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The multidimensionality of electricity reform—an Australian perspective
Energy Policy 31 (2003) 1093–1102
The multidimensionality of electricity reform—an Australian perspective$ Deepak Sharma* Energy Planning and Policy Program, University of Technology, P.O. Box 123, Broadway, 2007 Sydney NSW, Australia
Abstract The electricity industry in Australia has over the last decade undergone fundamental and profound change. The industry has been functionally unbundled. The generation and retail segments of the industry have been exposed to competition. The transmission and distribution monopolies have been reoriented to foster competition. The customers are being offered increasing choice in the selection of their energy providers. The ownership of the industry is generally moving away from the public domain to the private domain. The rules for the governance of the industry have been developed in the form of a variety of market codes and regulation. Much of the debate about industry reform is being conducted exclusively in the economic domain. There is a general lack of any serious analysis and debate on the political, social, environmental and other dimensions of reform despite a wide consensus on the criticality of such dimensions. This is clearly unhelpful and could lead to obfuscation of the real challenges confronting the industry and preclude the development of responsible policy prescriptions to meet such challenges. There is an obvious need to devote some direct attention to these neglected dimensions of reform. This paper is one such attempt. It draws together the various dimensions of reform and provides a firmer basis for meaningful analyses and concrete debate on the issues. While the discussion focuses on Australian experience, the messages are relevant for other countries engaged in electricity reform. r 2003 Elsevier Science Ltd. All rights reserved.
1. Introduction The electricity industry in Australia and indeed the worldover has, over the past decade or so, undergone profound reform in its structure, ownership, and mindset. Much of the industry has been structurally separated into generation, transmission, distribution and retail segments. The competitive segments of the industry (generation and retail) have been progressively exposed to competition; the monopoly segments (transmission and distribution) have been reoriented to foster competition; the consumers have been offered increased choice in the selection of their service providers. Further, the ownership of the industry has either moved—or is under increasing pressure to move—away from the public domain into the private domain. The rules for the governance of the industry have been
$
An earlier version of this paper was presented at the 23rd Annual Conference of the International Association for Energy Economics, Sydney, June 7–10, 2000. *Tel.: +61-2-9514-2422; fax: +61-2-9514-2633. E-mail address: [email protected] (D. Sharma).
developed in the form of a variety of market codes and regulation. The quintessence of the debate on this reform— rationale, market structure and performance—seems to revolve around an all-encompassing economic indicator—price. There is a general lack of serious debate on other dimensions of reform (namely, political, social, environmental, technical) despite a broad consensus on the importance of these dimensions. This preoccupation with the economic dimension of reform has, in some quarters, created the impression that other dimensions of reform are either integral to the economic dimension, or they are somehow subservient to it, or they are not important in the larger context. This, clearly, is unhelpful. It also explains much of the hubris that surrounds the debate leading to rather extreme viewpoints (‘for’ or ‘against’; ‘all’ or ‘nothing’) and obfuscates the real challenges that confront the electricity industry and precludes the development of responsible policy prescriptions to meet such challenges. There is therefore a need to devote some direct attention to these neglected dimensions of reform. This paper is one such attempt. It does not seek to break new theoretical or methodological frontiers relating to the
0301-4215/03/$ - see front matter r 2003 Elsevier Science Ltd. All rights reserved. PII: S 0 3 0 1 - 4 2 1 5 ( 0 2 ) 0 0 2 1 7 - 3
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mechanics or economics of reform. Instead, it simply draws together the various dimensions of electricity reform in the context of Australia and provides a firmer basis for some meaningful analysis and a concerted debate on the issue. While the discussion in this paper focuses on Australian experience, the messages are relevant for other countries engaged in electricity reform.
2. Evolution of the Australian electricity industry This section of the paper provides a brief overview of the evolution of electricity industry in Australia with a view to demonstrate the multifariousness of the influences that have shaped the Australian electricity industry. Australia is a confederation of six states and two federal territories (for simplicity of exposition, the territories are referred to as states in this paper). The electricity industry in each state developed around the respective state capitals and rural towns in the late 19th century. The industry consisted of private and public enterprises, electricity generation was typically distributed with separate plant supplying electricity to each town or community. In the earlier decades of the 20th century, the state governments began to realize the development potential and the political appeal of electricity and progressively enacted legislation to own and operate the electricity supply industry. By the late 1940s, the electricity industry in Australia was predominantly owned by the state governments. A typical state utility was vertically integrated and planning and operation of the electricity system was centralized (Sharma and Bartels, 1997). The next three decades witnessed a consolidation of this model of industry structure, ownership and planning philosophy. This consolidation was assisted by a host of factors including: post-war development euphoria; belief in the role of electricity in development; trend towards bigger governments; perceptions about the responsibility of the government in promoting economic development, social welfare, employment, equity, justice and community interests; realization by the political parties of the electoral appeal of electricity; arguments about the specialized nature of electricity and electricity business necessitating integrated planning and centralized operation under the direct guidance and control of technical experts; and improvements in technical efficiencies of electricity generation and transmission. A confluence, over time, of these forces created a system of mutually beneficial symbiosis between the political, cultural, social and technical interests which encouraged further entrenchment of the traditional model of the electricity industry. A review of history
suggests that electricity infrastructure was used by the political parties in Australia (much like rest of the world) to promote their political agendas and hence to improve their electoral prospects. This political predilection was well supported by the electricity bureaucracies which continued to amass enormous power through optimistic demand forecasting and aggressive system expansion, while at the same time avoiding public accountability and scrutiny. This was done under the guise of the argument that electricity is a specialized business, and its management required specialized technical expertise possessed only by the few working in the electricity industry. Political backing, a great succor in promoting this line of reasoning, was easily forthcoming given the political appeal of electricity. Kellow (1996) succinctly describes how distributed politics of electricity in Australia and elsewhere promoted reverse adaptation (adapting ends to suit the means at disposal) by electricity utilities. An interesting feature of electricity development in Australia is that each state developed its electricity industry in complete isolation from another. Reasons include: constitutional status of electricity as a state matter; fierce inter-state rivalries; and state penchant for sovereignty, as epitomized by the Australian rail gauge syndrome. Consequently, the Australian electricity industry comprised distinct state-based electricity systems with contrasting technical standards and benchmarks, voltage systems, structures and governance philosophies, and virtually no interconnection between them. Each state governed its electricity industry exclusively according to its priorities, e.g., promoting the use of state resources, creating employment within the state, ensuring complete independence from other states for meeting electricity needs of the state. The promotion of comparatively expensive brown coal electricity in Victoria, a near-complete absence of electricity interconnection and hence trade between the populous south-eastern states in Australia, and regulatory restrictions on competition from the private sector are testimony to such isolationism.
3. Initial pressures for reform By the early 1980s, concerns began to be expressed about the inefficiencies inherent in the electricity industry in Australia. Excess generating capacity, overstaffing, inflexible pricing and lack of accountability were the often cited reasons behind such inefficiency. Further, the traditional view on the ‘control of industry by technical experts only’ came under challenge due to technological innovations, public awareness and changes in the political climate. The political authorities viewed these concerns as an opportunity to tame the hitherto largely unaccountable electricity monoliths and
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at the same time improve their credentials as responsible economic managers. The electricity utilities viewed these concerns as an opportunity to undertake strategic initiatives to improve their image and to ensure their longer-term survival. Consequently, a number of legislative and nonlegislative measures—focusing mainly on better management and control of the industry—were taken by the governments (often in the face of opposition from the electricity utilities) to reform the electricity industry. And the utilities also undertook a number of reform measures. Such measures included: establishing independent enquiries to review industry performance; appointing outside (i.e., non-electricity-industry) experts to the boards of electricity utilities; developing accountability criteria; tightening the scrutiny of industry plans; changing accounting practices; restructuring utilities and commercializing their operations (see Johnson and Rix (1991) and Kellow (1996) for a fuller detail of these measures). The purported aim of these initiatives was to improve the efficiency of the electricity industry. This notion of efficiency included several dimensions—reliability, safety, cost, price, labour and other factor productivities, employment, community service obligations, and rural electrification. Different states in Australia adopted a different mix of measures to improve the efficiency of their electricity systems. For example, in Victoria, a process of substantial industrial and organizational reform was initiated which resulted in the restructuring of the electricity utility into three ring-fenced and commercially oriented strategic business units linked through transfer pricing. These initiatives resulted in appreciable efficiency gains. During 1985–1990, the operating costs in Victoria declined by 40 percent and staff numbers by 21 percent. The reserve plant margin reduced from 40/50 to 25/30 percent and the plant available capacity factor increased from 59 to 69 percent. Electricity sales increased by 42 percent and there was a 3 percent average annual reduction in electricity prices over the period (Kellow, 1996). In New South Wales (NSW), by 1991, the generation segment of the principal electricity utility had been restructured as a stand-alone business and commissioners with non-engineering background had been appointed. By 1995, the transmission segment had been separated and corporatized. By 1996, three separate and independent generation businesses had been established. Between 1986 and 1994, the workforce in the NSW electricity industry was reduced from 28 800 to 17 060; a number of inefficient plants were retired; plant availability improved from 63 to 90 percent and thermal efficiency from 33 to 35 percent; and generation forced outrage rates were reduced from 22 to 2 percent. The
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cost of electricity generation was reduced from 7.3 to 4.8 cents per unit and the price from 7 to 6.1 cents per unit. Electricity sales increased by 25 percent and profits by nearly 600 percent (Kellow, 1996; Trimmer, 2000; ESAA, various issues). A review of the history of electricity in Australia also reveals that reform measures actually adopted by the respective state governments (from among those recommended/dictated by various inquiries/economic analyses) were well circumscribed by the political exigencies of the time. Selected excerpts from Kellow (1996) should substantiate this observation: ‘y in Victoria y the recommendations to ensure public consultation in energy policy were not implemented as they did not find favour with the government y the government did not take initial steps to implement recommendations arising from integrated least-cost planning study y (and) found the electoral attraction of power station construction irresistible y the energy policy document was carefully crafted to woo swinging voters y addressed concerns about employment and environmental protection y decision to proceed with a (particular) project was not based on careful economic analysis but on the fact that it would provide continued employment y government’s flip-flopping before and after the election.’ The foregoing discussion suggests that political dimensions of electricity development are paramount, notwithstanding a genuine desire in the political and industrial spheres to improve industry efficiency. The very political forces which contributed to the development of an inefficient electricity industry in Australia also contributed to the improvements in its efficiency. To quote Rousseau: ‘y I had come to see that everything was radically connected with politics, and that whatever was done about it, no nation would be other than what the nature of its government made it y’ (Rousseau, 1968).
