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Electricity sector “gold plating” behind sky-high prices – not renewables

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Another major new report has confirmed that the “gold-plating” by Australia’s privatised electricity networks has been a key driver of an almost 200 per cent rise in electricity prices, that has been costing the nation’s households up to $500 a year.

The report, published by The Australia Institute on Thursday, is just the latest in a raft of papers and studies trying to peel back the layers of the nation’s soaring power prices. It is also the latest to say that the effect of the renewable energy target – and Australia’s short-lived carbon price – has been negligible.

The report reveals that the cost of electricity in Australia has increased by a whopping 183 per cent over the past 20 years, pushing up power prices at almost three times the rate of the national consumer price index, as you can see in the chart below.

Electricity Price Rise Table copy

“In those figures,” it adds, “the carbon price was barely noticeable.”

As the TAI notes, this 1996 – 2016 period happens to coincide with the time during which the “privatisation, corporatisation and marketisation” of Australia’s electricity sector was taking place – a shift that has led to a “blow-out” in management and salespeople.

“Electricity now employs an army of sales and marketing and other workers who do not actually make electricity,” the report says.

“In addition the reforms seemed to encourage profit gauging on the part of companies in the industry who are able to inflate the asset base used in calculating the permitted return on assets.”

This rather oblique statement seems to touch on the kind of strategic discounting practices being used by powerful incumbent “gen-tailers”, that have frustrated smaller retail players like Energy Locals founder Adrain Merrick.

“The fact that an essential service in Australia can carry a discount between bugger all and approaching half price – given the ‘secret cupboard’ offers that retailers offer customers when they look like leaving – would be laughable if it wasn’t hurting customers so much,” Merrick told RE just this week.

David Richardson, a senior research fellow at TAI and author of the Electric Costs report, echoes Merrick’s concerns.

“Electricity sells itself. People think it’s bizarre that electricity companies hire a sales staff and marketing people which then adds to the costs they charge us for buying something we have to buy,” he said.

“Then they pad their costs with returns on notional capital.”

As the report explains, this idea of “notional capital” is a sort of “weird circular process in which high rates of return are capitalised in ‘goodwill’ and other fictitious or notional items while high profits guarantee high retained earnings which also feed into the asset base.”

In that way, the report continues, “the unproductive capital base is allowed to increase and we are charged for capital that has no real function in producing electricity.”

It is confusing, particularly for the average consumer, who TAI says, when surveyed, tend to blame the electricity providers themselves for power price hikes.

Others, of course, might put the blame on the rise of renewable energy generation in Australia, if they believe the relentless campaigning of various prominent members of the Coalition government, not least its previous leader, Tony Abbott.

“A host of factors have been blamed for the increase in electricity prices relative to other prices,” the TAI report acknowledges. “But we would point out that the main departure from the rest of the price
index (pictured in the chart above) happened post privatisation and corporatisation.

“Too often we assume that private and corporatised state-owned corporations are operating efficiently. In the real world such as in the Australian economy where the checks and balances are imperfect and companies exercise considerable power,” it says.

“The report The Australia Institute has released today shows that a major factor (driving up electricity prices) is the gold-plating of financial services by private electricity companies are being paid for by consumers to the tune of four-to-five hundred dollars a year per household,” said TAI’s Ben Oquist.

“(The) process in which high rates of profits are used to ‘gold plate’ the financial asset base – without even improving the ability to generate electricity – is leading to higher prices for consumers,” he said.  

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  • George Darroch

    How do we simultaneously have a “gold plated” system and apparent transmission bottlenecks?

    • MaxG

      It is called price-gauging for profits. I think it is almost pointless to state: there would not be a profit margin and the overheads of retail, if the energy would have remained in public hands.

      Let’s not forget that Energex and Ergon in Qld had fully functional retail divisions. Hence, removing the the retailers, their operational cost and profit-taking and the price of electricity would certainly be lower.

    • Mike Westerman

      By over investing at the distribution level in added redundancy at substations for one! And by allowing virtual assets, monopoly valuations and high regulated rates of return. Transmission constraints can then be used to wield market power by incumbent generators.

    • Andy Saunders

      Too-high reliability standards (in the case of NSW, courtesy of a stitch up between a Labor govt and the electricity-sector unions)… meaning almost any investment is justified. And a regulator that wasn’t on top of the ball so the investments weren’t curtailed as not being needed…

    • Andrew Roydhouse

      Think of it this way, you give a child a $100 note and tell them to buy some food. Do they come home with fruit and vegetables, meat & fish or sweets, ice cream & chips.

      The transmission companies (to help their sale) were guaranteed to earn (aka Risk free return) 12% which subsequently for new spending dropped to 10% per annum on every $1 they spent on capital equipment.
      It did not matter if the capital equipment was not needed though or was not even connected to the grid (so many examples).

