Regulation of state government-owned network companies
The terms of reference for this inquiry contained specific statements
about the actions of state government-owned network companies, such as how they
have calculated their weighted average cost of capital (WACC).
As some of the issues are relevant to all network companies, whether
publicly or privately owned, the discussion in other chapters of the report is
generally applicable to both. This chapter differs in that it deals with some
particular issues that either clearly are, or were considered by submitters to
be, unique to government-owned network companies. Specifically, this chapter considers
the evidence received about:
the relative efficiency of government-owned networks compared to
the privately-owned networks;
the application of competitive neutrality principles that require
government-owned companies to be compared to a benchmark efficient entity;
how inaccurate revenue determinations can provide a lucrative
source of revenue for state governments; and
past inefficient expenditure and calls for asset write-downs, particularly
in the context of privatisation proposals.
Efficiency of state government-owned networks
Mr Bruce Mountain argued that analysts have 'long recognised', and the AER
has also accepted in its latest benchmarking report, that the government-owned
distribution network companies are less efficient than the privately-owned
companies in terms of operating expenditure.
Indeed, it is evident that this issue has been considered thoroughly elsewhere.
When the Productivity Commission (PC) recommended in 2013 that state and
territory governments should privatise their government-owned network
businesses, it stated that:
State-owned network businesses appear to be less efficient
than their private sector peers. This is not surprising given their multiple
objectives, political intervention and the imposition of non-commercial
Mr Mountain provided some charts to illustrate the higher costs
associated with state government-owned networks (Figure 5.1 and Figure 5.2)
Figure 5.1: Regulated revenue of distributors per
Source: Mr Bruce Mountain, Submission
19, p. 4.
Figure 5.2: Average electricity network services
prices per household for distribution network service provider in 2014
Source: Mr Bruce Mountain, Submission
19, p. 6.
Government-owned network companies were questioned about their
efficiency. When asked why Ergon was identified by both an independent
Queensland government review and the PC as the most inefficient network in
Australia, Mr Ian McLeod, Ergon's chief executive officer, responded that
Ergon's customer profile and geographic coverage means 'simple maths' will make
it the highest cost network in the country. He advised that Ergon distributes
to 44 per cent of the NEM's geographic area, but only to seven per cent of the
NEM's customers. To put it another way, Ergon serves 170,000 customers in an
area of 160,000 square kilometres.
However, Mr McLeod contended that Ergon was not the most inefficient
network. He provided the following explanation:
We have done multimodels of productivity. From a customer
perspective, we certainly look inefficient. You can look at it from an actual
asset perspective and you will see that makes us look efficient compared to the
others. We can look at it from a load perspective. Our customers use more load
than any others—mines and those sorts of things. That makes us look efficient.
We have quite a substantial amount of generation connected to the grid, which
does not pay towards the grid costs. So that is also a challenge. We have done
a multifactor productivity analysis and, whichever inputs you put in and
whichever model you use, it drives a different outcome. However, on top of
that, we think it is a challenging network. The integration of technology
is part of the solution. We have certainly been leaders in that space. We have
a huge amount of distributor generation in solar PV. We are more advanced on
batteries, we have more demand under control than any other network. I think it
drives innovation in Ergon. We do not think we are at the efficient frontier.
We think we can get there, though, and will aim to get there. Are we the most
inefficient? I would argue we are not.
The privately-owned Victorian distribution businesses argued that their
ownership structure was a key reason for their lower network costs and stronger
records of reliability. Mr Alistair Parker, the general manager of asset
management at AusNet Services, a privately-owned transmission and distribution
network service provider in Victoria, discussed the relative performance of the
Victorian businesses compared to those in other states, particularly
Queensland. He recognised that Queensland businesses face particular
challenges, such as cyclones and difficult topography. Nevertheless, he argued
that the AER takes this into account as part of its benchmarking process and,
even then, the privatised distributors 'remain the most efficient networks on
Mr Parker explained why he attributes this disparity in performance to the
different ownership structure:
[The privately-owned businesses] aim to spend less to get the
same outcomes. We have investors, and I use that term very carefully. We do not
have owners; we have investors, and we have investors like superannuation funds
and so on, who demand a return from us. Our commercial view is that, while
there is potentially an incentive to increase your RAB—to increase your asset
base—we make more money by responding to the AER's efficiency incentive
schemes. So we do better by spending less. We do better over the long run
by spending less, by finding cheaper alternatives to deliver good outcomes. And
we need to innovate, and we need to really have a culture that is seeking to do
that at all times to get to that point.
