MICHAEL KEATING. Electricity Prices.

Electricity prices are a hot topic at present. Amidst the welter of claim and counter-claim as to what is the cause of higher electricity prices, there has been remarkably little use of the available evidence.  

In the first Oil Crisis back in 1973, OPEC not only jacked up oil prices, but actually stopped the flow of oil altogether to some European countries. Since then there have been recurring international oil and energy price crises, and the price of energy has been a hot topic, with petrol prices being particularly closely watched and widely discussed in Australia. Recently, however, the price of electricity seems to have replaced the price of petrol as the most sensitive price.

The widespread assumption seems to be that electricity prices have recently risen extraordinarily fast, and ipso facto they are higher than they need to be. Nor are we short of possible explanations. On the one hand, the Right led by Tony Abbott have claimed that the price of electricity first rose to unacceptable levels because of the carbon tax and later because of the impact of the renewable energy target. More recently, it would seem that the Left, as epitomised by some readers of this blog, have persuaded themselves that the high price of electricity is due to privatisation.

Both explanations are distinguished by their failure to examine the evidence regarding how much electricity prices have in fact risen and when.

In any such examination, it is important to establish a standard against which the rise in electricity prices can be compared, and the obvious standard is the rate of inflation generally as measured by the consumer price index (CPI). In the table below I compare the increase in household electricity prices as measured in the CPI with the increase in the CPI itself. The periods chosen are when the increase in the CPI exceeded the increase in electricity prices for a sustained period of two or more years or vice versa.

Comparison of increase in electricity and all consumer prices

Average annual rate of increase between the June quarter

in the initial year and the June quarter in the final year

Period CPI Electricity Prices
1981-1985 8.1 13.3
1985-1990 8.0 4.9
1990-1993 2.1 4.9
1993-2000 2.1 0.1
2000-2007 3.2 4.5
2007-2014 2.7 11.4
2014-2017 1.5 0.6

 

Looking at this evidence of what has happened to electricity prices, I would like to suggest that the following tentative conclusions emerge. First, the two periods when electricity prices increased by much more than consumer prices generally were 1981-1985 and 2007-2014, and they were both periods when international energy prices increased dramatically; the latter period being especially true for international gas prices, which is increasingly being used to fuel electricity generation. In this context, it is also worth noting that international gas prices fell in 2015 and 2016, which is the obvious reason for the low rate of increase in electricity prices shown for the last period, 2014 to 2017. However, over the last twelve months international gas prices have accelerated again, and electricity prices increased by as much as 7.8 per cent between June 2016 and June 2017, after having fallen in the previous two years.

The second interesting observation is that the period when retail electricity prices hardly changed was 1993-2000, and this was the period when national competition policy was being introduced. Both electricity generation and retailing were made competitive, although transmission inevitably remained a regulated natural monopoly. In addition, electricity authorities were corporatized to make managers more accountable for their performance, and some were privatised.

Along with most of the economic literature, I personally doubt that ownership matters all that much, but competition and corporatisation does. Furthermore, I think the above evidence does suggest that the introduction of these policies did help in restraining and even lowering electricity prices in the 1990s, although any such impact is inevitably mostly a one-off impact while the new competitive regime is being bedded down. After that competition can help restrain future price increases, but it will not actually drive prices down further after productivity reaches best practice levels.

Furthermore in 2005, the Productivity Commission in an exhaustive review of the impact of National Competition (NCP) found that ‘Before NCP and related reforms, it was widely recognised that electricity production and distribution activities were working well below best practice’. I can also vouch for this in my role as Chairman of the Independent Pricing and Regulatory Tribunal of NSW (IPART), which used to be responsible for determining retail electricity prices in that State. IPART used to benchmark the NSW electricity authorities against best practice elsewhere, and found that there was considerable room for improvement in efficiency before competition policy was introduced. As the Productivity Commission put it: electricity production and distribution were ‘characterised by significant over manning and sub-optimal reserve plant margins’. The increased productivity in response to the reforms led to much bigger increases in productivity than before or since, with the Productivity Commission finding that ‘The largest improvement in labour productivity has been observed in Victoria followed by South Australia and New South Wales.’

In sum, discussion of electricity prices needs to start first from an assessment of what has been happening to the price of the raw materials, which in the case of carbons are internationally traded and highly volatile. In addition, it is likely that increased reliance on renewables could reduce the volatility of future electricity prices, especially if the capability and cost of battery storage comes down as can be expected, as the cost of electricity will then reflect much more the conditions in local markets rather than in international markets.

