Time for tough decisions on health

As Victorians now know, the state has a world-class health system.

We know because we are told daily by Premier Steve Bracks that it is so.  The State Government is flooding the media with ads telling us it has fixed the system and made it world class.  In large part, the ads are correct except for one big issue -- costs.

The Bracks Government has pumped billions into the public hospital system.  Since it was elected in 1999, public hospital budgets have increased by about $3.5 billion, or nearly 70 per cent.  This has included over 5000 additional nurses, a substantial increase in their wages and a reduction in their workload, and thousands of additional doctors, medical professionals and health administrators.

Indeed, Victoria's public hospitals now have the highest staffing levels of any state system.  The Government has also spent heavily on new beds and facilities without closing existing ones.  As a result, it has increased the total capacity of the system.

The spending program has achieved its stated aims.  It has made key stakeholders, particularly nurses, very content.  After a disconcerting delay, it has resulted in sharp, across-the-board reductions in waiting lists.  Indeed, as a result of the expansion program, waiting lists have been cut from among the highest to the lowest in the country.

The extra funding has increased throughput in the system not only by expanding capacity, but by greater use of same-day procedures.

Politically, the program has also worked.  Surveys show punters hate hospital waiting lists, trust nurses and are pleased with the changes.

The problem is costs.  Health expenditure per person in Victoria is now the highest in the country (except for Northern Territory) and hospital cost per person, which in the 1990s was below the rest of Australia, is now 15 per cent above the average of the other states.  In short, Victoria's world-class health system has been built on piles of money allocated without much focus on efficiency.

Thanks to its $1.7 billion inheritance and the huge revenue windfall from the GST and the property boom, the Bracks Government has been able to afford this rate of spending to date.

However, it will struggle to do so in the future.  State revenue will not continue to grow at the rates experienced over the past five years and the inheritance has been spent.  The challenge going forward is to build on the recent injection of resources and drive greater value for money.  This will include rationalisation of hospitals, greater contracting-out of services, injecting competition into the system and making greater use of non-hospital facilities.

Mr Bracks is aware of this need.  Indeed, to his credit, he has made reform of health a central plank of his New Wave reform agenda.

However, spending money on health is easy and driving efficiency is tough.  But the latter needs to be done if we are to have a sustainable, world-class health system.

ADVERTISEMENT

Reducing Red Tape in New South Wales

Submission to IPART investigation into the burden of
regulation in NSW and improving regulatory efficiency

THE REGULATORY MIND-SET

We have recently emerged from an era, which peaked some three decades ago, during which socialist thinking dominated government decision taking.  This perspective led many to believe that "experts" provide more accurate determinations of demand (and more appropriate supply responses) than the various individual decision makers in the community.

More recently, government intervention within the economy has been normally justified by the claim that there are "externalities" that render individual demand and supply decisions inadequate as the determinant of income maximisation.  Externalities as unpriced values concomitant with a transaction offer ready justification for government interventions of all kinds.

Nonetheless there has been a clear recognition that those governments which undertake such intervention most frequently and intensively tend to preside over economies that perform poorly.  Hence there have been increased calls for deregulation.

This focus upon Red Tape has assumed a higher profile over the past year or so and both the State and Commonwealth Governments have given a high priority to the issue.  At the February 10 COAG meeting regulation was a major agenda item and governments agreed to:

• establish and maintain effective arrangements to maximise the efficiency of new and amended regulation and avoid unnecessary compliance costs and restrictions on competition;
• undertake targeted public annual reviews of existing regulation to identify priority areas where regulatory reform would provide significant net benefits to business and the community;
• identify further reforms that enhance regulatory consistency across jurisdictions or reduce duplication and overlap in regulation and in the role and operation of regulatory bodies;  and
• in-principle, aim to adopt a common framework for benchmarking, measuring and reporting on the regulatory burden

There is now a far greater realisation of the costs that over-government and over-taxation can bring even to economies that not so long ago were regarded as engine rooms of world growth.  If for no other reason, retaining our competitiveness makes it vital that Australian Governments do all they can to minimise regulatory excessive costs.

REGULATORY TRENDS IN NSW

The most obvious point to make about the level of regulation in Australia is its extraordinary growth over time.  Parliaments seemingly have an almost insatiable desire to push through ever greater amounts of legislation and regulation with every passing year.  In the years from 1991 to 2004, the Commonwealth Government produced approximately as many pages of legislation as had been passed over the previous nine decades since Federation.

Though NSW has not been the Australian jurisdiction with the fastest increase in regulatory burden, governments in the State have continued to add increasing numbers of new regulations over recent decades.  The following chart (Figure 1) covering pages of acts and regulations is indicative.

Figure 1:  New pages of NSW rules

It should also be remembered when looking at this graph that this represents only the flow of new legislation every year.  What individuals and businesses have to daily comply with however is the actual stock of legislation already in existence and constantly been made worse by the cumulative effect of new legislation that is continually being added.

There is no need for this continual growth in regulation -- life is getting safer, sellers are becoming more accountable.  This begs the question as to why regulation continues to increase.  To some extent it may simply reflect increased wealth causing us to become more risk-averse and are more likely to demand regulation to minimise risks that were once regarded as being part and parcel of daily life.  However, as British Prime Minister Tony Blair has pointed out, it is neither possible nor even necessarily desirable to eliminate risk beyond a certain point.  There is an urgent need for Australian governments at all levels to make this point to their own constituents, and point out that demands for risk-minimisation can be very damaging and counterproductive when taken to the level that is now becoming increasingly common.

Perhaps even more importantly however, there is also a need for governments to look at the institutional drivers of regulation and whether the incentives facing regulators are at present aligned with what is in the interests of the broader public.  Much legislation is now undoubtedly being driven by bureaucratic empire building or alternatively by risk aversity among policy-makers seeking to insulate themselves against blame for future potential problems.  This is legislative overkill.  It is important that all levels of government, but particularly the state level, create more coherent and sensible processes for the introduction of new legislation to ensure consistency and transparency and to assure themselves that the benefits will outweigh the costs.

The focus of our own advice is three areas:  building and planning regulations;  energy regulations;  and labour related regulations.  In addition, we nominate some reforms in the process of regulation review which could be helpful to a government determined to reduce the regulatory burden.

BUILDING REGULATIONS

Over the past two decades, what is now called the Building Code of Australia (BCA) has developed from different state codes that were less than consistent with one another.

A major deregulatory thrust took place in the 1980s when the states agreed to shift the Code requirements onto a non-prescriptive basis with certain approaches given a "safe harbour" deemed-to-comply status.  At the same time the Code itself was re-written in plain English.  This allows cost savings in building construction by -

1. permitting the innovative use of alternative materials and forms of construction or designs while still allowing existing building practices through the Deemed-to-Satisfy Provisions;
2. allowing designs to be tailored to a particular building;  and
3. being clear and providing guidance on what the BCA is trying to achieve.

However, in response to regulatory pressures, the Code has been diverted into a more regulatory set of measures over recent years.  Two areas of particular concern are with respect to energy conservation and to promote better access for people with disabilities.

ENERGY REGULATIONS AND HOUSE BUILDING

In 2003 the Australian Building Codes Board (ABCB) introduced energy efficiency requirements for Class 1 buildings -- i.e. detached houses -- into the Building Code.  This has proven to be a mere start of a steadily escalating process.  Jurisdictions are competing with each other to introduce escalating regulatory measures on house construction for energy saving.

Among the most onerous are the NSW BASIX requirements.  These are comparable to the Victorian "5 Star" energy saving regulations for housing.  This, according to a survey by Master Builders Australia of its members revealed that the cost of a three-bedroom brick-veneer dwelling had increased by between $13,000 and $18,000 depending on design and location.

Energy saving regulations constitute a clear case of regulatory reflex actions that are imposing considerable costs on the economy.  Because they focus on the least affluent sections of the community -- those who do not have their own home (and those who are unaware of and politically disorganised to counter adverse regulatory impacts) the outcome is all the more regrettable.  Indeed the zenith of hypocrisy is observed when the most vociferous proponents of additional measures to save energy are volunteering new houses as the vehicle for achieving this.  In general those campaigning for the regulation already own a house, the value of which will be lifted by measures imposed on new houses.

No further regulations aimed at energy savings should be proceeded with and existing ones should be critically reviewed to determine their merit.

ENERGY REGULATIONS IN COMMERCIAL BUILDINGS

A further area of market failure which BCA proposals seek to address arises from the presumption that building owners do not in all circumstances have incentives to specify optimal levels of thermal performance.  This problem is said to arise particularly in relation to rental accommodation.  Buildings are complex products and it is likely that, in many cases, owners will not be able to retrieve the marginal costs of specifying higher levels of thermal efficiency from tenants in terms of higher rents.  That is, energy efficiency represents only one small element of the bundle of "goods" that a prospective tenant obtains by renting an apartment and so preferences for greater efficiency are unlikely to be translated into effective demand in the market place.

The wrong conclusions can be drawn from such starting positions.  Thus it is often argued that a developer who intends to sell a house or building is not concerned about the ongoing energy costs that the occupier must bear, except to the extent that purchaser preference for higher levels of efficiency is translated into higher sale prices.  Again, because of the complex "bundle" of characteristics or services effectively provided by a building, the ability of consumers to express effectively their preferences for higher levels of thermal efficiency may be limited in practice.  That is, market failure may derive from demand signals not being effectively perceived by suppliers.  Alternatively, the complexity of the services provided by buildings may mean that consumers are not sufficiently informed about the impact of thermal performance on running costs and comfort levels and, as a result, do not express a demand for higher levels of performance.

Regulatory implications stemming from these sorts of arguments are highly suspect.  In fact building owners need to attract customers and develop an attractive amalgam of features and cost savings to maximise their profits by developing appealing packages.  There is no less likelihood that the builder as the "agent" of the renter or subsequent owner is any less careful in this than the designers and builders of other complex purchases like cars or trucks.  As the Productivity Commission has demonstrated, the evidence that there might be market failure as a result of a difference of interests between owners and renters is far from convincing.

NSW should abandon all plans to introduce energy savings requirements into commercial buildings.

REGULATIONS TO IMPROVE ACCESS TO COMMERCIAL PREMISES FOR PEOPLE WITH DISABILITIES

There is a proposed Disability Standard for Access to Premises (Premises Standard), which is intended to codify the general requirements of the Australian Government's Disability Discrimination Act 1992.  The DDA prohibits discrimination against people with disabilities in a range of contexts, including access to premises.  The technical requirements of the Premises Standard would also be adopted as part of the Building Code of Australia.

The proposed Premises Standard would include specific requirements aimed at providing greater access to premises for people with mobility disabilities, as well as people with vision and hearing impairments.  Matters that would be regulated include ramps and doorways, corridor widths, lifts, sanitary facilities, seating spaces in auditoria, car parking spaces and provision of signage.

It would affect virtually all new commercial building, valued at around $15 billion per annum as well as major refurbishments valued at about $8 billion per annum.

It is believed that the standard, if adopted for commercial buildings would lead to costs in the hundreds of millions of dollars per annum and mean that many buildings would be less useful as a result of the spatial and access reorganisation that would be required of new buildings and buildings subject to refurbishment.

The measure is aimed at those with disabilities especially those within the workforce.  The concern is waste, both personal and economy-wide, where people with disabilities are prevented or discouraged from work as a result of building design.

Frisch ⁽¹⁾ points out that the 80,000 wheelchair users in the community between 15 and 65 years old have a workforce participation rate of only 38 per cent compared with a rate of 76.9 per cent for those without disabilities.  He looked to regulatory change to bring about a doubling of the workforce participation rate for people with disabilities.

Unfortunately, a rigorous review of the outcomes by Schwochau and Blanck ⁽²⁾ indicates that the US regulations introduced with the Americans with Disabilities Act of 1990 have failed to increase employment levels among people with a disability.  This is supported by research by the National Organisation on Disability/Harris ⁽³⁾ which indicated that 29 per cent of individuals with disabilities were employed in the survey of 1998 compared with 31 per cent in 1994 and 34 per cent in 1986.

The failure of US regulations to improve employment levels among people with a disability may be due to a regulation's inability to address on-going reluctance on the part of employers to hire people who, once hired, may require special and costly facilities in workplaces that would not otherwise be required.  But even if this is the case there is little governments can do to remedy it -- at least through regulatory means.

In sum, empirical data does not provide substantial evidence of equivalent legislation having achieved the effects sought of Australian regulations.  The Frisch suggestion of a doubling in employment rates for users of wheelchairs would seem to be unrealistic.  The benefits of the regulatory proposals are correspondingly reduced.

The Government should not proceed to regulate with the proposed "premises" standard to require buildings be more "useable" to the handicapped.

REGULATIONS TO IMPROVE ACCESS TO HOUSING FOR PEOPLE WITH DISABILITIES

The Australian Building Commission Board is investigating requiring that all houses incorporate features that make them more accessible to people with disabilities.  Many advocates argue that better design inputs can deliver accessibility at no additional cost compared with current practices.

The sort of features that are valued to promote accessibility include, wider passageways, stepless entry, larger bathrooms with grab handles and other features that facilitate wheelchair use, graded pathways, and so on.  Often these features are easier to incorporate into larger dwellings and Australian norm of single storey houses makes one feature of these, a downstairs toilet, automatically easier to accommodate than in most other countries.

There is a great deal of literature on the costs for and the need for such regulations.  Many suggest that the costs are trivial.  However there is evidence from the government housing authorities (which commission a considerable part of the housing that is specifically geared towards the needs of people with disabilities) that the costs of the building are increased by at least 4% and up to 20% where house are built fully compliant with the relevant Australian Standard (AS4299 Part C).

Some argue that as we age we will increasingly value the features of accessibility and we need regulation on accessibility to save us from our own myopic decision framework.  This is perspective of little merit.  Purchases, especially major ones like a house, are best left to individual choice.  If we do not weigh up the various options available to us and the budget constraints facing us with the purchase of a house we can never hope to do so for other goods and services.

In abandoning consumer choice and substituting the decision taking of experts we are abandoning the free market.  Moreover, as with so many features impacting upon housing, regulatory impacts are on the new home owner.  Not only is this segment of demand less affluent than others but it would also be less likely to value the costs that make housing more accessible or liveable to those with disabilities.

No regulations of housing to require "accessible" or other features to cater for the needs of people with disabilities should be introduced.

