For Sale: The Power of the People

Sharon Beder

Citation: Sharon Beder, 'For Sale: The Power of the People', Australian Financial Review, 4 July, Weekend Review, p. 10.

This is a final version submitted for publication.
Minor editorial changes may have subsequently been made.

Sharon Beder's Other Publications

Sharon Beder - on the battle for control of the world's electricity

Since the mid-1990s dozens of governments around the world have chosen to restructure and privatise the provision of electricity. As a result there have been black-outs, price spikes, price manipulation, bankruptcies and electricity shortages. The privatisation of electricity is not something that their citizens have demanded or wanted. In fact, popular uprisings and mass protests have occurred in Argentina, South Africa, India, Indonesia, Ghana, Peru, Ecuador, Paraguay and the Dominican Republic.

Despite its lack of popular support electricity privatisation has become the accepted wisdom among governments and opinion leaders. "Liberalisation" has seen the goal of reliable, universal electricity service delivered at a reasonable price replaced by the goals of efficiency, competition and consumer choice.

Restructuring and privatisation are supposed to introduce competition into electricity provision and expose the newly privatised firms to the disciplines of the market so that they become more efficient and electricity prices are reduced. They are also supposed to raise revenue for governments, provide new sources of investment capital for expensive electricity infrastructure and reduce the government's role in the economy.

In reality, electricity prices have increased or at least become exceedingly volatile as a result of privatisation and restructuring. The supposed disciplines of the market have been eclipsed by price manipulation as electricity companies seek to boost electricity prices and maximise profits.

Increased government revenue has often turned out to be little more than a mirage because the loss of dividends and the cost of controlling prices has outweighed the financial gains.

The private sector has been slow to invest in new infrastructure because prices are higher if electricity is in short supply. And governments have had to become more involved, not less, in order to sort out the problems that have ensued.

Britain, which was one of the first nations to privatise electricity, is supposed to be the model of success. Although British prices for electricity have fallen since privatisation, this has been due to lower fuel costs rather than to the increased efficiency of privatised companies. Prices would have fallen even if electricity had remained in public hands.
The greatest share of benefit from those fuel cost reductions went to shareholders rather than consumers. The private electricity companies reaped huge profits, paying large dividends and executive salaries. But retail prices for small households remained high by European and US standards and many nations that have not liberalised their electricity markets continue to offer cheaper electricity.

The reason that the fuel savings were not passed on to consumers is that electricity generators manipulated the prices of wholesale electricity in the artificial power market established to facilitate competition and the market was abandoned in 1997. Efforts to disaggregate the industry to promote competition were counteracted by a wave of mergers and acquisitions. And although privatisation was supposed to reduce regulation it has actually led to more complicated regulation.

In a comparative study of total factor productivity rates in different countries, Mary O'Mahony and Michella Vecchi found that UK productivity growth rates before privatisation, at over 2 per cent, were similar to those achieved in the US and higher than those in Europe, apart from France, which had a strong state-owned electricity system. However, after privatisation productivity growth fell: "By 1997 productivity levels in the UK were some 20 per cent below those in the US and France."

After the introduction of new electricity trading arrangements in 2001 UK wholesale prices dropped dramatically but the industry is now claiming that prices are too low and are putting electricity generating companies out of business. Hardest hit have been generating companies that have not merged with retail supply companies so that they can recoup losses from consumers. For example, British Energy faced bankruptcy because, it claimed, wholesale prices were below the cost of generation by its nuclear power plants.

A spokesperson for the industry regulator argued that it was expected that some companies would fail in a market system. However the British government was unable to stand by and watch British Energy go bankrupt, leaving its eight nuclear power plants sitting idle with no-one to decommission them. It agreed to pay $$3 billion to bail the company out after receiving only $$2.1 billion for the sale of British Energy in 1996.

Price manipulation has also been a feature of Australia's electricity market, which runs along the same lines as the abandoned UK trading system. The Australian Bureau of Agricultural and Resource Economics, a supporter of deregulation and competition, has confirmed this. Though the primary aim of the national electricity market was to facilitate competition, an ABARE study found that market prices were not competitive.