Mr Parker noted another key difference between the privately-owned
business in Victoria and others that arises from the use of 'probabilistic
investment'. He provided the following explanation of how the adoption of probabilistic
investment affects how his company approaches investment decisions:
...what we do is we look at the value that we believe customers
and the Australian Energy Market Operator place on reliability, we look at the
probability of having a problem on our network, and we only invest if there is
not an alternative solution like demand management and if the economic value of
the loss of supply outweighs the cost of doing something about it. This means,
in practical terms, we invest later than somebody in New South Wales will. We
are currently doing, as a transmission company, a huge redevelopment of the CBD
supply in Melbourne. My guess—it is not accurate—is that we are doing that four
or five years later than somebody in New South Wales would do it, and we look
at that all the time to check: if we can avoid the investment, we will
avoid the investment. It means we have to do some things in terms of
contingency plans, but if we can avoid an investment we will.
Application of competitive neutrality principles
The current framework is designed so that state government-owned
networks are treated as if they are privately owned. This section examines the
rationale for this and the evidence received about whether this is appropriate
and in the long-term best interests of consumers.
Overview of competitive neutrality
The current regulatory treatment of government-owned companies follows
the development of a national competition policy. The 1993 report on the
subject chaired by Professor Fred Hilmer (known as the Hilmer Report) called
for pro-competitive structural reform of public monopolies so that natural
monopoly elements were no longer integrated with potentially competitive
To facilitate this, the Hilmer Report proposed several principles that
Commonwealth, state and territory governments would abide by. The Council of
Australian Governments' (COAG) Competition Principles Agreement, which was
entered into in 1995, contained the final principles the governments adopted
and required COAG members to issue a policy statement on competitive
neutrality. The following objective is contained in the Agreement:
The objective of competitive neutrality policy is the
elimination of resource allocation distortions arising out of the public
ownership of entities engaged in significant business activities: Government
businesses should not enjoy any net competitive advantage simply as a result of
their public sector ownership. These principles only apply to the business
activities of publicly owned entities, not to the non-business, non-profit
activities of these entities.
Among other things, the Competition Principles Agreement requires that
the following are imposed on government-owned businesses:
full Commonwealth, State and Territory taxes or tax equivalent
debt guarantee fees directed towards offsetting the competitive
advantages provided by government guarantees; and
on an equivalent basis as private companies, regulations to which
private sector businesses are normally subject to, such as planning and
Following the competition reforms, governments separated the generation,
transmission, distribution and retail components of electricity supply. The new
generation and retail businesses were opened up to competition,
whereas the transmission and distribution businesses were regulated as
Application of competitive
neutrality principles to electricity networks
Evidence taken by the committee considered what effect the competition
neutrality principles have had on electricity prices. The principles underpin
the current framework and have informed both the AEMC's and AER's decisions.
For example, the AEMC has decided against proposed rule changes on the basis
that the rule would be inconsistent with the concept of competitive neutrality.
The AER's determinations do not take into account that state governments have a
stronger credit rating than that used for the benchmark efficient entity. As
Energex noted, the AER's method of determining the rate of return by reference
to a benchmark efficient entity means the ownership structure of a network company
'should be irrelevant'.
However, the Energy Users Association of Australia (EUAA) questioned the
AEMC's and AER's application of the Competitive Principles Agreement to electricity
network businesses. The EUAA argued that the Agreement was 'designed to apply
to businesses that operate in competitive markets—not to regulated monopolies'.
