Electricity Reform and Gains from the Reallocation of Resources

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1 Electricity Reform and Gains from the Reallocation of Resources Malcolm bbott, Ph.D., is currently a Senior Manager of KPMG and works in New Zealand and ustralia. He is also a Research ssociate at the Centre for Research in International Education in uckland, New Zealand. He is a past Dean of the School of International Studies at IS St Helens in uckland. In the past he has been an economic advisor to the state government of Victoria in ustralia and the ustralian Government s Competition and Consumer Commission. He has also carried out consulting work for agencies of the ustralian, New Zealand, Chinese, and U.K. governments. He holds degrees from La Trobe University and the University of Melbourne in ustralia. He can be contacted at mjabbott@kpmg.com.au. Perhaps the greatest beneficiary of electricity reform in ustralia was the state government of Victoria itself, which was able to reduce debt levels and post budget surpluses even while increasing expenditure and employment levels in education, health care, and law and order. Malcolm bbott I. Introduction Since the 1980s the electricity industry in many countries has been through a process of restructuring and reform. The general trend of this reform has been toward opening up the industry to competition in order to encourage efficiency gains. In some cases, as well, the privatizing of government-owned assets has occurred in order to both enhance competition and transfer risk from the public to private sector and make additional resources available to governments (Wolak and Patrick, 1997; Steiner, 2000; Hirsh, 1999; PEC/BRE, 2002). T he pressure to reform the electricity industry was driven by a number of factors, differing in their intensity across the world. These factors involved such things as technological changes, evidence of underperformance in the industry, and a general trend toward privatization. Since this reform process has been undertaken there has arisen ample evidence that there have been improvements in efficiency /$ see front matter # 2007 Elsevier Inc. ll rights reserved., doi:/ /j.tej The Electricity Journal

2 (Joskow, 2003, 2006). Markiewicz et al. (2004) have found that the operating costs of generating plant fell more in those states in the United States where restructuring to support competition occurred compared to states where this did not occur. Bushnell and Wolfram (2005) found that divested plant and those that were subject of incentive regulation improve fuel efficiencies compared to other companies. In the ustralian case, bbott (2005) found that the ustralian industry increased its level of productivity substantially over the period of restructuring and reform. Other studies have found significant efficiency improvements in South merican countries during the course of reform (Rudnick, 1998; Rudnick and Zolezzi, 2001) as well as in England (Newbery and Pollitt, 1997). lthough the raising of efficiency levels has been the most important motivation for introducing reform, the desire to reduce the financial burden on governments has been a contributing factor. In doing so it has become possible for governments to reallocate resources to other uses, whether through reduced taxation levels or though the provision of additional public services. In the state of Victoria in ustralia this has certainly been the case since the industry in that state was opened up to competition and privatized during the 1990s. Leaving aside the gains that competition introduced in terms of efficiency, the privatization process left the state government of Victoria with a substantially reduced level of debt in the late 1990s and a capacity to expand the provision of public services that would not have been possible if the reform process had not occurred. The purpose of this article is to look at the impact of the privatization process in the State of Victoria on the level of debt of lthough raising efficiency levels has been the most important motivation, the desire to reduce the financial burden on governments has also been a factor. the Victorian government and its subsequent ability to deliver public services. What occurred was a transformation of the capacity of the government in the state of Victoria in terms of its ability to deliver public services in the areas of health, education, and law and order. II. Victorian and ustralian reform The State of Victoria lies in the southeast corner of ustralia. In 2006 the state s population was approximately 5.1 million with the bulk of its population concentrated in its capital city Melbourne (population 3.5 million). In 2006 the state s electricity consumption was approximately 55,000 Gigawatthours, the bulk of which was supplied from power stations within the state, with a minor part being supplied from the neighboring state of New South Wales and from the national/ state government-owned Snowy Hydro Limited. ustralia has a federal system of government which comprises a national government, six state governments, and two territory governments, as well as local government authorities. Traditionally electricity supply has been under the responsibility of the state and territory governments although the reform of the industry was undertaken by a national approach which involved the cooperation of the various governments together. s well as electricity supply, the state governments in ustralia are responsible for the provision of a large range of publicly provided services such as schools, hospitals, law and order, and public transport. Prior to 1990 the Victorian electricity supply industry as was normal in ustralia at this time was dominated by a single vertically integrated stategovernment-owned authority (the State Electricity Commission of Victoria). s well as being responsible for the bulk of generation, distribution, transmission, retail and system ug./sept. 2007, Vol. 20, Issue /$ see front matter # 2007 Elsevier Inc. ll rights reserved., doi:/ /j.tej