LAND USE REGULATIONS

PLANNING FOR HOUSING

Throughout Australia, state and local authorities have placed serious restraints on the location of new home building.  These restraints have been particularly severe in NSW with the previous Premier placing a high priority on restraining population growth, but the same general trend is evident throughout Australia.  As a result, although house building costs have been kept at around the general level of prices (quite an achievement in view of the increased regulatory impositions on the industry and the fact that new house sizes have gradually increased), new homes have risen markedly in price.

This and its cause is illustrated in Figure 2.

Figure 2:  Housing prices, country-wideABS (Consumer Price Index, Australia, Cat no. 6401.0;
House Prices Index:  Eight Capital Cities, Cat no. 6416.0)

The land component of the new home package, which in 1976/7 comprised 32% of new home in Sydney, in 2005 comprised 62%.  This has been mainly due to the squeeze on land availability originating from misplaced desires to prevent "urban sprawl".

Australian house prices are now, in terms of multiples of household income levels, among the highest prices in the world. ⁽⁴⁾

According to the Demographia 2006 International Housing Affordability Survey, Sydney ranked seventh in the least affordable housing market from their study of 100 cities in North America, New Zealand, Australia and the United Kingdom.  The study rates urban areas in terms of median housing costs and median income levels.

The most affordable cities, which include several of comparable size to Sydney like Pittsburgh, St Louis, Atlanta, Houston and Quebec, have median house prices that make them only one third as expensive in relation to median income levels.

The key cause of this is planning constraints that have reduced the availability of land for housing and house tax measures often in the guise of development contributions.  Raw land on the periphery suitable for housing has an alternative use of only a few thousand dollars per hectare.  Planning constraints result in a price at $300,000 a block and more.  Increased prices in existing zones are caused by government created regulatory scarcity on the periphery, an effect that is often compounded by local NIMBY action designed to prevent more intensive land use.

As part of this regulatory price forcing, the HIA estimate that the direct regulatory "tax" on new subdivisions in western Sydney is $60,000.  Though some of this may contribute to the value of the subdivision, much of it is for social infrastructure like "affordable housing contributions", local community facilities, public transport contributions and the employment of community liaison officers.  These costs are further amplified by joint actions between developers (often government owned) and councils.  Thus in NSW, the Government owned Landcom uses its influence to obtain development rights, earning $150 million a year profit from sales of $320 million.  Moreover, such developers obtain the necessary rezoning of land by making commitments to local authorities for tennis courts, neighbourhood centres and other infrastructure over and above the already sizeable mandatory contributions.  Consumers have no opportunities to decide for themselves whether such expenditure meets their preferences -- the costs are rolled up in a price that they are obliged to pay.

There are some hopeful signs for reform in this area, not least of which were comments made by the Prime Minister on the issue at the HIA conference in November 2005 calling for an expansion of land availability. ⁽⁵⁾

In the case of development approvals, winners are created as a result of the zoning system.  In order to plan their business futures, house builders and land developers take positions and buy land at the inflated prices the regulations create.  They then have a vital interest in ensuring that the regulations do not leave them with an asset that is reduced in value at the stroke of the same administrative pen that brought the inflated value.  These forces are aided and abetted by very prosperous individuals living in areas that are relatively close to major urban areas but have features of remoteness and exclusivity.

Land regulations, in particular zoning laws also pose considerable dangers to the integrity of the political process.  When vast profits can be made by a politically directed and essentially arbitrary reclassification there are grave dangers of political corruption.  Those dangers extend beyond individuals' cupidity and can infect the political process by providing funds for political parties to use for electoral purposes.  In such cases, the community would be seeing its net real income levels reduced by a regulatory tax, with part of the proceeds diverted to the re-election of those purporting to represent their interests.

Unfortunately, the administration of planning regulations has become infested by elected busybodies and appointed experts who are determined to tell consumers what is good for them and to prevent them from doing anything else.  In many cases, builders rather than suffer the costs of delays that are entailed in contesting demands on them for the construction of houses with particular features, acquiesce in the demands, unwarranted though they are.  For the commercial builder, the alternative is costs that will not be reimbursed.

Although these regulatory trends have not yet escalated the costs of the house building itself, they are poised to do so.  We have cost impositions requiring water storage, heating measures, and room layouts which are stopping entry into the industry.  The restraints on supply together with the imposts placed on developers have clearly been the major if not the only factors in pushing up the prices of housing.

Figure 3:  20 Most Unaffordable Housing Markets

Rank	Housing Market		Median Multiple
1	US	Los Angeles	11.2
2	US	San Diego	10.8
3	US	Honolulu	10.6
4	US	Ventura County	9.6
5	US	San Francisco	9.3
6	US	Miami	8.8
7	Australia	Sydney	8.5
8	US	New York	7.9
9	US	Riverside	7.7
10	US	San Jose	7.4
11	UK	London	6.9
12	UK	Bristol	6.8
12	US	Fresno	6.8
12	US	Sacramento	6.8
15	NZ	Auckland	6.6
15	Australia	Hobart	6.6
15	Canada	Vancouver	6.6
18	Australia	Adelaide	6.5
19	US	Las Vegas	6.4
19	Australia	Melbourne	6.4

Demographia

All this is at the expense of the weakest and poorest members of society -- the mainly young first home buyer.

The restoration of low costs for the home building industry requires measures like:

• relaxation of restraints on where homes may be built even if this means the urban sprawl.  This might entail restricting area restraints only to areas of great natural beauty such as national parks.
• considerably curtailing requirements on builders to set aside land for public use.
• restraining the demands that can be placed on developers for expenditures on infrastructure by redefining infrastructure to mean such essential features as water, sanitation, and local roads and by recognising that much of the expenditure for these services is funded out of general state and local charges.

OTHER PLANNING ISSUES

SHOPPING CENTRE AND SIMILAR DEVELOPMENTS

Clover Moore and State Government Ministers have expressed strong opposition to the Sydney Airport Corporation Ltd.  (SACL) providing facilities on Commonwealth land for new shopping malls and cinema complexes.

There are many links between property development, politicians and regulation.  Planning approvals form the bedrock of a system of patronage that has long been the bankroller of NSW politics.  Sydney airport threatens to seriously undermine this.

Politicians use their veto powers on new development proposals to allow favoured parties to proceed with such infrastructure.  The regulatory system allows a scarcity of such facilities and those fortunate enough to obtain approval are therefore cushioned from competition.  Political power both grants planning approval and can deliver regulatory protection to those that have the approvals.  This regulatory constraint means higher prices than would otherwise be necessary to attract the consumer.  Higher profits from higher prices to the consumer are the corollary.

Some of these profits are passed back in informally pre-arranged payments to those politicians at a local and State government level that are manning the political gates.

Although very few politicians are corrupt in the sense of openness to personal bribes, they rely on networks of patronage in terms of helpers and cash to fund their election and re-election.

With Sydney Airport, SACL finds itself within a federal enclave inside Sydney.  It therefore represents a rival planning body and this seriously undermines the State Government's planning approval monopoly.

In setting up the privatised airports authorities, the Commonwealth was alive to the opportunities for higher sales prices that were being created by the regulatory created shortage of urban infrastructure.  Both Melbourne and Brisbane have seen some developments as a result.  But it is the planning restraints in place in southern Sydney that have the greatest profit potential.  SACL as landlord now intends to exploit the high prices brought about by the area's shortage of the services.

Where planning regulations create restraints to trade removing monopolies over planning will unleash competition and reduce prices.  There is a massive upside for the community as a result of this subversion of monopolistic protective planning structures.  Undermining those monopolies unleashes competition and provides the consumer benefits that have previously been skimmed off by the protected suppliers and their associated political patrons.

A preferable approach would be for the regulations themselves to be dismantled and for those wishing to develop new shopping centres to be made subject only to provision of the stand-alone and support services that are required.  There should be no test of whether the facility is "needed" or whether a new competitor would harm existing facilities.  The greatest enemy of a cow is another cow;  the greatest enemy of a car factory is another car factory.  But in neither of these cases should governments be involved in making decisions about whether to permit a rival.  It should exit this function in the planning arena both to ensure a reduced risk of corrupting the democratic process and to bring about lower prices for consumers.

The government should rescind planning rules that seek to ration the availability shopping and other common services and abandon criteria which seek to establish a "need" for new facilities and assurances that new facilities will not operate to the detriment of existing facilities.

APPROVAL PROCESSES

Councils essentially act as the agent of the State Government in progressing planning applications.  The whole process should be considerably simplified.  In addition, some councils operate on the basis that they and their constituents are opposed to additional development in the area.  This should not be a legitimate stance in public policy -- land is owned by individuals and responsible government should place limitations on those claiming to act on behalf of the "community" to infringe upon individuals' peaceful and unhampered use of their own possessions.

In addition, considerable costs are absorbed as a result of the slow progress in obtaining approvals.  Greater electronic mechanisation could allow planning applicants and service providers like Telstra and Sydney Water to determine where proposals are within the system and to expedite progress.  The State government could introduce training facilitation and implement incentive structures to expedite the planning approval process.

Introduce requirements on councils to grant development approvals and penalties on those which restrain development through delays.

Introduce incentives to councils for expediting the progress of planning applications.

REGISTRATION OF BUILDERS

The career development from unskilled labourer or skilled tradesman to house builders of substance has brought hundreds of Australian success stories.  And it has done so concurrently with -- indeed has contributed to -- the impressive efficiency found in the house building industry.  The system of sub-contracting greatly facilitated this progression from subbie to main contractor.

More recently there has been a rise in credentialism.  Unlike in the past, builders now must take written tests and demonstrate to the authorities a knowledge of building procedures and laws, business and other matters.  This level of credential testing has not proved to be necessary in the past.

One outcome has been an increase in people purporting to be "owner-builders" to escape the regulatory restraint.  This in turn has led to a vast expansion in the so-called owner builder applications.  The Department of Fair Trading issues between 16,000 and 20,000 owner-builder licenses each year.  This infers a share of about 10 per cent of new permits but it is apparent that some owner-builder licenses in NSW are being used to construct multiple residencies while some may not be activated in the year of their issue.  The Independent Commission Against Corruption is examining NSW licensing operations.

The authorities in all Australian jurisdictions have sought to counter this by imposing limitations on the ability of an owner-builder to construct new houses and major extensions.  Inter alia, they require the would-be owner-builder to attend a largely useless building course to force up the regulatory costs of opting for this method of building.

These provisions have no effect in terms of the safety or functionality of the work (mandatory insurance is necessary in any case and there is no evidence that owner builder work is any less satisfactory than that built by registered builders).  Owner-builders operate on the same sub-contracting principles that prevail throughout the industry.  The owner or the head builder is unlikely to be the actual roofer or carpenter undertaking the work.  It is the sub-contracting system that has made the industry so efficient and responsive to the consumers' needs and, incidentally, to allowing the cost impositions introduced by building regulatory requirements to be minimised.

The subbie turned major contractor is the way by which the industry has been able constantly to renew itself and to ensure incumbents maintain their competitive edge.  Re-creating a medieval guild system that freezes out new players would be highly detrimental to the industry's vibrancy and resilience.

Allow anyone to become a builder and rely on the insurance system as a means of ensuring safety and quality.

OCCUPATIONAL HEALTH AND SAFETY

Most people running businesses in Australia would describe workers' compensation and occupational health and safety (OHS) laws as two of the most frustrating and confusing areas of government regulation.  The laws frequently fail to provide clarity and are, for the most part, inordinately complex.

Occupational Health and Safety laws vary widely between the States in terms of their core structure and definitional approach.  NSW is the worst of the states;  Victoria is probably the best.

This confusion and complexity is made worse because there is a high level of inconsistency in regulatory design, approaches, systems and administration between the States.  This inconsistency is not being addressed by the States.

Existing workers' compensation and OHS schemes directly and unnecessarily increase operating costs, dampen productivity and constrain business success.  Further, the key national priority—targeting safe working arrangements and compensation for genuine injuries across Australia—is compromised.

What needs to be understood is that a significant percentage of the systemic problems directly flow from a fundamental design flaw, namely the conceptual underpinning of the schemes by employment concepts.  If this design flaw is not addressed the systemic problems will remain.

National leadership by NSW on these two issues should be viewed as a priority.

A FLAWED CONCEPTUAL FRAMEWORK

Most analysis of OHS and workers' compensation problems focuses on the details of how the various schemes across Australia are administered.  That is, the usual focus is on "red tape" compliance issues associated with the schemes.  This, however, is inadequate, because both regulatory areas suffer from a key flaw in the conceptual framework with which all state schemes operate.  It is this which is at the heart of the compliance problems.

Both OHS and workers' compensation take as their starting point the elements of control which are embedded in the employer-employee legal relationship.  The crucial feature of this relationship is that the employer has the "right to control" the employee.  The inference contained within the legal relationship is that the employer is all powerful in the work relationship and, further, that the employee is in most respects powerless.  The legislative structures of OHS and workers' compensation are both predicated upon the existence of the employment relationship and it has, therefore, come to dominate the cultures and administration of the institutions that administer the laws.

This results in a number of assumptions being built into the design of regulations that are highly suspect when it comes to practical work realities.

Those assumptions are that:

• When a work injury occurs, the employer, however defined, is responsible for the injury.
• Employees have diminished capacity to control the work environment and, when an injury occurs, are assumed to be blameless.

Thus, the employer (however defined) is presumed to be at fault regardless of the actual causes of any particular injury.  This distorts the effective functioning of workers' compensation arrangements as insurance schemes and OHS laws as injury-prevention mechanisms.

This is the starting point from which the policy and operational distortions that occur in workers' compensation and OHS laws can most readily be understood.

THE ISSUE OF "CONTROL"

The closest public policy parallel to workers' compensation and OHS laws are the road laws.  By contrasting the two areas, the inconsistencies in public policy approach become clear.

Both road laws and work safety laws have to consider "who controls the situation" in order to create effective rules which (a) reduce the incidence of injury and (b) facilitate enforcement.

However, when it comes to the funding and administration of the rehabilitation of injured individuals:

• who controlled the vehicle and caused an injury is not taken as relevant under road laws but,
• who is assumed to control the work situation is central under work injury insurance laws.

For example, road laws operate on a practical basis that drivers control vehicles and are held personally liable for their driving behaviour.  But, unlike property insurance, compulsory personal injury insurance for vehicle-related accidents does not apportion blame.  In fact, to apportion blame for personal road injury insurance purposes would distort the operation of this insurance.