4. Further impetus to the reform process Further impetus, and a different character, to the reform process was provided by a mix of external factors. These factors and the associated reasoning included: increased globalization of the world economies thus creating pressures to improve international competitiveness of individual economies; a view that domestic competitiveness is a prerequisite for improving international competitiveness; a belief that domestic competitiveness is best measured in terms of ‘economic efficiency’ and that economic efficiency is synonymous with community welfare (also called ‘public interest’); faith that economic efficiency is best enhanced by organizing and managing the economy according to the free market principles, largely dominated by the
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private sector (generally called ‘the market model’); the argument that open and unfettered competition and free choice are the cornerstones of the market model and hence for maximizing economic efficiency; and a perception that infrastructure industries (electricity—in the context of this paper) are generally inefficient and, given their central role in promoting economic growth, they should therefore be prime targets for reform. It should also be noted here that this thinking coincided with (or was it promoted by?) the ascendancy of the belief in the supremacy of market economics and associated trends towards smaller governments. The case for electricity reform was further assisted by: the spread, in the civilian sphere, of high-powered, small-size and low-cost gas turbines in the 1980s (their use until then had been restricted mainly to the spheres of military and space exploration); easing of the restrictions on the use of natural gas for electricity production in the US and Europe; and a view that competition in generation was possible (as based on experience in the aftermath of the Public Utilities Regulatory Policy Act of 1978) and indeed desirable (as promoted by the proponents of the market model) (also see Hunt and Shuttleworth, 1996). In Australia, the arguments for electricity reform were further strengthened by the findings of the reviews of electricity industry performance by the Industry Assistance Commission in 1989 and by the Industry Commission in 1991. These reviews concluded that the Australian electricity industry had not performed to its fullest potential in the 1980s. This, the reviews reasoned, was due to poor investment decisions leading to overcapacity, overstaffing and pricing inefficiencies (IC, 1991). These reviews argued for wide ranging reforms to bring performance on par with the international best practice (ESAA undated). According to the Industry Commission ‘y there was a need to promote competition in the industry, that transmission, generation and distribution needed to be separated, that utilities needed to be corporatized and interconnection between the states should be improved’ (Roarty, 1998). These reviews came under criticism, not without some justification, from a number of industry associations, trade unions and community groups. For example, Johnson and Rix (1991), while recognizing the need to reform the electricity industry, argued that ‘y the measure of performance of the electricity industry used by the Industry Commission y is based on deficient theory, and its application results in gross inaccuracies y the illusion of gross inefficiency in the electricity supply industry that is created by the Industry Commission can only be seen as ideological in nature to provide a basis for policy proposals like privatization y when inefficiency has been detected, rather than address its causes if these are known, or find out what they are, some agencies and groups have suggested
privatization and the establishment of competitive markets discipline as a ‘cure-all’ y this is a misplaced faith y we describe this attitude towards competition as an article of faith or dogma y what is required (to improve the efficiency of the electricity industry) is better control of these enterprises and better production, distribution and end-use information as the basis for making better decisions about them’. The Electricity Supply Association of Australia (ESAA), in their response to the Industry Commission, presented arguments which were at variance with those expressed by the industry performance review. For instance, according to ESAA (1996): ‘The electricity supply industry does not have a poor productivity performance, just a different structure to most industries y the analysis of the data provided by one report comparing the relative productivity of inputs of the two industries (US and Australia) reveals that the ‘efficiency’ gap is not related to productivity of inputs but to the manner in which they are measured’. It was also argued that these reviews completely ignored the substantial efficiency gains (as noted in the preceding section of this paper) that had been achieved by the electricity industry as a result of reform measures adopted over the last several years. For example, according to Johnson and Rix (1991): ‘y the Report suggests an almost pathological desire to indicate labour inefficiency despite the acknowledged fall in labour force over the last 5 years’. Further, ‘y the structural reforms became a focus of the electricity supply industry before the first of these enquiries, driven by the need to cut operating costs y Australia’s price advantage is not an outcome of chance event in any one year y it is the end result of at least three decades of strong productivity growth y’ (ESAA, 1996). Johnson and Rix (1991) further suggest that these efficiency gains have resulted simply from better planning and management of the electricity industry and that there was no need to now radically depart from this reform path. Such criticism was however unable to dent the political opinion in favour of change. The political imperative to introduce reforms in the industry was compelling: domestic and international competitiveness; credit ratings by international credit agencies; efficiency payments by the Commonwealth government in return for states’ participation in the reform process. And the political attractiveness of undertaking reforms was overwhelming: y the electricity industry is inefficient y people are currently paying too a high price for electricity y they deserve a lower price y reform will lead to lower electricity prices y annual disposable income per household will rise by $330 and income taxes will fall by 0.7 percent y economy will grow as a result of lower prices y national output will increase by $2.7bn annually y 9400 new jobs will be created (Johnson and Rix, 1991) y money from the sale of
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assets will be spent on schools, hospitals, roads and other projects which will improve the quality of life of ordinary citizens y the country would move into the next millennium with increased confidence y (moreover) the reform is also beneficial for the environment.