Prices were initially manipulated by withholding actual generating capacity. Generators moved to economic withholding in 2000 bidding large chunks of their capacity at very high prices. This practice began in Victoria and spread to more companies and other states in 2001.

A study by consulting firm Bardak Ventures concluded that while in some high price incidents examined, there had been an initiating event, such as the loss of a generator, interconnection limitations or exceptionally high load forecasts, "the major factor contributing to the price spike is the bidding and rebidding practices of the generators".
It has also become clear that the national electricity market provides little incentive for generators to invest in new capacity because undersupply keeps pool prices high and the standby plant necessary to ensure system reliability erodes profits. Also, existing generators can drop prices when potential competitors are seeking finance for generation facilities.

Traditionally governments took responsibility for system reliability but with privatisation that task has been handed over to the market, which has other priorities. By mid-2002 there was a call for more generating capacity. ABARE forecasts increasing electricity demand and the Electricity Supply Association of Australia has estimated that at least $20 billion must be invested in fuel supply and generation to meet that demand.

The problem is: Who will make that investment? Rather than investing in new infrastructure, many of the private generators have been selling up. Ten billion dollars' worth of existing electricity infrastructure was up for sale in 2002.

Wholesale electricity prices increased again in the winter of 2002 as a result of concerted rebidding by generating companies. From average prices of $20 to $30 per megawatt hour, the pool price began to sit at around $112 per MWh all day, peaking much higher in the evening when people turned their heaters on. Major companies in NSW and Victoria were offering limited amounts of electricity at thousands of dollars per MWh on cold evenings.
South Australia has been hardest hit by the price hikes because it imports so much of its electricity from Victoria and privatisation has only made matters worse. When the Olsen government privatised electricity in South Australia in 1999, despite election promises to the contrary and strong public opposition, it argued that privatisation was necessary to eliminate risks to taxpayers associated with the national electricity market and to enable the state government to pay off its debts.

The Electricity Trust of South Australia had contributed some $2 billion to state revenue over the previous decade and its operating costs had decreased significantly. Economist Richard Blandy pointed out last year that "South Australians now face historically high electricity prices compared with the rest of Australia for no net benefit to the state government finances".

In 2002 South Australian households paid 30 per cent more than in non-privatised NSW (compared with 10 per cent more pre-privatisation and the opening of markets). When some 2800 middle-sized businesses became contestable and had their electricity prices deregulated in July 2001, they experienced price increases of between 30 per cent and 80 per cent.

By mid-2001 large businesses, which had pushed for privatisation, found that their prices had increased by 25 per cent above inflation rates. Spot prices were so high that some businesses were calling a halt to normal operations and selling the power they would have used.

Some blamed undersupply for the severe problems in South Australia but not all generating capacity was being offered for sale. Often this was part of a price manipulation strategy. If a generating company has more than one generating unit, it can increase the price by withdrawing one unit. In fact, in the summer of 2000-01, when South Australia was suffering shortages and black-outs, South Australian power companies were selling power to Victoria. Prices on the national electricity market soared to the $5000 per MWh cap and South Australian privatised companies made millions selling electricity to Victoria while 35,000 South Australian households went without power.

The other consequence of privatisation has been a decline in service reliability, with the regular failure of fuses and transformers across South Australia. Before privatisation ETSA had maintenance teams which monitored transformers and replaced them before they failed, thus ensuring minimal interruption to the electrical supply.

One theory for the increased failure of transformers after privatisation is that these teams were discontinued and instead transformers were left in place till they failed, giving them a slightly longer life of a year or two. This would have saved money at the expense of reliability. Also the lives of transformers can be increased by downrating them, so that they do not run at full load and do not get so hot. This could be done by installing lower-rated fuses in the transformer boxes on suburban power poles. These fuses would blow before reaching full load. The power supply would be cut but the fuse could be replaced rather than the transformer a much cheaper option at $10 per fuse.

Indeed, many of the interruptions to power supply in South Australia in 2000-01 were being caused by transformer fuses blowing. In just one night in February 2001 fuses blew on 45 transformers, cutting electricity to 750 homes which wasn't restored for up to two hours. In the previous summer 270 fuses went in a couple of months, cutting power to 3000 homes. ETSA Utilities responded by blaming air conditioners for placing too big a load on the fuses. Unions claimed that the 900 workers formerly employed to check and repair power lines had been reduced to about 300, while maintenance crews had been cut from 270 to 90.
According to South Australian auditor-general Ken McPherson, the leasing arrangements did not require companies leasing generating facilities to upgrade or even maintain those facilities. And certainly the market provided little incentive to do so.