Road laws clearly stipulate what drivers can and cannot do.  It is recognised that if the laws are ambiguous or confusing, this will result in car crashes.  Drivers are held responsible for their individual actions over what they personally control.  Serious breaches of road laws resulting in crashes, death and/or injury can result in criminal charges being laid with possible imprisonment as punishment.  Manufacturers of vehicles are required to supply vehicles to minimum regulated safe standards, given technical limitations.

With car insurance, when crashes result in personal injury, the insurance schemes operate on a no-fault basis (this is different to non-compulsory property insurance).  All vehicles must be insured for personal injury cover, individual premiums are not adjusted according to claims history, and all injured persons are treated equally and have access to medical, compensation and rehabilitation services.  Even a driver who may have caused a crash is not denied medical insurance services.

This system works well and is accepted as fair and just because the individual who controls a vehicle is easily identified.  If fault is to be apportioned under the road laws, this is tied to the discovery of facts.  Drivers are not held to be liable for situations beyond their practical control.  But control and blame are not relevant for the purposes of rehabilitating injured persons.

WORK SAFETY

Under work safety laws, however, the apportionment of blame dominates.  Work safety laws take it as given that the employer controls the work situation and is therefore responsible and liable under both workers' compensation insurance and OHS.

But the reality of work situations is that many different individuals have combined control over work.  The truth is that there are normally multiple "hands" on the steering wheel of the work "vehicle".  Work safety laws, however, are biased toward the assumption that only one "hand" -- the employer's, controls work.  This is a false assumption based on the presence of a legal contractual relationship called employment.  The truth is that employers do have significant control, but so too do employees and many others, including unions, suppliers and government authorities.

The outcome of this false assumption about employer control is that:

• Individuals who did not have practical, effective or total "control" are held to be totally liable, both from an insurance perspective and a prosecution perspective.
• Other individuals who did have control or shared control in any situation are not held liable in any respect.

Twisting the truth about "work control" in such a contorted way diminishes community trust in the fairness and justice of work safety laws, causes people to spend time and energy trying to avoid the injustices of the laws, and reduces the effectiveness of public policy targeting safe work.

Further, this key conceptual point—"employment control"—if ever it was valid, is quickly being deconstructed by the rapid rise of independent contracting which organises work without using the employment contract.  The response of work safety regulators to this development has been to further distort the law by selectively and inconsistently "deeming" some non-employees to be "employees".  This process has layered regulatory confusion upon confusion to the point where the "road laws" of OHS and workers' compensation cannot effectively be known in advance by the community.  This confusion of work safety "road laws" must, of itself, work against safe work.

The extent to which this confusion and distortion occurs varies from State to State, thereby creating further confusion.  Some States, however, have made positive developments to have the law reflect work realities and create clarity.  Other States have actively distorted the law.

CORE LEGISLATIVE STRUCTURES

The international benchmark for OHS laws are established under the Robens principles of the UK, and ILO Convention 155.  These hold that individuals should be held liable and responsible under OHS for what they control within the bounds of what is practicable.

NSW has grossly distorted the international OHS principles and, in so doing, has created significant community distrust of their OHS laws.

The NSW approach is an extreme case of where the laws assume that the legal status of the employer results in the employer being assumed to be in total control of work.  In doing this, the NSW laws effectively strip employees of any individual responsibility to comply with statutory OHS responsibilities.

In NSW:

• Employers, independent contractors, suppliers of equipment and so on have a statutory obligation to ensure that no injuries or deaths occur.  There is no tempering of this in terms of what is practical or what they in fact control.
• This statutory requirement to "ensure" creates presumption of guilt under NSW OHS laws.  "Practical control" only applies as a defence.  This is a distortion of international OHS principles rather than an application of them.  In particular, the statutory presumption of guilt has led to a serious lack of confidence in the justice and fairness of NSW's laws.
• Employees do not have a specific statutory obligation to comply with OHS laws.  Employee obligations are limited to "co-operating" with the employer's obligations.  This effectively transfers liability for the actions of the employee to the employer.  This creates presumed guilt on the part of an employer, even if the breach of OHS laws occurred because of the negligent actions of an employee.  This sends powerful signals to employees that they can ignore OHS obligations, and equally powerful signals to the community that the OHS laws defile justice.  This strips the NSW laws of integrity.

Further compounding this defiance of international OHS obligations, the NSW laws:

• Conduct prosecutions in the IRC jurisdiction, as opposed to proper courts as applies in all other States.
• Deny access to trial before jury.
• Prevent full rights of appeal in prosecutions relating to injuries and fines.
• Allow unions to act as prosecutors and to receive up to half of the fines imposed and have their legal fees paid by the party prosecuted.

As a consequence, these laws have bred an aggressive prosecution culture within the NSW Workcover authority.  This is highlighted by the fact that NSW conducts over 60 per cent of OHS prosecutions Australia-wide, but has only one-third of the Australian workforce.  Further, 65 per cent of Australian OHS convictions occur in NSW.

No other State has OHS laws as distorted as NSW.  Instead, they all have a general application of international OHS principles but with variations in their legislative structures.  The emphasis is on control within the bounds of practicability.  None has applied presumption of guilt.  But none has gone as far as Victoria in making it absolutely clear that employees as individuals have equal OHS responsibilities and liabilities alongside all other individuals—regardless of legal or contractual status.

UNIONS

All States grant unions some form of special OHS authority, including access to workplaces.  NSW is the only State that gives unions prosecutorial powers.

Union special privileges for OHS purposes are generally justified on the grounds that employees need a safety voice "on the ground".  Unions are chosen because historically they represented a large proportion of employees in the workplace.  With the collapse of union membership and the rise of independent contractors, however, special OHS privileges for unions in fact act to disempower employees' OHS voices.  This is dangerous for work safety objectives.

OHS AND CRIMINALITY

All jurisdictions have the normal processes of criminal liability applying alongside OHS laws.  This replicates the road laws.  That is, if an individual knowingly and/or with gross negligence does something that leads to the injury or death of a person in the work situation, the individual can face criminal prosecution through the normal criminal courts and with all the rights of criminal justice applying.

Over the last decade, however, there has been a strong push to embed additional criminal or quasi-criminal sanctions inside OHS laws.  This is not consistent with international OHS principles.  Such laws distort justice.

NSW provides for imprisonment of individuals when death or serious injury occurs.  For second offences under its 2000 Act, presumption of guilt applies, trial is before the IRC, trial before a jury is denied and full appeal rights are denied.  Imprisonment for first offences applies under its 2005 Act, with presumption of guilt and trial before the IRC.  Trial before a jury is still denied, but full appeal rights apply.

Restore normal rights to employers (presumption of innocence) in cases of workplace injury.

WORKERS' COMPENSATION

Workers' compensation is distorted by confusion of intent.  The essence of the problem is that the person paying the premiums (ie the employer, however defined) does not receive the benefit of any claim but suffers the losses resulting from a claim made by someone else.  Under normal insurance the person paying the premium is the person covered and liable to receive the benefit in the event of a claim.  It is in this basis that actuarial risk is assessed.  However workers compensation design distorts normal actuarial risk assessment.

The Heads of Workers' Compensation Authorities insist that workers' compensation benefits apply only to employees and that self-employed individuals cannot be covered by the schemes.  However, if self-employed individuals structure themselves as a company, they normally become subject to the schemes by virtue of becoming an employee of their company, even though they are effectively the employer of themselves.  Further, NSW has created definitions of employment for the purposes of workers' compensation that go beyond common law and which bring some individual self-employed persons within their scheme and leave others out.  There is high level confusion about the status of self-employed individuals and entities that engage self-employed individuals for the purposes of workers' compensation.

NSW will not register self-employed individuals but has a bureaucratic expectation that entities which engage such individuals should pay premiums on the individuals engaged.  But the authority will not guarantee that it will honour claims on such individuals, even where premiums have been paid.  NSW also lists a variety of occupations where self-employed persons are declared "employees" and subject to the schemes.

NSW is currently undergoing an aggressive audit by Workcover in which businesses that have used independent contractors in good faith are being confronted with retrospective premium bills large enough to cause business closures.  Some businesses have, in fact, closed as a result.

Cease using workcover arrangements to discriminate against independent contractors.

ENERGY MANAGEMENT ISSUES

ENERGY REGULATORY TAXES

The main schemes that tax electricity in NSW, ostensibly with a view to imposing penalties to encourage consumption of fuels that produce lower carbon dioxide emissions per unit of energy, are:

• the Federal Government's Mandatory Renewable Energy Target (MRET);  and
• the NSW Greenhouse Gas Abatements scheme.

These schemes' costs are

Commonwealth (6)	$380M
NSW (7)	$221M

The MRET scheme's focus is on renewable energy and requires retailers to acquire and annually surrender a progressively increased number of Renewable Energy Certificates (RECs).  The major beneficiary was hydro in 2003, with Snowy having some 490,000 RECs, worth some $16 million to the business.  Although accounting for only 10 per cent of the RECs created in 2003, wind is likely to increasingly account for the growth in new RECs.

The NSW scheme seeks to introduce a penalty on CO₂ graduated in line with the emissions per unit of energy of each electricity generation source.

The default penalty costs of the two regulatory measures provide a cap on the costs.  These costs entail a premium over the costs of conventional electricity to retailers.  By 2010, when the schemes are at full maturity, the fall back penalty rates for the Commonwealth and NSW schemes respectively are $40, and $14.3 per MWh. ⁽⁸⁾  These rates provide the (maximum) subsidies to the non-carbon or low-carbon emitting fuels.  In after-tax terms, costs to retailers of the two schemes' subsidies are $57 and $20.4 per MWh. respectively.  These costs are over and above the basic wholesale (contract) price of electricity, which is likely to remain close to its present level of $35 per MWh.

For NSW, existing requirements of NSW Greenhouse Gas Abatements scheme and MRET combined will force an increase in sub-optimal energy supply from 5 per cent in 2004 to over 23 per cent in 2011 (see Attachment).

The NGAC scheme has certain advantages over the Commonwealth's MRET scheme especially since it attempts to be neutral between sources of savings.  However, it cannot be wholly so since it is reliant on savings (in dependently verified) that firms say they will make in efficiency based on their existing levels of output.  As such it would tend to favour those facilities that presently emit higher levels of CO₂ per output of electricity.  These facilities are likely to find it easier to raise output per unit of input and thereby obtain the subsidy.  Hence it will offer those facilities a subsidy for improving their efficiency and this will either be in excess of the worth of the improvement or will be unnecessary and provide a windfall gain.

Over and above these considerations, NGAC represents the State Government venturing into an area of Commonwealth expertise and responsibility.  In imposing a cost on the NSW economy, it reduces the real income of the State and brings a distortion vis-à-vis the Australian economy as a whole.

NSW should dismantle the NGAC Scheme at the earliest opportunity.

DEREGULATION OF PRICES

The Green Paper into NSW Energy Policy Directions issued late in 2004 made some commendable suggestions for lifting price regulation between now and 2007.  Such a plan should be put into effect.  They need to be introduced and the Electricity Tariff Equalisation Fund (ETEF) abolished.

In spite of ETEF and the price caps there has been some significant churn among NSW customers.  Around 10 per cent had switched from their franchise retailer as of December 2004 (in Victoria around 25 per cent had switched) and many more had re-negotiated contracts with their franchise retailer.

The justification for ETEF is the regulated nature of the price to small customers.  In Victoria and South Australia regulated prices have not required the additional distortion of an ETEF scheme.  Though it might be argued that this is because the other states have been less draconian than NSW in forcing prices below their market levels, the fact that churn is occurring in NSW indicates pricing headroom for some smaller customers.  Even if it maintains price regulation -- and the degree of new competition shows this to be unnecessary -- the Government should raise the maximum price level to enable more meaningful levels of competition and allow price to become a more accurate market signal of the demand and supply balance.

Because it operates as a form of mandatory insurance for the small customer load (half of the market), ETEF prevents the normal interplay of commercial responses to consumer need.  It also inhibits out-of-state retailers with no regulated hedge with the state generators from competing for customers.  The Green Paper, quite appropriately, recommends the policy be allowed to expire on its due date of June 2007.

The Government should abolish the Electricity Tariff Equalisation Fund and cease regulating electricity prices.

SNOWY PRIVATISATION

We are highly supportive of the move that the NSW Government initiated to privatise Snowy.  We are hopeful that it will presage further divestment in the electricity industry.

While privatisation should entail little regulatory change, in the context of the management of the system, the opportunity should be taken to clarify any outstanding areas of rights and obligations that have been left to ad hoc decision making backed by regulatory powers.  Chief among these appears to be the monthly flow obligations of the Snowy Hydro.

As befits a business that earns little from its water provision responsibilities and almost all its income from electricity production, the current output is geared to maximising income by releasing water when it is most profitable to do so.  As we understand it, the monthly release schedule is loosely based on "best endeavour" principles.  It is likely, given that the within-year spectrum of electricity prices broadly coincides with the within-year value of irrigations water, that there will be little conflict between these two prime uses.  Even so, as the privatisation is the culmination of the facility's journey from government department to fully commercial business, we consider that the existing rights and obligations be fully clarified in contractual terms rather than be left open to a regulatory solution to some future dispute that might arise.

Clarify and formalise any existing informal obligations of Snowy Hydro to irrigators and other water users.

GOVERNMENT POLICIES TO COMBAT OVER-REGULATION

All jurisdictions could improve their handling of regulation.  The evidence of over-regulation is clear.  The following are some recommendations that should be required prior to new regulations being introduced:

• Require a review to ensure the new regulation is fully consistent with the letter and spirit of the freedom of inter-state commerce provisions of the Constitution
• Introduce the regulation under a two stage process approach:  the first simply setting out the issues in a dispassionate and non-committal manner, and the second seeking comment on the agency's preferred approach.
• Require an independent analysis to verify that the regulation is merited.  This might be a scientific review in the case of measures mooted that guard against health or environmental externalities.  And it may use formalised and independent economic analysis to review alleged economic benefits from an externality.
• Establish disciplines that ensure the regulatory burden does not increase.  In this respect a useful approach would be that of the UK Prime Minister's direction to the Better Regulation Task Force to look at:
• First measuring the administrative burden then setting a target to reduce them (the Dutch approach) and
• A "one in, one out" approach to new regulation, which forces a prioritisation of regulation and its simplification and removal.