A similar point was made by Mr Bruce Mountain; he noted that the
Competition Principles Agreement makes no provision for the principles to apply
to monopolies. He described competitive neutrality principles applied to a
monopoly as 'an oxymoron'.
The EUAA stated that requiring the regulator to ignore 'that government owned
networks are funded by low cost state government debt' and providing the
companies 'with "theoretical" debt and equity raising costs that they
do not incur' was an approach that is unique to Australia.
Submitters that argued against the application of the Competitive
Principles Agreement to government-owned network companies highlighted what
they consider are adverse outcomes from this practice. Mr Mountain argued
that the treatment of government-owned networks as if they are a private
company has 'had a significant impact on incentives to invest'. Mr Mountain
pointed to borrowing costs as an example:
...over the last five years state government borrowing costs
were typically in the range from 3% to 5%. Under the current revenue/price
controls however they have been allowed to charge consumers a rate of around
8.8%. A conservative estimate of the excess above reasonable costs would be
around 300 basis points. The regulated asset base of government-owned
distributors (in the NEM) in 2013 was $42.8bn. A 300 basis point excess
translates into a revenue premium of $0.8bn per year (only 60% of the asset
base is assumed to [be] financed through debt).
Submitters suggested that the benchmarking framework is far removed from
the actual outcomes. The Agriculture Industries Electricity Taskforce argued
that debt and equity raising allowances given to state government-owned network
companies do not correspond with reality. This is because the government-owned
networks do not incur equity raising costs and state treasuries do not incur
many of the debt raising costs network companies seek to recover.
A similar argument was made by the EUAA, which used the experience in New South
Wales to demonstrate its point. The EUAA claimed that in 2010 the New
South Wales government received an effective rate of return of around 29 per
cent on its electricity networks, which was around three times higher than that
allowed by the AER's determinations. The EUAA explained this higher return was
due, in large part, to:
the New South Wales government's ability to collect both the
profits and tax on profits delivered by the networks it owns; and
the margin added by the New South Wales government to the cost of
debt that it provides to the network companies.
The treatment of tax was delved into further by Mr Mountain. He noted
that the government-owned network companies are 'in effect exempt from income
taxes', as although a tax allowance payment is calculated, the payment is
collected by the shareholder anyway.
Mr Mountain provided the following example that not only illustrated his
argument about the flaws in this arrangement, but also showed how the AER can
use resources defending decisions based on unrealistic benchmarking:
In 2011 the two Queensland distributors successfully appealed
against the AER's decision on dividend imputation in the calculation of income
tax allowances. Their argument was based on the imputation of dividends paid by
privately owned companies and ignored the fact that these distributors' profits
are effectively untaxed (because the Queensland Government collects the income
Mr Mountain advised that the successful appeal meant the distribution
businesses were entitled to recover additional revenues of around $400 million.
However, following the appeal, the Queensland government 'instructed its
distributors not to raise their revenues by the additional amount'.
The AER was, nevertheless, left with over $1.2 million in costs that it
incurred defending its decision.
Response to concern about the
competitive neutrality principles
As noted above, it was argued that the approach of regulating state
government-owned electricity network companies as if they were private
companies is unique to Australia. However, the AER suggested that a mix of
public and private‑owned network companies was a situation unique to
Australia anyway. AER officials gave the following evidence on this subject:
Typically in...overseas jurisdictions they tend to be either
fully government or fully private, so it is a little bit unusual to have the
mix of the two. If you look at the UK and the US, they are all private and in
Europe it is mostly all government. So we tend to have, if you like, a one-zero
scenario. I cannot think of another jurisdiction which has such a clear mix as
* * *
While [New Zealand has]...a mix of privately owned, you would
characterise it as more municipally owned. They are government owned businesses
but they are quite often community trusts or the equivalent of local
government...The US and Canada are regulated on a state basis. A lot of
municipally owned businesses are community trusts, so they are probably more
akin to government ownership than to private sector, but they are a slightly
different model. In Australia we do not have the municipally, local government,
owned business sector.
The AEMC argued that if consumers paid the state borrowing rate rather
than the benchmarked efficient costs of a stand-alone network business,
decisions about investment would be distorted.