5. Electricity industry reforms Against this background, the Australian governments initiated a series of reforms under the broad banner of ‘microeconomic reform’. The main objective of the reform was to improve economic efficiency (and hence community welfare/public interest). This would be achieved through the introduction of effective competition in all sectors of the economy. The rules for promoting and facilitating competition are enunciated in a policy framework called the National Competition Policy (NCP) (AGPS, 1993). A review of the NCP however suggests that the precise meaning and interpretation of community welfare/public interest was not clearly defined. Nor was it clearly stated how community welfare would be measured and assessed, especially in situations where social considerations might require a recourse to non-market solutions (also see APH, 2000). The absence of a focused consideration of these issues has created an impression that the sole objective of the NCP is to facilitate, through open competition, the maximization of narrowly defined economic efficiency devoid of non-market yet socially desirable aspects of community welfare. Further, it has also resulted in relegating the questions of the measurement and assessment of the success of reform to the obvious and easily administrable indicator of price. It is even argued by some (understandably, although somewhat unfairly) that the sole objective of NCP is to promote competition for the sake of competition (also see APH, 2000). These observations are given further credence if one reviews the process and the nature of electricity reform in Australia which was an integral aspect of the microeconomic reform program. In 1991, the state governments agreed on a reform package for the electricity sector which included the creation of a National Electricity Market (NEM) in accordance with the precepts of the NCP. The underlying rationale for the NEM is the belief that considerable efficiency gains, and lower prices, can be achieved through free and fair competition. The NEM will help create this environment by providing: freedom of choice for electricity buyers; non-discriminatory access to transmission and distribution networks; no discriminatory legislative or regulatory barriers to entry for new participants in electricity generation and retailing, and no barriers to interstate and/or intrastate trade (Ray, 1997). The emphasis here is clearly on price reduction, and
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competition is seen as the means to achieve this objective. In order to comply with the requirements of the NEM, the Australian states which were party to the NEM, restructured their electricity industries. As electricity is constitutionally a state matter in Australia, each state followed a different approach to restructuring with regards to the shape and size of its restructured industry and the speed of restructuring. Notwithstanding these differences, the general nature of structural change in each state included the separation of generation, transmission, distribution and retail segments of the industry; introduction of competition in generation and retail, re-orientation of transmission and distribution to support and encourage competition. Additionally, each state has adopted a different model of industry ownership—private, de facto private, private/public, tenuously public, and public. The NEM encompasses a competitive wholesale market for generation, regulated transmission systems with legislated access rights and a system controller. The regulated distribution networks and the retail supply markets remain within the jurisdiction of the state governments. In the NEM, all generators greater than 30 MW compete by lodging bids to supply electricity to a common pool on a half-hourly basis. Bids are ranked and dispatched on the basis of a purely economic criterion, namely, lowest to the highest bid prices. The pool price for any half hour is the price of the highest bid by a generator that is scheduled, i.e., its short-run marginal cost. All generators that run during a particular half hour receive remuneration at the pool price for that half hour (Sharma and Sproule, 1998). These principles for the operation of the pool do not clearly encourage any consideration of technical (other than in an immediate sense), social, or environmental factors which will invariably result in higher costs. The best strategy for the generators is obviously to minimize costs and maximize profits. The thrust of the regulatory framework for transmission and distribution networks too is to provide incentives to minimize costs and maximize profits. Accordingly, the regulatory framework is generally biased in favour of industry. The matters of consumer interest do not receive adequate attention (also see Coyle et al., 2000). In the fully operational version of the NEM, wholesale traders (licensed retailers, wholesale electricity customers and independent traders) will be able to purchase electricity directly from the pool and manage price volatility with bilateral hedging (Sharma and Sproule, 1998). Licensed retailers have access to transmission and distribution networks on equal terms, and compete for the non-franchise market. It is planned that the regional retail franchises will progressively be abolished in all
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states, and by the end of 2002, all customers will be able to choose their own retail suppliers. At the retail level, there are significant contrasts across the retail markets in terms of their structures, the nature and intensity of institutional involvement, customer contestability schedules, metering provisions, environmental protection measures, contractual arrangements, health and safety aspects, and quality of supply (Sharma et al., 1999). Such contrasts are a reflection of the desire on the part of the states to exercise control over matters within their jurisdictions in a manner commensurate with state political priorities and sensitivities. The retail end of the electricity market is generally politically sensitive. Consequently, in the Australian NEM, there is one wholesale market and five distinct retail markets, now-withstanding the efficiency arguments! The political underpinnings of structural change also become obvious if one takes note of the rejection by the South Australian government of an otherwise economically sound proposal for transmission interconnection with NSW to take advantage of low price surplus electricity in NSW. The proposal was rejected in favour of a comparatively high cost privately owned new generating station located within the state. ‘Potential reliability concerns’ was a reason forwarded by the state in support of this decision. One could then ask the question: what is the purpose of a NEM reliability standard? Another aspect of electricity reform where politics has exerted a perceptible influence is the question of industry ownership. In Victoria, the entire industry has been privatized ostensibly to attain economically efficient outcomes, but in reality to retire state debt. The South Australian government has initiated, immediately after the last state election, the privatization of the state electricity industry after having categorically rejected this option prior to the elections. The government even revived the proposal to interconnect with NSW. The industry stays under government control in Queensland and Tasmania. The NSW government has failed in its recent efforts to privatize the industry due to intra-party and community opposition. Pressures to privatize the industry however remain. It should also be noted here that the debate on the issue of privatization has been opaque and surreptitious. The purpose of the foregoing discussion is not to dwell on the merits or demerits of a particular model of structure or ownership. Rather, it is to demonstrate the importance of political dimensions of electricity reform.
6. Experience with reform This section of the paper analyses the wider implications of electricity reform in Australia, in particular
arising from a lackadaisical attitude towards public interest in the NCP and a preoccupation with the narrowly defined concept of economic efficiency (as discussed in terms of price). The nature of this analysis is inferential, based on: discussion with a cross section of electricity industry professionals directly involved in the design and implementation of the electricity markets; research; personal observation; and published and unpublished reports and other material. Accordingly, emphasis here is not on the accuracy of data or methodological sophistication—rather it is on discerning general directions and trends which could provide some insights into the subtleties of various dimensions of reform. It should also be noted here that the classification of various dimensions of reform adopted in this section of the paper is somewhat arbitrary and that there are overlaps between the various categories. 6.1. Economic 6.1.1. Prices As noted earlier in this paper, the price of electricity is considered by the proponents of the market model as the main measure of the success of reform. Table 1 shows electricity prices in the residential, commercial and industrial sectors in the major states in the NEM. Table 1 reveals that, during the period 1986–1994, there was a noticeable decline in average prices in the commercial and industrial sectors, and a relatively stable-to-modest-decline in residential prices. These trends were due mainly to the reform measures taken by the respective governments during the initial round of reform aimed at improving electricity supply efficiency, and generally reducing the subsidization of the residential sector by commercial/industrial sectors. The trend in the decline of commercial/industrial prices has appreciably accelerated as a result of ongoing market reform, whereas residential prices show a stable trajectory. The proponents of the market reform claim that these gains in commercial/industrial prices are a direct outcome of their approach to reform. This claim however appears weakened when viewed in a wider societal context. The following points are forwarded to support this observation: (a) The declining trend in prices was already well established prior to the start of market reform (as is evident from Table 1) (also see Johnson and Rix, 1991; Kellow, 1996; ESAA, 1996). (b) It is common knowledge that non-contestable customers (mainly residential and small business) are currently paying a much higher price (approximately $45=MWh; based on vesting contracts) as compared with large contestable customers (approx. $20–30=MWh—the recent past average pool price). These contestable customers are generally
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term. This raises concerns about equity and justice—hallmarks of a civilized society.
Table 1 Electricity prices (c/kWh, 1997 prices) Initial reforms
Market reforms
1986
1990
1994
1998
Residential NSW Victoria Queensland South Australia Average
10.8 12.3 13.7 12.4 12.3
10.3 11.3 10.7 11.6 11.0
10.2 13.4 10.3 11.7 11.4
9.9 12.8 9.7 12.5 11.2
Commercial NSW Victoria Queensland South Australia Average
18.9 17.0 15.5 16.9 17.1
17.9 14.8 12.1 14.6 14.9
12.1 12.8 9.4 11.4 11.4
6.7 7.3 8.7 8.3 7.8
Industrial NSW Victoria Queensland South Australia Average
8.3 9.0 11.3 12.9 10.4
7.9 7.0 9.2 11.4 8.9
6.4 6.8 9.8 10 8.3
6.7 5.7 8.7 8.3 7.4
Sources: ESAA (various issues). Notes: (1) Initial reforms refer to reforms undertaken by various states in the mid-to-late 80s and early 90s. (2) Market reforms refer to the ongoing reforms in accordance with the precepts of the National Competition Policy. (3) Various prices shown are weighted averages.
(c)
(d)
(e)
(f )
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large volume customers with strong financial standings to negotiate even cheaper prices. There is a general consensus that the current pool price is unsustainably low; that generators are suffering substantial ongoing losses; that pool price has to increase in the near-medium-to-longer-term (indications are that this trend has already started); and that the pool price may stabilize in the $35–40 range. This clearly suggests that by the time all noncontestable customers become contestable and vesting contracts are replaced by market prices, much of the gains expected by residential/small business customers may have disappeared. Moreover, residential/small business customers are typically a diffused constituency and high-fixed-cost and low-volume customers. They therefore are unlikely to be in a strong position to bargain for cheaper prices in the market. Further, the inevitable attempts by industry participants to regain revenues lost during the melee to gain market share in the initial stages of reform are also likely to result in the subsidization of large customers (who benefited from initial low-priced long-term contracts) by small customers. The market outcomes are therefore distinctively biased in favour of relatively well-off large customers. The residential/small business are unlikely to benefit in any significant manner even in the longer-
Concerns are also emerging that the high compliance costs—due to the inherent complexity of the Australian regulatory framework—are likely to exert further upward pressure on electricity prices (Sharma, 2001). The ESAA argues that ‘y the overall cost to electricity supply business and governments across Australia of regulation was of the order of $100 million per annum, with costs to the business being in excess of $50 million y actual costs may in fact be higher y ongoing costs are eroding the benefits of competition to a significant extent y there are a number of burdens imposed by current regulatory frameworks and approach that are adding to the costs y they are due to numerous Acts, plethora of orders, regulations, guidelines and codes pursuant to each Act y more onerous due to inconsistencies, complexity, ambiguity and overlap or duplications across the jurisdictions y’ (ESAA, undated). Future increase in prices is also expected due to the high degree of regulatory risk in Australia (Sharma, 2001). 6.2. Social 6.2.1. Employment Table 2 suggests that the number of people employed in the electricity industry have continued to decline since the onset of reforms in the mid-80s. It is noteworthy that in Victoria where restructuring of the industry was accompanied by its privatization, the number of employees nearly halved between 1994 and 1998. The proponents of market reform justify these job losses in terms of improvements in economic efficiency and argue that many of these job losses are offset by job creation elsewhere in the economy. This argument however masks the deeper social impact of job losses and the commodification of human professional skills, namely, lowering of morale; lowering of skills base due to reduction in training expenditure, outsourcing of work and complete dismantling of research and development activities; alienation in the workforce due to the weakening of the bonds with the workplace and the culture of camaraderie; low investment in human capital; lack of trust, and the consequential weakening of the social fabric. The following excepts from APH (2000) capture these sentiments: ‘y unemployment is the most important single violation of the competitive market assumptions y workers displaced by competition may experience prolonged periods of unemployment y there is no theoretical basis for the supposition that losses experienced as a result of higher unemployment will be offset by gains in other sectors of the economy y workers in
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1100 Table 2 Employment in electricity industry
1986 1990 1994 1998
Table 3 Electricity reform and CO2 emissions
NSW
Victoria
Queensland
South Australia
28754 22240 17060 12527
19989 17962 9382 5420
11440 8553 7658 7024
5111 5214 2881 2298
Sources: ESAA (various issues).
