Electricity sales can power renaissance for the states

by Tony Wood and Danielle Wood

Published by The Australian Financial Review, Thursday 22 January

In the next few months, the decisions of two state premiers and the federal Treasurer will tell us a lot about whether Australian governments have established a new and effective approach to selling and buying infrastructure, or whether we are condemned to permanent pork barrelling.

After years of prevarication, the Queensland and NSW governments are seeking mandates from their electorates to sell or lease electricity distribution infrastructure, and, in the case of Queensland, generation and retail assets as well. Both governments are adopting the leasing alternative to try to make the transfer of control to the private sector more palatable to suspicious voters.

The federal government has provided an added inducement by offering to give the states 15 per cent of the sales proceeds to invest in new infrastructure through its asset recycling initiative.

While that is highly appealing for state politicians, the new initiative will only generate promised improvements to productivity and growth if both sale and investment decisions make economic sense.

The electricity sales do so. In the past, government ownership of networks was considered necessary because they were natural monopolies. Private owners able to charge monopoly prices could harm the economy and vulnerable consumers. Yet developments in economic regulation enable society to avoid the pitfalls of monopoly pricing while reaping the benefits associated with private sector ownership and operation.

Government-owned businesses in Queensland and NSW generally spend more on distribution investment and operating costs to deliver the same service and level of reliability than do privately owned businesses in Victoria and South Australia. The greater efficiency of the private sector means that governments get more value by selling these assets than by keeping them.

Transferring them to the private sector will also save consumers money.

The case for selling electricity generation assets is even stronger, even though over-supply in the generation market has reduced the sale price that would probably have been achieved only a few years ago. Hanging on will not improve the price. Electricity generators operate in a competitive market, so the monopoly argument for government ownership does not apply.

On the investment side, governments have a greater challenge to prove the benefit of new infrastructure. The key is to lift productivity. Governments should only invest public money in projects that provide value for money (in which the benefits of investment exceed the costs) and where private investors do not capture enough of the gains to proceed with the project alone.

There are three main reasons why government might invest in infrastructure projects. First, it can be difficult to charge users for some types of infrastructure. Roads are a good example, although this is changing with technology. The private sector will not undertake investments if it cannot recover its outlays. But governments can use tax revenues to ensure everyone pays.

Second, some benefits from infrastructure investment can flow to people other than the direct users of the service. A new public transport investment might also benefit road users through reduced congestion, yet the private sector will not factor this into its decision making.

Finally, a government subsidy might be required to facilitate investment in a project – port infrastructure with strategic significance, for example – where the major benefit comes from security of supply rather than regular use.

The Productivity Commission argues that project selection is vital to making good decisions on public infrastructure. Often governments make poor infrastructure decisions: they like iconic projects, their analysis can be inadequate, and political considerations can overwhelm economic sense. The television series, Utopia, captures these failings in sharp detail.

The Asset Recycling Fund is a $5 billion carrot that must not feed more questionable project decision-making.

One early and troubling example is the Queensland government’s intention to secure money from the Fund to invest in the Indian company Adani’s $2 billion rail line from the Galilee Basin to the Abbot Point coal port. It looks like a bad idea, for several reasons. First, current coal sector economics and longer term climate change concerns mean the coal industry looks like a particularly tough investment at present.

Second, there seem to be no barriers to private sector investment beyond the commercial viability of the project. The capital markets’ lack of appetite for the project should be a caution for the government rather than an inducement to provide a subsidy to a large listed company.

Whatever the results of the impending state elections, pre-election positioning must be followed by hard-nosed reality. In the words of the Productivity Commission, it is important that white elephants remain an endangered species.