The AEMC also observed that such a framework would allow network businesses in
some states to offer pricing that was lower than what is 'reflective of the
true stand-alone costs of providing those network service'.
Mr Matthew Warren, the chief executive officer of the Energy Supply
Association of Australia (ESAA) expanded on this; he noted that the competitive
neutrality principles prevent state governments that own utilities (or other
businesses) from utilising their influence 'to unfairly compete with or attract
businesses from other states'.
The committee notes that a review of competition policy was recently
completed. The review, which was chaired by Professor Ian Harper, released its
final report on 31 March 2015. In the report, the Harper Review expressed
support for the principle of competitive neutrality, although it noted that
'competitive neutrality policies benefit consumers in markets where both
governments and other providers deliver services'. Among other recommendations,
the draft report suggested that all Australian governments should review and
update their competitive neutrality policies.
Revenue raising via electricity companies
State governments collect significant amounts of revenue from the
network companies they own. This revenue is in the form of dividends received
as shareholders, fees associated with the provision of finance and the income
tax allowances that are calculated. Examples of these payments were provided by
submitters. Mr Bruce Robertson reported that in New South Wales, the combined
dividends paid by the network companies totalled $872 million, with a further
$829 million collected from income tax equivalent payments.
It is also evident that at least some state governments have been
enjoying increasing payments. A community group that opposes a certain
network investment proposal, VETO, advised that its inspection of the
Queensland distributor Energex's annual financial reports revealed that
Energex's dividends paid to the state government have increased from $103
million in 2009 to $406 million in 2014. Over that same period, the tax
equivalent payments that the state government collects increased from $47 million
to $215 million.
It has been suggested the state governments that own electricity network
companies benefit from the current regulatory arrangements as the money
collected from high revenue determinations effectively act as a hidden tax on
consumers. As a result, it is argued that the state governments have a conflict
of interest when it comes to electricity regulation. The potential benefits of
a system where a Commonwealth regulator determines the revenue of a state
government-owned network company based on rules put in place by state
governments are evident when regulatory decisions are made. For example, the
Australian Sugar Industry Alliance considered that Ergon and its owner, the
Queensland government, 'misrepresent the binding nature of the AER's decision
around the regulation of revenue'. The Alliance explained:
The AER sets the maximum revenue that a network operator can
recover. The regulated amount is not a mandated recovery amount and it is not a
minimum revenue recovery amount. Some state governments, with network
ownership, have foregone the maximum allowable revenue determined by AER for
their particular network, to reduce the financial strain on the dependant customer
base. In Queensland, the government continues to argue that it has been
directed by the AER to collect this level of revenue.
Submitters called for greater transparency of what they consider is a
We are a developed, rich
country and international policy, government policy, is absolutely unanimous on
not hiding our taxes, being transparent, and having accountability at suitable
levels. I do not believe that we should have the arrangement that we have. I do
not believe it constitutes transparent and good government. It is a right of
the states, in answer to their voters, to do what they choose. If they seek to
tax electricity supply to meet other objectives, I think that is their
decision. But I think those things should be made clear...
Mr Robert Mackenzie from Canegrowers Isis suggested that the
government-owned distribution network companies, and therefore the government,
are enjoying rent for the assets they own. Although addressing this would
affect the state government's revenue, he argued this should not be the main
Governments raise revenue by a variety of means. They should
not be raising it through electricity. It acts as a tax on doing business. It
stifles business. It stifles GDP. It stifles activity. It is just a bad way of
raising revenue, in my opinion. We should be looking at other ways. We should
be taxing outputs rather than inputs.
The equity implications of state governments raising revenue from
electricity prices were also noted. Mr Oliver Derum from the Public Interest
Advocacy Centre argued that such practices were regressive as low-income people
use a greater percentage of their income to pay their electricity bills.
Mr Mountain similarly argued that a tax on electricity is 'highly
regressive' for low-income consumers and inefficient as taxes should tax
outputs and not inputs. Mr Mountain concluded:
From an efficiency and fairness perspective, the current
arrangement seems to be the worst of all words: a regressive input tax that
misallocates resources and results in stranded assets.
