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Australia – Key Benefits Associated With Privatising Queensland’s Electricity Assets.

10 April, 2014

 

Legal News & Analysis – Asia Pacific – Australia – Energy & Project Finance

 

On 13 March 2014 the Productivity Commission released a further draft report pointing out that ‘there is no continuing case for retention of certain infrastructure in public hands’.1 Although the report is concerned primarily with the efficient delivery of public infrastructure, it makes the specific recommendation that ‘State and Territory Governments should privatise their government-owned… electricity generation, network and retail businesses’.2 In view of this recommendation, we thought that this would be an appropriate time to highlight what we see as two of the key benefits associated with privatising Queensland’s electricity assets.

 

The State’s Resources Could Be Redirected To Other Sectors

 

Electricity infrastructure is expensive to build and maintain. It weighs heavily on the balance sheet, particularly when trading conditions are soft. According to the 2013 Queensland Commission of Audit, capital investment of AUD 14.3bn will be needed to sustain the State’s electricity businesses to 2016-17.3 Treasurer Tim Nicholls confirmed that only a portion of this is capable of being funded out of retained earnings, thereby necessitating investment from the private sector or an increase in State debt.4

 

Services Competing For Investment

 

The Commission of Audit pointed out that the Government is not well placed to manage the commercial risks faced by, nor to fund the significant injections of capital that are likely to be required to support, the electricity sector.5 In this context, the electricity sector is competing for Government resources with core public sector services such as transport, health, education and social services. The desire to reduce the State’s debt and restore the AAA credit rating is likely to require that choices are made between services that are competing for investment.

 

Impact Of Privatisation

 

According to the Commission of Audit, the book value of Queensland’s electricity assets is around AUD 25bn.6 A release of this capital value would immediately alleviate some of the competition for investment in other public goods and services.

 

In addition, the released capital could be used to reduce the State’s debt levels, thereby reducing the time required to return the budget to surplus, improving the State’s creditworthiness and reducing its debt servicing costs. In October 2013, Infrastructure Partnerships Australia valued the bottom line impact of electricity privatisation on Queensland’s finances, taking into account avoided capital expenditure and debt over the next four years, at AUD 40bn to AUD 48bn (in 2012 dollars).7

 

The combined effect of freed up cash flow and access to finance at cheaper rates is an ability for the State to direct more resources into high priority community projects, such as highways, rail infrastructure and flood prevention measures.

 

Incentives To Recycle Capital

 

On 28 March 2014 Federal Treasurer Joe Hockey announced a proposal to establish a Federal fund that would be used to pay each state 15 cents for every dollar that the state receives from privatisations and ‘recycles’ into new public works such as roads and railway. Under the proposal, the states have until 30 June 2016 to decide which assets to sell and must complete the process within five years.8 The Queensland Government has backed the offer. State Treasurer Tim Nicholls said ‘it will add to the conversation we are having with Queenslanders when we can say here are the choices – massively increasing taxes and charges, cutting or reducing services or recycling capital’.9

 

Union-backed infrastructure funds AustralianSuper, Industry Funds Management and Hastings Fund Management have come out in support of the proposal, reinforcing the strong appetite from super funds for infrastructure assets.10 Industry Super Australia’s chief executive officer David Whitely pointed out that if assets are sold to super funds ‘in many respects, the community continues to own the asset, now through their super fund rather than as a taxpayer’. Hastings Fund Management chief executive Andrew Day cautioned that the industry would prefer a straight trade sale rather than some of the hybrid schemes proposed by the Queensland Government for its electricity networks.11

 

In its recent draft report on public infrastructure, the Productivity Commission observes (in the context of capital recycling) that the decisions to privatise government owned assets and to invest in new infrastructure should be made separately. In other words, the benefit of each of these actions should be assessed independently in order to ensure a ‘robust cost-benefit analysis’.12 Although cautionary, this observation is not inconsistent with the fact that there is a benefit associated with the State’s resources being redirected to investment in new public infrastructure projects.

 

Privatisation Would Drive Certain Efficiencies In The Sector

 

Government Owned Corporations (GOCs) often need to take into account non-commercial and political considerations in addition to the usual commercial and economic considerations common to all businesses. This can hinder the efficient provision of electricity network services, with consequential detrimental impacts to the interests of consumers and taxpayers.