rural and regional areas who lose their jobs are not easily re-employed y the employment effects of privatization and corporatization of electricity services in Victoria have been considerable y the brain drain and the loss of morale is apparent and the community in the La Trobe Valley has been devastated y changes are contributing to higher levels of insecurity in the community y unemployment causing poverty traps and increasing welfare dependency y erosion of equal opportunity principle y contracting out is leading increasingly to the de-skilling of service providers which is ultimately likely to result in a loss of service quality’. 6.2.2. Consumer interests There are concerns that consumer interests are not very well looked after in the restructured and privatized electricity industry. For example, in the context of Victoria, Coyle et al. (2000) have the following to say: ‘y the transition to privatized electricity and the related separation of generation, transmission, distribution and retail along-with distribution price review has created enormous complexity in protecting consumer interests y the existing regulation regime has no mechanism for allowing consumer interests to be protected from exploitation through unfair discriminatory tariffs y residential customers are vulnerable to unfair discriminatory pricing y full retail competition introduces new risks for individual consumers including the loss of privacy and the possibility of being discriminated against in marketing by retailers’. Similar sentiments are echoed by Paddon and Small (1999): ‘ystructural changes y against a backdrop of jurisdictional differences and territoriality y provide no longer-term basis for consumers to believe that their interests will be protected’. Also, according to ESAA: ‘y regulations at national levels y at state levels y multiplicity of interfaces y issues of fairness and equity also arises y regulators are not sufficiently accountable for their decisions y’ (ESAA, 1998). 6.3. Environmental The environment is another area associated with reform that is a subject matter of increasing concern. Studies reveal a trend towards increasing carbon dioxide
Period
NSW exports (GWh)
NSW imports (GWh)
Additional CO2 emissions (ktons)
Winter 97 Spring 97 Summer 98 Fall 98 Winter 98 Spring 98 Summer 99 Fall 99 Winter 99 Spring 99 Summer 00 Fall 00
82 228 55 131 90 108 64 1 12 1 51 3
830 449 1263 959 788 624 494 610 580 574 574 637
299 89 483 331 279 206 172 243 227 230 209 254
Sources: TransGrid (1998), and others.
ðCO2 Þ emissions from the electricity sector since the introduction of competitive markets (Table 3). The main factors contributing towards this trend are: market criteria on ranking and dispatching power plants on the basis of short-run marginal costs alone; differing practices adopted by various states in the NEM to determine the short-run marginal costs; and the nature of contractual arrangements between various market players. These market features have generally resulted in an increase in the share of electricity generated from low-cost-high-CO2 -emitting brown coal at the expense of relatively high-cost-low-CO2 -emitting black coal (Sharma and Sproule, 1998). Evidence also suggests that electricity reforms have contributed to a substitution of high-quality-low-CO2 emitting black coal by low-quality-high-CO2 -emitting black coal. This is mainly due to the propensity by the: (a) generators to secure low cost coal to minimize their short run marginal costs, and (b) mining companies to export high quality black coal at higher prices and to maximize profits. Further, the current low pool price also appears to militate against the increased use of natural gas (a high short run marginal cost but lowCO2 -emitting fuel) for electricity generation. Energy and CO2 intensities of the economy seem to have been adversely effected by the ongoing industry reform. Evidence suggests that these intensities have significantly increased over the reform period 1994/95– 1998/99 (ABARE, 2000). This is mainly due to the rise in share of brown coal for electricity production. The reasons for this increase in share include: relatively low marginal cost of brown coal electricity; low pool price thus resulting in the underutilization or mothballing of some high-cost black coal and gas plants; rehabilitation of some old brown coal plants; high rate of use of brown coal in anticipation of policy changes to restrict greenhouse gas emissions. These trends clearly do not augur well for a country which has less than credible environmental credentials
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and is on notice from the international environmental community to improve its environmental performance. It is often argued that market-based emission trading and selective regulation to promote renewable technologies would ameliorate this problem. But these approaches are obviously in conflict with the costminimizing objective of the competitive market. 6.4. Technical Increasing concerns are being expressed by the technical professionals working in the electricity industry about the potential longer-term detrimental effects of operating technical systems on the basis of (short-run) costs rather than technical specifications. These concerns typically relate to: the reduction in potential life of power plants and other equipment due to cost-driven operating schedules; slackening in the preventative maintenance thus deferring the problem to the future; reliability; quality of service; and system stability. These concerns are especially important for large plants which constitute an overwhelming bulk of the existing electricity system in Australia. According to Coyle et al. (2000) ‘y there is no clear incentive for distributors to improve service quality and reliability if this is going to decrease short-term profits y there is an incentive for managers and owners to cut costs too severely, potentially creating longer-term cost and reliability problems y under price regulation there is an incentive to promise higher reliability levels that require substantial operating and capital expenditures in order to justify a more remunerative cap formula y then, after the fact, underachieve the proposed reliability levels with lower expenditures, thus producing excess profit’. Further a complete dismantling of research and development activities and a lack of data in the public domain under the pretext of commercial confidentiality could deprive the industry of potentially useful inputs for ensuring its longer-term health.
7. Epilogue The foregoing discussion suggests that the question of electricity industry reform has several dimensions, namely, technical, environmental, economic, social, political. These dimensions are inextricably linked to each other though a complex web of complementary and conflicting relationships. Each dimension represents a specific aspect of the overall objective of the electricity industry. Collectively, they symbolize the raison d’e#tre of the electricity industry. An industry paraphernalia (structure, ownership, planning philosophy, rules—for simplicity, let us just call it structure) is a means to achieve the overall
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objective of the electricity industry in the best possible manner. Clearly then, the efficacy of a particular structure would be determined by how effectively it meets this objective. The structure of the industry is however not a fixed entity. It is constantly in need of evolution (reform) to accommodate changing perceptions (based on history, experience, and vision) and to take advantage of conceptual, technological and methodological advances. While the intensity and nature of reform would depend on specific circumstances (and they are different for each electricity system), it would nevertheless still require a consideration of the various dimensions which are embodied in the overall objective of the industry. The ongoing debate on electricity reform is being conducted exclusively in the economic realm, which for practical reasons has been further relegated to the economic indicator of price. The underlying assumption is that economics encapsulates all relevant dimensions of reform. This is shortsighted and is likely to be potentially damaging to the overall health of the economy. Evidence—its impartial and broader assessment—and some retrospection (towards which a limited attempt has been made in this paper) should support this claim.
Acknowledgements The author would like to express his appreciation to Tony Sproule (Pacific Power), Peter Trimmer (TransGrid) and Frank Xing (ESAA) for providing valuable inputs for writing this paper. The author is, of course, responsible for the contents.
References ABARE (Australian Bureau of Agricultural and Resource Economics), 2000. Trends in Australian Energy Intensity: 1973–74 to 1998–99. Draft Report, ABARE, Canberra. AGPS (Australian Government Publishing Service), 1993. National Competition Policy. AGPS, Canberra. APH (Australian Parliament House), 2000. Socio-economic consequences of the National Competition Policy. APH, Canberra. /http://www.aph.gov.au/senate/committeeS: Coyle, G., Mardon, C., Ray, D., Washusen, J., 2000. Protecting Consumer Interests in Electricity Distribution. Pareto Associates Pty Ltd., Victoria. ESAA, (undated). Australia’s Electricity Supply Industry. ESAA, Sydney. ESAA, 1996. Submission to Industry Commission: The Microeconomic Reform Agenda. ESAA, Sydney. ESAA, (various issues). Electricity Australia. ESAA, Sydney. ESAA, (various issues). Electricity Prices in Australia. ESAA, Sydney. Hunt, S., Shuttleworth, G., 1996. Competition and Choice in Electricity. Wiley, Chichester.