      So investment bank consultants and smart corporates worked out they could borrow a billion or $45 at anything from 5% and get a guaranteed 10% return for the life of the new assets.

      Think of it like this, You take out a loan from the CBA at 5% and put the money into the “Australian Magic Pudding Fund” which guarantees you will earn 10% PA for as long as the money stays there. CBA even lets you use your future investment in the AMPF as security for your loan.

      How much money would you borrow? $45 billion sound about right?

      Welcome to the wonderful world of snouts-in-the-trough.

      Trouble is while the smart ones, who thought up this gravy train, get their tens of millions in bonuses – the community sees power and gas prices go through the roof.

      Funny thing happened with water desalination plants as well.

      I wonder who subsequently became directors (and received directors fees for 1 to 3yrs) for shelf companies linked to these projects, their debt and their operating companies. Nice pay if you can get it.

      • Ian

        Could this snout-troughing explain the extreme costs for the Pacific Motorway?

        The time is coming when a real competitor to the grid electricity supply will disrupt their kleptomaniac business model, namely, solar and storage. It behoves those with the finances to actually install this sort of grid-independent system, so that others can benefit from downward pressure on prices.

    • ajnorthy

      I think the other main point to consider is they aren’t just gold plating the system but also the financial base (their words) meaning they can base their prices on the cost to operate which includes every single employee. So bolster your staffing numbers, ie with more marketing staff, and those costs can be passed on. This approach will definitely not lead to any improvement in network performance, but it is quite a simple and clever way of choosing profits at the sake of customers. Just a shame the regulations allow it to happen.

      • Adam Smith

        Just remember state governments still own a big chunk of the assets, so they have a big say in what happens, plus sway with the feds on the AER. Sure, get rid of the “marketing”staff and the solar proponents can just wait and see when and if their connection will happen. It is a pity that Rudd and Gillard was completely missing in action on the energy sector and it got to the state where something had to give. In the longer run, either the consumers will go bust or the industry will or both. It is unsustainable either way and change is and will happen. The irony is that this all happened before and the Governments set up committees to fix it and now they are using more committees to fix it again. Maybe governments should get out of the way and let markets decide!

        • Mike Westerman

          State governments still own the transmission assets but that is not where the costs are being generated. Tas and Qld are the only states in the NEM where the distribution assets are still beneficially owned (NSW and SA’s are leased so still “gov owned” but that’s a fudge).

  • MaxG

    Every time I read something like this, I am wrapped that I am running my own energy system. 🙂

  • Radbug

    The distributors are sweating blood on EV’s in order to avoid write-downs.

    • David Hiley

      If the distributors are banking on EVs to save their bacon, they certainly aren’t showing it as they have done virtually nothing to support electric vehicles in Australia over the last 5 years.

      • Phil

        Yes they need to be ramping up to a significant number of charge points NOW. Takes years to make it happen

        No one is making a significant investment now.

        And unlike EV’s built by robots in super factories , the regulatory, labour and available site costs for charge points will no doubt increase as each year goes by

  • Andy Saunders

    It’s not really a function of privatisation. Qld still has state-owned generators and distributors, and until the recent “get the price down” edict had the highest prices in the NEM…

    • david lymn

      It’s a bit like price fixing. The privateers set a high price and then everyone follows. SA prices are high because Electranet capitalises on the fact that they are the only owners of the lines from the east coast to SA. They can jack up the prices as high as they like. The SA renewables generators say that if the other guys can charge high prices, so will we.My guess is that as renewable supply grows and we start to get real competition, prices in SA will fall to close to wholesale. The government must take back the grid. Those towers that blew over in the storm last year were 50 years old and rusted out. Not so much goldplating there. These privateers will make as much money as they can and when the gear falls to bits, they;ll walk away, eg Hazelwood and others

      • Andy Saunders

        David, whilst you have some reasonable points, perhaps you don’t realise how the merit-order price-setting works. Even if a renewables generator bids into the NEM at zero or even negative prices, it will receive the clearing price (often set by a gas generator).

        You’re possibly confusing the grid (I presume you mean transmission, and maybe distribution) with the generators. As a natural monopoly, T&D generally is regulated as a monopoly on a rate-of-return basis.

        I don’t believe the SA towers were “rusted out”. Not much could withstand tornado-strength winds.

        Please see my previous comment about government-owned generators – re-nationalising is patently not the sole solution. I didn’t touch on T&D rorts though – these are probably even worse than generator rorts as it shows many regulators to be asleep at the wheel.

  • Goldie444

    “In those figures,” it adds, “the carbon price was barely noticeable.”
    I think this could be restated as “In those figures,” I say “the carbon price was very noticeable as over 3 years, it was the only time the price of electricity showed a down would move in the whole 35 years of the graph profile.”

  • Brunel

    Given that inequality is soaring, Gillard should have given a $900 cheque to each poor voter after putting in the carbon tax.