The Dutch approach has three dimensions.  First it involves measuring the burden on business using a standardised approach.  They examine the administrative burden only.  This is what the US agencies refer to as the paper burden and which typically amounts to 30 per cent of total regulatory costs.  According to Crews ⁽⁹⁾ in his annual assessment of US regulatory costs, those of the federal government amount to 8.7 per cent of GDP.

Crews's assessment is based on long standing analyses conducted by the Office of Management and Budget and goes back to work undertaken by Wiedenbaum in 1979.  It is broadly consistent with the Dutch estimate of 3.6 per cent as the cost of the administrative burden alone -- using the 30 per cent rule of thumb this would amount to 12 per cent of GDP but differences are inevitable due to different roles of the US states and the EU. ⁽¹⁰⁾  Various studies have been assembled by the PC and its ORR/BRRU agency which place estimates in the same ball park.

Crews argues that we have very little idea whether the benefits of any of the regulations exceed the costs at present.  He considers that legislators have been derelict in allowing regulatory agencies to introduce regulations without proper oversight.  He says, "Agencies face overwhelming incentives to expand their turf by regulating even in the absence of demonstrated need, since the only measure of agency productivity—other than growth in its budget and number of employees—is the number of regulations.  The unelected rule when it comes to regulatory mandates".

To counter this growth, the second arm of the Dutch approach involves setting a target for reduction of the burden -- after an early false start the Dutch have chosen 25 per cent over four years.  The focus on the administrative burden was purposely adopted since it would bring about less political opposition (in the event no political opposition) than measures that confront policy head-on.

Finally, the organisational structure must be appropriate.  Too many good intentions about reducing the paper burden evaporate after the first flush of press releases.

Though Crews is right that agencies tend to be regulation-philes, in developing new rules they are giving expression to political representatives' broad intentions.  Regulation is not simply some abstract body of laws developed by an impersonal bureaucracy.  Governments and Parliaments must generally therefore impose disciplines on themselves if they are to reduce the burden they place on the electorate.  In the Netherlands the organisational structure to facilitate this involves an independent watchdog body which reviews the calculations of the costs that departments themselves estimate before legislation proposals are sent to Parliament.  The Cabinet is also obliged to consider the estimates of costs before endorsing new legislation and each government department has a body of officials with responsibilities designated to reducing the regulatory burden.

As in the US, the regulatory agency falls under the Minister for Finance.  Such machinery in principle already exists within the Commonwealth, Victoria and to a lesser degree other states.

Confessing some initial scepticism about the practical outcomes of the Dutch approach, the UK Better Regulation Task Force found evidence that the Netherlands was in fact achieving its target reduction.  The Task Force proposes to marry this with the sloganistic "One in one out" approach.  Again the intent is for the government to place a discipline on itself by forcing a search for regulatory economies especially where new regulatory measures are proposed.

Over the past year or so, Victoria has adopted the most rigorous regulatory review machinery with the Victorian Competition and Efficiency Commission (VCEC).  This is a statutory body, established under the State Owned Enterprises Act, which has the role of acting as the government's primary source of advice on regulatory reform policy.  The three Commissioners are statutory appointments and are therefore independent of the government.  This model clearly strengthens the Commission's role in assessing the adequacy of RIS's by granting ultimate authority for the function to these independent statutory appointees.

This model is probably superior to the Commonwealth government's Office of Regulation Review because of its independence and a more rigorous requirement it has in place for the conduct and publication of Regulation Impact Statements.  The VCEC will normally insist that RIS's be undertaken independently and issued before any legislation is tabled.  By contrast, Commonwealth Departments undertake in-house RIS's which are often simply a rubber stamp on a policy that has already been formulated.

RECOMMENDATIONS

1. GENERAL REGULATION REVIEW

We recommend that the Victorian system be generally adopted together with:

• Measures aimed at simplifying regulation and consolidating it to make it more accessible (a process that is also likely to make it more internally consistent).
• Sunsetting regulations and putting into place a more rigorous renewal machinery.
• Establishing clear Ministerial responsibilities for regulatory reform.  The US lodges its own regulatory oversight body within the Office of Management and Budget (the equivalent to the NSW Finance Department).  Some have called for it to be lodged directly within the Prime Minister's portfolio.  Either way it must be given robust responsibilities for blocking regulations and for having them reviewed.
• Using regulatory budgets, a variation of the "one in one out" provisions under which departments are forced to hold or decreases the total costs of the regulations.

2. BUILDING REGULATIONS

Review the Role of the ABCB

Much of the impetus for cost imposing new regulatory pressures on the building industry derives from the make-up of the ABCB.  In a number of very important areas including energy savings, regulations for houses to assist people with disabilities, the ABCB is taking a social policy approach and is being over-anxious to ensure uniformity even if this means raising standards (and hence prices) far above those merited on safety or quality grounds.

NSW should raise concerns about the regulatory intrusion agenda of the ABCB and seek to confine the organisation to areas of safety regulation and facilitating design consistency.

Remove Social Regulatory Requirements on New Homes

• The Government should not proceed to regulate with the proposed "premises" standard to require buildings be more "useable" to the handicapped.
• No further regulations aimed at energy savings should be proceeded with and existing ones should be critically reviewed to determine their merit.

Remove Social Regulatory Requirements on Commercial Buildings

• NSW should abandon all plans to introduce energy savings requirements into commercial buildings.
• The Government should not proceed to regulate with the proposed "premises" standard to require buildings be more "useable" to the handicapped.

3. REVIEW LAND USE REGULATIONS

In order to reduce the affordability of buying a home for the consumer the NSW government should introduce the following measures:

• Relax restraints on where homes may be built.  This might entail restricting area restraints only to areas of great natural beauty, for example, national parks and so on.
• Considerably curtail requirements on builders to set aside land for public use.
• Restraining the demands that can be placed on developers for expenditures on infrastructure by redefining infrastructure to mean such essential features as water and sanitation, and local roads, and by recognising that much of the expenditure for these services is already funded out of general State and local charges.
• Immediately remove restrictions on land outside of the growth boundary to allow house building on the scale and to the extent that the builder( and developer) sees fit.
• Allow shopping centres to be built without reference to perceptions of "need" and without insistence of installing transport and other services that the owner does not consider appropriate to meet the target ed consumers.
• Train administrators in local authorities on how to expedite planning applications and introduce a system of performance based incentives to support this.  Penalise councils which restrain development through delays.

4. REMOVE UNNECESSARY CREDENTIAL TESTING FOR BUILDERS

The building industry has existed successfully for many years without requiring individuals be tested for their credentials in managing building work.  Many successful builders have an aversion to school based learning and first entered the profession to avoid this.

Current regulatory measures discourage the entry of subcontractors into the industry and thus put at risk the ability of owner-builders to respond to consumer needs efficiently.  The government should remove limitations on owner-builders to construct new houses and major extensions and also remove requirements for owner-builders to obtain credential by attending building courses that add cost and offer no safety of functionality gains.

5. MAKE EMPLOYEES AND EMPLOYERS EQUALLY ACCOUNTABLE FOR OHS

The NSW government should follow undertake the following measures:

• Participate in a national OHS review in order to try and reduce inconsistency in regulatory design, approaches, systems and administration between the States.
• As part of this review the OHS and workers compensation NSW OHS laws should be changed to recognise that both the employer and employee have "control" over their working environment and that both can be at fault in any given circumstance.
• Provisions should be made in NSW that remove the requirement on employers, independent contactors and suppliers to "ensure" safety and the law should be applied more practically to recognise that they do not necessarily control every situation.
• Requirements for employees to comply with statutory regulation should be introduced rather than them having to simply co-operate with employer obligations.  This will increase the safety of the working environment by making everyone equally accountable for the safety of the conditions they work in.
• Look at reducing regulations in order to reduce operating costs, increase productivity and business success.
• Union special privileges that work against OHS should be reviewed and removed.
• OHS laws should remove criminal sanctions and leave these for the courts where justice can be more fairly applied.
• Workers compensation should be made payable to anyone who suffers losses from a claim including an employer.

6. REMOVE ENERGY REGULATORY TAXES

• Penalty costs on businesses as a result of the NSW Greenhouse Gas Abatement scheme should be removed.
• Consumer price caps on energy should be removed
• The Electricity Tariff Equalisation Fund should be abolished or allowed to expire at its due date in June 2007.

---

REFERENCES

1.  The Benefits of Accessible Buildings and Transport:  An Economist's Approach, Dr Jack Frisch.

2.  Scwochau S and Blanck P. D., "The economics of the Americans with Disabilities Act.  Part III:  does the ADA disable the disabled?", Berkley Journal of Employment and Labor Law vol 21 2000 p. 271-313

3.  Chartbook on Work and Disability, National Institute on Disability and Rehabilitation

4.  See http://www.demographia.com/dhi-rank200502.htm

5.  http://www.pm.gov.au/news/speeches/speech1681.html

6.  Based on 9,500 GWh at a penalty cost of $40 per GWh

7.  Based on:

• benchmark of 7.27 tonnes CO₂ per capita totalling 52.054 million tonnes in 2010
• 2010 business-as–usual emission level estimated at 71.406 million tonnes
• Giving State gap of 19.352 million tonnes CO₂ less MRET credit estimated at 2.808 million tonnes
• Giving 16.544 million tonnes
• With penalty rate at $13.36 per tonne CO₂ ($10.5 escalated at 3.5 per cent per annum)
• Gives total cost at $221 million

8.  Penalties under the NSW scheme are subject to indexation;  annual inflation of 3.5 per cent is assumed.

9.  http://www.cei.org/gencon/005,04896.cfm.  See also Making Sense of Regulation -- 2001 Report of the US Office of Management and Budget to Congress. (p.3)

10.  About half of new European regulations now come from EU legislation.

---

Appendix:  NSW Retail License Requirement

	2003	2004	2005	2006	2007	2008	2009
Calc of Electricity Sector Benchmark
Emissions Benchmark (Tonne CO2 / capita)	8.65	8.305	7.96	7.615	7.27	7.27	7.27
NSW Population (k people)    Assumes 1% p.a.	6678	6752	6812	6880	6949	7019	7089
NSW Benchmark set by MEU (ktonnes CO2 eq)	57768	56076	54226	52394	50521	51026	51536
Calc of Total Emissions
Total Electricity Purchased Assume 2% increase	63,178	65,671	66,611	67,943	69,302	70,688	72,102
Emission factor	0.897	0.906	0.913	0.930	0.930	0.930	0.930
No Measures Emissions (ktonnes CO2 eq)	56671	59498	60816	63187	64451	65740	67055
Calculation of REC Surrender under MRET
Renewable Power Percentage	0.009	0.013	0.016	0.020	0.025	0.029	0.034
Number of RECS converted to CO2	499	744	967	1295	1602	1938	2302
State Gap (ktonnes CO2 eq)	1,596	2,678	5,623	9,498	12,328	12,776	13,217
Penalty under scheme ($tonne CO2)	10.50	10.87	11.25	11.64	12.05	12.47	12.91
total penalty cost ($millions)	-16.76	29.10	63.25	110.57	148.54	159.33	170.59
Total gap	-1097	3422	6590	10793	13930	14714	15518
NGAC proportion	1.45	0.78	0.85	0.88	0.88	0.87	0.85
MRET proportion	-0.45	0.22	0.15	0.12	0.12	0.13	0.15
Factor	0.31	0.28	0.17	0.14	0.13	0.15	0.17
credit for recs	499	744	967	1295	1602	1938	2302

The Electricity Industry in Australia: Problems Along the Way to a National Electricity Market

Chapter 6 of International Experience in Restructured Electricity Markets ⁽¹⁾

SUMMARY ⁽²⁾

In Australia prior to 1994 virtually all electricity was supplied through vertically integrated state monopolies.  Adecade later, the integrated monopolies had been disaggregated into different businesses with the competitive aspects of supply (generation and retailing) reconstituted into dozens of independent firms, many of them privately owned and the rest "corporatised" and operating at arms length from their government owners.  Monopoly aspects of supply are regulated by agencies independent from the jurisdictional governments.

The key milestones have been as follows:

Sequence of events:

• Industry Commission Report into electricity, 1991.
• Tasman Institute report on Victorian electricity corporatisation and privatisation, 1991.
• National Grid Management Council's National Electricity Market (NEM) Paper Trial, 1993/1994.
• Victorian Electricity Market was commenced on 1994.  This comprised six major generation businesses, a transmission business and five distributor/retailers.  Distribution regulated by independent body.  Market gradually opened to competition in 1995-2001.  Some price caps remain on household supply.
• Victorian electricity and gas privatisations 1995-1999.
• Competition Principles Agreement, 1995 (A$4.2 billion of Commonwealth funds were set aside for the period of 2005/2006 to implement electricity reform).
• New South Wales (NSW) Electricity Market, 1996.  Competitive arrangements were established that were similar to Victoria's.  Market opened to competition in 1996-2002 with some price controls on households remaining.
• Agreement on National Electricity Code, 1996.
• Start of NEM, 1998 with the National Electricity Code Manager and the Australian Competition and Consumer Commission (ACCC) setting rule changes at the national level and ACCC setting transmission prices.
• Queensland Electricity Market, 1998.  Market opened to competition in 1998-2004 except for households.
• South Australia privatisation, 2001.  Full retail competition phased in 1998-2003.
• Australian Energy Regulator (AER) (price setting) and Australian Energy Market Commission (AEMC) (Rule changes) commenced operation in 2005.
• Western Australia de-aggregation of supply but with the generation left within one business, 2005.

Outcomes of these developments have been reductions in prices, especially for commercial users, which were previously subject to Ramsey-type price gouging. ⁽³⁾  The reformed system has delivered increases in capacity in line with market needs and vast improvements in productivity and reliability across the industry.

Government interventions have, however, not been eliminated and continue to threaten the on-going orderly development of the market.  Among these potential market distortions are the ramifications stemming from state governments' ownership of over half of the industry.  Although all government businesses are corporatised and operate under company law, government ownership brings corporate inflexibilities and sometimes means political interference in key commercial decisions.

More generally, electricity remains an industry with a high political profile.  Federal and state governments see electricity supply and pricing as providing them a somewhat unique legitimacy to control.  At the very least, this brings distractions to the industry's entrepreneurship and there is ample risk of more serious consequences to the industry's efficiency.

1. THE MARKET BREAKDOWN AND SUPPLY PROFILE

1.1. THE MARKET PROFILE

Australian electricity demand is about 200,000 GWh/annum, which is transmitted along some 850,000 km of lines of which some 26,000 km is along circuits rated at 220 KV or more.  There are some nine million customers with demand being divided almost equally between households and industry.  Figure 1 illustrates this.

