nino and La Nina events have nothing to do with the recent global warming, but rather are a natural part of the climate system and have been affecting the Pacific Basin for thousands of years.

Over the past week Cyclone Ingrid has been compared with Cyclone Tracy -- the cyclone that destroyed much of Darwin in the Christmas of 1974.  Interestingly, however, the wet and cyclonic conditions of 1973 and 1974 have been attributed to the strong La Nina (rather than the present El Nino) conditions that prevailed at that time.

Overall, 1974 was a bad year for cyclones.  It was in January 1974 that Cyclone Wanda crossed the Queensland coast near Maryborough resulting in the flooding of 6000 homes in Brisbane.  A few weeks later, on February 6, a very large and intense Cyclone Pam passed 500km to the east of Brisbane.

Then, four days later, Cyclone Yvonne struck near Dunk Island, tearing off roofing iron and uprooting large trees.  A month later, on March 13, Cyclone Zoe crossed the coast at Coolangatta with more flooding in Brisbane and landslides in northern NSW.

The Bureau of Meteorology in Brisbane has information on 208 cyclones that have affected the Queensland coast dating from the mid-1800s.  The first record is a Sydney Morning Herald report about a cyclone that uprooted trees on Green Island (off Cairns) in January 1858.

Worst accounts include two cyclones that devastated north Queensland in January and then March of 1918.

Complete records on tropical cyclones in northern Australia, however, are available only from 1967, the start of routine monitoring by satellites.

According to a CSIRO review, and also an assessment by the United Nations' Intergovernmental Panel on Climate Change, there has been a slight, but not statistically significant, decline in the number of tropical cyclones in the Australian region since 1971 and a slight, but not statistically significant, increase in the intensity of these cyclones.

Environmental activists, however, try to create a popular perception that there has been an increase in extreme weather events, worldwide.

Late last year Greenpeace executive director Stephen Tindale said "no one can ignore the relentless increase in extreme weather events and so-called natural disasters, which in reality are no more natural than a plastic Christmas tree".

This claim was based on a real increase in insurance claims from natural disasters in 2004.  This is attributable to a dramatic increase in the number of people living by the sea and, at least in the US, building more expensive homes in hurricane-prone areas -- not an increase in the number or severity of hurricanes.

The interest in global warming (largely driven by environmental campaigning) has distracted governments from what's really happening with climate change and the reality that places such as coastal Queensland have always, and will always, be susceptible to severe cyclones.

Large amounts of money are spent by the Australian Government on its global warming program.  Last financial year the Greenhouse Office received $107 million for tasks including "leading the agenda" and "promoting sustainable energy" -- as though this might make cyclones go away.

You can be sure that in the future severe cyclones will hit populated centres such as Mackay and Brisbane.  Now is the time to think seriously about mitigation -- issues such as drainage management and building codes -- to reduce the risk of homes being flattened and flooded.

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Picture this: a sheep-less future

People for the Ethical Treatment of Animals (PETA) has really stirred up rural and regional Australia (for example, "Wool 'too slow' against PETA", The Land, pg 8, March 3).  However, I consider PETA less offensive than many of the more mainstream environmental groups because PETA are at least straight forward and upfront about their intentions.

PETA is now running a campaign against mulesing on the basis it is cruel to sheep.

But the animal rights organisation's website and various media statements makes it very clear they are against the use of animals for food and fibre.  Period.

In contrast, groups like the Australian Conservation Foundation (ACF) pretend that they are the friend of farmers and do deals with the National Farmers Federation, yet all the while they are campaigning for more and more regulations and restrictions that will slowly kill innovation and the long term competitiveness of our primary industries.

Take the three big recent campaigns:  the campaign against genetically modified (GM) foods, the campaign to save the Murray River and the campaign against broad-scale tree clearing.

Each campaign was dishonest.

The campaign against GM food suggested that GM canola was a first, ignoring GM cotton as an important existing source of vegetable oil.

The campaign against the Murray River claimed deteriorating water quality and increasing salt levels when there has been clear improvement over the last 20 years.

The campaign to ban broad-scale tree clearing claimed we have declining forest cover when there has actually been a net increase in forest cover -- even in Queensland during the 1990s at the height of land clearing.