3 operation in Victoria, this authority was also responsible for regulation of the industry in such areas as electrical safety. fter 1991 the ustralian state and territory governments began working to restructure their electricity authorities, although the pace of this reform varied across the different states. 1 The State of Victoria led the way in the implementation of this process. Initially Victoria s integrated company was disaggregated into three interim operating businesses (generation, transmission, distribution/retail). Subsequently distribution/retail was divided into five companies with separate franchise areas and generation was broken up into seven separate generation companies. In the years 1995 to 1997 these companies were privatized. 2 Victoria was also the first state to establish a wholesale electricity pool, which opened in In 1996 Transgrid began operating the New South Wales wholesale market. These two were joined subsequently and, in 1998, the National Electricity Market (NEM) commenced. The NEM is a wholesale market for the supply and purchase of electricity combined with an open access regime for the use of transmission and distribution networks in the participating jurisdictions of the CT, New South Wales, Queensland, South ustralia, Tasmania, and Victoria. When the National Market was created in ustralia in 1998, a governmentowned company, NEMMCO, was made responsible for the operation of the system, thus separating ownership and operation of the transmission system. s well as establishing a wholesale electricity market for electricity, the vertically integrated electricity companies in all of the states (not just Victoria s) were broken up into constituent parts (generation, transmission, distribution, retail, system operation) and corporatized. In the State of Victoria the separated companies were also privatized. The gross proceeds of the sale of the electricity industry were $23 billion (ustralian), or $13 billion US, net after the Victorian Government had paid off debt associated with the industry. 3 s well, $5 billion was obtained from the sale of natural gas industry assets and additional smaller sums from other privatizations. The Victorian Government s uditor General s department estimated that annual savings net of expenditures were about $760 million from the sale of electricity, gas, and transport assets, net of dividends that would otherwise have been expected. fter the sale of these stateowned assets the Victorian Government used much of the proceeds to retire the debt of the government. Figure 1 shows the level of net general government debt of the Victorian Government as a percentage of gross state product and the cost of servicing debt (interest payments) made as a proportion of total outlays of the Victorian Government. The retirement of debt that was achieved by the sale of the electricity industry assets greatly relieved the debt burden on the state and helped substantially to push the state s budget back into surplus. Figure 2 shows the budget surplus/deficit of the Victorian state government as a percentage of gross state product. Once debt levels and interest payments had been reduced, levels of Figure 1: General Government Net Debt as a Proportion of Gross State Product and Interest on Debt as a Proportion of Total General Government Outlays, Percentage /$ see front matter # 2007 Elsevier Inc. ll rights reserved., doi:/ /j.tej The Electricity Journal

4 Figure 2: Net Borrowing Requirement of the Victorian Government (Surplus +/Deficit ) expenditure were also reduced, which made it easier for the government to generate budget surpluses. combination of expenditure cutbacks and reductions in debt and therefore interest payments helped to push the Victorian government deficit into surplus from the mid- 1990s. I n the case of the industry itself, the introduction of competition and privatization led to substantial improvements in productive efficiency (bbott, 2005; ccess Economics). Capital utilization rates were greatly increased and staff numbers reduced. ccording to the Electricity Supply ssociation of ustralia, employment numbers in the Victorian industry fell from 17,237 in 1991 to only 6,230 by 2000 (Electricity Supply ssociation of ustralia). The increased levels of efficiency achieved in the industry meant that price reductions were able to be passed onto consumers once retail competition commenced. The largest gainers from this were the large industrial and commercial consumers, who were able to take advantage of retailers competing for their business. Residential consumers saw little change in the real average price of electricity. T he overall economic performance of the Victorian economy also gained, indirectly, as price reductions to industrial and commercial users were eventually passed on to others in the economy in the form of lower prices for goods and services. s well, the overall economy benefited from lower taxes and increased government spending that otherwise would have occurred. This has been estimated at around 0.5 percent of gross state product (ccess Economics). The reduction in staffing levels in the industry placed a heavy burden of cost on many who worked directly in the industry but it also released large numbers of young, skilled, and experienced workers to be employed in other industries. s the generation sector of the electricity supply industry is one that is heavily concentrated in one region of the state (the Latrobe Valley), this community suffered from a reduction in employment levels and income. Small businesses in particular in the region were adversely affected. regional development program was eventually undertaken by the state government to assist employment growth in the region. III. Public Services in Victoria lthough the industry experienced a substantial change in its levels of operational efficiency, substantial gains were also achieved elsewhere. One of the most important direct gainers from the process was the Victorian state government itself. The debt burden on the Victorian government in the early 1990s had meant that the government had to restrain spending on government services and infrastructure to protect its finances. Once this burden was lifted by the retirement of debt made possible by the privatization process, expenditure on these services could be, and was, increased considerably. The lifting of the debt burden on the government meant that gradually in the late 1990s it was able to increase expenditure on the provision of ug./sept. 2007, Vol. 20, Issue /$ see front matter # 2007 Elsevier Inc. ll rights reserved., doi:/ /j.tej

