Making the case for selling off Queensland’s power assets

Queensland Premier Campbell Newman has the support of his federal government colleagues to privatise assets, but the electorate remains unconvinced. Dan Peled/AAP

Queensland’s Campbell Newman-led coalition will seek a mandate to privatise the electricity sector, along with two ports and water pipelines, in next year’s state election, despite it being rejected by voters in the past.

While there may be solid arguments for privatisation, the political debate continues to lack substance. In particular, the use of long-term, 50-year leases, with an option to extend for another 49 years, rather than a straight out sale, and the argument that voters have to choose between schools, roads or hospitals and owning assets are both red herrings, and distract from the substantive issues.

For all practical purposes, there is no meaningful difference between a straight out sale and a long-term lease. With the exception of land, very few if any physical assets will be around in 50-years’ time and none in 99-years’ time. Additional public funding for schools or roads or for paying off the debt will only be available if the revenue generated by the sale of these income generating assets is greater than the net present value of the income generated by these assets under government ownership.

Therefore, the debate on privatisation ought to be instead framed around the conditions under which Queenslanders will be better off if assets are transferred to private owners.

Realising benefits

Two conditions have to be met for this to happen. First, the assets need to be more valuable in the hands of the private sector than in the hands of the government. Second, the sales process should be able to extract this additional value from the buyers.

Electricity assets may be worth more in the hands of the private sector because private ownership is often associated with incentives for managers to pursue profit maximisation and to innovate. It is difficult if not impossible to replicate such incentives under public ownership.

There are, however, two approaches to profit maximisation, which have different implications for electricity users. Profit maximisation can be pursued by raising revenue, lowering costs or a combination of both.

In the monopolistic world of electricity distribution and transmission, it is cheaper to serve the market with a large facility rather than with two smaller facilities. To constrain such monopoly power, the Australian Energy Regulator sets the maximum prices that electricity distribution companies are allowed to charge consumers and the maximum revenue that electricity transmission companies can recover from users.

So would a private monopolist be able to charge a higher price to the detriment of consumers, undermining the case for privatisation? A possible way for this to happen is for the private monopolist to behave somewhat more aggressively in its dealing with the regulator than a public monopolist.

Efficiency is king

In a paper with Bob Breunig at the ANU, I examined whether Australian regulators treat private and public monopolists differently. In particular, controlling for different industries, regulators and time, we found regulators appear to be tougher when the decision relates to a privately-owned firm than to a publicly owned firm.

Taken at face value, this evidence suggests private ownership of electricity distribution and transmission can lead to higher profits only if it leads to more efficient operation and lower costs, since the option to raise revenue by raising prices is constrained.

International evidence suggests electricity assets may be worth more in private hands and not because it leads to higher prices but rather because of more efficient operations and lower costs.

But the potential additional value of private ownership still needs to be captured by the sale process in order for privatisation to be worthwhile for Queenslanders.

A well-designed IPO or a direct sale via a cleverly designed auction are likely to lead to the best value for taxpayers.

But it is also important to look at the cost of running the sale. This is an area where there is very limited information, likely for commercial reasons. There is also a public perception that investment banking and advisory firms benefit disproportionately from the process through the fees they charge.

More transparency required

Summing up, it may be possible to build a case for the privatisation of electricity assets in Queensland based on a coherent narrative about why these assets may be more valuable in private hands and some reassurances that the sales process will be able to capture a significant part of this additional value.

In addition, greater transparency and debate around the cost of the sales process, and its beneficiaries, may go a long away to reassure the public that privatisation may be beneficial to Queenslanders.

While the arguments above are complex, continuing to focus on differentiating between a long-term lease and a straight out sale and asking voters to choose between owning assets and more hospitals and new infrastructure risks alienating the public, and undermining any support for privatisation.