This is an issue that has raised some interest at the regulatory conference. So let me expand further on my earlier thoughts – made more concrete through various conversations here in Brisbane.
Let’s focus on a simple example. Pick a regulated sector with no competition, like electricity transmission. There is no issue of public and private firms competing. In Victoria the transmission system is private and owned by SPAusNet. (Of course, this is 52% owned by Singapore Power which is ultimately owned by the Singapore government – but let’s not go there given recent political comments on foreign ownership). In most other states the electricity transmission networks are government owned. The systems are regulated by the Australian Energy Regulator (AER). Should the AER treat the transmission systems identically despite different ownership?
Well, why not? Let’s take a couple of simple examples. Part of the return that a private utility requires is the compensation for sovereign risk. The government may intervene in a way that harms the private company and this will be reflected by investors requiring a higher return to compensate (a nice presentation at the conference using European data illustrated this). So if the transmission company is private, the private-company return set by the regulator may be, say, 4% above the risk free rate, of which 1% is compensation for sovereign risk and 3% relates to ‘other’ risk. (The numbers are purely for illustrative purposes).
What if the transmission company is government owned? The ‘other’ risk is still there and this involves a return of 3% above the risk free rate. But there is clearly no sovereign risk. The government does not need a return to protect it from itself! So what ‘return’ should the regulator build into electricity prices through transmission charges for the government-owned transmission company? The 4% risk that the private firm faces or the 3% risk that deducts the 1% sovereign risk that is irrelevant for the public firm? If we regulate the companies the same regardless of ownership, then the answer is 4%. But this distorts electricity prices by compensating the government-owned company for a risk that it does not face.
Let’s take another example. Suppose the private firm is more efficient at reducing operations and maintenance costs than the public firm. Further, this inefficiency is not something that can be corrected ‘by force’. It just reflects that public sector managers and private owners (and their managers) face different incentives. These incentives are beyond the regulator’s control.
So we know that under private ownership a particular cost will be $1 per kWh of electricity transmitted. Under public ownership the cost will be $2 per kWh. The regulator allows the privately owned transmission company to build this cost into electricity prices, at $1 per kWh. But should it do the same for the public firm or should it build in the higher cost of $2 per kWh?
It could be argued that the regulator should only allow $1 even though the cost to the public firm is $2. After all why should electricity consumers be required to pay a cost that arises solely due to government ownership?
The counterargument is that if the cost is really $2, then this should be incorporated into the price to ensure consumers see the full cost of their electricity consumption. If they only paid $1 per kWh when the cost is $2 per kWh then they will use too much electricity and create an economic loss. So, according to this argument, the regulator should include the true cost of $2 in the transmission prices set by the government-owned company.
In both these cases, I am dubious of the ‘regulate regardless of ownership’ argument. I am happy to be shown that I am wrong – but as these (and numerous other) examples show, this is an issue that Australian regulators need to think about.