Second, the available evidence when independently assessed strongly suggests that the neo-liberal reforms of the 1990s did result in a substantial improvement in productivity and brought down electricity prices. However, the biggest impact of such reforms on productivity is a one-off. Subsequently competition can keep the producers honest, and create the incentives for further improvement, but the big gains from removing previous poor practices can only be gained once.

Michael Keating was formerly Secretary, Department of Finance, and Secretary, Department of Prime Minister and Cabinet. 

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4 Responses to MICHAEL KEATING. Electricity Prices.

  1. michael lacey says:

    On July 27, 2016, the chairperson of the Australian Competition and Consumer Commission (Rod Sims), the federal regulatory institution that is pro ‘competition’ (neo-liberal style), was reported as saying that the history of privatisation in Australia had been “severely damaging” for the economy.

    It was a stark statement given how he has been a well-known “former advocate of privatisation”.

    His story was told in the Guardian article – ACCC’s Rod Sims says privatisations ‘severely damaging’ economy – where the ACCC head said that:

    … governments have repeatedly botched the sale of airports, electricity infrastructure and major ports – making things worse for consumers – because, when selling the assets, they have been motivated by maximising profits rather than making efficiency gains …

    governments have created private monopolies without sufficient regulation to stop those monopolies overcharging users …

    He was quoted as saying that “I’m now almost at the point of opposing privatisation because it’s been done to boost proceeds, it’s been done to boost asset sales, and I think it’s severely damaging our economy … let’s just stop the privatisations … It is increasing prices – let’s call it out”.

  2. derrida derider says:

    “discussion of electricity prices needs to start first from an assessment of what has been happening to the price of the raw materials, which in the case of carbons are internationally traded ”
    Not really true for Aussie carbon used for electricity generation. Our power stations all have dedicated mines/gas fields associated with them, so generator input costs do not vary with the world price of coal or gas; the only exception to this is the recent gas troubles, and even they have not affected gas peaker plant costs (as distinct from household gas supply) much.

    The current problems with domestic electricity are a bit like air disasters – if investigating you should start from the premise that the disaster was at the end of a complex chain of decisions rather than simply one thing going wrong. But those decisions do include an inflexible design for the NEM, flawed privatisations by state governments, total lack of leadership on renewables by the Commonwealth, and political games creating excess investment uncertainty.

  3. Dog's breakfast says:

    A good statistician will always be able to support their case with numbers, but even then I’m not sure the numbers provided support much of any argument.

    The periods chosen seem somewhat arbitrary, leaving one open to ‘cherry-picking arguments. Must say I am surprised by the small rise in prices over the last 3 years, that is not the lived experience on the ground, but remembering that this brief interregnum was taken over by huge increases in gas prices, so no respite for the poor home owner. If Muhammaed Ali stops beating you up, but sends in George Foreman to replace him, it doesn’t actually feel like relief.

    And all this ignores the numerous inquiries that showed that the pricing regulation body was being gamed by the private owners, ‘gold-plating’ was the extant term, and although you don’t think ownership matters, it would have been hard to argue for a public body to be getting away with same. Guaranteed returns above market interest for infrastructure capital investment, why wouldn’t you.

    And privatisation, by your own arguments, wasn’t necessary to extract the once-off dividend. Efficiencies could have been extracted as a public enterprise, best of both worlds.

    And it is the neoliberal economic argument that we have to pay world gas prices when we have gluts of the stuff. Public enterprises could extract the gas, get fair recompense and we would have the cheapest energy market in the world, which given our natural resources, seems fair enough. But no, Japan gets our gas cheaper than we do, as is well documented.

    And we have an 18% rise in electricity prices, which is a fair sort of margin above CPI, which just misses the cut-off for these figures.

    The better measure would have been CPI without the energy component factored in, compared with the energy component, compared with average wages, with trend lines to smooth them out. It would have been more transparent in my view.

    Appreciating your contributions Michael and aware of your stature. My arguments can be considered a flea bite on an elephant, but I do have a keen sense of when I’m being sold a lemon.

  4. Subsequently competition can keep the producers honest, and create the incentives for further improvement, but the big gains from removing previous poor practices can only be gained once.

    And it seems they weren’t happy with a once off gain then they slowly resorted to gouging.

    May or may not be true but it feels like it.

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