Fig. 1. Electricity consumption.Source:  NEMMCO.

The geographic spread of generation facilities and transmission and distribution lines is illustrated below.

1.2. THE FUEL PROFILE OF AUSTRALIAN ELECTRICITY GENERATION

Australia is fundamentally a coal-based electricity system.  Coal represents some 85% of electricity supply, roughly one third of which is Victorian and South Australian brown coal.

Hydro capacity is relatively small despite the large land area and is nearly fully developed.  Tasmania has further minor potential but green activism will prevent any substantial new development.  The share of hydro within total supply has, therefore, been falling to its current level of about 7%.

Gas has shown a modest increase growing from less than 2% of generation 15 years ago to 7-8% at present.  Much of this is in the least heavily populated states of South Australia, Western Australia and the Northern Territory where coal is more expensive.  Elsewhere gas mainly fills a peaking role due to its lower capital but higher fuel cost.

Figure 2 illustrates the fuel sources of electricity.

Fig. 2.Source:  ESAA.

Australia's eight States and Territories vary in size, with New South Wales and Victoria being the most populous and the two Territories, the city-state Australian Capital Territory and the vast Northern Territory each having populations of a few hundred thousand.  Most people live along some 4000 km of coastline from Adelaide in South Australia to Cairns in North Queensland.  This has resulted in a long, skinny interconnected grid:  the NEM.  The island of Tasmania is in the process of connecting to the NEM via a 600 MW undersea cable.  The only other significant population center, South West Western Australia, has its own grid, which is not economic to connect to the NEM.  The same applies for smaller isolated population centers such as the Northern Territory.

Each state has only one pricing node ⁽⁴⁾ that sets price for all customers and generators within that state.  Generally there is little transmission congestion within the states, and a moderate amount between the states - with "interconnectors" constraining ~5% of the time.  At these times, the regional prices diverge, sometimes by thousands of dollars per MWh, but very rarely for more than a few hours.

Queensland and Victoria are major net exporters of electricity via the NEM (to South Australia and New South Wales respectively) and New South Wales is also an exporter because it hosts the jointly owned Snowy Mountains Hydro-Electric facility.  Tasmania is hydro based and Basslink will allow Tasmania to export its hydro at times of high mainland prices and import baseload low-priced mainland-generated electricity at other times.

Figure 3 illustrates the relative size of the NEM States in terms of energy sent out.

Fig. 3.Source:  NEMMCO.

2. REFORMING THE STATE OWNED INTEGRATED UTILITIES

2.1. THE PROCESS OF REFORM

The development of a market for electricity got underway in the early 1990s and had three precursors:

• the recognition that other countries were achieving considerably greater efficiencies than Australia in electricity supply; ⁽⁵⁾, ⁽⁶⁾
• National Competition Policy (NCP) involving a general review of the operations of "essential facilities" (which were, in the main, owned by governments) and a requirement that they be opened to non-affiliates on reasonable terms;  and
• the consequences of poor financial circumstances in the States of Victoria and South Australia resulting in new governments which sold its energy assets partly in pursuit of a privatisation agenda and in part to reduce debt.

The State of Victoria initiated the reform process.  By the early 1990s the then Labor Government had commenced a process of reform particularly focusing on labor shedding in the monopoly supplier, the State Electricity Commission of Victoria (SECV).

A Liberal (Conservative) Government, which won office in 1992, set about a much more aggressive reform and privatisation process.  That Government had a strong philosophical belief in the beneficial effects that capital markets could bring to a business as well as being attracted to the idea of transferring risk to private equity.  However, the Government was equally determined to get the structure of the market right first.  In this, lessons were learned from the outcome of the structural weaknesses in the UK wholesale generation market, where the two dominant suppliers were able to operate so that prices remained high (See Newbery).  Great care was therefore taken to establish competition in supply with this being given a higher priority than maximising sale proceeds.  7500 MW of plant was privatised as seven generating companies with transitional prohibitions on re-aggregation.

For downstream supply, five distribution/retail businesses were created and transmission assets were vested in a single business.  An independent regulatory framework, the Office of the Regulator General (ORR) later renamed the Essential Services Commission (ESC) was put into place to set prices on the monopoly network assets.  This body also gathered performance data that would prove invaluable in defusing claims that privatisation had led to higher prices and lower reliability.

The program for reform was a challenging task.  Not only did it involve the need to establish a regulatory framework, in which Australia had no experience, but also because the reform process faced considerable hostility from the unions, the Labor opposition and much of the media.  However by the time of the Liberal Government's fall in 1999, the electricity industry had been privatised and assets transferred to seven generation businesses, five distributor/retailers plus a transmission business.  There has since been some merger rationalisation as well as some new entry.  The sale process earned A$23 billion, far more than the $9-10 billion that was widely expected.

The gas industry's downstream assets were also privatised;  gas production was always privately owned.

The fully privatised Victorian electricity and gas industry has three main retailers (CLP Power's TRUenergy, Origin Energy, and AGL), four distribution businesses (CKI-Powercor, Alinta, AGL, and SPI), a single transmission business (SPI) and five major generators (International Power, CLP Power's TRUenergy, Loy Yang Power, Ecogen, and Southern Hydro).  There have also been significant new entrants into the competitive generation and retailing businesses.

South Australia, which is only one quarter Victoria's size in terms of customers, privatised its industry (in 1999 and 2000).  Its previous government monopoly supplier had been the ETSA Corporation.  As in other jurisdictions, ETSA's disaggregation preceded the industry's full privatisation.  There is now one distributor, the CKI owned ETSA Utilities and one transmission company, ElectraNet.  Only one retailer was created at privatisation, which AGL bought, however there has been significant new entry.  Privatised generation is owned by International Power, NRG, and TRUenergy.  AGL and Origin built significant new generation capacity early this decade.

In Queensland, the Queensland Electricity Commission (QEC) was a vertically integrated organisation responsible for virtually all electricity supply and was disaggregated in several steps into separate distributor/retailers, a single generation business and an SPI.  In 1997 a further progressive disaggregation took place which has resulted in the present industry profile comprising government ownership of two main distributor/retailers (Energex and Ergon), a transmission business (Powerlink) and four generation businesses (Enertrade, CS Energy, Stanwell, and Tarong Energy).  There is also private ownership of generation including Intergen and NRG.

The New South Wales Government's prior ownership of the integrated Electricity Commission has undergone several iterations of disaggregation but the separate businesses remain under government ownership.  Individual suppliers include four distributor/retailers (Energy Australia, Integral, Country Energy, and Australian Inland) a transmission business (Transgrid) and three coal-based generation businesses (Delta Electricity, Macquarie Generation, and Eraring Energy).  There are also two smaller private generators and the Snowy Hydro jointly owned with the Victorian and Commonwealth Governments.  The Commonwealth, NSW and victorian governments, which jointly own Snowy, announced in early 2006 that they are to privatise it.

The other jurisdictions have also disaggregated their formerly integrated industry but Tasmania (which will be linked to the mainland grid in 2006) and Western Australia have retained government ownership.

The major ESI businesses and their ownership are shown in Table 1.

Table 1. Major Australian electricity supply businesses.

	Ownership	State of operations
Major generators
Macquarie	NSW government	NSW
Delta	NSW government	NSW
Snowy	NSW, Vic federal governments	NSW, Vic
Eraring	NSW government	NSW
TRUenergy	CLP	Vic, SA
CS energy	Qld government	Qld
Loy Yang	AGL, Tokyo electric and others	Vic
Intergen	International consortium	Qld
Tarong	Qld government	Qld
NRG flinders	NRG	SA
International power	International power	SA, Vic
Stanwell	Qld government	Qld
Origin	Australian private	Vic, SA, Qld
Ecogen	International consortium	Vic
NRG Gladstone	NRG, Comalco	Qld
Hydro Tasmania	Tas government	Tas
Southern hydro	Meridian energy	Vic
Enertrade	Qld Government	Qld
Major transmission
SPI	Singapore power	Vic
Transgrid	NSW government	NSW
Powerlink	Qld government	Qld
Electranet	public private consortium	SA
Major distribution
AGL	Australian private	Vic, SA
Alinta	Australian private	Vic, WA
Aurora	Tas government	Tas
Citipower/Powercor/ETSA	CKI	Vic, SA
Country	NSW government	NSW
Energex	Qld government	Qld
Ergon	Qld government	Qld
energyAustralia	NSW government	NSW
Integral energy	NSW government	NSW
SPI	Singapore power	Vic
Major retailers
AGL	Australian private	Vic, SA
Aurora	Tas government	Tas
energyAustralia	NSW government	NSW
Integral energy	NSW government	NSW
Country	NSW government	NSW
Energex	Qld government	Qld
Ergon	Qld government	Qld
Origin	Australian private	SA, Vic
TRUenergy	CLP	Vic, SA

Overall Australia's ESI remains mainly under government ownership as illustrated in Figure 4.

Fig. 4.Source:  ESAA

2.2. THE NATIONAL SETTING FOR ELECTRICITY MARKET REFORM

The Victorian disaggregation and privatisation took place as a result of financial pressures and pro-competition/privatisation views that were especially prevalent in that state.  In the case of other states, the reforms followed on a program of NCP, agreed by the state and Commonwealth Governments in 1996.  This was given expression in a new provision of the Trade Practices Act, Part IIIA, an important provision of which required essential facilities to be opened to competition, clear structural separation for the competitive and monopoly parts of integrated businesses and, where practicable, non-natural suppliers were to be divided into rival businesses.

The competition policy reforms called for natural monopolies to be opened to all users on terms that were fair and reasonable.  Provisions were made to ensure that regulatory arrangements were put in place to determine where such access was required and, in the event of disputes, the prices at which the access was to be made available.  Far and away the most important monopolies over essential services were those of governments themselves - in addition to electricity and gas they included ports, airports, rail, and telecommunications.  Indeed, the government owned or controlled businesses were the only ones that in practice had the integration and monopoly characteristics that required the regulatory control. ⁽⁷⁾

2.3. MARKET GOVERNANCE

The national market was devised jointly by the state and Commonwealth governments and refined and approved by the national regulator, the ACCC.  It originally envisaged two bodies:  the National Electricity Code Administrator (NECA) and the National Electricity Market Management Company (NEMMCO) being responsible respectively for the market rules and the market scheduling and planning matters.  In the event, the confluence of the electricity market developments and NCP meant that the national regulatory body, the ACCC had to have a role in approving market rule changes because of the inherent monopolistic "collusion" that the NEM entails.  The ACCC also was given the role in setting prices for the transmission lines and for gas transmission and the market code for gas.

In addition, state regulators were put in place to set prices for the distribution lines so that in all there were some 12 bodies involved in economic regulation of the industry.  Also, there were Ministerial Councils that set agenda issues and generally sought to influence the market.  Fortunately, inconsistencies in decisions from such a plethora of regulatory bodies was not as serious as it might have been since there were strong liaison relationships forged through an informal "Energy Regulators' Forum".

Even so, the process of National Electricity Code change was proving somewhat unwieldy with each proposal being examined first by NECA and then by the ACCC.  New arrangements were agreed in 2005 that introduce a rationalised control of the industry so that the AEMC is responsible for market rules for both gas and electricity and the AER is responsible for policing the rules and for network price setting at all levels of supply.  NEMMCO's functions (as Market/System Operator) remain as those of the ACCC, which also has common staff with the AEMC and AER, with regard to control of mergers and monopolies.  It is, of course, uncertain that the changed arrangements will prove more workable especially as there are statutory requirements for these bodies to follow the policies established by the collective state and federal governments.

The AEMC is responsible for rule making and market development.  The rule-making role does not involve initiating changes to the Rules other than where the change involves correcting minor errors or where the change is of a non-material nature.  Rather, the role involves managing the rule change process, and consulting and deciding on rule changes proposed by others.

In regard to its market development function, the AEMC conducts reviews at the request of the Ministerial Council on Energy or at its own volition on the operation and effectiveness of the Rules or any matter relating to them.  In doing this, the AEMC relies on the assistance and cooperation of industry relationships and interested parties in its decision making.

2.4. STRUCTURAL DEVELOPMENTS

At the onset of both the Victorian and the later National Market rules, the provision implementing structural separation of generation, transmission and distribution/retailing contained no specific long-term measures to prevent re-aggregation.  This was because there were no firm views as to the most productive structure of the industry, only that the previous state owned integrated monopolies were not optimal.

Although retailing and distribution were sold as combined units, they were to be "ring fenced" to prevent the distribution business favoring its affiliate.  The ring fencing has generally proved satisfactory.  Not only have incumbent affiliates not been favored but new retailers have entered the market and all five of the original Victorian host distribution business/retailers now have separate companies handling the two activities. ⁽⁸⁾  This reflects the very different types of business involved.  Retailing involves strong marketing and risk management skills in assembling and promoting packages of supply, while distribution is much more concerned with maintaining and reducing costs of an established business.  Two of the three major retailers, Origin and TRUenergy, no longer are affiliated with a distributor.  Their disaggregation was driven by a search for improved shareholder value whereby different types of business can appeal to different types of investor.

There has also been a trend towards an unexpected form of re-aggregation.  This has not been to restore monopolistic supply, which in any event would be combated by general anti-trust laws administered by the ACCC.  Instead, all the privatised retailers and many of those remaining in government hands have moved to acquire some generation of their own.  Also, Snowy Hydro and several privatised generators have created retail arms.  These developments are a function of the need that generators and retailers see to manage risk.  Risk management strategies that firms have employed, cover a gamut from different forms of contracting through ownership of supply.  Seeking some control over their supply (for retailers) or customers (for generators), is a risk management strategy that follows from the wholesale price shifts to which electricity is now subject.

Early concerns that retailer and generator amalgamations would lead to monopoly power and market inefficiencies have tended to abate as a result of evidence that competition is bringing lower prices and retail churn.  The generator-retailer re-aggregation that has occurred has not been anti-competitive.  The fact is that electricity retailers like other firms that assemble supplies sourced from affiliated and non-affiliated businesses are forced by market circumstances to ensure that the affiliates are not favored.  The risk of high-price occurrences are too great for electricity retailers to gamble on fulfilling most of their needs in-house and the costs of alienating other sources by unprofessional behavior far outweigh any short-term benefits possible through collusion with in-house suppliers.

