NSW Electricity Privatisation

In the Sydney Morning Herald, Ross Gittins hits out at detractors of plans to privatise the remaining government-owned electricity generating and retail assets in NSW.

They may be economic geniuses, but they have more to learn about the politics of economics.

Here he is referring to John Quiggin and Nicholas Gruen and their demolition of the argument that the reason to have a sale of government assets is to improve NSW’s fiscal position. Gittins claims that they don’t understand that this is just the reason the government is giving for privatisation. The ‘real’ reason is deeper.

Let me say first, demolishing ‘stated’ reasons for government policy is a legitimate exercise because, let’s face it, it is hard for we academic types to tell whether politicians really believe their arguments or not. The public has a right to know the real story and so taking down ‘stated’ stories is legitimate and in the public interest.

Now let’s turn to the ‘real’ reason as given by the Owen report into the issue. That is, that sometime in the future NSW is going to need more electricity investment and the government would like the private sector to undertake that investment. First of all, let’s note that there is no actual impediment to the private sector taking that investment now. They can invest in NSW electricity generation unimpeded and in fact are doing so with new gas fired plant coming on line. The problem arises apparently because of their incentive to do so.

So let’s understand that argument. It says that a private investor may not invest because (a) it is worried that the ‘crazy run’ publicly owned generators may just keep prices artificially low; and/or (b) that the NSW government might wake up one morning and plonk a whole heap of new investment themselves on the NSW grid. Ross Gittins appears to endorse this type of argument:

A further advantage is that this resolves the Government’s conflict of interest in being a player in the market it regulates. Some firms are reluctant to enter a market where they’d be competing with the regulator – and with an owner having the financial clout to make unprofitable investment decisions should the mood take it.

But let’s evaluate it more closely. First, the national electricity market has an independent regulator and so it really isn’t a case like we had in telecommunications (and still do) where the level of government that ‘owns’ the regulator also owns industry assets. So the conflict isn’t really over regulation and let’s face it, even if it were on the retail side, it seems hardly a joy for investment there for that conflict to be removed (it can only mean lower prices — which, by the way, is a good argument for privatisation).

Second, if there is an electricity shortage then having artifically low prices does not deter investment. Capacity constraints will mean that the prices received by new entrants will be high, regardless. So there is no reason to privatise on that account.

Third, suppose we do privatise current assets. Then the NSW government could still wake up one morning and build another power plant. That doesn’t go away because it sells off its current assets. Indeed, when you think about it, the NSW government is more likely to be an entrant post-privatisation because it would not cannabilise existing profits! The only way this argument works is if the NSW government comments to no public investment but how exactly can it do that?

And let’s turn to the private investment equation for a second. If the NSW government privatises assets, private investors will buy them. Do we really think that if private funds spend $15 billion into NSW electricity now they are going to sink further funds into similar investment any time soon? At the moment, entry is the only means of getting a stake in the industry. With privatisation on the cards, there is a safer bet of existing assets. Actually, when you think about it, it may be the fact that privatisation is on the cards that is deterring that investment as opposed to it actually occurring.

There are two forces at work in a real privatisation decision. First, as John Quiggin has long argued convincingly, the public sector has a lower cost of capital than the private sector and hence, there are good reasons to take advantage of that — especially for infrastructure investment. Gittins mean bemoan that this argument leads to nationalisation of everything but that is only because he is presuming that it is the only argument. It is not. There are balancing forces.

The big balancing force is that sometimes assets are managed and run more efficiently in private hands. This is an argument developed by Stephen King and Rohan Pitchford. However, this argument is easily evaluated — NSW can just look to other states that have privatised to see whether the efficiencies have been realised or not. I do not know if that is the case but it seems to me that this is the only ‘real’ reason to consider privatisation and should be the only thing really discussed in the debate. Putting blind faith in the idea that those efficiencies exist, as Gittins appears to do, is not the way to go.

5 thoughts on “NSW Electricity Privatisation”

  1. Yup – fully agree.

    Also very hard to do. Paucity of data at a state level is a signficant problem.

    The ERIG taskforce had a go but ended up falling back on several partial indicators – and ran the line that any single partial indicator is of dubious indicator, however, a weight of partial indicators indicated that generator performance in NSW on productivity was behind that of other NEM regions as were price outcomes and signals/incentives.

    cheers,
    Christopher

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  2. I’m not economically trained and I’m not qualified to comment on a lot of this, but part of Gittins’ argument was that it makes no sense, when assessing the economic costs and benefits of an action, to disregard the likely political implications, chiefly because those political implications in turn have economic implications.

    Part of what he was saying was that there is a political limit to the level of debt that the NSW Government is going to be able to carry, whatever the economic arguments. You might not agree with that political assessment but if it is correct then it has real implications when asking the question, what are the economic costs and benefits of privatising the electricity industry? If it’s true that there is a political cap on how much the NSW Government is going to be able to borrow and political restrictions on what they can borrow for, and I think there are, it might make a lot of sense to direct borrowing to things that have greater benefits attached, which is part of what Gittins says.

    Having said that, I thought Gittins was a bit unfair. After all, it is precisely the work of economists and economic commentators in recent times, pointing out that Government debt can be good, that has increased the political cap on borrowing for infrastructure.

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  3. Yesterday’s decision against privatisation is a huge win on the greenhouse gas front. If a company spends 15 billion or so to purchase the system, then they will want to make profit from that system, which stifles innovation.
    Consider the two possibilities: 1. The new technology from the university of NSW enables households to generate their own hydron, greenhouse gas free. These hydrogen cells can produce energy for transport as well as electricity. This makes part of the grid obsolete, as well as huge power stations. The purchaser would actually buy a dud, but would try to prevent the above technology because it would eat into their profits. They would have to pay carbon taxes, which they pass on to the consumer, and then they’d plaster the continent with pipelines for carbon capture, the cost of which would also be passed on to the consumer. The NSW government, having cashed in on the assetts, would be lobbied to disallow the new technology.
    2. With hydrogen cells on 1.6 million households, powered by the sun, as the University of NSW has developped, none of these costs would arise. Even the retailing business would not be what it once was.
    Privatising NSW electricity would be innovation stifling and perpetuate the emissions of greenhouse gases, so it does not make sense. If capacity constraints are around the corner, then the new technology should be introduced as soon as possible.

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  4. Ummm, governments do not have a lower cost of capital. In economics, there is a concept of opportunity cost, that is what actual costs are measured by. The same amount of resources need to be sacrificed to make a government owned power station as a private one (perhaps more if the government is less efficient at building it), the difference lies in the fact that because the government has the power to tax, it can subsidise its losses in an area and still afford to pay back its creditors, hence it is a superior credit risk and faces lower interest rates. But this does not mean that it can builds things at a lower real cost. The real savings that are diverted from the private sector’s savings hoard to make the power station are the same. In short, government borrowings crowd out savings for private borrowings increasing interest rates at the margin for them. Or to put in another way, a dollar spent on infrastructure, capital etc by the government is one less dollar spent by the private market.

    I find it astonishing that anybody with the slightest knowledge of economics could fail to understand this.

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