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IC (Industry Commission), 1991. Energy generation and distribution. Report No. 11, Australian Government Publishing Service, Canberra. Johnson, M., Rix, S. (Eds.), 1991. Powering the Future: The Electricity Industry and Australia’s Energy Future. Pluto Press, NSW. Kellow, A., 1996. Transforming Power: The Politics of Electricity Planning. Cambridge University Press, Cambridge. Paddon, M., Small, R. (Eds.), 1999. Competition: in whose interest? The socio-economic impacts of National Competition Policy. Public Sector Research Centre & Public Interest Advocacy Centre, Sydney. Ray, D., 1997. Electric Power Industry Restructuring in Australia: Lessons from Down-Under. Paper #20, The National Regulatory Research Institute, The Ohio State University, Ohio. Roarty, M., 1998. Electricity Industry Restructuring: The State of Play, Science, Technology, Environment and Resources Group. Department of Parliamentary Library, Canberra.
Rousseau, J., 1968. The Social Contract. Penguin, London. Sharma, D., 2001. Australian electricity reform: a regulatory quagmire. Proceedings of the 24th Annual International Conference. IAEE, Houston, 2001. Sharma, D., Bartels, R., 1997. Distributed electricity generation in competitive energy markets: a case study in Australia (Special Issue). The Energy Journal 17–39. Sharma, D., Sproule, A., 1998. The nexus between competitive electricity markets and the environment. Proceedings of the 21st Annual International Conference. IAEE, Ohio, pp. 391–398. Sharma, D., Beardow, M., Sproule, A., 1999. Regulatory issues in the restructured electricity industry in Australia. Proceedings of the 22nd Annual International Conference. IAEE, Rome, pp. 451–460. TransGrid, 1998. /http://www.tg.nsw.gov.auS: Trimmer, P., 2000. Development of the Australian Electricity Industry. TransGrid, Sydney.
The multidimensionality of electricity reform—an Australian perspective$ Deepak Sharma* Energy Planning and Policy Program, University of Technology, P.O. Box 123, Broadway, 2007 Sydney NSW, Australia
Abstract The electricity industry in Australia has over the last decade undergone fundamental and profound change. The industry has been functionally unbundled. The generation and retail segments of the industry have been exposed to competition. The transmission and distribution monopolies have been reoriented to foster competition. The customers are being offered increasing choice in the selection of their energy providers. The ownership of the industry is generally moving away from the public domain to the private domain. The rules for the governance of the industry have been developed in the form of a variety of market codes and regulation. Much of the debate about industry reform is being conducted exclusively in the economic domain. There is a general lack of any serious analysis and debate on the political, social, environmental and other dimensions of reform despite a wide consensus on the criticality of such dimensions. This is clearly unhelpful and could lead to obfuscation of the real challenges confronting the industry and preclude the development of responsible policy prescriptions to meet such challenges. There is an obvious need to devote some direct attention to these neglected dimensions of reform. This paper is one such attempt. It draws together the various dimensions of reform and provides a firmer basis for meaningful analyses and concrete debate on the issues. While the discussion focuses on Australian experience, the messages are relevant for other countries engaged in electricity reform. r 2003 Elsevier Science Ltd. All rights reserved.
1. Introduction The electricity industry in Australia and indeed the worldover has, over the past decade or so, undergone profound reform in its structure, ownership, and mindset. Much of the industry has been structurally separated into generation, transmission, distribution and retail segments. The competitive segments of the industry (generation and retail) have been progressively exposed to competition; the monopoly segments (transmission and distribution) have been reoriented to foster competition; the consumers have been offered increased choice in the selection of their service providers. Further, the ownership of the industry has either moved—or is under increasing pressure to move—away from the public domain into the private domain. The rules for the governance of the industry have been
$
An earlier version of this paper was presented at the 23rd Annual Conference of the International Association for Energy Economics, Sydney, June 7–10, 2000. *Tel.: +61-2-9514-2422; fax: +61-2-9514-2633. E-mail address: [email protected] (D. Sharma).
developed in the form of a variety of market codes and regulation. The quintessence of the debate on this reform— rationale, market structure and performance—seems to revolve around an all-encompassing economic indicator—price. There is a general lack of serious debate on other dimensions of reform (namely, political, social, environmental, technical) despite a broad consensus on the importance of these dimensions. This preoccupation with the economic dimension of reform has, in some quarters, created the impression that other dimensions of reform are either integral to the economic dimension, or they are somehow subservient to it, or they are not important in the larger context. This, clearly, is unhelpful. It also explains much of the hubris that surrounds the debate leading to rather extreme viewpoints (‘for’ or ‘against’; ‘all’ or ‘nothing’) and obfuscates the real challenges that confront the electricity industry and precludes the development of responsible policy prescriptions to meet such challenges. There is therefore a need to devote some direct attention to these neglected dimensions of reform. This paper is one such attempt. It does not seek to break new theoretical or methodological frontiers relating to the
0301-4215/03/$ - see front matter r 2003 Elsevier Science Ltd. All rights reserved. PII: S 0 3 0 1 - 4 2 1 5 ( 0 2 ) 0 0 2 1 7 - 3
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mechanics or economics of reform. Instead, it simply draws together the various dimensions of electricity reform in the context of Australia and provides a firmer basis for some meaningful analysis and a concerted debate on the issue. While the discussion in this paper focuses on Australian experience, the messages are relevant for other countries engaged in electricity reform.
2. Evolution of the Australian electricity industry This section of the paper provides a brief overview of the evolution of electricity industry in Australia with a view to demonstrate the multifariousness of the influences that have shaped the Australian electricity industry. Australia is a confederation of six states and two federal territories (for simplicity of exposition, the territories are referred to as states in this paper). The electricity industry in each state developed around the respective state capitals and rural towns in the late 19th century. The industry consisted of private and public enterprises, electricity generation was typically distributed with separate plant supplying electricity to each town or community. In the earlier decades of the 20th century, the state governments began to realize the development potential and the political appeal of electricity and progressively enacted legislation to own and operate the electricity supply industry. By the late 1940s, the electricity industry in Australia was predominantly owned by the state governments. A typical state utility was vertically integrated and planning and operation of the electricity system was centralized (Sharma and Bartels, 1997). The next three decades witnessed a consolidation of this model of industry structure, ownership and planning philosophy. This consolidation was assisted by a host of factors including: post-war development euphoria; belief in the role of electricity in development; trend towards bigger governments; perceptions about the responsibility of the government in promoting economic development, social welfare, employment, equity, justice and community interests; realization by the political parties of the electoral appeal of electricity; arguments about the specialized nature of electricity and electricity business necessitating integrated planning and centralized operation under the direct guidance and control of technical experts; and improvements in technical efficiencies of electricity generation and transmission. A confluence, over time, of these forces created a system of mutually beneficial symbiosis between the political, cultural, social and technical interests which encouraged further entrenchment of the traditional model of the electricity industry. A review of history
suggests that electricity infrastructure was used by the political parties in Australia (much like rest of the world) to promote their political agendas and hence to improve their electoral prospects. This political predilection was well supported by the electricity bureaucracies which continued to amass enormous power through optimistic demand forecasting and aggressive system expansion, while at the same time avoiding public accountability and scrutiny. This was done under the guise of the argument that electricity is a specialized business, and its management required specialized technical expertise possessed only by the few working in the electricity industry. Political backing, a great succor in promoting this line of reasoning, was easily forthcoming given the political appeal of electricity. Kellow (1996) succinctly describes how distributed politics of electricity in Australia and elsewhere promoted reverse adaptation (adapting ends to suit the means at disposal) by electricity utilities. An interesting feature of electricity development in Australia is that each state developed its electricity industry in complete isolation from another. Reasons include: constitutional status of electricity as a state matter; fierce inter-state rivalries; and state penchant for sovereignty, as epitomized by the Australian rail gauge syndrome. Consequently, the Australian electricity industry comprised distinct state-based electricity systems with contrasting technical standards and benchmarks, voltage systems, structures and governance philosophies, and virtually no interconnection between them. Each state governed its electricity industry exclusively according to its priorities, e.g., promoting the use of state resources, creating employment within the state, ensuring complete independence from other states for meeting electricity needs of the state. The promotion of comparatively expensive brown coal electricity in Victoria, a near-complete absence of electricity interconnection and hence trade between the populous south-eastern states in Australia, and regulatory restrictions on competition from the private sector are testimony to such isolationism.