5 government services and infrastructure. O ne of the most ironic outcomes of the reform process was that the government that carried out the reforms was not to benefit from the subsequent increases in public sector expenditure. The conservative coalition government made up of the Liberal and National parties led by Jeff Kennett which carried out the privatization process was defeated at an election in 1999 and replaced by a Labor Party government led by Steve Bracks. lthough the Labor Party had opposed privatization while in opposition, it did not reverse the process once in office but instead decided to concentrate on expanding the provision of public services. Perhaps the most important area in which this occurred was in the case of expenditure on public hospitals. Figure 3 shows the annual rate of growth of real expenditure on public hospitals in Victoria and the growth of the gross state product. From 1995 onwards, growth in real expenditure on public hospitals tended to exceed that of growth of the state s economy in general. lthough there had been some growth in this expenditure early in the 1990s, growth in expenditure was far higher in the early 2000s than it had been 10 years earlier. S omething similar occurred in thecaseofspendingon school education. Figure 4 shows the growth in spending on primary and secondary schools in Figure 3: Growth in Real Gross State Product and Real Recurrent Expenditure on Public Hospitals, Percentage Victoria during the 1990s. Early in the decade spending on schools was cut back in order to reduce the size of the state government s budget deficit. Later in the decade, spending on Victorian schools was increased as the financial position of the government was eased. This growth in government service provision can be seen perhaps more dramatically in terms of the number of police, government schoolteachers, and nurses employed in state hospitals. Table 1 provides data on the number of police, government schoolteachers, and public hospital nurses employed by the Victorian government in 1990/1991 (before the reforms occurred), as well as in 1997/1998 (when many of the assets sales were complete), and 2005/06. In the first half of the 1990s, numbers of these employees tended to be stable (police and nurses) or to fall (schoolteachers). From the mid-1990s, in each case Figure 4: Growth in Real Gross State Product and Real Recurrent Expenditure on Schools, Percentage /$ see front matter # 2007 Elsevier Inc. ll rights reserved., doi:/ /j.tej The Electricity Journal

6 Table 1: Police, Schoolteacher and Public Hospital Nurse Numbers in Victoria there was a substantial increase in the numbers employed, the largest increase occurring for nurses employed in public hospitals. lthough general growth of the economy and the population of Victoria helped to boost these numbers, there is some indication that numbers employed compared to the 1990/ / /2006 Police (sworn-in police) 9,726 9,750 11,601 Police per thousand population Teachers (FTE) 45,696 42,034 49,056 Teachers per thousand students Nurses in public hospitals 16,621 17,214 24,372 Nurses per thousand of population Source: ustralian Institute of Health and Welfare. ustralia, steering Committee for the Review of Commonwealth/ State Service Provision. Victoria Police. population also grew. From Table 1 it can be seen, for instance, that the number of police employed per thousand Victorians grew from 2.05 in 1997/1998 to 2.29 in 2005/2006. The number of nurses per thousand people in Victoria also rose from 3.6 in 1997/98 to 4.9 in s well, the number of schoolteachers per thousand students rose from 8.06 in 1997/98 to 9.15 in 2005/06. lthough this growth in government service provision was assisted by a growth in tax revenues as the general economy grew and from the sale of other state assets besides the electricity industry, the sale of the electricity industry assisted in enabling the state government to allocate additional resources into the service provision. It is quite clear that although the electricity industry was directly affected to a very large degree by the reform process, so too were other parts of the economy including the public sector. The reform of the industry Perhaps the greatest beneficiary of electricity reform process was Victoria. ug./sept. 2007, Vol. 20, Issue /$ see front matter # 2007 Elsevier Inc. ll rights reserved., doi:/ /j.tej

