The Department of Innovation, Industry and Regional Development. Economic Impact of the Natural Gas Extension Program

Transcription

1 The Department of Innovation, Industry and Regional Development Economic Impact of the Natural Gas Extension Program This report contains 36 pages 05-NGEPEEcoImpactCFFinal.doc

2 Contents 1 Executive summary 2 2 Introduction Natural gas in Victoria The natural gas extension program Structure of this report 7 3 Data collection and modelling approach Capital expenditure associated with infrastructure extension Industrial, domestic and commercial connections Approach to modelling 11 4 Results of the economic review Direct Impacts Indirect Impacts Flow-On Effects 20 5 Summary and conclusions 23 A Data tables 26 B Potential household savings arising from conversion to natural gas 28 i

3 Disclaimer Third Party Reliance This report is solely for the purpose set out in Section 2 of this report and for the Department of Innovation, Industry and Regional Development s () information, and is not to be used for any other purpose or distributed to any other party without KPMG s prior written consent. This report has been prepared at the request of in accordance with the terms of the Agreement dated 8 October 2003 and Purchase Order Number KPMG/007. Other than our responsibility to, neither KPMG nor any member or employee of KPMG undertakes responsibility arising in any way from reliance placed by a third party on this report. Any reliance placed is that party s sole responsibility. Inherent Limitations This report has been prepared as outlined in Section 3. The procedures outlined in Section 3 constitute neither an audit nor a comprehensive review of operations. In the course of our work, projections have been prepared on the basis of assumptions and methodology which have been described in our report. It is possible that some of the assumptions underlying our projections may not materialise. Nevertheless, we have applied our professional judgement in making these assumptions, such that they constitute an understandable basis for estimates and projections. Beyond this, to the extent that certain assumptions do not materialise, then you will appreciate that our estimates and projections of achievable results will vary. No warranty of completeness, accuracy or reliability is given in relation to the statements and representations made by, and the information and documentation provided by Regional Development Victoria, consulted as part of the process. KPMG have indicated within this report the sources of the information provided. We have not sought to independently verify those sources unless otherwise noted within the report. KPMG is under no obligation in any circumstance to update this report, in either oral or written form, for events occurring after the report has been issued in final form. The findings in this report have been formed on the above basis. 1

4 1 Executive summary Approximately 90 per cent of Victoria s residential and business premises have access to natural gas, with around 75 per cent actually connected to the network. Most of these are in the Melbourne metropolitan area or in major towns. In its first term, the Government consulted widely throughout regional and rural Victoria, discovering a relatively strong interest from areas without reticulated natural gas for this service to be provided to support community and economic development in these towns. Due to a number of factors which adversely impact on the economics of supplying natural gas to regional Victoria including the limited size of the gas load in regional towns and the distance of towns from existing infrastructure, there has been little incentive for the privatised Gas Distribution Businesses to extend the existing network. Through the financial commitment of $70m to the Natural Gas Expansion Program (NGEP) and fostering an environment conducive to investment by the Private Gas Distribution Businesses, the Victorian Government has sought to overcome this impasse and facilitate expansion of the natural gas network. This report presents an economic review of the impacts arising from supplying 34 towns with reticulated natural gas. The capital cost of this network expansion is estimated at $147 million, with 20 years of operational and maintenance costs estimated at $14.6m, estimates made in June 2004 dollars. The Victorian Government is providing a financial incentive, by committing the available NGEP funds. Regional Development Victoria (RDV), a division of the Department of Innovation, Industry and Regional Development, commissioned KPMG to provide an economic review of the NGEP. Our report is presented in four parts. Following an introduction to the program, we detail our data collection approach and the modelling undertaken. We then present our results and concluding comments. Data for this economic review was sourced from the documents provided by the gas distribution businesses as part of a tender process to select both which towns would benefit from the NGEP and the government s preferred supplier to construct and operate the expanded infrastructure. These bid documents detail expansion of the reticulated natural gas network to 34 towns with local households and small commercial premises having the potential to access the expanded network. The economic implications of the tranche of the NGEP have been measured in terms of impact on gross state product (GSP) and employment creation. The approach adopted to quantify estimates of economic impact involved the use of a computable general equilibrium (CGE) model. The economic implications of the project were also evaluated in terms of the construction phase of the project and its operations phase. We also considered direct, indirect and flow-effects on the economy as a result of the natural gas network expansion. The chart below illustrates the impact on Victoria s GSP resulting from construction and investment. The direct impacts are as a result of the pipeline construction activities. Indirect impacts include the effect of commercial and industrial facilities in the 34 towns expanding their operations having been stimulated to invest following the delivery of natural gas. Flow-on effects are broader economy wide implications arising from households directing their savings arising from the availability of a cheaper fuel source to other economic activity. 2

