Opinion
Energy

Microeconomic reform has failed in every part of the supply system and it needs to be redesigned from the ground up


The recent proposal by the Greens for the establishment of a publicly owned electricity retailer is the latest of a series in which proposals for renewed public intervention have emerged across the political spectrum. The Queensland Labor government has committed to the establishment of a publicly owned renewable electricity generator, to be called CleanCo. At the federal level, the Labor leader, Bill Shorten, has repeatedly stated that electricity privatisation was a mistake. The LNP government is still committed to the Snowy 2.0 hydro scheme, while the climate denialist faction wants public money for a new coal-fired power station.
This renewed appetite for public ownership is accompanied by general recognition that the national electricity market has been a complete failure. As I discuss in my contribution to a new book, Wrong Way, How Privatisation and Economic Reform Backfire, microeconomic reform has failed in every part of the electricity supply system.
Unfortunately, no one has much of an idea what to do about the problem. Restoration of public ownership will help but the system needs to be redesigned from the ground up. Before putting forward blueprints for a redesign, it’s important to consider, at a more fundamental level, what went wrong.
Certainly, privatisation was a mistake and markets haven’t yielded the promised benefits but electricity systems with predominantly private ownership and designed markets have performed relatively well in some places. For example, the Electricity Reliability Council of Texas (Ercot) has done a good job in managing the transition from coal-fired power to renewables while holding prices down.
Why has Australia done so badly? The reform process in Australia has treated markets and competition as goals in themselves, rather than as policy instruments designed to produce useful price signals and thereby guide investment and consumption decisions.
The failure to consider the appropriate role of prices can be seen at every stage in the process, from generation to retail.
Let’s start with generation. The Australian Electricity Market Operator operates on the basis of a “spot” or “pool market”, in which the wholesale price of electricity is set by auctions, reset every five minutes. The only exception is in periods of very high demand when a market price cap (MPC) of $14,500 a megawatt-hour (MWh) is applied.

"Before putting forward blueprints for a redesign, it’s important to consider, at a more fundamental level, what went wrong."

A better solution would be for the market operator to make long-term power purchase agreements with generators, based on auctions or tenders, and then to dispatch power on an “order of merit” basis. The messy problems of reliability and peak load would be addressed through coherent planning, while prices would serve to secure investment in an appropriate mix of generation at the lowest possible cost. This cost of generation should of course take into account the cost of carbon dioxide emissions.
Turning to transmission and distribution, the biggest contributor to increased electricity costs in Australia has been the massive increase in rates of return paid to the owners of “poles and wires”. Under public ownership, these assets were financed by semi-government bonds, paying a small premium over the AAA government rate. Under reform, they have been paid a much higher “weighted average cost of capital”.
The appropriate role of prices in a natural monopoly activity such as electricity distribution is simple. The price should be as low as possible, while covering the costs of necessary investment. The best way to ensure this is to shift to a publicly owned national grid, replacing the current patchwork of private networks and the pre-1990s set of disparate state networks. Until this can be done, regulated rates of return should be lowered to bring costs down over time.
Finally, there is retail competition. Retail price policy should have two goals. The first, obviously, is to keep prices as low as possible while covering the costs of supply. The second is to allow consumers to manage their demand so as to use more electricity when it is cheap. To achieve this with any accuracy, it is necessary to use smart meters, capable of allowing flexible pricing.
As with everything else, Australia’s electricity reformers made a hash of this. After a ham-fisted attempted to force Victorian consumers to pay for new meters in 2009, the whole idea was soft-pedalled. Meanwhile, under the banner of choice and open markets, reformers pushed ahead with full retail competition.