Nevertheless, the view that state governments with their own networks
have a conflict of interest in relation to electricity prices was not shared by
all stakeholders. The ESAA maintained that state governments would either need
to raise the money from electricity prices by some other means or cut
expenditure. A general manager at the ESAA stated:
...while I understand those frustrations about the way that
competitive neutrality payment is applied, the money that those state governments
receive is money they would either have to raise from other forms of taxation
or they would have to reduce spending. Whilst you could make a change to that
rule, it would just be moving money around between the people of New South
Wales and Queensland as electricity consumers and essentially the same people
as taxpayers. It is really just moving money around, whereas in terms of really
driving down their power bills going forward, the obvious point to tackle is
the future efficiency of operating and capital expenditure.
Asset write-downs and privatisation proposals
Whether the value of inefficient and underutilised assets included in
the regulatory asset base should be written down is an issue that was
considered generally in Chapter 4. Evidence taken by the committee, however, indicated
there were distinct considerations when the assets belong to government-owned
network service providers. Some submitters added that the correct value of
assets is also relevant to proposals for privatising these businesses. This
section considers these issues.
Revaluing the assets of state
government-owned network companies
As discussed in Chapter 4, one of the arguments used to counter asset
write‑down proposals is that such action may actually lead to higher electricity
prices for consumers as higher sovereign or regulatory risk would need to be
taken into account in the future. Although he considered it would be
'problematic' to revalue privately-owned assets, Mr Bruce Mountain submitted
that, for government-owned businesses, the sovereign risk argument does not
apply. He argued that 'governments are not able to expose themselves to
sovereign risk, to suggest otherwise is just nonsense'.
State governments are also not normal shareholders. While they may seek
returns from their assets, other political and economic considerations also
influence their decisions regarding how their assets should be used. This
tension was highlighted by the Public Interest Advocacy Centre. Using New South
Wales as an example, the Centre argued that if the state government decided to
write-down the assets of a government-owned network business, it follows that
the 'asset belonging to the people of New South Wales would, according to its
book value, be worth less'. However, the Centre argued that this would be
offset by consumers paying less for their electricity.
EnergyAustralia acknowledged that governments, like businesses, do not
like to write down the value of assets. Nevertheless, it argued that the fall
in electricity demand and low growth forecasted by the AEMO compels the
government to take such action. EnergyAustralia argued the alternative option
would be a continuation of 'the "death spiral" which will only
increase hardship cases for those that remain connected to the network'. 
However, another witness speculated that a state government may be
reluctant to write-down assets as doing so may have implications for a
government's future capital raising activities:
Write-downs of the asset
values would cause difficulties with the government raising capital in the
capital markets. If the assets were written down to their true level,
Queensland Treasury and the Queensland Treasury Corporation may find some
embarrassment when they are looking to be raising capital.
Asset write-downs in the context of
Proposals for leasing publicly-owned electricity assets to private
sector companies were key issues at the January 2015 Queensland election and
the March 2015 New South Wales election. As a consequence, submitters also
considered the re‑valuation of assets in that context.
Some submitters were nervous that privatisation proposals would threaten
efforts to reform the regulatory system and cause the less than optimal
outcomes achieved for consumers under the current system to be locked in for
the future. The Agriculture Industries Electricity Taskforce argued that
the New South Wales Government appears to be prioritising the sale of its
network assets above any possible reform. The Taskforce suggested this was
evidenced by that government's opposition to the AER's draft determinations for
New South Wales distribution networks.
Unless 'credible regulatory arrangements are established', the Taskforce feared
that leasing or privatisation will mean:
...a government monopoly will be replaced by a private monopoly
but with continued inadequate regulation. Regulatory reform in the context of
private ownership will be even more difficult since it will raise the prospect
of sovereign risk for the new private investors. It is essential that the
regulatory challenges are dealt with now as a priority, before privatisation.