Unlike PETA, organisations like the ACF appeal to science and a scientific consensus to support their mantra.  They pretend their position is science-based.

But this is misrepresentation.  Like PETA, they are really just about promoting a different value and belief system.

PETA is much more upfront.  It actively promotes a vegetarian lifestyle and also synthetic alternatives to wool.

Its website states that "choosing to buy nonwool products (polyester fleece, synthetic shearling, and other cruelty-free fibres) not only helps the animals, but can also reduce or eliminate many of the consumer problems and inconveniences that go along with wearing or using wool".

PETA is clearly promoting a different Australia:  one which might arguably be more humane.

If we were all vegetarian then no animals would need to be slaughtered.

In fact, we could do away with the Australia's pastoral industry altogether, though we might still sing "Waltzing Matilda" in remembrance of the then-extinct Australian merino, saved from mulesing.

Whether metropolitan Australia buys the PETA argument or not, PETA hasn't really misrepresented their intensions or position.

Groups like Greenpeace (who work through the Network of Concerned Farmers) and the ACF also represent a different value and belief system and are essentially against modern high yielding agriculture, but because these groups are more devious in their tactics, rural industries are slower to respond.

In fact, there are industry groups that actively fund environment groups whose long term objective is the demise of the same industry.

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The only man for the job

In February 1972, Richard Nixon became the first president of the United States to visit the People's Republic of China.  Nixon had made his reputation as a warrior of the Cold War, his party was virulently anti-communist and most of his key supporters viewed the Chinese as no less evil than the Russians.  A leader without Nixon's credentials would not have dared such a task for fear of being seen to be weak on communism.

The trip was hugely successful.  Domestically it helped propel Nixon to re-election by a landslide later in the year, and it dramatically strengthened America's strategic position.  His meeting with Mao Zedong was the defining positive moment of Nixon's presidency.

Those events of 1972 have since been the subject of numerous television documentaries and countless scholarly papers.  It was even the subject of a classical opera.  Beyond the importance of the event itself, the phrase "Nixon in China" has been used to describe a particular phenomenon.

A Nixon in China moment occurs when leaders act against the short-term interests of their own minority constituency to achieve a long-term benefit for a majority not necessarily part of that constituency.  The distinguishing feature of such moments is that the outcome could only have been achieved by leaders who would have been expected to do the opposite of what they did.

Pursuing a Nixon in China moment is not without its risks, as leaders face the threat of alienating their own supporters and not winning the backing of those who have yet to gain from a policy change.  Only leaders who have accumulated sufficient political capital and who are trusted by their own followers can contemplate such a strategy.

Nineteenth-century Britain provided one of the most famous Nixon in China moments.  In the 1840s, prime minister Robert Peel convinced the Conservative Party to repeal tariffs on food imports.  The immediate economic effect of the decision was to reduce the earnings of British farmers who had sheltered behind protection, while politically the Conservative Party was split because the agricultural sector was a key voting bloc on which the party relied.  But in the long term the policy was hugely beneficial.  The living standards of the working class rose as the price of food fell, and a free-trade policy ensured the country's prosperity into the second half of the 19th century.

The ALP-ACTU accord of the 1980s is a more recent example closer to home.  Bob Hawke and Paul Keating recognised that labour costs had to be reduced and profits on capital increased to ensure future economic growth, and that if this happened there would be financial and political costs for the labour movement.  Only Hawke, the man who had made his reputation representing trade unions, could have struck a deal that limited the growth in real wages for union members.  If the coalition had attempted something similar the ACTU would have rejected it out of hand and fought it tooth and nail.

John Howard is facing a Nixon in China moment.

Any worthwhile tax reform must substantially reduce income tax rates and eliminate the myriad anomalies that infest the tax regime (for example, the differential tax treatment of companies and trusts).  But for this to occur the coalition must cut government expenditure, something it has so far been unwilling to do.  One of the reasons for this reluctance to reduce spending is that a core constituency of the Prime Minister, Liberal MPs in marginal seats and the Nationals, have come to rely on the distribution of commonwealth largesse to secure their re-election.

