Privatisation of swathes of the electricity grid has caused the market to distort and buckle to breaking point, a new paper finds. For prices to fall to acceptable levels and renewable energy generation to gain traction, the NEM needs to be renationalised. Jeremy Chunn reports.

Those who hold faith in privatisation hang their belief on the sturdy hook of free markets. When industries are unencumbered by subsidies, government interference or ideological objectives, the focused forces of supply and demand are free to do their thing. The result is price realisation fair and true.

Or so the theory goes.

But John Quiggin, Australian laureate fellow in economics at the University of Queensland and a visiting professor at Flinders University’s Australian Industrial Transformation Institute, says it was a shift to privatisation that doomed Australia’s National Electricity Market to the broken, malfunctioning, over-priced tangle it has become today.

If the NEM’s job is to provide affordable electricity or reduce emissions of carbon dioxide, it has failed, he writes in Grid Renationalisation – a discussion paper. “The current NEM is not designed for this purpose and cannot achieve it,” the paper says. “Even for a fossil-fuel-only system, the NEM was poorly designed.”

The most obvious proof of failure, he says, is rising prices.

“Privatisation is part of the story,” Quiggin told EcoGeneration, “but there’s the whole model, in which privatisation is an integral part, to do with market-oriented reform in general.”

John Quiggin: “The monopolies that own the distribution and transmission assets have effectively gamed the system, to extract substantially higher rates of return than would have been justified.”

How did we get here?

That reform began in the early 1990s when state-level, largely integrated electricity supply was replaced by a national grid connecting the eastern states, South Australia and Tasmania. At the same time privatisation and corporatisation were replacing public ownership as “efficient” business models.

Slowly, cold theoretical economic forces enabled price distortions as oligopolies sought to satisfy shareholders, whose expectations for returns were much higher than would be expected from an investment where the risk premium under public ownership was set only marginally higher than the government bond rate.

“For the distribution networks, which are the regulated part, we’re giving them a rate of return which seems much higher than is needed given the protection they have,” Quiggin says. In the case of generation and retail the creation of the market produced risk that didn’t exist previously.

“Instead of investor risk being about on par with the bond rate, generally speaking the market has created a whole series of additional risks which add probably 2 or 3c/kWh to electricity bills.”

Rates ratchet higher

Turning public monopolies into private ones and giving them a high regulated rate of return is one problem, he says. The other is the separation of generator and retailer while trying to promote competition, which has created a great amount of risk without delivering any benefits.

As assets changed hands, the new owners were tempted by new incentives. Falling wholesale prices, for example, are bad for generators but good for retailers, and vice versa. “Under the old system they were the same person … and so all those risks were cancelled out,” Quiggin says. But not under the new order.

The Australian Energy Regulator sets revenue limits for networks based on submissions that factor in projected energy demand, operating costs, depreciation of assets and reliability. “Decisions generally apply for five years, and network businesses adjust their prices annually during the five-year period,” the AER website states.

However, the AER applies a weighted average cost of capital which is based on a private sector model that assumes a lot more risk than is justified, Quiggin says.

“What we see is the assets invariably are valued by the market much more than the regulator has estimated the cost of construction to be, and that reflects the fact that the rate of return is much higher – about 40% higher – than the market thinks is actually needed.”

Networks are natural monopolies, and the theory goes that monopolies will demand high prices unless they are regulated. In the case of private operators, however, the introduction of price regulation can be seen as an incentive to delay investment.

“The monopolies that own the distribution and transmission assets have effectively gamed the system, to extract substantially higher rates of return than would have been justified.”

The breakdowns

Failures in South Australia, Victoria and Tasmania have focused attention on the inadequacy of the national grid, Quiggin says. Under the old regime the publicly owned Tasmanian and Victorian networks would have sorted out the Basslink fault between them, but instead the complications of multiple owners, some of them foreign governments, turned it into a game of hardball. In South Australia, a unified electricity supply industry would not have delayed turning on a power station to provide emergency supply, Quiggin says.

“[Instead] when these problems emerge, which are inevitable, the system just grinds to a halt.”

The “fragmentation of responsibility” between the electricity generators, owners of state transmission networks and interconnectors and the multiple regulators is plain to see. “What you have a system where we ought to be working together as a network but instead we have dozens of different players and multiple regulators all stepping on each other’s feet.”

The answer is a national grid, including all transmission and interconnectors, he says. Going further, there is a “strong case” for renationalisation of electricity distribution and investment in renewable energy.

Proposals by the South Australian government to invest in storage and Malcolm Turnbull’s Snowy Hydro announcement show government is prepared to re-enter the market. But it isn’t enough, Quiggin says. “We need to look at the whole history of failure over the past 25 years and reconsider the system from the ground up.”

It’s a pattern which has played out around the world, he says, from the California energy crisis of 2000-01 to Europe’s struggles to integrate renewable energy into the market system. “Privatisation is an essential part of the story and reversing it is the only way the problems can be addressed.”

On the agenda

Apart from Quiggin’s academic conjecture and the impending Finkel Review, the architecture of the national grid is also being tinkered with at the Australian National University in Canberra, where Professor of Engineering Andrew Blakers has been using a computer model to suggest improvements that would allow far greater penetration of renewables.

“By one means or another we need good decisions so that there is adequate storage and adequate interconnection to support a high wind and photovoltaic grid,” Blakers told EcoGeneration.

Blakers agrees with Quiggin’s assertion that natural monopolies such as high-voltage transmission don’t easily lend themselves to a market. “A colleague once told me long ago that the only thing that’s worse than public monopolies are private monopolies,” he says.

“I’m unconvinced that a private model can perform better than a model where government has a much larger role, because government has a role anyway as the chief blame-getter when things go wrong, without a huge amount of ability to influence things before they go wrong. So somehow or other that has to be fixed, so responsibility is sheeted home to those who wear the blame if things go wrong or the credit if things go right.”

But how can the grid be renationalised? The solution is for the government to buy the assets back using debt. To get the private owners to the point where they are willing to sell, Quiggin suggests rates of return be pushed down to levels paid by government bonds, “because after all the asset is like a bond.”

That wouldn’t go down very well with the current owners, but Quiggin sees it from a much broader perspective. “I think it will go down marvellously with the Australian public.”