2.5. RETAIL PRICE CONTROL AND COMPETITIVE CHURN

Retail was a part of the electricity industry envisaged as being contestable and requiring no more regulation than is found in other retail activities.  Given its relatively small share of aggregate revenue, retail was also envisaged as being only a minor actor within electricity supply.  However, retailing's importance has been re-assessed.  In a competitive situation retail, as the interface with the consumer, drives efficiencies by signaling demand shifts and eroding cross-subsidies.

For businesses, full retail competition has been extended to all but the smallest customers and in the four major eastern states probably half the commercial load has shifted from its original retailer.

Governments have been more cautious about deregulating household supply.  In NSW, South Australia and Victoria, retail competition at the household level has been accompanied by maximum prices that make it less attractive for retailers to poach customers.  Nonetheless there has been a quite considerable churn rate - some 16% in NSW, 42% in South Australia and 44% in Victoria after 3 years of open competition. ⁽⁹⁾, ⁽¹⁰⁾

In Queensland, Tasmania and Western Australia households are captive to their host retailers which are all owned by the respective state government.  In Queensland, household rates are fixed and managed so that Brisbane subsidises the provincial areas.  The Brisbane-based supplier is levied a surcharge which is passed to the supplier of provincial areas.  The cross-subsidy would be placed under considerable pressure with full retail competition (See Haas in this volume) and the electoral implications of this present the main barrier to the Queensland Government allowing full retail competition.  In September 2005, the Queensland Government announced that full retail competition, albeit with a regulated price cap, would be introduced in 2007.  Table 2 shows the timetable for retail competition by state and user tranche.

Table 2. Timetable for retail competition.

	Date for eligibility	Site thresholds	Estimated number of customers	Percentage of total energy
New South Wales	October 1996	≥40 GWh	47	14
	April 1997	≥4 GWh	660	29
	July 1997	≥750MWh	3560	40
	July 1998	≥160MWh	10,860	47
	January 2001	≥100MWh	19,000	49
	July 2001	≥40MWh	53,000	53
	January 2002	All sites	3,000,000	100
Victoria	November 1994	≥5MW	47	23
	July 1995	≥1MW	380	29
	July 1996	≥750MWh	1900	41
	July 1998	≥160MWh	6900	49
	January 2001	≥40MWh	N/A	N/A
	January 2002	All sites	2,100,000	100
Queensland	March 1998	≥40GWh	80	16.0
	January 1999	≥4GWh	540	15.0
	January 2000	≥200MWh	8110	15.0
	1 July 2004	≥100MWh	7890	8.0
South Australia	December 1998	≥4GWh	160	30.0
	July 1999	≥750MWh	760	40.0
	January 2000	≥160MWh	3360	50.0
	January 2003	All sites	720,000	100.0
Western Australia	July 1997	10MW	N/A	N/A
	July 1998	5MW	N/A	N/A
	January 2000	1MW	120	N/A
	July 2001	230KW	450	N/A
	January 2003	34KW	2550	N/A
	January 2005	50MW	10,000	N/A
Tasmania	July 2006	20GWh	10	N/A
	July 2007	4GWh	54	N/A
	July 2008	750MWh	295	N/A
	July 2009	150MWh	1030	N/A
	July 2010	All customers	230,000	N/A

2.6. OTHER FORMS OF RETAIL REGULATION

On top of price safety nets, the Labor state governments have all imposed their social and green policy objectives via retail regulations for domestic customers.  This has resulted in a considerable mish-mash of compliance requirements for retailers selling to small customers and reduced the potential for competition.

From the social policy side we have seen prohibitions on pre-payment meters and latepayment fees supposedly in the interest of protecting the poor.

From the green side we have seen irksome rules like requiring minimum area allocations on retailers' bills for graphs on usage and implied carbon release.  More significant are the requirements on retailers to source different percentages of variously defined green power within their aggregate supply.  This is addressed in Section 7.

2.7. CONTROL OF TRANSMISSION

Each State has one transmission owner but the planning models are inconsistent.  In Queensland, NSW and Tasmania, the transmission owner itself is responsible for planning.  In Victoria, a government agency, VENCorp, is responsible for planning the network and SPI owns and operates the assets, whilst South Australia has a hybrid model.  SPI in Victoria is unique in that it acquired assets formerly owned by TXU so that it now also owns part of Victoria's distribution network.

A centrally planned provision of transmission was the basic model adopted from the outset.  However, it was also recognised that transmission and new generation are alternatives.  If transmission is provided free or at regulated prices this may discourage a more rational and lower cost development of new generation.  The trade-off between nearby and remote generation (via transmission) is uniquely critical for Australia, where distances between load centers and therefore the cost of transmission are very large, and fossil fuel sources are relatively inexpensive and quite widespread.

This led to provision being made for entrepreneurial interconnects in the National Electricity Law.  And Transenergie, a subsidiary of Hydro Quebec, built two of these entrepreneurial links where transmission links were less than robust.  Transenergie sought to finance these links by selling generators' access rights to markets and by itself arbitraging price differentials.  This merchant transmission gave rise to issues concerning the circumstances under which a regulated augmentation of links should be permitted.  Along series of hearings on a regulated link between South Australia and New South Wales resulted in stalemate, with the NSW government transmission business (Transgrid) apparently abandoning its proposal, possibly because NSW is not envisaged to have a generation surplus in future years. ⁽¹¹⁾  In the event, the merchant links in Australia could not compete against the links receiving a regulated return and have applied for and been given regulated status. ⁽¹²⁾

The danger is that links which are financed by a compulsory charge on the customer, might lead to incentives to site generation in places that are distant from major markets.  If someone else is paying for transmission, the rational generation business will be indifferent to its costs thus distorting the efficient trade-off transmission costs and generation costs.

It is argued that the externalities are too great to allow profitable merchant transmission since the benefits of lower prices (actually arbitraged prices) accrue to all and not only to those paying for the asset.  However, this is not markedly different from the situation concerning a new generation facility, which will tend to suppress the price of all delivered electricity in its interconnected region.  Few would argue that by analogy all generation should therefore be government owned or subsidised even though many argue for a form of general overhead support in the form of capacity payments.  The fact is that supply across the economy is seldom unaccompanied by some externalities.

Associated with the claim that transmission would be inadequately provided in the absent of it being made subject to regulated support, is the contention that a transmission line has market power and its prices should be regulated.  However, for the most part, transmission inter-ties or inter-connects offer no more market power than that of a significant generator portfolio.  Inter-ties in Australia can account for some 35% of supply (Victoria to South Australia) but normally provide much less than this.  Their market power is confined to influence over those wishing to export and such firms are normally capable of writing contracts to cover and vulnerabilities they foresee.

Issues on how best to allow expansion of transmission, especially in terms of the regional linkages has been subject to heated debate in Australia.  An uneasy compromise is presently in place for transmission under which regulated links will be permitted as long as a net market benefit is judged by the regulator to be the outcome and as long as the proposed link is the best of a range of feasible alternatives.  This, however, remains dissimilar from the decision making structure that is seen in the generation sector or in markets more generally since it may incorporate some to the network benefit externalities which an comparable investment in a new generator would not capture.

The competing solutions that generation and transmission often offer mean disputes about the merits of a new transmission solution are likely to remain.  These may be exacerbated since the Queensland Government has encouraged new government owned capacity to be built in that State, driving down prices below those in NSW and is seeking to augment transmission links.  Other states regard this as facilitating dumping and are opposing to having expanded capacity financed as a regulated link since most of the costs fall directly on consumers.

These considerations have been further complicated by the growth of subsidised wind generation.  Wind power is always likely to be relatively dispersed and remote and, in addition to production subsidies, its sponsors have already extracted concessions from some governments that smear its transmission costs.  Over a thousand MW are planned in South Australia where conventional capacity is only 3000MW.

2.8. NETWORK PRICE SETTING

The ACCC is responsible for setting prices for electricity transmission lines (as well as those of gas).  Local State regulators at the present time are responsible for setting distribution prices.

The price setting process has assumed a vast complexity as the regulator and the businesses each hire accountancy and economics advice to determine the appropriate prices.  Regulated businesses are never likely to express satisfaction with the determinations of a regulator, but for the most part over recent years the outcomes have been more predictable and less contentious.  There remains the risk that price cuts can induce sub-optimal investment.  In Victoria, following a price reduction on distribution businesses averaging 15% in 2001 further real price cuts averaging 14-26% are proposed for 2006 when the businesses claim that all the fat was cut out in the first price re-set.

In the case of gas transmission emerging competition is generally to be seen across the country.  In spite of this, the ACCC has been seeking to maintain its regulatory powers and its decisions have been at variance with those of the market itself.  Both the Minister for Energy, ⁽¹³⁾ who has review powers over certain ACCC decisions, and the Productivity Commission, ⁽¹⁴⁾ the advice of which has been sought by the government, have suggested that the ACCC's powers be curtailed somewhat where, as is evidenced with gas, competition is itself providing adequate market disciplines.

The danger of a regulator setting transmission prices too low is that this will result in inadequate new investment.  Setting prices too low on existing network facilities (transmission and distribution), irrespective of any general provisions that are in place to maintain quality, will also result in inadequate maintenance.  A claimed outcome of mandated price cuts by the Queensland regulator was a series of blackouts in 2004.

On the other hand is the risk of setting regulated transmission returns too high.  Where these are provided by compulsory charges there is likely to be over-building with the previously discussed adverse impacts on alternative, more efficient solutions like additional local generation capacity.  This has been foreseen in the NEM Code which has provisions for rationalising redundant facilities.  These however are difficult to activate.

3. OPERATIONS OF THE NATIONAL MARKET

3.1. THE SPOT AND CONTRACT MARKETS

The Australian National Market is underpinned by a "gross pool" system under which all major suppliers must bid.  There is no capacity payment system and the market for energy is linked and simultaneously cleared to eight separate markets for reactive power and other "ancillary services".

Although virtually all power must be bid into the pool (a major exception being wind power, which must be taken as it comes) few customers or suppliers would find it prudent to rely solely on pool prices.  In effect the market is now a multiplicity of bilateral contracts between generators and retailers, usually in the form of contracts for difference, strongly underpinned by the "gross pool".  Essentially the NEM is a one-way market with the demand emerging from whatever end-users require and with supply being offered by generators at different price levels.

Through the pool, all supply is paid the same price, that of the highest bid supply that is dispatched.  In the short term, generators are relatively indifferent to the price of that part of their supply for which they have contracts (probably 90% plus of the market) and will usually bid close to their marginal costs for this part of the load. ⁽¹⁵⁾  Compared to a price norm of about $A30/MWh, at present prices can rise to as much as $A10,000/MWh which makes retailers especially keen to be fully contracted or to manage spot exposure through ownership of peaking capacity.

A complex National Electricity Code controls the rules under which generation and transmission are placed on the market.  Generators bid in a maximum of 10 price bands and although there are restraints on price re-bidding, there are none on shifting energy between different price bands meaning, in effect, that prices can be changed at any time prior to 30 seconds of dispatch.  Each generator has controls built into the dispatch algorithm covering ramp rates and minimum loads.

Loads can also bid to be offloaded though few do.  In some cases this is due to lack of "smart" metering though it is likely that only those users, for example smelters, who have energy as a very large share of their aggregate costs would consider it worthwhile to make savings by shutting down and re-starting.  It is an assumption of those calling for mandatory roll-outs of smart meters that this will markedly influence household behavior.  It is, however, likely that any such influence would be in the form of contracts that suppliers arrange with households for automatic partial disconnect for short periods.  How prevalent these will be is open to conjecture.

As an insurance against inadequate capacity, there is a (supposedly temporary) provision for a "Reserve Trader".  This entails NEMMCO seeking additional supply offers (or demand side offers) in the event of it determining that a shortfall will occur in forward supply.  Such a shortfall would be determined from forecasts of maximum capacity 2 years ahead that generators are required to provide, forecasts that are married to NEMMCO's own demand forecasts.  Under current standards, which are a combination of N-1 and unserved energy standards, NEMMCO is required to ensure 850 MW of reserve is carried across the entire NEM - including during the periods of extreme demand - to provide the required level of supply reliability.

Though the Reserve Trader provisions have in fact been used, they have an intrinsic deficiency in that they simply call forth supplies that are available in any event.  No government body would contemplate building additional capacity solely for reserve purposes.  Reserve Trader capacity, therefore simply adds to costs unless the market manager has superior prescience to the various market participants.  This is because, absent the government intervention, to the degree that supply shortfalls emerge, prices will be driven up and suppliers have every incentive to make plant available that was formerly mothballed, due for scrapping or being restrained to economise on maintenance.

Moreover, a Reserve Trader policy carries seeds that can distort the entire market.  If the Reserve Trader is in place and is offering higher prices than those anticipated by market participants, a rational generator will withdraw capacity thus exacerbating the apparent future shortfall.  If such actions were to snowball, there would be a progressive increase in the apparent shortfall and an increasing need for the authorities to contract outside of the normal market, thus undermining it.

3.2. MARKET INTEGRATION:  ACCESS TO TRANSMISSION

Although Australia does not have a nodal pricing system, there are procedures in place that in principal, lead to new regions being created when areas are islanded with significant price separation for more than 40 hours/year.  However, political pressure has prevented new regions being created, notably in Queensland where the entire state remains a region in spite of considerable transmission weaknesses between the populous south east of the state and the northern parts.

Loss factors for transmission and capacity constraints mean that there may be significant differences in the spot price for any trading interval across NEM regions, though market separation rarely occurs for more than an hour or so.  Once a region is created, inter-regional settlements are auctioned.

These settlements represent the difference between the value of electricity in the region where it is generated and its value if sold in another region.  The settlement residue that accumulates is made available to the market by the conduct of an auction.  Holders of this auctioned revenue value have a form of hedge that contributes to facilitating inter-regional trade by providing market participants a risk management mechanism as protection against high prices.  The risk is however not eliminated since if the link constrains, revenues are not able to benefit fully from high prices in one region because of volume shortfalls.

3.3. ISSUES CONCERNING GENERATOR MARKET POWER

Market supplies in Australia have on the whole been sufficiently disaggregated to prevent monopolistic power to be exercised other than on a transitory basis.

In the interconnected NEM of six regions, the largest generation business has only 14% of the market and two other businesses each have over 10%.  Concentration is somewhat greater in individual regions and these sometimes have constrained interconnects.

Three businesses have 10% or more of the national market's capacity (one of which, Snowy, is a hydro generator with the maximum annual output equal to about one quarter of capacity).  A further 11 businesses each have 2-8% of the capacity market while a host of smaller suppliers collectively account for about 10% of the market (Fig. 5).