5 The net present value of the construction and investment effects illustrated below across the 20- year period of this analysis is estimated at $118.1 million. Impact on GSP in Victoria resulting from construction & investment $ million Direct Indirect Flow-on The chart below illustrates the impact on the Victoria s GSP resulting from gas operations and supply to rural and regional areas. The direct impacts are the smallest of the three types of impact and arise from the increased activity in the gas distribution sector as they supply gas to an increased number of household and industrial/commercial facilities. The indirect impacts arise from estimates of increased turnover and exports from industrial and commercial facilities that may have been able to expand or convert to natural gas. The flow-on impacts represent broader economy-wide effects. The net present value of the effects arising from increased business activity and customer savings illustrated below, across the 20-year period of this analysis is estimated at $309.5 million. Impact on GSP in Victoria resulting from gas operations and supply $ million Direct Indirect Flow-on 3

6 Overall, the net present value of the entire project across the construction ($118.1 million) and operations ($309.5 million) phases is estimated at $427.6 million. This increased economic activity will generate employment growth in Victoria. Over the 20- year period of this analysis additional employment is estimated at over 7,900 employment years (an average of around 395 full time equivalent employees each year sustained over the period of analysis). Employment effects arising from extension of the natural gas network Emplyment years Direct Indirect Flow-on A relevant question to ask in an economic review of the NGEP and the financial incentives provided by the Victorian Government, is whether this is a worthy intervention. The Victorian Government committed to the expansion of the natural gas network on the basis that it would provide positive economic benefit. This report has reviewed and attempted to quantify the economic implications of the program. Overall we find positive returns to the Victorian economy that are greater than the incentive provided to the gas distributors. Importantly, this project delivers benefits to Regional Victoria and key industrial sectors, such as the food and beverage industry are likely to derive significant benefit from the availability of natural gas. It is also worth noting that the introduction of natural gas to an additional 34 towns in regional Victoria for domestic and commercial applications has the potential to substitute a fuel that releases less pollutants into the atmosphere than its alternatives (e.g. less CO 2 than from brown coal fired power stations and less soot and smoke from wood burning). It was outside the scope of this report to describe more fully and attempt to quantify any of these potential environmental advantages. 4

7 2 Introduction The Department of Innovation, Industry and Regional Development () has commissioned KPMG to undertake an economic review of the Victorian Government s Natural Gas Extension Program (NGEP). Information in this report is designed to assist in understanding the potential economic implications of the Government s $70 million NGEP. 2.1 Natural gas in Victoria Natural gas first became available to Victorians in During the 1970s and 1980s distribution infrastructure gradually extended across the metropolitan areas and into major regional centres. During the 1990s expansion of the distribution system has been mainly limited to new housing areas adjacent to existing infrastructure. Three licensed gas distributors presently serve Victoria: SP AusNet (formerly TXU); Envestra Ltd; and Multinet Gas Distribution Partnership. Table 1 provides an overview of the existing distribution system. Table 1: Overview of Victoria s gas distribution system Area serviced Network length Network area Number of connections Load (Petajoules) SP AusNet Envestra Multinet Services the western and northwestern areas of metropolitan Melbourne and 19 centres in central and western Victoria including Ballarat and Geelong 8,000 km of distribution pipelines (inc. 183 km of transmission pressure lines) Services major metro fringe and regional centres including Shepparton, Wangaratta, Wodonga, Berwick, Frankston, Rosebud, Mornington, Moe, Morwell, Traralgon, and Sale. 8,381 km of distribution pipelines (inc. 331 km of transmission pressure lines) 2,000 km 2 n/a 1,603 km 2 Over 432, , ,500 Services Melbourne's inner and outer eastern and south eastern suburbs. 9,280 km of distribution pipelines (inc. 170 km of transmission pressure lines) n/a 56.7 PJ (at June 2004) 60 PJ (at 2003) Source: and viewed April While gas networks have expanded in metropolitan Melbourne over recent years, expansion of natural gas reticulation for domestic and commercial use in regional communities has been 1 Many of the comments in Section 2.1 are sourced from KPMG s 2003 report on development of the NGEP. 5