    There is no other way of tackling inequality.

    • Joe

      What Carbon Tax? Please call it what it was…an ETS with a fixed price for 3 years. The compensation that was given covered the impacts of The ETS and those impacts were predicted. So what is the point of your…$900.00 cheque nonsense. Then PM Rudd and Treasurer Swan provided a ‘Stimulus’ package when The GFC hit, part of ‘Stimulus’ were $900.000 payments….nothing to do with The ETS under PM Gillard.

    • Mike Shackleton

      They did – they raised the tax free threshold to $17000 and adjusted the income tax rates below $80k so that you should have been no worse off due to increased prices associated with the carbon price.
      As an electricity consumer in locations where you could freely choose your supplier (say in Victoria) you could avoid paying the carbon price on each unit of electricity you bought by choosing a supplier like say, Momentum (100% hydro).

      • Brunel

        Of course I did not vote for Tony Abbott, but the electorate did not link the income tax cut to power price rises. And not everyone had a job at the time.

        Nick Xenophon is giving out $75 cheques to pensioners and he is the only politician to have a net positive approval rating!

        Imagine the optics of giving out $900 cheques with the words “electricity bill help cheque”. The bogans would have lapped it up.

    • Ren Stimpy

      The carbon tax was a way of addressing inequality seeing as it caused electricity prices to fall. Then dear old Tony came along and axed the carbon tax and all the investment certainty that came with it – he cut off the nose to spite the face.

  • George Michaelson

    I don’t understand why the state governments act like this cannot be changed. I do understand its a high risk high consequence decision, but facing the actual economic outcome, I think declaring some change by legal fiat, laws, whatever mechanism is needed to terminate the income/spend relationship and having these companies write off the unachieved income is about all we have left.

    The alternative, to say “oh, sorry, we didn’t understand the longterm consequences of the contract” and wear it, feels like a huge mistake. Contracts are designed to give people certainty but they are also designed in a context of assumed fairness and equity and whilst its distasteful, there are legal mechanisms to declare them null and void.

    Is it “sovereign risk” to make companies meet a social obligation? Should it be sovereign risk?

  • Interesting to note that Rod Sims (at the ACCC) referenced 6 factors (not just 1) contributing to higher prices:
    http://www.wattclarity.com.au/2017/07/accc-chief-rod-sims-includes-6-factors-driving-retail-electricity-prices-higher/

    My take is that it’s more than 6 – and that ultimately “it’s all due to gold plating” and “it’s all due to renewables” are both serving us poorly in this energy transition.

  • Adam Smith

    That is one opinion. The correlation with the Labor Government of Rudd/Gillard/Rudd should also be realized and the curtailment of the growth when the LNP was elected should also be noted. You can say gold plating, but the network builds to 50 year horizons and in the early 2000’s up until about 2011, it was expected there would be strong growth in demand, but the cost escalation kyboshed the growth in demand. State Governments (mostly Labor) also owned the majority of the network, except Victoria, until recently. There is a lot more to this than the commentators know or are saying. The discontinuance of the merits review by the AER is also another knee jerk reaction which means that the AER is now a dictatorship, whereas before a network owner could contest an unfair action by the AER. Gees who would want to be a network operator today!

  • Phil

    Yep it’s an ENERGY MARKET now . More so than a service or product. “Clarke (r.i.p) and Dawe Nailed it” https://www.youtube.com/watch?v=ELaBzj7cn14

    The only consumer options to bring down the cost is to use less of the Grid or offset with their own renewables.

    • Mike Westerman

      Yes and a very different energy system than the past. Our energy system at the moment derives energy from coal (32%), oil (38%), gas (24%), RE (6%), with end uses transport (27%), electricity (27%), manufacturing (20%), mining (9%), residential (8%), commerce (5%), ag (2%), other (2%). Looking at the future, where transport is moving to largely EV with air transport biofuel, it’s easy to see that intermittency becomes less and less an issue as time progresses, since so much of the demand is intermittent. The load will reshape to fit supply, and where it can’t, will either pay a high premium or make other provision or both. The great thing is that with the revolution now happening in batteries, we know that 100% local reserve for non-curtailable loads, with supply from local RE costs around the cost of doing the same with diesels, as was done in the past, but without the attendant cost and issues of fuel handling, engine maintenance, test running etc – that is, cheaper and better.

      When you have enough wind and solar to displace the coal, gas and oil, particularly since solar and offshore wind is likely to dominate, and demand is conditioned to its low costs but supply patterns, adding additional reserve is marginal at most.

      • david lymn

        Robotics will assist in reshaping load. If companies design production systems to match the availability of RE, you will see a significant increase in the deconstruction of fossil fuel generators. It’s a bit like what happened with industrialisation in reverse; you set up the machinery to operate when energy is available and not coerce workers to report to work 9-5 daily.