Fig. 5.Source:  NEMMCO.

In some states the capacity is more concentrated.  Thus, NSW has three baseload generators (all government owned) controlling 70% of capacity and it is claimed that they have used market power on occasion to ensure that the mandatory insurance system for retail prices created by government regulation (and discussed in Section 7) does not accumulate income.  NSW market shares are shown in Figure 6.

Fig. 6.Source:  NEMMCO.

In addition to this level of market supply, there are two transmission links from Queensland, theoretically rated at a combined 880MW.

In Victoria and South Australia, which have strong transmission capacity links with each other, the market supply includes that which can be transferred through Snowy either from the hydro facility itself or from NSW power suppliers.  As from early 2006 a further transmission connection from Tasmania will operate with a capacity of 300 MW into Victoria and 630MW into Tasmania.  Even though CLP has over 30% of the capacity, there are several other powerful suppliers and there are few concerns about abuse of market power (Fig. 7).

Fig. 7.Source:  NEMMCO.

The fact that there is so much flexibility in bidding under the Australian system has contributed to unease in certain quarters that price oscillations have been due to supplier market manipulation.  Of course, such price oscillations have always been present - they are inevitable because of the wide and sometimes rapid variations of demand (and occasionally supply).  They were masked in the past because the monopoly provider called in higher merit order plant to cover peaks or sudden needs without this actually being specifically priced.

The sharp oscillations in price now visible have led to claims that the generators are unfairly "gaming" the market, driving up prices to take advantage of opportunities in which there is a monopoly.  A lengthy series of investigations into the structure of the bidding rules was underway between 1999 and 2002.  Similar debates were held in the UK and other countries.

In the event there was recognition that temporary market power is common to many industries and that attempts to combat it by fixing or constraining prices could exacerbate the underlying conditions that create it.  Thus an ability to earn very high prices from being able to react quickly to opportunities or provide capacity in an area that can become islanded and subject to sudden price surges/supply shortfalls tends to encourage desirable investment behavior.  Requiring a window of several hours between bid and dispatch would frustrate this.

By the same token, preventing firms from reacting quickly to cover their contracts in the event of an unexpected outage is likely to result in over-cautious holding back on capacity and higher costs.  The abandonment of proposals to place restraints on re-bidding close to dispatch was influenced by observations that most of the very late changes to price in the market had been price reductions.  These reflected decisions by marginal suppliers to bring plant on line in response to market opportunities that were unfolding (due to a demand surge, network constraint, etc.).

Following the various investigations into market power, changes to the Code were made to recognise the possibility that a supplier could bid erratically and benefit from creating great instability to the market. ⁽¹⁶⁾  Hence rules were tightened to require some explanation of re-bidding behavior.  These changes were more of the nature of increased insurance against aberrant bidding behavior rather than affecting bidding patterns themselves.

3.4. PRICE OUTCOMES IN THE WHOLESALE MARKET

The resiling from major changes to the market rules was made more acceptable in view of the very low prices that had on average prevailed in the market.

Compared to a notional wholesale price pre-market of around $A38/MWh in Victoria and $A40/MWh in NSW, competition has maintained average prices at low levels, below $A35 for most of the period.  Higher prices prevailed early in the Queensland and South Australian regions as they were being bedded down.  Table 3 illustrates the price developments in each of the regions.

Table 3. Average price ($A/MWh).

Year	NSW	QLD	SA	SNOWY	TAS	VIC
1998-1999	33.13	51.65	156.02	32.34		36.33
1999-2000	28.27	44.11	59.27	27.96		26.35
2000-2001	37.69	41.33	56.39	37.06		44.57
2001-2002	34.76	35.34	31.61	31.59		30.97
2002-2003	32.91	37.79	30.11	29.83		27.56
2003-2004	32.37	28.18	34.86	30.80		25.38
2004-2005	39.33	28.96	36.07	34.05	190.38	27.62
2005-2006 (2 months)	26.68	19.48	32.36	27.33	110.63	28.61

Source:  NEMMCO.

In addition, the forward price has tended to be stable, though edging up beyond the $A40 level by the end of the current decade, indicating a need, though not a pressing one, for new plant since at such prices new coal-based plant investment is profitable in Queensland, NSW, and Victoria.  A synthetic forward price is published with the following indicative price for baseload energy (Fig. 8).

Fig. 8. Forward baseload price.Source:  NECA.

4. PERFORMANCE OF THE REFORMED ELECTRICITY MARKET

4.1. GENERATION

The outcome of Australia's reforms has been considerable improvements in productivity.  In the case of power stations, increases in labor productivity since 1990 have ranged from a fivefold improvement in Victoria to a 50% improvement in Queensland, where it is generally acknowledged that power stations were operated more efficiently at the outset.  Although there has been some new construction, the stock of generating capacity has not markedly changed over the period.  Figure 9 illustrates the improved productivity.

Fig. 9.Source:  ESAA.

In spite of these vast improvements in labor productivity, Australia's power stations have also shown much greater reliability.  As illustrated in Figure 9, the "Availability to Run" has improved in all of the States but especially in NSW and Victoria.  This in itself has raised the de facto capacity of the industry.

The comparisons indicate a relatively better performance on the part of those states that have privatised their businesses.  In the privatised Victorian and South Australian systems, labor productivity has respectively increased fourfold and threefold.  NSW with its government owned generation business and Queensland, under predominantly government ownership, have seen more modest increases - twofold in the case of NSW.  In terms of labor productivity and plant availability, the privatised Victorian system now surpasses the performance of the state owned NSW system.  This is in spite of Victoria having the disadvantage of relying predominantly on brown coal, which requires greater processing before being burned than black coal, which is the fuel source of the NSW system.

Part, but by no means all of the relative Victorian improvement is due to greater use of contractors in the privatised firms.  Moreover, to the extent that NSW uses fewer contractors this is likely to be a reflection of its shareholder's preferences for union labor and would contribute, of itself, to lower levels of efficiency.

There is also some indication of improved capital productivity in the privatised businesses.  In particular, privatisation brought a new lease of life to International Power's 1600 MW Hazelwood brown coal generator in Victoria.  The station had been previously scheduled to close in 2005 but has had its capacity increased and now likely to operate for another 20 years.

4.2. DISTRIBUTION

As with generation, distribution, which accounts for over 40% of final costs, has shown strong productivity improvements.  Figure 10 shows that customers per employee in Victoria and NSW have almost doubled and all states, bar Queensland, have shown impressive gains.

Fig. 10.Source:  ESAA.

Again Victoria shows impressive labor productivity (the Western Australian system applies only to the interconnected, relatively urbanised system).

In terms of outages the system performance has been mixed - in most areas outages are heavily influenced by occasional severe storms that do not occur with any degree of regularity.  Figure 11 below indicates that outages have generally remained low and shown little trend, except in Victoria where they have been reduced and become comparable with outages in other states.

Fig. 11.Source:  ESAA.

4.3. CONSUMER PRICE OUTCOMES

Price level comparisons are distorted by the previous, and for households to a major degree on-going, regulation of maximum prices.

Household retail price controls have suppressed prices in all states, though in recent years price controls have been eased or been allowed to rise in response to regulated increases permitted in line charges.  This is especially the case in South Australia, where electricity costs are intrinsically higher than in other states and where the load profile is more skewed towards the summer peak than in other states.  Household consumers' prices in NSW and Queensland remain under relatively tight government control and are below those that would prevail in a commercial market.

Over the past 7 years real prices for residential consumers have risen by as little as 9% in NSW and as much as 52% in South Australia.  Those in Victoria have risen by 15%.  As expected from a system with access to low-cost energy inputs, Australian prices remain among the lowest in the world.

Business customers have been freed from price controls for several years.  In the past, the business customers subsidised household customers but once the market became contestable this was no longer possible.  As a result, real prices for business customers have fallen by over 23% in the three eastern states;  they have risen about 2% in South Australia.

Figure 12 below illustrates the trends.

Fig. 12.Source:  ESAA.

5. ISSUES CONCERNING PUBLIC AND PRIVATE OWNERSHIP

The post 1990 period in Australia has seen dramatic improvements in the productivity of the ESI.  Initially these strides were made under public ownership with reform of the over-staffed integrated utilities and their incorporation under company law.

A further productivity improvement took place with the privatisation of the Victorian industry from 1997.  State owned businesses generally adopted many of the labor saving and production enhancing measures of their private sector counterparts.  However the fact that the Australian industry remains mostly under public ownership carries several potentially damaging consequences.

The first of these is the intrinsically greater incentives to save on costs that are present in privately owned businesses.  Part of this may be due to government as the shareholder and appointer of the company boards, is more reluctant than a private company to shed labor;  allied to this is close links that the Australian State Governments owners of the electricity businesses have with trade unions.  This means they are reluctant to allow non-union labor and keen to ensure that union rights and privileges are maintained.  In the main this will reduce the capacity of the managements to manage.  The evidence available in Figures 9-11 indicates that the efficiency levels of the private sector businesses exceed those of the public sector firms.

Public ownership also impedes firms from re-arranging their assets.  All of the private sector businesses post-privatisation have undergone several structural changes as parts of them have been spun off, other parts have been augmented and some have undertaken major new investments.  Private sector businesses, in search of operational economies and improved shareholder value have re-arranged asset ownership so that activities are better grouped together.  In the case of the distributor/retailers, this has led most of the private sector to have the two functions separated and housed in differently owned firms, whilst none of the public sector businesses have taken such steps.

The public sector businesses need to approach their government shareholder for approval of any new capital investment.  These decisions face the familiar issues of government decision taking.  In New South Wales for example, the State Government has adopted an anticoal philosophy on greenhouse grounds (in June 2005 the "ecologically friendly" then State Premier even opened up the debate on nuclear generation, a debate that had been dormant due to opposition by green groups and because cheap coal offers a more economic baseload solution).

By contrast to the NSW Government's restraint on new investment, it is claimed that the Queensland State Government is accepting a lower than commercial rate of return in order to encourage the building of new power stations.  It is certainly the case that most new capacity has been built in Queensland and about 60% of this has been government financed but Queensland also has the fastest growing load and has the cheapest coal.  In this respect, data for Queensland (Table 3) shows spot prices were one third less than in NSW in the early part of 2005/2006.  This may offer some corroboration of the over-build of generation in the State;  however, the spot market data does not appear to be reflected in higher contract prices (Fig. 7).

Whether or not Queensland new generation investment has been fully justifiable on profit grounds, public ownership adds a non-commercial dimension into the industry which diminishes the predictability of private firms' competitive environment.  Other things being equal, this brings additional business risk, excessive conservatism and higher prices/lower reliability.

6. GOVERNMENT MARKET INTERVENTIONS

6.1. MANDATORY INSURANCE SCHEMES

Public ownership leaves governments with greater political vulnerability in the event of poor decision making.  Hence decisions by both the NSW and the Queensland Governments to implement a form of mandatory insurance for the supplies to household retail customers.

This, called the Electricity Tariff Equalisation Fund (ETEF) in NSW, tends to blunten the market forces through reducing apparent retail risk by having the government assume much of it.  One outcome is price suppression, especially for peaks, and a muted demand signal for new investment.  ETEF operates by placing a ceiling and floor on wholesale prices as they impact on the household part of the aggregate load.  When prices are high the generators receive only the stipulated price and reserves are accumulated in the fund;  these are released when spot prices are below the floor set for the fund.  As well as creating an insurance risk for the state, it is likely that such measures also impede the market for various financial instruments, the depth of which in NSW lags considerably behind Victoria.

Although having similar features, the Queensland scheme, called the Long-term energy procurement or (LEP), has been designed with the aim of increasing liquidity and market depth by encouraging the incumbent retailers to actively seek contract cover for the franchise load.  That is, the structure of the LEP is such that the incumbent retailers are exposed to energy price and volume risk and have incentives to manage their position through contracting, with compensation provided for efficient purchasing against a benchmark.

6.2. RETAIL PRICE CONTROL

Retail prices to business consumers have been deregulated in all states but all retain some controls over household prices.  In the case of Victoria and South Australia, these controls are not considered to be significantly in excess of underlying market prices, and in both states there has been significant customer churn.  This is also true to some degree of NSW and to a lesser extent in Queensland.

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 ESI.  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.  Even so, the residual retail price controls dampen the economic signals that businesses need to determine the optimum time to invest or undertake other strategic decisions.

6.3. GREENHOUSE GAS ABATEMENT SCHEMES

Australian coal is inexpensive and located conveniently to major electricity loads.  However, its economics change markedly in a Kyoto constrained electric power future, whether the measures in place to reduce carbon dioxide emissions are a form of cap and trade regulation, a carbon tax or even a more arbitrary set of regulations that have similar effects.

Australian measures ostensibly aimed at reducing emissions of carbon dioxide appear in many forms and are inconsistent from one State to another.  They impact most heavily on coal, Australia's lowest cost energy source and include:

• the federal government's mandatory renewable energy target (MRET),
• the Queensland's 13% gas target,
• the NSW's Greenhouse Gas Abatement Certificate (NGAC) scheme,
• subsidies to wind and other exotic renewable sources offered through the Australian Greenhouse Office and state governments (the latter in the form of regulatory measures that reduce connection costs to wind generation), and
• schemes that mandate minimum energy savings on appliances.  First applied to fridges and freezers and targeted at energy conservation, these regulatory requirements have been re-badged as greenhouse measures and extended to include houses as well as other appliances.

The MRET scheme's focus is on renewable energy and requires retailers to acquire and annually surrender a progressively increased number of Renewable Energy Certificates (RECs).  These essentially require usage of novel energy sources like wind, though some existing and expanded hydro capacity has managed to redefine itself to be eligible.  By 2010, 9500GWh (around 4.5% of demand) will be required under the MRET scheme.  For the three schemes combined over 30,000 GWh is estimated to be covered amounting to over 13% of total demand. ⁽¹⁷⁾

The Queensland scheme seeks to substitute gas for coal-based electricity inputs.  The NSW scheme seeks to introduce a penalty on carbon dioxide graduated in line with the emissions per unit of energy of each electricity generation source.

The default penalty costs of the three regulatory measures provide a cap on the costs they are likely to entail.  These costs entail a premium over the costs of conventional electricity to retailers.  By 2010, when the schemes are at full maturity, the fall-back penalty rates for the Commonwealth, NSW and Queensland schemes respectively are $A40, $A14.3 and $A13.1/MWh.  These rates provide the (maximum) subsidies to the non-carbon or low-carbon emitting fuels.  The Commonwealth's RECs during 2005 were trading 20% below the maximum rate.