8 limited primarily due to the cost associated with developing the necessary infrastructure. The cost of gas distribution infrastructure has two primary drivers: 1. the distance from an existing gas transmission line or gas distribution main 2 ; and 2. the density of housing (or other users) in an area 3. Notwithstanding relatively poor supply economics, Victorian regional communities that are not presently reticulated, in general seek access to natural gas. They clearly understand that gas has a variety of economic, environmental and social benefits for residents and businesses, principally driven by the price differential between natural gas and alternative fuel sources such as LPG, electricity and wood. In the period since Victoria s gas industry was privatised, several Councils have commenced processes aimed at providing their communities with reticulated natural gas. More often than not, these efforts have failed to achieve their objective. These exercises have highlighted that many gas extensions need a degree of external funding in order to secure the commitment of a gas distribution business, and that in some of these cases the broader consumer benefits from gas extensions, through reduced energy costs, greenhouse emissions and the social benefits of more affordable energy, could justify such a contribution from Government. The State Government has recognised the benefits that may accrue from the extension of the gas network, providing funding for the $70 million NGEP. 2.2 The natural gas extension program In June 2003 the Minister of State and Regional Development, the Hon John Brumby and the Minister for Energy Industries and Resources, the Hon Theo Theophanous announced the Government s plans to invest up to $70 million towards the capital costs of extending Victoria s natural gas network. RDV is responsible for delivering the NGEP. Local councils nominated towns from around Victoria to be a part of the extension program. Gas distributors (including the existing suppliers in Victoria - SP AusNet, Multinet and Envestra) then submitted bids into the Government s centralised tendering process to supply the businesses nominated towns with natural gas. The Government has approved extensions to 34 towns, with each distributor receiving a proportion of the total funding available under the NGEP. 2 Customers in a remote network pay for local infrastructure and the cost of transporting the gas to the remote location. In metropolitan areas the next group of customers may be the other side of the highway. In regional areas, the next group of customers may be 20 or 30 km away. 3 Higher housing densities make for more attractive network economics through more customers (and use of gas) for less pipe and other infrastructure. Regional towns often have lower housing densities. 6

9 Table 2: 29 towns currently approved as part of the NGEP Towns Agreed Supplier Towns Agreed Supplier 1. Bairnsdale Envestra 18. Wesburn Multinet 2. Paynesville Envestra 19. Wonthaggi Multinet 3. Balnarring Envestra 20. Woori Yallock Multinet 4. Balnarring Beach Envestra 21. Yarra Glen Multinet 5. Merricks Beach Envestra 22. Yarra Junction Multinet 6. Somers Envestra 23. Gisborne SP AusNet 7. St Andrews Beach Envestra 24. Lancefield SP AusNet 8. Hurstbridge Envestra 25. Macedon SP AusNet 9. Launching Place Multinet 26. New Gisborne SP AusNet 10. Inverloch Multinet 27. Riddell's Creek SP AusNet 11. Korumburra Multinet 28. Romsey SP AusNet 12. Lang Lang Multinet 29. Woodend SP AusNet 13. Leongatha Multinet 30. Barwon Heads SP AusNet 14. Millgrove Multinet 31. Camperdown SP AusNet 15. Seville Multinet 32. Port Fairy SP AusNet 16. Seville East Multinet 33. Creswick SP AusNet 17. Wandin Multinet 34. Maiden Gully SP AusNet This report has been commissioned at a time when the Victorian Government has negotiated development agreements with SP AusNet, Envestra and Multinet. As such detail is now available to estimate the capital spend required to reticulate the 34 agreed towns and the potential penetration of gas usage in to domestic and commercial applications. This report outlines the assumptions and outcomes in terms of identifying a quantified value of the potential economic impacts of the gas extension program. The benefits are primarily in terms of the implications of the project for net job growth and income creation within the state of Victoria. This assessment is categorised in terms of the direct impact (impact pertaining to the project itself); indirect impacts (the generation of economic activity in response to access to gas in the various regional areas); and the flow-through effects (the broader, or economy-wide response to the project). 2.3 Structure of this report Following this introduction, Section 3 discusses our approach to the economic review providing details of: the proposed value of the private capital investment required for construction and connection of natural gas infrastructure; the estimated annual consumption of natural gas as a result of new connections; and the approach taken to modelling the potential economic impact arising from the abovementioned activities. 7

10 Section 4 then reports on the potential impact on the Victorian economy, focusing on employment impacts, and income value added to Victoria as a result of the infrastructure construction, connection and uptake of alternative fuel by domestic and commercial users. Our conclusions are discussed in Section 5. 8

