Citation: Sharon Beder, ‘The Real Cause of Electricity Price Rises’, Australian Options, Autumn 2013, pp, 14-16.

This is a final version submitted for publication. Minor editorial changes may have subsequently been made.

Privatisation is generally sold to the public as being a way to reduce the cost of public services and provide ready cash to government coffers. However, the reality is quite different. Privatisation is undertaken to swindle the public out of rightful control over essential public services and is conceived and perpetrated by vested interests who seek to gain from private control. It results in pricing policies more concerned with private profits than public interest.

Why are we are currently cursed with the imperative for privatisation of essential services? There are three main reasons. The first is the prevailing neoliberal ideology that private business is able to run services more efficiently than governments. The second, partly informed by the first, is the reluctance of governments to raise taxes to pay for the expansion of services demanded by the public. The sale of public assets is a short-term, short-sighted, substitute source of capital. And the third reason is that the world is awash with surplus capital seeking the safe and profitable investment opportunities that private ownership of essential services generally provide. This funds a powerful lobby for neoliberalism and privatisation.

The case of electricity privatisation in Australia is a good example. Prior to privatisation and deregulation, electricity rates in eastern Australia tended to fall over time and were amongst the cheapest in the world. Now that situation has reversed. Rates are soaring and are now amongst the most expensive in the world. The federal opposition blamed this on the carbon tax even before the carbon tax came into being and despite evidence to the contrary since.

The government blames it on the 'gold-plating' of the distribution and transmission networks and the usage of electricity at peak times by households. It urges further privatisation and deregulation as the solution. Yet, in reality, it is privatisation and deregulation that are the cause, not the solution.

In 1995 the state governments in Australia agreed to facilitate private provision of public infrastructure, including electricity. The initial reluctance of the states had been overcome by incentive payments of $16 billion from the federal government. A National Competition Council was set up to oversee the restructuring process. In each state generation, transmission, distribution and retail supply of electricity were separated and corporatised. Barriers to interstate trade were removed and open access to electricity networks established.

Prices increased in the states that privatised their electricity during the 1990s— Victoria and South Australia—in preparation for the sell off and subsequently. Between 1994 and 2002 residential rates in SA increased by forty percent, householders paid thirty percent more for their electricity than in NSW (compared with ten percent more pre-privatisation and the opening of markets). Business too suffered. When some 2,800 middle-sized businesses became contestable and had their electricity prices deregulated in July 2001, they experienced price increases of between 30 and 80 percent.

For some years the example of lower electricity rates in NSW and Queensland were an awkward reality for privatisation advocates; and those wayward state governments were under great pressure to privatise despite public opposition. Both states have since privatised their retail electricity sectors, and in NSW the trading rights to the electricity generated were sold by an already unpopular Labor government, preparing the way for the incoming Liberal government to privatise the generators.

The Problem of Peak Electricity

The federal government argues that one cause of rising electricity prices is that it costs so much to provide electricity when demand peaks because extra power plants are required to provide electricity at these times that otherwise sit idle. However, in an electricity market the prices at peak times are more likely to be determined by the price manipulation of power companies than by the actual cost of generating electricity.

At times of peak electricity demand electricity generating companies can use their market power, or create artificial shortages of electricity, to force the price up to very high levels. They have made large profits by charging outrageously high prices when demand is high and reserve capacity low. Generators supplying the National Electricity Market (NEM) are able to withhold capacity on hot days until the price peaks and then they can rebid their electricity at inflated prices. This means that prices can vary from $30 to $12,500 per MWh, even though the average price is less than $60. Generators admit that the reason for rebidding is 'financial optimisation' – that is making bigger profits.

A 2002 Council of Australian Governments (COAG) report admitted that the system enables one or two generators to 'effectively set the price at a level they choose' up to the $10,000/MWh price cap. A study by the Australian Bureau of Agricultural and Resource Economics (ABARE), a supporter of deregulation and competition in electricity markets, has confirmed that price manipulation occurs in the National Electricity Market. Such uncompetitive bidding has cost the Australian economy hundreds of millions of dollars.