Of course, not every spending promise made in the last election campaign was a bad one.  But real tax reform is dead in the water for as long as the coalition continues to extend to the wealthy middle class non-means-tested benefits such as the baby bonus, and fund regional development projects whose only justification is political.

Fortunately, on more than one occasion the Prime Minister has been willing to undertake hazardous tasks.  In 1996 he single-handedly drove changes to national gun laws, which undoubtedly cost him votes in the short term.

Now he has another opportunity to seize the moment.

His leadership is unassailable and he will have control of the Senate.  He is the only person with the moral and political authority to lead and win a debate on the need for fundamental reform to the coalition's taxation and expenditure policies.  And while reform definitely threatens the political interests of some coalition MPs, there is the prospect of benefiting the interests of all Australians.

The question is, can Howard do a Nixon in China?

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Wrong way, go back

THE Howard Government is going down a centralising route which is not only poor policy but poor politics.

Over the past month the Government has announced decisions to nationalise the industrial relations system, to establish a national year 12 exam, to nationalise the universities;  and to establish national TAFE colleges.  It has also publicly considered the idea of taking over public hospitals.

While frustration with the actions of the states on all these fronts is understandable, the aim should be to use the influence of the Commonwealth to get the states to improve their service delivery rather than taking these service over.

While our federal system has many faults, it has many benefits.  Firstly it does allow policies to be more closely tailored to the needs of local concerns.  For example, West Australian industrial regulation in response to the needs of its remote mining industry allowed more intense working hours, long before they were allowed for in federal awards.  The fact is Australia is a large and economically and geographically diverse continent and needs policy tailored to these differences.

Second, federalism allows experimentation.  The Kennett Government was, because of the dismal outlook of the state economy, able to push the policy frontiers and experiment with a raft of reforms that were not politically possible elsewhere.  Most of the experiments were successful and were subsequently adopted to some degree by other states and the Commonwealth.

Third, the federal system can act as an insurance against government failure.  That is it allows the nation to avoid putting all its eggs in one basket.

This is particularly relevant too for industrial relations.  The Howard Government is likely to put in place a far better IR system than currently exists in the states.  Eventually, however, the ALP will regain power federally and, judging from the union-dictated IR policy it brought to the last election, they are likely to wind back these changes.  And if the Howard plans are carried out, there will be no state alternative on which to fall back.

Fourth, federalism can give rise to constructive competition between the states.  Also, the fact is the Commonwealth bureaucracy has no expertise at service delivery.  It should act like a head office of a large firm.  Which is to set measurable goals, preferably with the agreement of the states, ensure that these goals are monitored effectively, provide incentives to meet these goals and report on the achievement to the public.

Such an approach would not only improve the operation of government but would be politically much safer and be consistent with the constitution.

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Exposing the Eco-Terrorists

State of Fear
By Michael Crichton
(Harper Collins, 2004, 603 pages, $24.99)

Those of us who had already read Michael Crichton's Caltech Michelin Lecture in January 2003, "Aliens Cause Global Warming", and his "Remarks to the Commonwealth Club" in San Francisco in September 2003, would not have been surprised when his new thriller State of Fear was published last December.

Nevertheless, the delight was palpable, just as was the predictable fury from various Green activists.  Readers of the White Picket Fence, the Lavoisier Group, sceptical environmentalists and leading atmospheric scientists from around the world will be satisfied.  Many of us have been trying hard to expose the Chicken Little scare of a runaway greenhouse effect and the ineffectual and economically damaging Kyoto Protocols.  We find at long last a big box office star providing a serious antidote to The Day after Tomorrow, and the biases of the media.

But unlike that film, and unlike the deliberate misinformation of Michael Moore's film, Fahrenheit 9/11, this book is a deadly serious attempt to straighten the record on these issues by an author who not only understands the scientific evidence but who, in his own words at the Commonwealth Club, considers

the greatest challenge facing mankind is the challenge of distinguishing reality from fantasy, truth from propaganda.  Perceiving the truth has always been a challenge to mankind, but in the information age (or as I think of it, the disinformation age) it takes on a special urgency and importance.

These are strong words.  Even though the book's implausible Hollywood grab-all, frenetic, action-packed story definitely distracts from the significance of the new book, it is just this genre of thriller that is perhaps necessary to get his important message across to a fatigued public.