11 3 Data collection and modelling approach The successful bids submitted by SP AusNet, Envestra and Multinet, supplied by Regional Development Victoria, were the main data source for this economic review. The data submitted by each distributor varied slightly in terms of the type of information provided and the level of detail included in each submission. As a consequence, we have made a number of assumptions and extrapolations to create 20-year forecasts of customer numbers and demand. These assumptions are discussed in further detail below. 3.1 Capital expenditure associated with infrastructure extension To complete the reticulation of natural gas to the 34 towns, SP AusNet, Envestra and Multinet have allocated $147 million 4 in capital expenditure and an estimated $14.6 million over 20 years for operations and maintenance (estimates made in June 2004 dollars). The majority of bids submitted by the suppliers included a town-by-town breakdown of the capital expenditure requirements of each town. 5 The factors effecting the capital expenditure requirement of the 34 towns will include the proximity to existing transmission or distribution networks, typography and land access. Capital expenditure associated with extending a gas network includes: the various types of pipes used to build a network, including Steel and Polyethylene pipe; city gates, heaters, and field regulators and other materials needed to control the flow and pressure of gas; construction costs including labour and plant, it is estimated that these cost represent approximately 50 per cent 6 of the overall construction of a gas pipeline; and engineering and project management costs. The 34 towns announced as part of the NGEP cover ten regions across Victoria.. Victoria s three gas distributors will undertake pipeline construction and connection activities as part of the NGEP. Each of the distributors has outlined a multi million-dollar capital expenditure program. A breakdown of the capital expenditure by distributor is provided in Table 3. 4 Figure compiled from the various bids as well as additional information provided from. 5 Some bids only included partial breakdowns. 6 Based on advice from an experienced natural gas engineering business. 9

12 Table 3: Capital expenditure by agreed supplier Agreed Supplier Capital Expenditure ($ 000) (estimates made in June 2004 dollars) SP AusNet 56,479 Envestra 28,949 Multinet 61,801 Total 147,229 The basis of the Victorian NGEP was government financial incentive provided to the gas distribution businesses undertaking the expansion of Victoria s gas network. The Victorian Government allocated $70 million to the program to connect the 34 towns approved under the NGEP. 3.2 Industrial, domestic and commercial connections Customer estimates supplied in the bids were based of tariff classifications. In Victoria tariff classifications are based on average gas usage during a one-year period. The two types of tariffs in Victoria are tariff V and D. Connections with annual usage of less than 10 TJ (tera joules) are classified as tariff V and those with annual usage of greater than 10 TJ are classified as tariff D. The distribution business identified three major tariff D gas connections in their bids to the Victorian Government. Table 4 describes the potential additional investment that three known industrial users in regional Victoria have described as a result of the availability of natural gas. 10

13 Table 4: Details of known commercial investments Company Industry/ description Location Investment Patties Bakery Pty Ltd Camperdown Cheese Company Patties is a 100% Australian owned bakery. Patties leading brands include 'Four'n Twenty', Herbet Adams and Nanna's Food production Bairnsdale, East Gippsland region Camperdown, Western Victoria GLAXO Smith Kline Pharmaceutical Company Port Fairy, Western Victoria Oven conversion estimated at $50, new jobs Facility expansion estimated at $20 million While all businesses in the newly supplied towns will have the potential to benefit from switching to natural gas only these three businesses have outlined plans for further investment and estimated their demand for gas. In their bid to the Victorian Government, the three distributors also estimated the number of tariff V customers with the ability to connect to the gas network and the potential market penetration they predict over the next 20 years. This modelling is based on the predicted gas uptake by tariff V customers. 3.3 Approach to modelling The analysis conducted as part of this report involved applying economy-wide modelling to estimate the value of direct, indirect and flow-through effects 7, which includes both positive and negative impacts on Victoria s economy. Each of the potential direct, indirect and flow on effects are described in sections 4.1, 4.2 and 4.3 respectively. This modelling is based on the application of a CGE (computable general equilibrium) modelling approach applying the Monash Multi-Region Forecasting model (MMRF) developed by the Centre of Policy Studies at Monash University. This modelling framework is used consistently around Australia for the assessment of policy issues Description of the Monash Model The MMRF model is a multi-regional, dynamic CGE model. It distinguishes up to eight Australian regions (six States and two Territories) and, depending on the application, up to 144 commodities/industries. In this application, the base model has been applied with 5 regions and 25 industry sectors 8. The model recognises: 7 Barry Burgan at Adelaide University assisted with this aspect of the project. 8 Eight regions and 144 commodities is the most detailed version of the model. The Centre for Policy Studies also makes a standard model available that includes 25 sectors and 5 regions. This standard model was deemed suitable in this instance given the nature of the investment, and that we are concerned with two regions Victoria and rest of 11