Table 4 below summarises the more readily identified costs.

Table 4. 2010 Costs of greenhouse gas support measures.

	MRET	NSW NGAC	Qld 13% gas	Commonwealth subsidies	State subsidies
$AM	380	222	68	124 (2006/2007)	32 (2004/2005)

Source:  Budget documents.

A greenhouse trading regime has considerable support in Australia, with most state governments urging its national adoption.  Figure 13 below estimates the costs of electricity with and without the sort of additional charges implicit if Australia adopted the EU cap and trade scheme and other schemes are left in place.

Fig. 13. Australian power generation costs with EU tradable rights prices.Sources:  Australian costs are based on recent estimates.  Nuclear power costs are based on University of Chicago, The Economic Future of Nuclear Power.  Carbon emissions per gigajoule of energy is derived from http://www.greenhouse.gov.au/workbook/pubs/workbook.pdf

Based on recent developments, we have relatively good information on the costs of conventional generation for the eastern seaboard of Australia.  Nuclear costs have been rigorously evaluated in a recent University of Chicago report that brought together three contemporary estimates of the costs of nuclear generation (excluding the disposal costs).  The models compared are the Shanghai automotive industry corporation (SAIC) industry model, the Scully Capital financial model, an Energy Information Administration (EIA) model and GenSim, which is based on the EIA approach. ⁽¹⁸⁾

Wind power costs are also relatively well known.  The price cited below ($A75/MWh) represents the costs at prime sites.  These costs exclude any additional transmission charges that may be required for the more remotely located facilities.  They also do not take into account the need for conventional power back up which is necessary once wind, with its unpredictable and intermittent nature, becomes a significant component of the aggregate supply.

At present, coal-based generation costs is estimated to vary from about $A32/MWh in Queensland, ⁽¹⁹⁾ around $A40 in NSW and $A38 in Victoria.  Gas is estimated at around $A45/MWh based on a cost of $A4/Gigajoule, a cost that may rise if greenhouse measures raise the demand for gas.  Nuclear costs exclude waste storage, the estimated costs of which vary.  One estimate by the Uranium Information Centre puts the decommissioning costs as adding 5% to the price and waste disposal a further 10%. ⁽²⁰⁾

Applying the EU price of euros 24/tonne of carbon dioxide, cost to current power sources would result in nuclear power based on some cost estimates becoming marginally cheaper than coal and natural gas generation.

Government greenhouse mitigation policies and laws have also been used by advocacy groups (themselves often government financed) to tie up new proposals in the courts.  The highest profile case, which is discussed below, has been the NSW State Government using greenhouse policies to maneuver itself out of a (high-priced) contract for a new generator designed to use waste coal.  Other cases have included the prevarication of the Victorian Government in granting approval for a major power station to have its life extended.

Snowy Hydro illustrates an outcome of subsidies that cannot or are not fully defined to meet their stated goals.  Snowy has been given an annual baseline level of generation above which it earns RECs that have a default value of $A40/MWh.  Because it does not receive penalties for underperforming, it operates its system to generate strongly in 1 year and build up its reserves for the next year.  This allowed Snowy to earn about $A67 million in essentially phantom RECs in 2003.

Not only did this not contribute in net terms to the government policy of reducing greenhouse gas emissions, it actually increased emission levels.  This is because 20% of Snowy's RECs may have been created through pumping water uphill for reuse.  Though the energy used in pumping is netted out from the REC creation, shifting water from an underperforming year to a hard generating year creates a credit.  In pumping water uphill, Snowy uses almost twice as much (coal-derived) energy as it produces in subsequent generation.

6.4. SOVEREIGN RISK

One further facet that is not considered in the comparative cost data is the sovereign risk involved in building fossil fuel power stations, especially involving coal.  The activities of the NSW Government in using environmental pretexts to renege on coal-based contracts and the additional costs the Victorian Governments have required of the Hazelwood Power station upgrade proposals are likely to require a risk premium for coal powered electricity.

The NSW Government has created obstacles and uncertainties in the way of new electricity generation.  These make it inevitable that investors will require a risk premium before committing funds, thus increasing the price of electricity in the state and the risk of shortages.

One example of this was the government's treatment of a private sector investment undertaken by the US firm National Power.  This stemmed from a commitment - in the event an unwise commitment - by energy Australia, the biggest retailer in the NSW for two power stations, Redbank 1 and 2.

Soon after the deal was struck, the price in the market halved and remains 30% below the Redbank contract price.  Some estimates put the contract loss at $A750 million.  To renege on the deal for the second power station, the NSW Government set up an inquiry into it.  Various Government funded green groups offered opposition to the project on grounds of its greenhouse gas emissions and the Government refused its development approval, thus avoiding an onerous contract.  In fact opposition to the development on environmental grounds is ironical since the project uses waste coal which could otherwise pollute the Hunter River.  Indeed, in 2001 Redbank 1 won the Institution of Engineers Award for Environmental Excellence.

The Government's performance on this matter must add to the risk premium required of private sector developers of power stations and will probably require some enforceable undertakings before any private funding is extended to coal-based generation in the state.

In addition, private sector investors, especially in coal-based generation, would hardly be re-assured by the statements the NSW Government makes in a Green Paper issued in January 2005. ⁽²¹⁾  This expresses considerable hostility to new coal power, canvasses greenhouse taxes and a policy (p. 24) by mid century ranging from stabilisation of emission at current levels to reducing them by 40%.  In terms of a business-as-usual growth in energy demand at 2%/annum, this range of outcomes would amount to a highly ambitious reduction of between 60% and 75% in emission levels.  In claiming in concert with this, that the Government will let the market decide which technologies should be developed, the Green Paper is giving expression to grand sounding laissez-faire principles that clothe a highly intrusive policy approach.  The Green Paper, due to proceed to a White Paper stage by June 2005, had not so progressed by October 2005.  In the interim, the State Premier, Mr. Carr who was highly supportive of greenhouse gas reducing initiatives, unexpectedly retired.

7. OUTCOME OF AUSTRALIAN ELECTRICITY MARKET ARRANGEMENTS

7.1. SUMMARY OF MARKET DISTORTIONS

Aside from sovereign risk associated with government de facto expropriations as occurred in the NSW Redbank case, distortions that could lead to serious market damage include:

• The NSW mandatory insurance system or ETEF, provides a weaker incentive for retailers to ensure that they are forecasting market demand accurately.  ETEF means the government has eliminated the risks to retailers of failing to forecast the household load accurately.  This may bring mistakes caused by unexpected demand shifts.
• Retail price caps being kept below market levels.  This is 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.
• The risk that regulators will offer inadequate incentives for expansions and optimal maintenance.  Major price reductions have been insisted upon by several state regulators.  Regulated businesses are always likely to profess dissatisfaction at such outcomes but a risk remains that price cuts can deter investment.  Such requirements may have been a feature of the fragility of distribution networks, especially in Queensland where the regulator demanded a 17% cost saving of the largest distributor, Energex, which was heavily criticised following power outages in 2005.
• Interventions favoring 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% of electricity is now slated to be subsidised;  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% 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.  Australia has not moved to create trading barriers in response to fears about market power being exercised in re-bidding.  Such measures would create major uncertainties by constraining generators' abilities to respond to sudden emergency issues, would have gummed up the bidding system and created costs and uncertainties.

7.2. OUTCOMES IN TERMS OF NEW CAPACITY AND PRICES

Notwithstanding the adverse effects of government intervention in Australia, a successful outcome has been observed.  Prices are lower than expected, reliability has been high, and although the most market exposed sector, generation, has seen very low returns, new investment has been forthcoming.  And the investment that has been made broadly corresponds to that which most experts expected:  increased peaking capacity in Victoria and South Australia and more baseload to meet the faster growing Queensland demand.

This demonstrates a resilience in markets.  As long as the various participants in the market are free to contract with each other and as long as there is no significant monopoly over supply, interventions may not seriously distort the market and lead to its failure.

Aside from wind power, which is totally dependent on subsidies, significant new power facilities built over the past 5 years are as shown in Table 5.

Table 5. New capacity 2000-2005.

	State	Capacity (MW)	Type	Ownership
Redbank	NSW	150	Coal	Private
Bairnsdale	Vic	92	Gas	Private
ValleyPower	Vic	300	Gas	Private
Somerton	Vic	160	Gas	Private
Laverton	Vic	312	Gas	Government
Loy Yang	Vic	236	Coal	Private
Oakey	Qld	282	Gas	Private
Millmerran	Qld	852	Coal	Government/Private
Swanbank E	Qld	360	Gas	Government
Tarong N	Qld	450	Coal	Government
Kogan creek	Qld	750	Coal	Government
Hallett	SA	220	Gas	Private
Pelican point	SA	320	Gas	Private
Ladbroke	SA	80	Gas	Private
Quarantine	SA	100	Gas	Private

Source:  ESAA.

Figure 14 illustrates how demand and supply have been fairly well synchronised over the past 6 or 7 years.

Fig. 14.Source:  NEMMCO.

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 6 years it has been operating.  It is however fragile and government actions could seriously harm investor confidence and lead to ever increasing interventions to ensure investment keeps pace with demand.  Such measures would gradually erode the massive lifts in productivity that has been observed over the past decade or so.

8. GLOSSARY OF ACRONYMS

ACCC = Australian Competition and Consumer Commission
AEMC = Australian Energy Market Commission
AER = Australian Energy Regulator
ESAA = Electricity Supply Association of Australia
ESC = (Victorian) Essential Services Commission
ESI = Electricity Supply Industry
ETEF = Electricity tariff equalisation fund
LEP = (Queensland) Long-term energy procurement
MRET = Mandatory renewable energy target
NCP = National competition policy
NECA = National electricity code administrator
NEM = National electricity market
NEMMCO = National electricity market management company
NGAC = (NSW) Greenhouse Gas Abatement Certificate
ORR = (Victorian) Office of the Regulator General
PC = Productivity Commission
QEC = Queensland Electricity Commission
REC = Renewable Energy Certificate
SECV = State Electricity Commission of Victoria

---

ENDNOTES

1.  Helpful comments were received from many people including Perry Sioshansi, Paul Simshouser (Braemar Power), Darren Barlow (Ergon Energy) and Ben Skinner (TRUenergy).

2.  Prices here are quoted in $A or cents, which refer to Australian cents.  The Australian dollar is worth around 75 US cents.

3.  Under the state owned vertically integrated monopolies, large, footloose users negotiated cost-based prices (below cost in the case of some aluminum smelting contracts).  Household supply benefited from a cross-subsidy paid for in higher prices to most business customers.  Since the market has been operating almost all business customers and many household customers have seen real price reductions.

4.  NSW has a second pricing node in the snowy mountains scheme, however there are no significant customers at this node.

5.  Project Victoria:  A Rebuilding Strategy for Electricity in Victoria, Tasman Institute, 1991.

6.  Industry Commission, Energy Generation and Distribution Report, No. 11, 1991

7.  Exceptions included gas where AGL had a monopoly in NSW and, arguably, BHP steel, the integrated plant of which had been found by the High Court, in the Queensland Wire case, to be required to be opened to competition.  (See W. Pengilly)

8.  Mergers have reduced the original five host distributors/retailers to three retailers and four distributors.  Only one of the retailers retains common ownership with its "host" distribution business.

9.  For Vic and NSW.  For S.A.

10.  These figures refer to small customers, some 95% of which are households.  They also include some double counting where customers have changed retailers more than once.  An alternative measure is of customers who are no longer with their original retailer.  For Vic as at September 2005, this is 32.5% and for NSW 11%;  these latter figures exclude customers who have new supply contracts with their original retailer.

11.  This has brought a voluminous level of studies.  Those in Australia include the skeptical like Mountain, B. and Swier, G. Entrepreneurial interconnectors and transmission planning in Australia, The Electricity Journal, March 2003.  London Economics in its work for the ACCC (Review of Australian Transmission Pricing, 1999), also concluded that entrepreneurial links could not cover their fixed costs.  This skepticism is also seen in the work of Joskow and Tirole (e.g. Merchant Transmission Investment, CMI Working Paper, 24 The Cambridge-MIT Institute, 2003).  The Australian 2002 Paper on Independent Review of Energy Market Directions saw a possible role.  Littlechild has been more supportive both in studies in Australia and Argentina (e.g. Littlechild, S. (2004) "Regulated and merchant interconnectors in Australia:  SNI and Murraylink revisited."  Applied Economics Department and The Cambridge-MIT Institute, Cambridge University, Cambridge Working Papers in Economics CWPE No. 0410 and CMI Working Paper 37;  and Stephen C. Littlechild and Carlos J. Skerk Regulation of transmission expansion in Argentina CMI, Working Paper 61, University of Cambridge, Department of Applied Economics, 15 November 2004).  Further complications to the issue also result from the flowgate and nodal pricing debate.

12.  This tends to confirm a dimension of Hogan's "slippery slope" hypotheses whereby due to its ability to compel payment government ownership tends to drive out private ownership.  Hogan W.W., Transmission Market Design

13.  Macfarlane I (Minister for Industry, Tourism and Resources) (2003), Applications for Revocation of Coverage of Certain Portions of the Moomba to Sydney Pipeline System:  Statement of Reasons.

14.  10 August (2004).  Review of the gas access regime, productivity commission, report No. 31.

15.  For a discussion on whether the generators exercise market power see, Wood, "Is there market power in Australian electricity generation?" ACCC Regulatory Conference, July 2004.  For an analysis of rational bidding strategies see Peter Cramton, Competitive bidding behavior in uniform-price markets.  Hawaii International Conference on System Sciences, January 2004.

16.  This led to minor modifications to the guidelines on re-bidding volumes close to dispatch.  See http://www.aer.gov.au/content/index.phtml/itemId/659216

17.  Richard J. Wood.  November (2004) Economic and Environmental Potential of Energy Efficiency Regulations:  Submission to the Productivity Commission Inquiry into Energy Efficiency

18.  See http://www.anl.gov/Special_Reports/NuclEconAug04.pdf

19.  Some private generators suggest this price, which is cited as being available from new government generators, is sub-economic price because it incorporates a de facto subsidy as a result of the Queensland government accepting lower levels of return than the private sector would require.

20.  Source Uranium Information Centre

21.  NSW Government, Energy Directions Green Paper.