The federal government's proposal to deregulate prices and introduce smart meters to solve the problem of peak electricity demand fails to recognise that even though peak electricity demand has been falling, electricity rates have been increasing, and that this will continue so long as there is an electricity market in which prices can be manipulated by electricity generators.

More importantly, the introduction of smart meters will shift the risk of price volatility caused by this price manipulation from the private retail companies to household consumers. Traditionally, it has not been politically acceptable nor feasible for retail prices to reflect electricity price fluctuations. Consumers expected a stable tariff and electricity retailers contracted to offer consumers electricity at a set rate for a period of time. This created risks for the retailer.

The obvious way for retailers to deal with this risk is to set electricity rates high enough to be sure that they can pay fluctuating wholesale prices and still make a profit. However, such high rates tend to be politically unacceptable and to make electricity unaffordable for some households. Governments have preferred to regulate retail prices to avoid that situation.

Until 2001, electricity prices to Australian households were protected from the volatile wholesale electricity market through regulated prices. These regulations are being progressively removed as retail markets are opened to competition and consumer protections are removed.

When the electricity retail market was opened up to competition in South Australia in 2003, for example, prices rose 28.3 per cent for households, on average. This rise was approved by the Essential Services Commission which had been established to determine whether price rises were justifiable. Commission Chair, Lew Owens, concluded that the price rise was justified because retailers could not be denied 'the opportunity to make profit commensurate with the risks'.

In 2007, the NSW Independent Pricing and Regulatory Tribunal (IPART) agreed to significant price increases that it said were necessary because 'retail prices need to be sufficient to recover the costs incurred in selling electricity in a competitive market, and to compensate retailers for the risks that they face' with an extra profit margin. However even these initial price rises have proven inadequate, and escalating prices since privatisation of the retail sector have caused political discontent.

Gold Plating of Poles and Wires

In preparation for privatisation, a pricing formula was set during the 1990s for the newly formed transmission and distribution corporations because they are 'natural monopolies' and not subject to competition. Governments traditionally charged electricity rates that covered the actual costs of transmission and distribution and were accountable to the electorate for any dividends they squeezed out of the system. However, private transmission/ distribution companies could theoretically charge whatever they wanted because electricity is an essential service and, without competition, the ratepayer would have no choice but to pay.

The pricing formula was supposed to ensure that the future privatised corporations would have a guaranteed return based on the value of their assets, thus ensuring they would have an incentive to invest in the infrastructure they owned. This was necessary because in a privatised electricity industry there would be no market mechanism to provide this incentive and no government planners deciding what maintenance and upgrades were necessary in the public interest.

The distribution corporations were in this way prepared for privatisation, which occurred in Victoria and South Australia. In NSW and Queensland they remained in government ownership and, for many years, all efforts to privatise electricity were thwarted by public opposition.

During this time, the government-owned distribution corporations took advantage of the new pricing formulas to invest in assets and reap the profits intended for the private companies that would eventually buy them. This is a win-win situation for government. Not only do these corporations pay large dividends but it makes them very attractive to private buyers when they are finally sold, creating a huge one-off inflow of money for these governments.

What is more, the rising cost of electricity distribution is creating public dissatisfaction with government ownership, eroding the opposition to privatisation. Once sold, the private companies will reap the returns always meant for them, and the price rises leading up to the sale will be blamed on government inefficiencies rather than privatisation.

Conclusion

The real cause of electricity price increases in eastern Australia have been: firstly the introduction of a national electricity market and the consequent price manipulation by electricity generators; secondly the shifting of risk arising from market price volatility from electricity retailers to ratepayers; and finally, the introduction of a pricing formula for electricity distribution companies which replaces investment decisions based on need and forward planning with those based on maximising rate of return. Further privatisation or deregulation is therefore a solution likely to exacerbate the problem rather solve it.