14 domestic producers classified by industry and domestic region; investors similarly classified; up to eight region-specific household sectors; an aggregate foreign purchaser of the domestic economy's exports; flows of greenhouse gas emissions and energy usage by fuel and user; up to eight state and territory governments; and the Federal Government. The model contains explicit representations of intra-regional, inter-regional and international trade flows based on regional input-output data developed at the Centre of Policy Studies, and includes detailed data on state and Federal governments' budgets. As each region is modelled as a mini-economy, the MMRF model is ideally suited to determining the impact of region-specific economic shocks 9. Second round effects are captured via the model's input-output linkages and account for economy-wide and international constraints. Outputs from the model can include projections of: GDP and aggregate national employment; Sectoral output, value-added and employment by region; Export earnings, import expenditure and the balance of trade; Greenhouse gas emissions by fuel, fuel user and region of fuel use; Energy usage by fuel, energy user and region of energy use; State and Territory revenues and expenditures; Regional gross products and employment; and Regional international export earnings, international import expenditures and international balance of payments. In this assignment, we specifically report on projections of impact on gross state product and employment, both at the State and regional level CGE modelling assumptions Industry specific impacts The NGEP will affect certain industries in Victoria. The increased demand generated by the extension of the natural gas network can be described as economic shocks. Australia. Use of the most detailed model would have been excessive for this situation, and any reconstruction of the standard model also unnecessary as it would not have altered the outcomes. 9 Economic shocks refer to new economic activity, such as the extension of the natural gas network and associated commercial developments, that would not have otherwise occurred in the absence of a particular project or policy. 12

15 We have determined the potential impacts of extension of the natural gas network using simulated shocks in the construction, gas production and food and beverage sectors. This is because the direct impacts of the project arise from increased construction activity associated with laying and installing the pipelines and related infrastructure and the increased sales of natural gas. Indirect impacts of the project arise from increased industrial output, and we have assumed a significant proportion of this will be in the food and beverage sector. We based the simulation around the food and beverage sector because major beneficiaries will be from that sector (e.g. Patties Pies, Camperdown Cheese Company) and given this project is largely being undertaken in regional Victoria, the smaller customers are also more likely to be from this sector. There may be other large commercial users (e.g. Bairnsdale Hospital), but in the absence of detailed information on predicted changes in turnover/expenditure of these organisations, we have contained this analysis around the dominant food and beverage sector. When we simulate the economic shock in the construction sector, the CGE modelling suggests that for a $17.8 million 10 in 2005 dollars net investment spend in the first year in the construction sector, there will be 0.006% increase in real GDP in Victoria (see Table 5). When we simulate the economic shock in the food and beverage sector, specifically evaluating the impact arising from an increase in exports, the CGE modelling suggests that for a $31.48 million 11 increase in export demand from the Victorian food and beverage would result in a 0.015% increase in real GDP (see Table 6). Table 5: Modelling re Capital Expenditure Shock Demand Shock Modelled ($ million, 2005 values) Vic (% of GSP) 0.01% Other Australia 1.78 National % Change in Vic Macro Variables Real GDP Real consumption Investment Interstate exports International exports Interstate imports International imports CPI Employment Table 6: Modelling re Ongoing Demand Shock (Food and Beverage Exports) Demand Shock Modelled ($ million, 2005 values) Vic (% of GSP) 0.02% Other Australia 0 National % Change in Vic Macro Variables Real GDP Real consumption Investment Interstate exports International exports Interstate imports International imports CPI Employment Comprising $11.2 million net spend on pipeline construction plus $6.6 million spend in individual investment. 11 Modelled at the year 12 level, with estimated increase in exports calculated at $31.48 million. 13

16 All of the modelling was undertaken for a typical year in 1996/97 dollars (i.e. the year of underlying tables in the MMRF model). Further, the economic shocks were adjusted to not only represent the economic expansion in 1996/97 dollars but also to ensure we modelled similar proportional changes in the sectors (i.e. if a shock of $X in 2005 represents a proportional increase of Y%, then a shock of $Z in 1996/97 should also represent a proportional increase of Y% in the sector of interest). Issues with model closure A discussion on model closure is important when dealing with CGE modelling as the decisions taken by the modeller in this regard influence the end result. Model closure refers to the set of variables the model user has to choose to define a model run. Each CGE model will have different closure rules. To obtain a solution for a CGE model, the number of endogenous 12 variables must equal the number of equations to be solved. To achieve this balance, some naturally endogenous variables need to be made exogenous 13 and certain assumptions are made about their values. In this instance, the MMRF model has been applied in a comparative statics context. In a comparative-static closure, the exogenous variables include: industrial sectors investments (i.e. those resulting from the NGEP); national aggregate employment; tax rates; national rates of return on capital; and other variables regarded as naturally exogenous to the model. 12 Endogenous variables are determined by some equilibrium condition when the model calculations are done. They include the answers for which the model has been constructed. 13 Exogenous factors are fixed with some known numerical value before the model calculations are performed. 15

