Biggest winners, and biggest losers, of network monopoly game

Based on all of the available information, the returns being realised by Queensland’s monopoly electricity networks are the highest of any electricity networks in the world.

Importantly, those returns are being realised despite Queensland’s electricity networks being amongst the most inefficient networks in Australia.

The Queensland government’s unsustainable income extractions

Despite the Queensland networks extraordinary profits, in every year over the past three years the Queensland Government extracted more income from the networks than the networks created.

Over the past three years the Queensland Government extracted a total income of $9 billion from the Queensland networks, equating to 167% of the networks’ total profits over the period.

Importantly, in 2014/15 the Queensland Government’s income extractions amounted to 270% of the networks’ profits (617% of Powerlink Queensland’s profits, 230% of Ergon Energy’s profits and 214% of Energex’s profits).

The Queensland Government’s profits from network charges

Over the past three years, for every dollar Queensland consumers paid in network charges, the Queensland Government collected 47 cents in profits – i.e. the Queensland Government collected a 47% profit margin from the Queensland networks.

This means that:

• For a Queensland household electricity bill with network charges of $1,000, the Queensland Government’s profits from the networks amounted to $470
• For a Queensland small business bill with network charges of $2,000, the Queensland Government’s profits from the networks amounted to $940
• For a large business user bill with network charges of $200,000, the Queensland Government’s profits from the networks amounted to $94,000

The transfer to national network regulation has been a catastrophic failure

The decision to transfer responsibility for the Queensland electricity networks’ revenue regulation to the national regulatory framework in 2006 was based on promises that it would deliver more efficient prices and improve the networks’ productivity levels.

However, rather than delivering those promised improvements, national regulation of the Queensland networks’ revenues has been a catastrophic failure, resulting in a more than doubling of the networks’ prices and dramatic declines in the networks’ capital and operational productivity levels.

Although the deficiencies in the national regulatory framework apply to both publicly and privately owned networks, the state government owned networks have exploited the deficiencies and loopholes to a much higher degree than the privately owned networks.

In essence, the national regulatory framework was designed for private ownership and has been unable to prevent government owned networks (with their access to low-cost finance) from exploiting the incentives for overinvestment and gold plating, and profiting from their inefficiencies.

As a result, the state government owned networks’ prices are over twice the efficient level, whereas the privately owned networks’ prices are around 30% above efficient levels.

The Queensland networks’ gaming of the national regulator

Since transferring to national regulation, the Queensland networks’ prices and profits have grown at the highest rates in Australia.

The Queensland networks have systemically exploited various deficiencies and loopholes in the national regulatory framework, securing revenue allowances from the national regulator (the Australian Energy Regulator (AER)) over twice the efficient levels:

Profiting from over-investment and gold plating

The Queensland networks receive guaranteed returns on their asset valuations – their regulatory asset bases (RABs). Those returns drive the majority of the networks’ revenues.

Prior to transferring to national regulation, the regulator was required to optimisethe networks’ RAB valuations – i.e. the regulator was required to exclude the value of any excess capacity from the networks’ RABs, thereby ensuring that consumers were not required to fund unnecessary or inefficient investments.

However, when the networks transferred to national regulation in 2006, the Queensland Government (and other state governments) insisted that major changes were made to the regulatory rules to prevent the regulator from optimising the networks’ RABs and to ensure that the networks received guaranteed returns on all investments irrespective of their prudency or efficiency.

Importantly, the removal of the regulator’s RAB optimisation powers contrasts sharply with the regulatory rules in other jurisdictions in Australia and overseas.

For example, the regulatory rules for Australia’s gas networks and the Western Australian electricity networks have always required the regulator to optimise the networks’ RABs.

As predicted by numerous stakeholders at the time, those rule changes gave the networks carte blanche to invest with impunity, resulting in extraordinary levels of over-investment by the Queensland networks.

The Queensland networks’ levels of overinvestment were the highest in Australia and the Queensland government is continuing to profit substantially from that over-investment, as the networks continue to receive guaranteed returns on under-utilised and redundant assets.

Profiting from operational inefficiencies

The Queensland networks are amongst the least efficient networks in the National Electricity Market (NEM).

The Queensland networks have managed to prevent the AER from properly applying benchmarking when setting their opex allowances, resulting in the AER setting their opex allowances on the basis of their historical costs, rather than efficient costs.

As a result, the Queensland networks’ total opex allowances over their current 5-year regulatory periods are $2.25 billion ($450 million per annum) above the efficient level.

Gaming the AER’s incentive schemes

The Queensland networks have realised major windfall profits from gaming the AER’s incentive schemes, taking advantage of information asymmetries and negotiating incentive scheme targets well above the efficient levels.

Successive Queensland governments have enabled the Queensland networks to exploit the national regulatory framework

Successive Queensland Governments have consistently deflected the blame for the networks’ price increases to the national regulatory framework, conveniently blaming the Australian Energy Regulator (AER) for the networks’ price increases.

However, the national regulatory framework and the AER’s regulatory powers are actually controlled by the state and territory governments through the COAG Energy Council.