Another example of this concern can be found in the evidence given by
the Australian Sugar Industry Alliance. One of its representatives told the
If you are looking at privatisation of a system which is
currently flawed and you have excessive tariffs and what we would say are
flawed tariffs within that current model, our fear is that you would lock those
flawed tariffs and that flawed profit model into some kind of privatised basis.
No-one is going to invest in purchasing assets if they are not going to be able
to generate a significant profit from that. So the end point is that you have a
flawed and abstract profit motivation in the current system, you privatise that
and you lock it in, and then it becomes a lot more difficult to deal with that
into the future.
It was also suggested that the Australian Government's asset recycling initiative
may also reinforce opposition to asset write-downs. The New South Wales
Irrigators' Council considered the asset recycling program provides a 'perverse
incentive' for asset values to remain inflated or to be inflated further. It
provided the following explanation:
If the payment from the Asset [Recycling] Scheme, as is suggested
in the Federal Government's Energy Green Paper, is a proportion of the value of
the asset, then it is an incentive for the State Government to 'inflate' the
asset value of the electricity network business in order to increase the amount
of payments it receives. However such an inflated asset base (and the return
that the network business currently receives on this asset base) will be passed
onto consumers in the form of higher network charges.
Some submitters expressly called for state governments that are seeking
to privatise their electricity network assets to examine whether those assets
are overvalued and should be written-down prior to privatisation.
EnergyAustralia declared that privatisation proposals are 'a unique circuit‑breaker',
with an opportunity for assets to be written-down to reflect reduced
electricity demand before privatisation.
The Public Interest Advocacy Centre, which also argued that network assets
should be examined before privatisation, provided the following overview of the
competing issues at play:
Higher-valued networks will yield greater proceeds from
privatisation, but consumers will, in effect, be funding those proceeds through
their electricity bills (as they repay the investment in the RAB through
network charges). On the other hand, if network values are written down then
electricity bills will be lower, but less funds may be available to governments
to fund infrastructure or other programs that benefit the community.
The Public Interest Advocacy Centre noted that it does not 'have a
definitive answer' to the question of whether the assets of New South Wales
distribution network companies are over-valued. It also advised it cannot
answer whether an asset write‑down would ultimately be 'good or bad for
the people [of New South Wales]'. Consequently, the Centre called for the state
government to consider these issues. However, the Centre advised that a report
it commissioned suggested that the writing down of the value of stranded assets
'may provide the best outcome for all parties'. In addition to lower
prices for consumers, it was suggested that 'a more accurately priced asset
would attract more attention from investors'.
The committee acknowledges that some aspects of the economic regulation
applied to government-owned network businesses appear to have led to perverse
outcomes. For example, assuming that a government-owned business has debt
costs comparable to those of a private company when its debt is secured by a
government with a strong credit rating is seemingly odd. It also results in
customers living in that state paying more for electricity than they would
otherwise need to, at least in the short-term.
Regardless of the relative merits of the arguments for and against the
application of competition neutrality principles to government-owned
electricity network businesses, the committee does not envisage a situation
where this arrangement would change. For governments that own networks, the
payments received as a result of these arrangements are a lucrative source of
revenue that, if abolished, would need to be replaced (or alternatively,
expenditure would need to be reduced). The governments that do not own networks
may be concerned that changes to the current arrangements would see the cost of
electricity fall in the states with publicly‑owned networks, potentially
attracting business to those states away from states with privately-owned
In any case, while there may be particular issues caused by the
regulatory treatment of state government-owned network companies, the committee
considers the matter of greatest concern is how the return on capital for all
network businesses is determined, as canvassed in Chapter 4.
In this regard, the committee notes that certain state governments have,
or are currently considering, proposals for privatising some of their network
assets. The committee considers those governments have a duty to their
citizens, and an obligation to potential investors, to demonstrate that the
value of the RABs for these businesses are reasonable. As noted in Chapter 4,
action taken now to ensure the RABs are accurate may prevent more difficult
decisions from being needed in the future.
The committee recommends that state governments seeking to privatise
their electricity network assets examine whether those assets are overvalued
and if the regulatory asset base should be written down prior to privatisation.
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