17 4 Results of the economic review 4.1 Direct Impacts The major impacts in a direct sense can be considered across both the construction phase and operations phase of the project. The direct impacts arising from the construction phase include economic activity resulting from installing the pipelines (e.g. earthworks, pipeline materials, other gas supply equipment) and the direct employment created as a result of this activity. The direct impact arising from the operations phase include the annual value of additional gas sales and the net new employment in the gas industry as a result of three distributors operating larger networks. Assumptions applied in the modelling of direct impacts include: 70% of the construction expenditure and 90% of the operating expenditure will occur on items sourced from Victoria. The government contribution is deducted from the capital spend, as it is assumed that this is transferred from other activities (an alternative, less conservative assumption would be to assume that the government contribution is funded by debt, and repaid over time); It is assumed that that the pipeline will produce a 44% saving in energy costs for small users (households and small business). Appendix B provides details of the calculations that derive an average saving of around $504, when households convert from electricity, LPG, wood and solar energy for space heating, hot water supply and cooking to natural gas. In the absence of detailed information on the savings that might be realised by larger industrial users, it is assumed conservatively these customers will realise a 40% saving; and impacts in terms of employment and incomes (contribution to gross state product) is calculated as the average ratio for the construction and the gas sectors for the Victorian economy. The employment ratio was adjusted for inflation and productivity growth. The results of the CGE modelling exercise reveal a peak in the project s potential impact on gross state product (GSP) in Victoria across 2005 and 2006 (or years 2 and 3 of the project). This is illustrated in Figure 1 Applying a real discount rate of 7.0 per cent 14, the present value of the potential gross state product impacts of both the construction and operations phase are calculated at $21.2 million. 14 Present values are calculated for the dollar values of future economic impacts, using a discount rate of 7.0% real (as recommended in Treasury guidelines for project evaluation). 16

18 Figure 1: Direct impacts on gross state product Direct impacts on Victoria's GSP $ million Construction Operation A similar pattern is observed with new employment that might arise as a result of the direct activities associated with extending the natural gas network. Over a 20-year period, the model predicts that direct activities associated with extending the natural gas network might create almost 300 person years of employment (i.e. an average of around 15 employment years each year), though these are obviously weighted towards the initial years of construction. This is illustrated in Figure 2. Figure 2: Direct impacts on employment creation Direct impacts on employment in Victoria Employment years Construction Operation 17

19 Modelling of the direct impacts also considers the potential savings to households and businesses in regional Victoria as a result of switching from previously available fuel sources (e.g. electricity and LPG) to natural gas, which as described in the assumptions above is a cheaper fuel than the alternatives. The net present value of potential savings over 20 years to Victorian households is estimated at $74.5 million, with the net present value of potential savings to Victorian businesses estimated at $24.8 million. These savings drive many of the indirect and flow-on impacts described in the sections below. 4.2 Indirect Impacts Indirect impacts arise from other activity induced as a consequence of the project, and of particular interest are the possible industry responses to the cost savings arising from the ability to switch to a more cost-effective fuel than alternatives such as LPG and electricity. Specifically the modelling of indirect impacts considered the induced capital expenditure associated with the commercial/industrial expansions at facilities such as Camperdown Cheese and GlaxoSmithKlein; and the induced capital expenditure associated with major conversions from existing fuels to natural gas at commercial/industrial premises. These expansions and conversions may generate new employment opportunities, and additional sales of products and/or services. In order to quantifying the extent of the indirect outcomes, the following assumptions were applied to the model: A price elasticity of supply of 10 is assumed. This says that for a 1.0 per cent cost reduction (shift down on the supply curve), a business will increase output by 10 per cent. This elasticity is consistent with the elasticity parameters of the MMRF model. Therefore, in terms of revenue a $456,300 dollar saving 15 in annual costs will produce a $4.563 million increase in value of output. An average 20 per cent return on investment is assumed. It is assumed that all of the investment spend will occur within the construction sector in Victoria (note that the construction sector as a direct import component in its production vector). On the basis of these two assumptions the net increase in spend is as illustrated below (see Figure 3 and Figure 4). The impacts of this spend in terms of direct increase in income and jobs is calculated using the ratio of employment and income to turnover for the construction sector (investment) and for the manufacturing sector (operation). 15 Calculated saving derived from the assumptions applied in the assessment of direct impacts. See table A.1 in

20 Figure 3: Indirect impacts on gross state product Flow-on impacts on Victoria's GSP $ million Construction Operation Figure 4: Indirect effects on employment Indirect impacts on employment in Victoria Employment years Investment Operation The modelling finds that the potential indirect impact of the project over 20 years, has a present value $143.8 million, made up of $53.1 million of incomes generated through the investment stimulated from the reduced business costs and $90.6 million in incomes through increased business activity. The additional activity has the potential to create over 3,300 person years of employment over the 20 years of the project reviewed. 19