The truth is that successive Queensland Governments have demonstrably failed to balance their conflicting roles of network owner and regulatory rule maker.

The paper outlines how the addiction of successive Queensland Governments to the networks’ extraordinary profits has severely compromised their approach to network regulation for many years.

It outlines how the Queensland Government has been the most proactive state government in constraining the AER’s powers and ensuring the retention of the deficiencies and loopholes in the regulatory framework that enable the Queensland networks to realise extraordinary profits from their overinvestment and inefficiencies.

The paper also exposes the hypocrisy of claims by successive Queensland Governments regarding their commitment to ensuring efficient and fair electricity prices for Queenslanders, providing various examples of Queensland Government decisions over the past decade that demonstrate that hypocrisy.

Assessment of efficient prices for the Queensland networks

This paper provides detailed estimates of efficient revenues and prices for each Queensland network – i.e. revenues that reflect reasonable returns on efficient investments and the recovery of efficient costs.

It demonstrates that the Queensland networks’ current revenues and prices are over twice the efficient levels.

Assessment of Queensland political parties policies

The paper provides a detailed assessment of the policies proposed by the Queensland political parties.

It outlines that those policies would potentially deliver network price reductions of up to 60%.

Business as usual is unsustainable

It is clear from the policies proposed by Queensland’s political parties that there is broad political awareness that business as usual is unsustainable.

The paper demonstrates that the Queensland networks’ excessive prices are driving an industry death spiral that will ultimately be much more destructive to the value and future viability of Queensland’s government-owned energy companies than the short-term impacts of implementing sustainable prices.

The new delicately balanced Queensland parliament provides an opportunity for the new Queensland Government to seriously address the key driver of Queensland’s excessive electricity prices and reduce the state budget’s dependence on unsustainable profits from Queensland’s monopoly electricity networks.

Recommendations

The paper provides 4 key recommendations:

Recommendation 1. Set the Queensland networks’ prices at efficient levels

As owner of the Queensland networks, the Queensland government has a high degree of control over their prices.

Rather than continuing to enable the Queensland networks to game the national regulator and charge prices over twice the efficient levels, the Queensland Government needs to exercise that control and ensure that the networks’ prices are set at efficient levels.

The Australian Energy Regulator (AER) sets a limit on the maximum revenues the Queensland networks are allowed to collect from their customers. The networks have complete autonomy regarding the actual revenue they collect, as long as their total revenue does not exceed their maximum revenue caps.

Importantly, setting the Queensland networks’ revenues at levels below their maximum revenue caps can be implemented immediately and does notrequire any changes to the national regulatory framework.

Decisions to collect revenues below the networks’ maximum revenue caps are not unusual and have been made by various network owners (including previous Queensland governments) in recent years.

For example, the NSW government recently directed Essential Energy (the NSW government-owned distribution network) to set its prices at 34% below the level that Essential Energy managed to game from the national regulatory framework.

Importantly, the paper outlines that the NSW government made that direction in response to NSW community outrage following the leaking of a document that confirmed that Essential Energy had cynically exploited its consumers, the regulator and the Australian legal system in its pursuit of excessive profits.

Recommendation 2. Revert to Queensland government controlled regulation for the Queensland networks

The paper support the proposals of some Queensland political parties to revert to Queensland Government controlled revenue regulation for the Queensland networks- as applied prior to 2006, and as currently applies to state–owned electricity networks in comparable federal countries.

Although Queensland Government controlled network revenue regulation will not be immune from political interference, the practical reality is that providing single point accountability to the Queensland Government for the networks’ prices and profits is much more likely to deliver efficient network prices than continuing to place false hope that future state governments will progress the numerous long-overdue reforms to the deeply flawed national regulatory framework.

Recommendation 3. Implement fiscal controls that restrict the Queensland government’s income extractions to sustainable levels

The paper demonstrates that the Queensland Government is extracting income from the Queensland networks at unsustainable levels.

It makes recommendations for stronger fiscal controls that make it more difficult for the Queensland Government to extract unsustainable levels of income from the Queensland networks.

Recommendation 4. Implement strengthened oversight of the Queensland networks

The paper demonstrates that successive Queensland Governments have had a “hands-off’ approach to the governance of the Queensland government owned networks, enabling the networks to exploit loopholes and deficiencies in the national regulatory framework, pursuing outcomes that are not in Queensland consumers’ long-term interests.

It provides detailed recommendations for improvements to the Queensland networks’ governance arrangements to ensure that they better reflect the Queensland communities’ long-term interests.

This document summarises the findings and recommendations of Hugh Grant’s latest paper: “The Winners And Losers Of The Monopoly Game – How The Queensland Government Profits From Queensland’s Excessive Electricity Prices”

Hugh Grant has performed various executive roles in the Australian energy sector. As Executive Director –  ResponseAbility, he currently assists a diverse range of consumer advocacy groups to develop submissions on energy market policy and regulatory developments, aimed at ensuring that consumers’ long-term interests are appropriately considered.