3. Initial pressures for reform By the early 1980s, concerns began to be expressed about the inefficiencies inherent in the electricity industry in Australia. Excess generating capacity, overstaffing, inflexible pricing and lack of accountability were the often cited reasons behind such inefficiency. Further, the traditional view on the ‘control of industry by technical experts only’ came under challenge due to technological innovations, public awareness and changes in the political climate. The political authorities viewed these concerns as an opportunity to tame the hitherto largely unaccountable electricity monoliths and
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at the same time improve their credentials as responsible economic managers. The electricity utilities viewed these concerns as an opportunity to undertake strategic initiatives to improve their image and to ensure their longer-term survival. Consequently, a number of legislative and nonlegislative measures—focusing mainly on better management and control of the industry—were taken by the governments (often in the face of opposition from the electricity utilities) to reform the electricity industry. And the utilities also undertook a number of reform measures. Such measures included: establishing independent enquiries to review industry performance; appointing outside (i.e., non-electricity-industry) experts to the boards of electricity utilities; developing accountability criteria; tightening the scrutiny of industry plans; changing accounting practices; restructuring utilities and commercializing their operations (see Johnson and Rix (1991) and Kellow (1996) for a fuller detail of these measures). The purported aim of these initiatives was to improve the efficiency of the electricity industry. This notion of efficiency included several dimensions—reliability, safety, cost, price, labour and other factor productivities, employment, community service obligations, and rural electrification. Different states in Australia adopted a different mix of measures to improve the efficiency of their electricity systems. For example, in Victoria, a process of substantial industrial and organizational reform was initiated which resulted in the restructuring of the electricity utility into three ring-fenced and commercially oriented strategic business units linked through transfer pricing. These initiatives resulted in appreciable efficiency gains. During 1985–1990, the operating costs in Victoria declined by 40 percent and staff numbers by 21 percent. The reserve plant margin reduced from 40/50 to 25/30 percent and the plant available capacity factor increased from 59 to 69 percent. Electricity sales increased by 42 percent and there was a 3 percent average annual reduction in electricity prices over the period (Kellow, 1996). In New South Wales (NSW), by 1991, the generation segment of the principal electricity utility had been restructured as a stand-alone business and commissioners with non-engineering background had been appointed. By 1995, the transmission segment had been separated and corporatized. By 1996, three separate and independent generation businesses had been established. Between 1986 and 1994, the workforce in the NSW electricity industry was reduced from 28 800 to 17 060; a number of inefficient plants were retired; plant availability improved from 63 to 90 percent and thermal efficiency from 33 to 35 percent; and generation forced outrage rates were reduced from 22 to 2 percent. The
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cost of electricity generation was reduced from 7.3 to 4.8 cents per unit and the price from 7 to 6.1 cents per unit. Electricity sales increased by 25 percent and profits by nearly 600 percent (Kellow, 1996; Trimmer, 2000; ESAA, various issues). A review of the history of electricity in Australia also reveals that reform measures actually adopted by the respective state governments (from among those recommended/dictated by various inquiries/economic analyses) were well circumscribed by the political exigencies of the time. Selected excerpts from Kellow (1996) should substantiate this observation: ‘y in Victoria y the recommendations to ensure public consultation in energy policy were not implemented as they did not find favour with the government y the government did not take initial steps to implement recommendations arising from integrated least-cost planning study y (and) found the electoral attraction of power station construction irresistible y the energy policy document was carefully crafted to woo swinging voters y addressed concerns about employment and environmental protection y decision to proceed with a (particular) project was not based on careful economic analysis but on the fact that it would provide continued employment y government’s flip-flopping before and after the election.’ The foregoing discussion suggests that political dimensions of electricity development are paramount, notwithstanding a genuine desire in the political and industrial spheres to improve industry efficiency. The very political forces which contributed to the development of an inefficient electricity industry in Australia also contributed to the improvements in its efficiency. To quote Rousseau: ‘y I had come to see that everything was radically connected with politics, and that whatever was done about it, no nation would be other than what the nature of its government made it y’ (Rousseau, 1968).
4. Further impetus to the reform process Further impetus, and a different character, to the reform process was provided by a mix of external factors. These factors and the associated reasoning included: increased globalization of the world economies thus creating pressures to improve international competitiveness of individual economies; a view that domestic competitiveness is a prerequisite for improving international competitiveness; a belief that domestic competitiveness is best measured in terms of ‘economic efficiency’ and that economic efficiency is synonymous with community welfare (also called ‘public interest’); faith that economic efficiency is best enhanced by organizing and managing the economy according to the free market principles, largely dominated by the
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private sector (generally called ‘the market model’); the argument that open and unfettered competition and free choice are the cornerstones of the market model and hence for maximizing economic efficiency; and a perception that infrastructure industries (electricity—in the context of this paper) are generally inefficient and, given their central role in promoting economic growth, they should therefore be prime targets for reform. It should also be noted here that this thinking coincided with (or was it promoted by?) the ascendancy of the belief in the supremacy of market economics and associated trends towards smaller governments. The case for electricity reform was further assisted by: the spread, in the civilian sphere, of high-powered, small-size and low-cost gas turbines in the 1980s (their use until then had been restricted mainly to the spheres of military and space exploration); easing of the restrictions on the use of natural gas for electricity production in the US and Europe; and a view that competition in generation was possible (as based on experience in the aftermath of the Public Utilities Regulatory Policy Act of 1978) and indeed desirable (as promoted by the proponents of the market model) (also see Hunt and Shuttleworth, 1996). In Australia, the arguments for electricity reform were further strengthened by the findings of the reviews of electricity industry performance by the Industry Assistance Commission in 1989 and by the Industry Commission in 1991. These reviews concluded that the Australian electricity industry had not performed to its fullest potential in the 1980s. This, the reviews reasoned, was due to poor investment decisions leading to overcapacity, overstaffing and pricing inefficiencies (IC, 1991). These reviews argued for wide ranging reforms to bring performance on par with the international best practice (ESAA undated). According to the Industry Commission ‘y there was a need to promote competition in the industry, that transmission, generation and distribution needed to be separated, that utilities needed to be corporatized and interconnection between the states should be improved’ (Roarty, 1998). These reviews came under criticism, not without some justification, from a number of industry associations, trade unions and community groups. For example, Johnson and Rix (1991), while recognizing the need to reform the electricity industry, argued that ‘y the measure of performance of the electricity industry used by the Industry Commission y is based on deficient theory, and its application results in gross inaccuracies y the illusion of gross inefficiency in the electricity supply industry that is created by the Industry Commission can only be seen as ideological in nature to provide a basis for policy proposals like privatization y when inefficiency has been detected, rather than address its causes if these are known, or find out what they are, some agencies and groups have suggested
privatization and the establishment of competitive markets discipline as a ‘cure-all’ y this is a misplaced faith y we describe this attitude towards competition as an article of faith or dogma y what is required (to improve the efficiency of the electricity industry) is better control of these enterprises and better production, distribution and end-use information as the basis for making better decisions about them’. The Electricity Supply Association of Australia (ESAA), in their response to the Industry Commission, presented arguments which were at variance with those expressed by the industry performance review. For instance, according to ESAA (1996): ‘The electricity supply industry does not have a poor productivity performance, just a different structure to most industries y the analysis of the data provided by one report comparing the relative productivity of inputs of the two industries (US and Australia) reveals that the ‘efficiency’ gap is not related to productivity of inputs but to the manner in which they are measured’. It was also argued that these reviews completely ignored the substantial efficiency gains (as noted in the preceding section of this paper) that had been achieved by the electricity industry as a result of reform measures adopted over the last several years. For example, according to Johnson and Rix (1991): ‘y the Report suggests an almost pathological desire to indicate labour inefficiency despite the acknowledged fall in labour force over the last 5 years’. Further, ‘y the structural reforms became a focus of the electricity supply industry before the first of these enquiries, driven by the need to cut operating costs y Australia’s price advantage is not an outcome of chance event in any one year y it is the end result of at least three decades of strong productivity growth y’ (ESAA, 1996). Johnson and Rix (1991) further suggest that these efficiency gains have resulted simply from better planning and management of the electricity industry and that there was no need to now radically depart from this reform path. Such criticism was however unable to dent the political opinion in favour of change. The political imperative to introduce reforms in the industry was compelling: domestic and international competitiveness; credit ratings by international credit agencies; efficiency payments by the Commonwealth government in return for states’ participation in the reform process. And the political attractiveness of undertaking reforms was overwhelming: y the electricity industry is inefficient y people are currently paying too a high price for electricity y they deserve a lower price y reform will lead to lower electricity prices y annual disposable income per household will rise by $330 and income taxes will fall by 0.7 percent y economy will grow as a result of lower prices y national output will increase by $2.7bn annually y 9400 new jobs will be created (Johnson and Rix, 1991) y money from the sale of
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assets will be spent on schools, hospitals, roads and other projects which will improve the quality of life of ordinary citizens y the country would move into the next millennium with increased confidence y (moreover) the reform is also beneficial for the environment.