21 4.3 Flow-On Effects Effects on a broader level have also been considered as part of this economic review. These include the potential positive and negative effects on Victoria s economy arising from, for example from: investment made by industry and trades in equipment and tools to provide natural gas installations; new turnover and employment generated in industry and trades providing natural gas installations; potential energy savings in households due to energy substitution; and potential downsizing of other energy businesses as a result of natural gas substitution (e.g. LPG and wood). However, only limited information on these potential aspects of the project was available for the modelling exercise. The extra activity generated through the project has the potential to provide additional opportunities for those sectors supplying these businesses, and through the cost savings to households generate the capacity to spend on other activities. On the other hand the extra opportunities generated by this project will divert resources from other projects and activities (as has already been directly recognised with respect to the government contribution being netted out). Therefore, in terms of flow-on effects, this balance of pressures needs to be considered. We have simply modelled these effects using the MMRF model and shocking it with an illustrative year of extra construction spend to reflect the investment increase, and extra manufacturing exports to reflect the increased supply of local product due to the cost savings. This modelling structure was discussed in more detail in Section 3.3. The outcomes in terms of impacts on GSP and employment were then ratio-ed across the years depending on the construction spends and operational outputs achieved as per the direct and indirect outputs as above. The results for this flow-on effect are illustrated below (see Figure 5 and Figure 6). These charts show the net outcome allowing for the inter-industry linkages and the resource transfer effect. The modelling finds that in relation to flow-on effects the potential impact on GSP over 20 years has a present value of $262.6 million, made up of $46.4 million of incomes generated through the flow-ons from the construction and investment effect and $216.2 million in incomes through increased business activity and lower household costs on energy. The additional activity has the potential to create around 4,300 person years of employment over the 20 years of the project reviewed. 20

22 Figure 5: Potential impact on gross state product arising from flow-on effects Flow-on impacts on Victoria's GSP $ million Construction Operation Figure 6: Potential impacts on employment arising from flow-on effects Flow-on impacts on employment in Victoria Employment years Construction and Investment Operation Impacts on the Regions A benefit not included in the above is that the distributional affect of economic activity to the regions. The same structured process of analysis has been undertaken for each of the regions, with a model developed as above for each of the regions. The major differences are: 21

23 At the regional level the state government contribution to the project is not netted out. From the perspective of each region the state government contribution to the project represents and external injection to the region and is less likely to be a transfer from other activity. The research process does not have access to regional industry ratios and multipliers for each of the areas. Therefore, it is assumed indicatively that the initial ratios (of employment and value added to turnover) are similar to the national level, while the flow-on impacts derived from the CGE analysis are halved, as the import content of local production is significantly higher. The results of the analysis by region are summarised in the following table. Because of the above effects, these estimates do not add to the state effect as they are measuring something quite different. Table 7: Potential regional effects Impact on GSP (PV, $'000) Const & Investment Operations Employment (person years) Const & Investment Operations Bairnsdale 8,814 48, Paynesville 2,407 4, Macedon Ranges 23,221 42, Mornington Peninsula 2,278 5, Yarra Ranges 15,518 36, Barwon Heads 4,171 5, Camperdown 8,431 20, Creswick 4,092 6, Hurstbridge 2,236 2, Maiden Gully 1,504 1, Port Fairy 17,408 28, St Andrews Beach 458 1, South Gippsland 21,045 36,

24 5 Summary and conclusions Impacts on Victoria The following chart combines the individual effects discussed in Section 4, summarising the net impacts of the gas extension project on the state of Victoria. At the peak of the construction phase of this project in 2006, Victoria s gross state product is predicted to expand by nearly $53 million ($36.0 million arising from construction activities, and $16.8 million arising from operational activities). The effects of increased construction activity beyond the first five years declines and we find that the impacts of ongoing operational effects become more important. For example, beyond 2020, when gas is connected in a number of domestic and commercial premises, Victoria s GSP is predicted to expand by more than $48.6 million in each year ($46.4 million arising from operational activities and $2.2 million arising from construction activities). Figure 7: Total impact on gross state product arising from direct, indirect and flow-on effects of natural gas network extension Impact on GSP in Victoria $ million Construction & Investment Operations Overall, this economic review has considered the impacts on Victoria s economy arising from: gas network construction activities; construction activities at major industrial facilities converting to natural gas; increased gas distribution activity; expanded industrial activity; and the potential savings to households switching from existing (usually more expensive) fuels to natural gas. 23

25 The net present value of these construction and operational impacts over 20 years, is calculated at $427.6 million and comprises $118.1 million of incomes generated through the investment created and $309.5 million in incomes through increased business activity and customer savings. The net present values of each of the direct, indirect and flow-on effects, combining to the above-mentioned total of $427.6 million are presented in Figure 8. Figure 8: Net present values of 20 years of increased economic activity arising from expansion of the natural gas network NPV of GSP impacts $ million Direct Indirect Flow-on Total Constuction Operations Constuction Operations The additional activity will have associated with it over 7, 900 person years of employment over the 20 years of the project reviewed (see Figure 9). This equates to around 395 full time equivalents (FTEs) in each year, however, higher level of job creation will most likely occur in the early years of gas network extension during the construction phase. 24