7 meant that the government could redirect substantial amounts of resources into the provision of general public services and infrastructure. IV. Conclusion lthough it is true that the reform of the ustralian electricity industry during the 1990s brought about substantial improvements in the efficiency and productivity levels achieved by the industry in Victoria, it also had a profound affect on the nature of state government finances and public service delivery in that state. Perhaps the greatest beneficiary of the reform process was the state government of Victoria itself, which was able to reduce debt levels, post budget surpluses while at the same time gradually increasing expenditure and employment levels in education, health care, and law and order. To a very large degree public resources were reallocated from investment in the electricity industry to a greater provision of public services that would probably not have been achieved if the industry had remained under government ownership. The benefits of electricity market reform and privatization, therefore, should not just be confined to the impact of the industry itself but also to the impact that it has on the greater economy itself and, in the case of privatization, on the delivery of public services as well.& References M. bbott, The Productivity and Efficiency of the ustralian Electricity Supply Industry, Energy Econ., 2005, 28 (4) at sia Pacific Economic Cooperation, Deregulating Energy Markets in PEC: Economic and Sectoral Impacts, PEC/ BREeconomics, ustralia, Industry Commission, Energy Generation and Distribution, IC Inquiry Report, 1991 May. ccess Economics, Impact on Victoria of the Privatisation of the State s Electricity and Gas ssets, Final Report, prepared for TXU, Canberra, ustralia, Steering Committee for the Review of Commonwealth/State Service Provision, Report on Government Services/Steering Committee for the Review of Commonwealth/State Service Provision, Melbourne, ustralian Institute of Health and Welfare, ustralian Hospital Statistics: n Overview, Canberra, ustralian Bureau of Statistics, Government Finance Statistics, ustralia, ustralian Bureau of Statistics, Canberra, J. Bushnell, C. Wolfram, Ownership Changes, Incentives dd Plant efficiency: The Divestiture of U.S. Electric Generation Plants, March, Univ. of California Center of Energy Markets, CSEM WP- 140, Electricity Supply ssociation of ustralia, Electricity ustralia...: The Electricity Supply Industry in ustralia Year, Melbourne, Richard F. Hirsh, Power Loss: The Origins of Deregulation and Restructuring in the merican Electric Utility System (Cambridge, M, and London: MIT Press, 1999). P. Joskow, Electricity Sector Restructuring and Competition Lessons Learned, Latin m. J. Econ., 2003, 40 (121) at P. Joskow, Markets for Power in the United States: n Interim ssessment, Energy J., 2006, 27 (1) at K. Markiewicz, N. Rose, C. Wolfram, Does Competition Reduce Costs? ssessing the Impact of Competition on U.S. Electric Generation Efficiency, Cambridge, Mass., MIT CEEPR Discussion Paper WP , D. Newbery and M. Pollitt, The Restructuring and Privatization of Britain s CEGB: Was It Worth It? J. Indust. Econ., 1997, 45 at H. Rudnick, Market Restructuring in South merica, IEEE Power Eng g. Rev. June 1998at 3 6. H. Rudnick, J. Zolezzi, Electric Sector Deregulation and Restructuring in Latin merica: Lessons to Be Learned and Possible Ways Forward, in IEEE PROCEED- INGS ON GENERTION TRNSMISSION ND DISTRIBUTION 148, 2001, at Steiner Faye, Regulation, Industry Structure and Performance in the Electricity Supply Industry, OECD Economics Dept. Working Papers No. 238, Paris, OECD, Victoria Police, nnual reports, Melbourne. Frank. Wolak and Robert Patrick, The Impact of Rules and Market Structure on the Price Determination Process in the England and Wales Electricity Market (Mimeo: Stanford Univ., 1997). Endnotes: 1. This process was initiated in May 1991 when the Industry Commission delivered its report entitled Energy Generation and Distribution, which recommended a major restructuring of the electricity industry by disaggregating utilities into generation, transmission, and distribution components. It also recommended that each element be corporatized and a competitive market be established. 2. The various states agreed to the establishment of a linked national market and the disaggregation of their respective electricity companies but also agreed to leave the issue of private versus government ownership to be decided on a state by state basis. In the states of Victoria and South ustralia, the decision was made to privatize electricity assets, while in the other states the respective governments decided to retain government ownership. 3. ccording to the uditor-general s Department, excluding franchise fees and other payments /$ see front matter # 2007 Elsevier Inc. ll rights reserved., doi:/ /j.tej The Electricity Journal