5. Electricity industry reforms Against this background, the Australian governments initiated a series of reforms under the broad banner of ‘microeconomic reform’. The main objective of the reform was to improve economic efficiency (and hence community welfare/public interest). This would be achieved through the introduction of effective competition in all sectors of the economy. The rules for promoting and facilitating competition are enunciated in a policy framework called the National Competition Policy (NCP) (AGPS, 1993). A review of the NCP however suggests that the precise meaning and interpretation of community welfare/public interest was not clearly defined. Nor was it clearly stated how community welfare would be measured and assessed, especially in situations where social considerations might require a recourse to non-market solutions (also see APH, 2000). The absence of a focused consideration of these issues has created an impression that the sole objective of the NCP is to facilitate, through open competition, the maximization of narrowly defined economic efficiency devoid of non-market yet socially desirable aspects of community welfare. Further, it has also resulted in relegating the questions of the measurement and assessment of the success of reform to the obvious and easily administrable indicator of price. It is even argued by some (understandably, although somewhat unfairly) that the sole objective of NCP is to promote competition for the sake of competition (also see APH, 2000). These observations are given further credence if one reviews the process and the nature of electricity reform in Australia which was an integral aspect of the microeconomic reform program. In 1991, the state governments agreed on a reform package for the electricity sector which included the creation of a National Electricity Market (NEM) in accordance with the precepts of the NCP. The underlying rationale for the NEM is the belief that considerable efficiency gains, and lower prices, can be achieved through free and fair competition. The NEM will help create this environment by providing: freedom of choice for electricity buyers; non-discriminatory access to transmission and distribution networks; no discriminatory legislative or regulatory barriers to entry for new participants in electricity generation and retailing, and no barriers to interstate and/or intrastate trade (Ray, 1997). The emphasis here is clearly on price reduction, and
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competition is seen as the means to achieve this objective. In order to comply with the requirements of the NEM, the Australian states which were party to the NEM, restructured their electricity industries. As electricity is constitutionally a state matter in Australia, each state followed a different approach to restructuring with regards to the shape and size of its restructured industry and the speed of restructuring. Notwithstanding these differences, the general nature of structural change in each state included the separation of generation, transmission, distribution and retail segments of the industry; introduction of competition in generation and retail, re-orientation of transmission and distribution to support and encourage competition. Additionally, each state has adopted a different model of industry ownership—private, de facto private, private/public, tenuously public, and public. The NEM encompasses a competitive wholesale market for generation, regulated transmission systems with legislated access rights and a system controller. The regulated distribution networks and the retail supply markets remain within the jurisdiction of the state governments. In the NEM, all generators greater than 30 MW compete by lodging bids to supply electricity to a common pool on a half-hourly basis. Bids are ranked and dispatched on the basis of a purely economic criterion, namely, lowest to the highest bid prices. The pool price for any half hour is the price of the highest bid by a generator that is scheduled, i.e., its short-run marginal cost. All generators that run during a particular half hour receive remuneration at the pool price for that half hour (Sharma and Sproule, 1998). These principles for the operation of the pool do not clearly encourage any consideration of technical (other than in an immediate sense), social, or environmental factors which will invariably result in higher costs. The best strategy for the generators is obviously to minimize costs and maximize profits. The thrust of the regulatory framework for transmission and distribution networks too is to provide incentives to minimize costs and maximize profits. Accordingly, the regulatory framework is generally biased in favour of industry. The matters of consumer interest do not receive adequate attention (also see Coyle et al., 2000). In the fully operational version of the NEM, wholesale traders (licensed retailers, wholesale electricity customers and independent traders) will be able to purchase electricity directly from the pool and manage price volatility with bilateral hedging (Sharma and Sproule, 1998). Licensed retailers have access to transmission and distribution networks on equal terms, and compete for the non-franchise market. It is planned that the regional retail franchises will progressively be abolished in all
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states, and by the end of 2002, all customers will be able to choose their own retail suppliers. At the retail level, there are significant contrasts across the retail markets in terms of their structures, the nature and intensity of institutional involvement, customer contestability schedules, metering provisions, environmental protection measures, contractual arrangements, health and safety aspects, and quality of supply (Sharma et al., 1999). Such contrasts are a reflection of the desire on the part of the states to exercise control over matters within their jurisdictions in a manner commensurate with state political priorities and sensitivities. The retail end of the electricity market is generally politically sensitive. Consequently, in the Australian NEM, there is one wholesale market and five distinct retail markets, now-withstanding the efficiency arguments! The political underpinnings of structural change also become obvious if one takes note of the rejection by the South Australian government of an otherwise economically sound proposal for transmission interconnection with NSW to take advantage of low price surplus electricity in NSW. The proposal was rejected in favour of a comparatively high cost privately owned new generating station located within the state. ‘Potential reliability concerns’ was a reason forwarded by the state in support of this decision. One could then ask the question: what is the purpose of a NEM reliability standard? Another aspect of electricity reform where politics has exerted a perceptible influence is the question of industry ownership. In Victoria, the entire industry has been privatized ostensibly to attain economically efficient outcomes, but in reality to retire state debt. The South Australian government has initiated, immediately after the last state election, the privatization of the state electricity industry after having categorically rejected this option prior to the elections. The government even revived the proposal to interconnect with NSW. The industry stays under government control in Queensland and Tasmania. The NSW government has failed in its recent efforts to privatize the industry due to intra-party and community opposition. Pressures to privatize the industry however remain. It should also be noted here that the debate on the issue of privatization has been opaque and surreptitious. The purpose of the foregoing discussion is not to dwell on the merits or demerits of a particular model of structure or ownership. Rather, it is to demonstrate the importance of political dimensions of electricity reform.
6. Experience with reform This section of the paper analyses the wider implications of electricity reform in Australia, in particular
arising from a lackadaisical attitude towards public interest in the NCP and a preoccupation with the narrowly defined concept of economic efficiency (as discussed in terms of price). The nature of this analysis is inferential, based on: discussion with a cross section of electricity industry professionals directly involved in the design and implementation of the electricity markets; research; personal observation; and published and unpublished reports and other material. Accordingly, emphasis here is not on the accuracy of data or methodological sophistication—rather it is on discerning general directions and trends which could provide some insights into the subtleties of various dimensions of reform. It should also be noted here that the classification of various dimensions of reform adopted in this section of the paper is somewhat arbitrary and that there are overlaps between the various categories. 6.1. Economic 6.1.1. Prices As noted earlier in this paper, the price of electricity is considered by the proponents of the market model as the main measure of the success of reform. Table 1 shows electricity prices in the residential, commercial and industrial sectors in the major states in the NEM. Table 1 reveals that, during the period 1986–1994, there was a noticeable decline in average prices in the commercial and industrial sectors, and a relatively stable-to-modest-decline in residential prices. These trends were due mainly to the reform measures taken by the respective governments during the initial round of reform aimed at improving electricity supply efficiency, and generally reducing the subsidization of the residential sector by commercial/industrial sectors. The trend in the decline of commercial/industrial prices has appreciably accelerated as a result of ongoing market reform, whereas residential prices show a stable trajectory. The proponents of the market reform claim that these gains in commercial/industrial prices are a direct outcome of their approach to reform. This claim however appears weakened when viewed in a wider societal context. The following points are forwarded to support this observation: (a) The declining trend in prices was already well established prior to the start of market reform (as is evident from Table 1) (also see Johnson and Rix, 1991; Kellow, 1996; ESAA, 1996). (b) It is common knowledge that non-contestable customers (mainly residential and small business) are currently paying a much higher price (approximately $45=MWh; based on vesting contracts) as compared with large contestable customers (approx. $20–30=MWh—the recent past average pool price). These contestable customers are generally
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term. This raises concerns about equity and justice—hallmarks of a civilized society.
Table 1 Electricity prices (c/kWh, 1997 prices) Initial reforms
Market reforms
1986
1990
1994
1998
Residential NSW Victoria Queensland South Australia Average
10.8 12.3 13.7 12.4 12.3
10.3 11.3 10.7 11.6 11.0
10.2 13.4 10.3 11.7 11.4
9.9 12.8 9.7 12.5 11.2
Commercial NSW Victoria Queensland South Australia Average
18.9 17.0 15.5 16.9 17.1
17.9 14.8 12.1 14.6 14.9
12.1 12.8 9.4 11.4 11.4
6.7 7.3 8.7 8.3 7.8
Industrial NSW Victoria Queensland South Australia Average
8.3 9.0 11.3 12.9 10.4
7.9 7.0 9.2 11.4 8.9
6.4 6.8 9.8 10 8.3
6.7 5.7 8.7 8.3 7.4
Sources: ESAA (various issues). Notes: (1) Initial reforms refer to reforms undertaken by various states in the mid-to-late 80s and early 90s. (2) Market reforms refer to the ongoing reforms in accordance with the precepts of the National Competition Policy. (3) Various prices shown are weighted averages.