26 Figure 9: Employment generated as a result of direct, indirect and flow-on effects of expansion in the natural gas network Impact on employment in Victoria Employment years Construction and Investment Operations Overall the Victorian Government s financial incentives to the gas distribution industry have stimulated an extension of the natural gas network with a capital works program forecast at $147.2 million and an estimated $14.6 million in operations and maintenance over 20 years, estimates made in June 2004 dollars. At the conclusion of this construction period local households, commercial and industrial facilities in thirty-four towns will be able to take advantage of natural gas. The Victorian Government s funds were committed on the basis of potential economic return. This analysis provides a quantitative estimate of that return in terms of impact on GSP and employment. We find, over the first 20 year period, the net present value of income added to the Victorian economy (impact on GSP) is estimated at $427.6 million, with the direct, indirect and flow-on effects of the project generating over 7,900 employment years over that 20 year period. As such, this project has the potential to provide positive economic value to Victoria in the future. These results suggest that the quantum of economic benefit potentially arising from the natural gas extension exceeds the government s initial financial incentive, offering the conclusion that there is justification for government s decision to commit to this infrastructure. 25

27 A ABCD Data tables A.1 Direct impacts Present value / Aggregate value Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Yr 12 Yr 13 Yr 14 Yr 15 Yr 16 Yr 17 Yr 18 Yr 19 Yr 20 Totals of impact Impact on GSP ($'000) Construction $18,458 $0 5,342 5,459 4,085 3,166 2,306 1, Operation $2,717 0 $ Total $21,174 $0 $5,391 $5,599 $4,256 $3,489 $2,783 $2,362 $714 $656 $550 $470 $498 $493 $494 $509 $500 $512 $502 $527 $513 Customer savings Households $74,480 $ ,380 3,809 4,970 6,526 7,979 8,808 9,352 9,837 10,158 10,476 10,916 11,248 11,595 11,901 12,216 12,544 12,859 13,149 Businesses $24,820 $ ,352 1,878 2,110 2,421 2,712 2,878 2,986 3,083 3,148 3,211 3,299 3,366 3,435 3,496 3,559 3,625 3,688 3,746 Total $99,299 $0 $938 $3,732 $5,687 $7,080 $8,947 $10,691 $11,686 $12,338 $12,920 $13,306 $13,687 $14,215 $14,614 $15,030 $15,397 $15,775 $16,169 $16,547 $16,895 Employment (Person years) Construction Operation Total A.2 Indirect impacts Present value / Aggregate value Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Yr 12 Yr 13 Yr 14 Yr 15 Yr 16 Yr 17 Yr 18 Yr 19 Yr 20 Totals of impact Impact on GSP ($'000) Investment $ 53,170 16,352 16,352 9,599 4,236 5,685 5,302 3,036 1,988 1, ,161 1,607 1,210 1,273 1,114 1,150 1,195 1,152 1,061 Operation $ 90,623 1,666 4,937 6,856 7,703 8,840 9,901 10,506 10,904 11,258 11,492 11,734 12,046 12,288 12,542 12,765 12,995 13,234 13,465 13,677 Total $ 143,793 18,018 21,289 16,455 11,939 14,525 15,203 13,542 12,892 13,029 12,664 12,895 13,653 13,498 13,815 13,879 14,145 14,429 14,617 14,738 Employment (Person years) Investment 1, Operation 2, Total 3, A.3 Flow-on effects Present value / Aggregate value of Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Yr 12 Yr 13 Yr 14 Yr 15 Yr 16 Yr 17 Yr 18 Yr 19 Yr 20 Totals impact Impact on GSP ($'000) Construction and Investment $46,436 14,168 14,211 8,640 4,278 5,078 4,593 2,418 1,612 1, , , Operation $216,208 3,973 11,764 16,302 18,530 21,437 24,167 25,092 26,021 26,719 27,278 27,826 28,592 29,163 29,772 30,295 30,837 31,398 31,947 32,447 Total $262,644 $18,141 $25,975 $24,942 $22,808 $26,515 $28,760 $27,510 $27,633 $28,157 $28,235 $28,783 $29,881 $30,152 $30,810 $31,209 $31,782 $32,373 $32,896 $33,321 Employment (Person years) Construction and Investment 1, Operation 2, Total 4,

28 A.4 Summary Present value / Aggregate value of impact Totals Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Yr 12 Yr 13 Yr 14 Yr 15 Yr 16 Yr 17 Yr 18 Yr 19 Yr Impact on GSP ($'000) Construction and Investment $118, Operation $309, Total Addition to GSP $ 427, Employment (Person years) Construction and Investment 3, Operation 4, Total 7,