In most countries around the world where electricity has been privatised or deregulated, retail electricity prices have increased, often dramatically for households and small businesses. Where wholesale prices declined, it was usually as a result of external cost reductions, particularly in the cost of fuel, as in the UK, and had the government-owned system remained in place consumers/taxpayers would have reaped the benefits. But in an unregulated private system, any savings have been largely retained by the private electricity companies along the electricity supply chain.

A study by the World Bank of 61 privatised electricity companies in 18 countries found that profitability increased by an average of 45 per cent during the 1990s. This was usually achieved at the expense of workers and consumers.

It has been more usual for wholesale prices to go up, because of market manipulation. In places where government-imposed price caps are in place, retail suppliers have not been able to pass these high wholesale prices on to consumers. The ensuing financial difficulties have led to black-outs and government bail-outs, as in California.

Service and reliability have also declined in privatised electricity systems. The supposed efficiency gains to be made by private, competitive companies have too often been made through short-term cost savings. These include cuts to safety, maintenance, training and research budgets. Old equipment is not regularly serviced nor replaced in advance of likely failure. As a result, accidents and equipment-related black-outs increase, as do black-outs related to network congestion because planning and responsibility for network maintenance and development is not a market priority.

Black-outs and price spikes also increase as a result of lower reserve levels of generation capacity brought about by the perverse incentives of the market system which give greater profits to private generating companies in times of electricity shortages. This not only discourages investment in new generation capacity but encourages withholding of electricity in times of peak demand to send prices higher.

What is more, it was the unwillingness of private companies to take on the risks associated with building capital-intensive electricity infrastructure that led to government provision of electricity in many countries in the first place. For private companies the biggest risk in building new generation facilities is that they will cause wholesale electricity prices to fall. In a public system, this risk of lower returns to taxpayers who pay for the infrastructure is balanced by the lower prices to electricity ratepayers, usually the same people.

A study by the Federal Bank of New York found that consumers could expect more volatility in prices with frequent price spikes and less reliability of supply: "Market forces may be inadequate to guarantee that providers can always deliver a sufficient quantity of electricity to maintain the grid's stability during peak load periods."

As part of the privatisation campaign, government debt has been stigmatised. However, there is nothing inherently wrong with debt and the privately owned electricity companies will continue to have debts bigger debts in many cases than when the electricity supply was publicly owned. Government debt can also be financially advantageous if income from assets is greater than the debt repayments. It enables the costs of building long-term capital infrastructure to be spread over the lifetime of the asset, which can cover several generations of taxpayers.

Before privatisation governments were able to use more profitable aspects of the business to subsidise the unprofitable social objectives, such as environmental protection or subsidies to poor or remote consumers. After privatisation, private companies, freed from social obligations, are able to undertake profitable activities while the government continues to pay for these unprofitable aspects of supply.

When bankruptcies are threatened governments have to be prepared to step in and bail out private companies so as to secure the electricity supply. Taxpayers have been caught having to bail out companies when wholesale prices went up, as in California, and when they went down, as in the UK. They clearly get the worst of both worlds. The reason for this is simple to understand: electricity is not a commodity that consumers can choose to take or leave depending on price and supply; it is an essential service central to themaintenance of modern lifestyles.

However, as time passes the opposition has become more outspoken and determined. The excuses for the fiascos that have resulted from restructuring, deregulation and privatisation are wearing thin. In California, a majority of people do not believe that their crisis was caused by a shortage of electricity and most think that deregulation was a mistake and favour re-regulation. It is becoming increasingly difficult to privatise electricity in developed nations like Australia, France and Canada due to voter opposition. In many developing nations privatisation proposals are being greeted with mass protest. It is unlikely that the trend towards electricity "liberalisation" can be sustained much longer.

Professor Sharon Beder is an honorary professorial fellow at the University of Wollongong.
Sharon Beder's Publications can be found at