 

Effect Of Non-Commercial Imperatives

 

Non-commercial imperatives are often inconsistent with the commercial imperative of maximising returns. By way of example, the Commission of Audit reported that the Queensland Government had the power to issue non-commercial directives to GOCs and in January 2013 had in place 21 policies and guidelines outside the Government Owned Corporations Act 1993 (Qld) that hinder management in running their businesses on a purely commercial basis.13

 

Political intervention can reduce income. It can also affect the spending of GOCs in a way that is not aligned with business considerations, for example by changing reliability standards or constraining expenditure because of a government austerity or debt reduction program.

 

Regulatory Framework

 

Efficiency in the sector is also linked to the efficacy of the regulatory framework. According to the Productivity Commission, incentive based regulation would be strengthened, rather than diminished, by privatisation. The existing National Electricity Rules lack effective incentives for GOCs to reduce costs and intra-government conflicts, and function best when the regulated businesses are motivated by generating returns.14

 

State ownership produces perverse interactions with these existing rules, which are likely to lead to overinvestment and ineffective cost controls. For example, it appears that GOCs can more easily access finance, when compared with private enterprises. This results in a gap between the true weighted average costs of capital (WACC) and the regulated WACC. Consequently, GOCs experience a disproportionately small financial penalty for overspending. Overspending can even be profitable for GOCs.

 

Operational Practices

 

The Productivity Commission has observed the differences in operational practices between GOCs and private network service providers. In particular, state owned networks generally have a lower ratio of customers per employee, after accounting for customer density, and allocate an average of 47 per cent of their labour, materials and contractors operating expenditure in house, compared to 32 per cent for private entities.15 Similarly, the Commission of Audit referred to substantial international evidence which indicates that privatised government enterprises can operate more cost effectively when allowed to make decisions without government interference.16

 

Consequences Of State Ownership

 

Overinvestment and ineffective cost controls in the electricity sector have a negative effect for both the State and consumers. For the State, returns are diminished and capital is used inefficiently. For consumers, the level of increased cost that they bear is not reflected in the marginal improvement in service levels.

 

Public Benefit

 

It is clear that these benefits, if realised, would have positive outcomes for the public, both as consumers and taxpayers.

 

The State’s resources should be deployed where they benefit Queensland the most. The redirection of the State’s capital to core public sector services and away from industries where the rationale for State ownership no longer exists would stimulate expansion and improvement of those services.

 

Meanwhile, greater efficiency in the electricity sector would allow electricity bills to be reduced, as efficiency levels are ultimately reflected in costs to consumers. Acceptable private sector services levels could be ensured through regulation.


End Notes:

 

  1. Productivity Commission, ‘Draft Inquiry Report on Public Infrastructure’, 13 March 2014, page 34.
  2. Ibid.
  3. Queensland Commission of Audit, ‘Final Report – February 2013’, 30 April 2013, volume 2, page 59.
  4. Treasurer and Minister for Trade, The Honourable Tim Nicholls Media Statement, ‘Government to seek private sector infrastructure investment’, 12 December 2013.
  5. Queensland Commission of Audit, above n 3, volume 1, page 12.
  6. Queensland Commission of Audit, above n 3, volume 1, page 14.
  7. Infrastructure Partnerships Australia, ‘Powering Queensland’, 14 October 2013, page 8.
  8. David Crowe, ‘$15bn fund to pay for asset sale bonus plan’, The Australian, 29 March 2014.
  9. Steven Scott, ‘Nicholls accepts Hockey’s deal to win a mandate to sell assets’, Courier Mail, 29 March 2014.
  10. Jonathan Shapiro, Mark Ludlow and Phillip Coorey, ‘Union funds back asset sale’, Australian Financial Review, 31 March 2014.
  11. Ibid
  12. Productivity Commission, above n 1, pages 109-210.
  13. Queensland Commission of Audit, above n 3, volume 2, page 54.
  14. Productivity Commission, ‘Final Report on the Electricity Network Regulation Framework’, 9 April 2013, pages 267-270.
  15. Ibid, page 258.
  16. Queensland Commission of Audit, above n 3, volume 1, page 7.

 

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