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When the Andrews government announced that it would reestablish the SEC, many in the progressive movement hailed this as the moment when the state would take a decisive step back in to the energy sector, to ensure that it was run in the public interest and not for private profit.
But this step has run into a little-understood agreement established in the early stages of privatisation. “Competitive neutrality” was designed to ensure that there was fair competition between privately owned and government owned enterprises. But there is an argument that its actual effect was to make it impossible for publicly owned enterprises to operate effectively in the public interest, leaving privatisation as the only viable way forward.
The Victorian government is now seeking to have this provision set aside in the case of the SEC. This debate has wide ranging implications for the future of privatisation and state-owned enterprises in Australia.
The 1995 Competition Principles Agreement between the Commonwealth, States and Territories enshrined a “competitive neutrality policy” which is designed in essence to prevent government owned businesses from being able to set prices in a way that confers an unfair competitive advantage on them.
Such advantage can arise in many ways but particularly by gaining access to cheaper loans, whose discount arises from governments’ taxing powers; or by being able to set prices at a level that reflects the fact that the owning government collects the taxes on the profits of corporations it owns, so that pre-tax profits are actually the same as post-tax profits.
Competitive neutrality requires charging a margin on loans that the government provides to businesses it owns (so that it is as if the loan was to an entity that did not have recourse to the Government), and imposing “full Commonwealth, State and Territory taxes or tax equivalent systems”.
This may seem very fair and reasonable, but there are some major practical objections.
The main reason for this is that hitherto (and at the time of the Agreement) states and territories have very little involvement in businesses that provide services in competitive markets. In fact, the vast bulk of the “businesses” to which this policy has been applied are monopolies (in particular water supply monopolies and electricity network monopolies). By definition, monopolies do not provide services in competition with others. There is no problem of “crowding out” to worry about with such businesses.
So, is it right that the users of those services provided by government-owned monopolies be charged the actual observed cost of capital that the governments actually pay to their lenders, or should they be required to pay a higher rate to reflect the discount that arises as a result of governments’ taxing powers and income diversity?
With respect to the treatment of corporates taxes, under the Australian Constitution, the Commonwealth can’t tax businesses owned by the States and Territories. Therefore, the compulsion under the Competition Principles Agreement for states and territories to set the monopoly businesses’ prices as if the owning governments did not receive income taxes on their profits, provides additional income to owning governments for the provision of monopoly services, that would not otherwise arise.
The assessment of the merits of competitive neutrality policy in respect of its application to government-owned monopolies (as noted by far the main “use-case” of this policy) reduces to an assessment of the effects of this policy on economic efficiency (which is indeed the stated rationale for the policy). So, is this policy resulting in the misallocation of resources?
My doctorate focussed on this question in the case of electricity distribution in the National Electricity Market. I concluded that the competitive neutrality policy encouraged inefficient expansion of the regulated asset base of government-owned distributors in order to deliver higher profits to their owning governments. This also encouraged government owners to attempt to limit the extent of regulatory powers, in order to protect those profits. I concluded that this policy was the main explanation for the absolute decline in efficiency of government-owned distributors and their even bigger decline relative to their investor-owned peers.
In Victoria, the Kennett Government privatised Victoria’s electricity wires and its gas pipelines. Therefore, unlike most other States, the main activity subject to competitive neutrality policy in Victoria is its government-owned water supply industry.
The Victorian Government’s budget papers suggest income to Victoria of $723m over the next four years in respect of the uplift between the cost of borrowing by the Treasury, and what the Treasury estimates the government’s water businesses would pay in interest if they borrowed money themselves directly, without recourse to the Government. This uplift is called the “Financial Accommodation Levy (FAL)”. Another $400m (roughly) is expected to be collected by Victoria from income tax on its water businesses’ profits.