(c)
(d)
(e)
(f )
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large volume customers with strong financial standings to negotiate even cheaper prices. There is a general consensus that the current pool price is unsustainably low; that generators are suffering substantial ongoing losses; that pool price has to increase in the near-medium-to-longer-term (indications are that this trend has already started); and that the pool price may stabilize in the $35–40 range. This clearly suggests that by the time all noncontestable customers become contestable and vesting contracts are replaced by market prices, much of the gains expected by residential/small business customers may have disappeared. Moreover, residential/small business customers are typically a diffused constituency and high-fixed-cost and low-volume customers. They therefore are unlikely to be in a strong position to bargain for cheaper prices in the market. Further, the inevitable attempts by industry participants to regain revenues lost during the melee to gain market share in the initial stages of reform are also likely to result in the subsidization of large customers (who benefited from initial low-priced long-term contracts) by small customers. The market outcomes are therefore distinctively biased in favour of relatively well-off large customers. The residential/small business are unlikely to benefit in any significant manner even in the longer-
Concerns are also emerging that the high compliance costs—due to the inherent complexity of the Australian regulatory framework—are likely to exert further upward pressure on electricity prices (Sharma, 2001). The ESAA argues that ‘y the overall cost to electricity supply business and governments across Australia of regulation was of the order of $100 million per annum, with costs to the business being in excess of $50 million y actual costs may in fact be higher y ongoing costs are eroding the benefits of competition to a significant extent y there are a number of burdens imposed by current regulatory frameworks and approach that are adding to the costs y they are due to numerous Acts, plethora of orders, regulations, guidelines and codes pursuant to each Act y more onerous due to inconsistencies, complexity, ambiguity and overlap or duplications across the jurisdictions y’ (ESAA, undated). Future increase in prices is also expected due to the high degree of regulatory risk in Australia (Sharma, 2001). 6.2. Social 6.2.1. Employment Table 2 suggests that the number of people employed in the electricity industry have continued to decline since the onset of reforms in the mid-80s. It is noteworthy that in Victoria where restructuring of the industry was accompanied by its privatization, the number of employees nearly halved between 1994 and 1998. The proponents of market reform justify these job losses in terms of improvements in economic efficiency and argue that many of these job losses are offset by job creation elsewhere in the economy. This argument however masks the deeper social impact of job losses and the commodification of human professional skills, namely, lowering of morale; lowering of skills base due to reduction in training expenditure, outsourcing of work and complete dismantling of research and development activities; alienation in the workforce due to the weakening of the bonds with the workplace and the culture of camaraderie; low investment in human capital; lack of trust, and the consequential weakening of the social fabric. The following excepts from APH (2000) capture these sentiments: ‘y unemployment is the most important single violation of the competitive market assumptions y workers displaced by competition may experience prolonged periods of unemployment y there is no theoretical basis for the supposition that losses experienced as a result of higher unemployment will be offset by gains in other sectors of the economy y workers in
D. Sharma / Energy Policy 31 (2003) 1093–1102
1100 Table 2 Employment in electricity industry
1986 1990 1994 1998
Table 3 Electricity reform and CO2 emissions
NSW
Victoria
Queensland
South Australia
28754 22240 17060 12527
19989 17962 9382 5420
11440 8553 7658 7024
5111 5214 2881 2298
Sources: ESAA (various issues).
rural and regional areas who lose their jobs are not easily re-employed y the employment effects of privatization and corporatization of electricity services in Victoria have been considerable y the brain drain and the loss of morale is apparent and the community in the La Trobe Valley has been devastated y changes are contributing to higher levels of insecurity in the community y unemployment causing poverty traps and increasing welfare dependency y erosion of equal opportunity principle y contracting out is leading increasingly to the de-skilling of service providers which is ultimately likely to result in a loss of service quality’. 6.2.2. Consumer interests There are concerns that consumer interests are not very well looked after in the restructured and privatized electricity industry. For example, in the context of Victoria, Coyle et al. (2000) have the following to say: ‘y the transition to privatized electricity and the related separation of generation, transmission, distribution and retail along-with distribution price review has created enormous complexity in protecting consumer interests y the existing regulation regime has no mechanism for allowing consumer interests to be protected from exploitation through unfair discriminatory tariffs y residential customers are vulnerable to unfair discriminatory pricing y full retail competition introduces new risks for individual consumers including the loss of privacy and the possibility of being discriminated against in marketing by retailers’. Similar sentiments are echoed by Paddon and Small (1999): ‘ystructural changes y against a backdrop of jurisdictional differences and territoriality y provide no longer-term basis for consumers to believe that their interests will be protected’. Also, according to ESAA: ‘y regulations at national levels y at state levels y multiplicity of interfaces y issues of fairness and equity also arises y regulators are not sufficiently accountable for their decisions y’ (ESAA, 1998). 6.3. Environmental The environment is another area associated with reform that is a subject matter of increasing concern. Studies reveal a trend towards increasing carbon dioxide
Period
NSW exports (GWh)
NSW imports (GWh)
Additional CO2 emissions (ktons)
Winter 97 Spring 97 Summer 98 Fall 98 Winter 98 Spring 98 Summer 99 Fall 99 Winter 99 Spring 99 Summer 00 Fall 00
82 228 55 131 90 108 64 1 12 1 51 3
830 449 1263 959 788 624 494 610 580 574 574 637
299 89 483 331 279 206 172 243 227 230 209 254
Sources: TransGrid (1998), and others.
ðCO2 Þ emissions from the electricity sector since the introduction of competitive markets (Table 3). The main factors contributing towards this trend are: market criteria on ranking and dispatching power plants on the basis of short-run marginal costs alone; differing practices adopted by various states in the NEM to determine the short-run marginal costs; and the nature of contractual arrangements between various market players. These market features have generally resulted in an increase in the share of electricity generated from low-cost-high-CO2 -emitting brown coal at the expense of relatively high-cost-low-CO2 -emitting black coal (Sharma and Sproule, 1998). Evidence also suggests that electricity reforms have contributed to a substitution of high-quality-low-CO2 emitting black coal by low-quality-high-CO2 -emitting black coal. This is mainly due to the propensity by the: (a) generators to secure low cost coal to minimize their short run marginal costs, and (b) mining companies to export high quality black coal at higher prices and to maximize profits. Further, the current low pool price also appears to militate against the increased use of natural gas (a high short run marginal cost but lowCO2 -emitting fuel) for electricity generation. Energy and CO2 intensities of the economy seem to have been adversely effected by the ongoing industry reform. Evidence suggests that these intensities have significantly increased over the reform period 1994/95– 1998/99 (ABARE, 2000). This is mainly due to the rise in share of brown coal for electricity production. The reasons for this increase in share include: relatively low marginal cost of brown coal electricity; low pool price thus resulting in the underutilization or mothballing of some high-cost black coal and gas plants; rehabilitation of some old brown coal plants; high rate of use of brown coal in anticipation of policy changes to restrict greenhouse gas emissions. These trends clearly do not augur well for a country which has less than credible environmental credentials
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and is on notice from the international environmental community to improve its environmental performance. It is often argued that market-based emission trading and selective regulation to promote renewable technologies would ameliorate this problem. But these approaches are obviously in conflict with the costminimizing objective of the competitive market. 6.4. Technical Increasing concerns are being expressed by the technical professionals working in the electricity industry about the potential longer-term detrimental effects of operating technical systems on the basis of (short-run) costs rather than technical specifications. These concerns typically relate to: the reduction in potential life of power plants and other equipment due to cost-driven operating schedules; slackening in the preventative maintenance thus deferring the problem to the future; reliability; quality of service; and system stability. These concerns are especially important for large plants which constitute an overwhelming bulk of the existing electricity system in Australia. According to Coyle et al. (2000) ‘y there is no clear incentive for distributors to improve service quality and reliability if this is going to decrease short-term profits y there is an incentive for managers and owners to cut costs too severely, potentially creating longer-term cost and reliability problems y under price regulation there is an incentive to promise higher reliability levels that require substantial operating and capital expenditures in order to justify a more remunerative cap formula y then, after the fact, underachieve the proposed reliability levels with lower expenditures, thus producing excess profit’. Further a complete dismantling of research and development activities and a lack of data in the public domain under the pretext of commercial confidentiality could deprive the industry of potentially useful inputs for ensuring its longer-term health.
7. Epilogue The foregoing discussion suggests that the question of electricity industry reform has several dimensions, namely, technical, environmental, economic, social, political. These dimensions are inextricably linked to each other though a complex web of complementary and conflicting relationships. Each dimension represents a specific aspect of the overall objective of the electricity industry. Collectively, they symbolize the raison d’e#tre of the electricity industry. An industry paraphernalia (structure, ownership, planning philosophy, rules—for simplicity, let us just call it structure) is a means to achieve the overall
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objective of the electricity industry in the best possible manner. Clearly then, the efficacy of a particular structure would be determined by how effectively it meets this objective. The structure of the industry is however not a fixed entity. It is constantly in need of evolution (reform) to accommodate changing perceptions (based on history, experience, and vision) and to take advantage of conceptual, technological and methodological advances. While the intensity and nature of reform would depend on specific circumstances (and they are different for each electricity system), it would nevertheless still require a consideration of the various dimensions which are embodied in the overall objective of the industry. The ongoing debate on electricity reform is being conducted exclusively in the economic realm, which for practical reasons has been further relegated to the economic indicator of price. The underlying assumption is that economics encapsulates all relevant dimensions of reform. This is shortsighted and is likely to be potentially damaging to the overall health of the economy. Evidence—its impartial and broader assessment—and some retrospection (towards which a limited attempt has been made in this paper) should support this claim.
Acknowledgements The author would like to express his appreciation to Tony Sproule (Pacific Power), Peter Trimmer (TransGrid) and Frank Xing (ESAA) for providing valuable inputs for writing this paper. The author is, of course, responsible for the contents.
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