To understand the depth of what Crichton has achieved, one must look at the long road he took in becoming a best-selling Hollywood storyteller.  After graduating from Harvard University in anthropology and studying further as a visiting lecturer at Cambridge, he began a medical degree back at the Harvard School of Medicine.  To help fund his studies, he started writing thrillers.  This led to The Andromeda Strain, and after several others, the well known book, Jurassic Park.  His novels have always been characterised by a profound knowledge and understanding of science and of all the latest research, even though couched in fictional plots.  He has always shown a keen interest in the political and ethical issues of the day and is considered the undisputed "father of the techno-thriller".

State of Fear differs from his previous novels in that Crichton packs the story not only with "real" science, but copiously footnoted research from peer reviewed published work!  The book includes a message from the author, two appendices -- "Why Politicised Science is Dangerous", and "Sources of Data for Graphs" -- and no fewer than 21 pages of Bibliography and explanatory notes!

Very briefly, the story itself is about an environmental group with a fanatical leader -- some think a Ralph Nader foil -- who schemes to criminally engineer several weather-related catastrophes.  A mysterious millionaire philanthropist supports the group with oodles of money to gain moral redemption and acceptance in the eyes of California's wealthy environmentally-conscious elites.  In the meantime, a slightly idealistic lawyer representing the millionaire, learns -- through the twists of the plot and through some lecturing by a mysterious, all-knowing and powerful undercover agent who seems to hold all the keys to the unravelling mystery -- that he is dealing with an eco-terrorist web, and that nothing is at it seems;  especially the integrity of the scientific claims of an impending catastrophe.  These little lectures have been criticised by several reviewers as being somewhat wooden and didactic -- and they do slow down the action -- but for those of us who know the arguments, and Crichton is at pains to give us all the salient details, it provides a satisfying exchange.  In these passages, one can only dream that Green fundamentalists reading the book will be forced to "wake up and smell the coffee", as it were.  There is certainly a sense of schadenfreude for this reader at seeing Green organisations being, just for once, depicted as evil and criminal and self-interested.

Of course, we should know better.  As with most ideas, those who understand the science will be chuffed:  a Michael Moore working for us.  Those who are dyed-in-the-wool fundamentalist believers in Greenhouse will be outraged, as indeed they have been.

Some comments from the Net at random are indicative:

I think Michael Crichton is a great writer in style.  His books are enjoyable.  It sounds like he is about to get back in my good graces with this global warming honesty, BUT ... He is a luddite.  Not a Marxist exactly, but a luddite in the same way that Marx was.

The only odious villain is Michael Crichton ... arrogant and self-righteous plus antiscientific and anti-environmentalist and very rich at the suckers-who-read-his-trash's expense.

Although this may be predictable, there is hope that his efforts will not be wasted.

I am very environmentally-minded, as is Michael Crighton, but after reading this book and some of the references he listed, it's clear that we are not being given all the facts by the media.

I don't know if I have ever read a novel where I learned more ... I'll be more cynical about what dangers are being presented to me as fact in the future by the media which acts as lightning rod for misinformation.

Apart from the scientific summaries of the issues, which are outstanding -- and I recommend the book to anyone who wants to read a bit about the science and the actual data and enjoy a compelling story;  it would be an ideal book for Year 12 English -- there is another dimension to it that will infuriate activists but ring a clarion bell to those of us who understand the nature of the beast.

Through the story, Crichton reveals the fanatical side to fundamentalist environmentalism.  He explains philanthropic motivation, how NGOs funnel money through to activist fronts, how government largesse is taken advantage of, and how these essentially self-serving unrepresentative groups use very sophisticated public relations teams to get the ear of the media and capitalise on fear and disinformation in the public.  It is truly an instruction manual of how Left activist groups work.

It is hard to know at this stage how the book will go, and whether timid and politically correct Hollywood will have the courage to make a film of it.  The book is still on amazon.com's 20 top-seller list after two months.  If it does make it to the cinema, it may just provide the turning point for public opinion and, subsequently, for politicians.

Unlike the agitprop PC films mentioned above, it has several things going for it:  common sense, political grains of truth, scientific facts and integrity.