This is a lot of money in absolute terms but much less so relative to the Government’s expected income of around $350bn over the next four years. It is also much less than the income that government-owned electricity distributors in other states have delivered to their owning governments. Prima facie therefore the incentives to fatten the golden goose and to shackle the regulator from preventing the goose’s obesity, will be weaker in water in Victoria than for electricity distribution in the other states. Nevertheless, water consumers in Victoria might reasonably point to the Competition Principles Agreement as the source of significant taxes on their water consumption and ask for evidence that such taxation is in the public interest. I shall not attempt to answer that question here, but can foresee that plausible arguments both for and against are likely.
Finally, let’s return to the revived SEC and the case for andagainst the CPA there. In the SEC’s inaugural 10 yearstrategic plan the Government committed to ensure that “the SEC complies with Victoria’s competitive neutrality policy”. Unlike water and electricity monopolies, the SEC will provide services in competitive markets (electricity production, storage and sales). The intent of the CPA therefore applies far more logically to the SEC than to electricity and water monopolies, and as set out earlier, the Government has so far committed to apply the CPA to the SEC.
But it is now apparent that the Government is willing to relent on the application of the CPA to the SEC, in an effort to obtain sufficient parliamentary support to amend the Constitution to enshrine the SEC in it. Leaving aside the merits of constitutional changes, is it in the public interest to apply the CPA to the SEC?
Competing investor-owned producers, storage providers and retailers can be expected to be concerned that their ability to compete would be undermined by an SEC able to charge lower prices if the SEC is able to access cheap loans from the Government and/or if it was required to achieve pre-tax rates of return on investment that are benchmarked against investor-owned participants’ post-tax rates of return.
This is a legitimate concern and Government might reasonably conclude (as it so far has) that a consequence would be to discourage private investor interest in clean energy and storage, without which the Government’s renewable electricity targets will not be met.
On the other hand, since governments (not just Victoria’s) have not been willing (or even if willing, not able) to internalise the environmental damage associated with fossil-based electricity production (i.e. to include the cost of this damage in the costs borne by fossil-fuelled generators) private investors now depend on policy support to under-write their investment in clean alternatives (plus the necessary storage).
From this perspective, policy support in many forms is essential and providing it to the SEC (by relenting in the application of CPA to the SEC) need not come at the expense of opportunities for investor-owned competitors.
Furthermore, and perhaps even more important than (likely misplaced) concerns about private investors being crowded-out, there is the observation that with the energy transition now so deeply (and inevitably) driven by policy, the co-ordination of policy-driven investment in generation, storage and transmission is ever more important.
The relevant question therefore is by what mechanism such co-ordination is achieved. It can’t be expected that market prices are able to co-ordinate effectively since such prices are themselves dominated by policy, not the interaction of buyers and sellers in a free market.
In this context, while the SEC is not the only mechanism by which better co-ordination of the expansion of clean energy, storage and transmission might be achieved, its potential to make a useful contribution to better co-ordination is the most plausible rationale for its existence.
Indeed, there is no reason to believe that the SEC is likely to be better at developing or operating generation or storage, or selling electricity to customers, than privately owned companies. To put it figuratively, it has much better prospects of success in steering the ship than of building it, shovelling coal into its boilers or maintaining it.
So now we have come full circle and hopefully can see through the looking glass less darkly to conclude that actually the gain from relenting on the application of the CPA to the SEC will therefore not arise from the advantage it offers of cheaper access to borrowing or a lower rate of return hurdle. Rather the gain will arise, or at the least has the potential to arise, if it symbolises the Government’s acceptance of the SEC as primarily a tool for effective planning and co-ordination of investment in clean production, transmission and storage.
The Government ruled out this sensible purpose for the revived SEC right at the outset of its work to re-establish the SEC. Now that the Government is contemplating relenting on the application of the CPA (ironically in order to secure other political objectives) there is the prospect that the SEC might be able to find a useful purpose in orchestrating the outcomes that seemed to resonate with the electorate.
Bruce Mountain
5 April 2024
Professor Bruce Mountain is a well-known Australian energy economist and Director of the Victoria Energy Policy Centre. Challenges that arise from the transition to renewable electricity have drawn his focus for most of the last two decades. He is interested in economics, policy and institutions in the tradition of political economy.
You can watch his address to the Victorian Fabians 2023 Annual Dinner here.
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