Why we should pull the plug on privatising electricity

History suggests privatisation of the electricity industry is not such a bright idea. Image from www.shutterstock.com

Surging power prices are having savage consequences for household discretionary incomes. Some would blame the government’s carbon tax, but the real culprit is price gouging. Judging from the pronouncements of government and industry — including mainstream economists — privatisation is the practical solution to achieve low prices. Indeed, Australian state governments have embarked upon privatisation programs to varying degrees since the 1990s.

There is only one small problem with privatisation: the long-term history of the electricity industry has shown it almost always leads to disaster. University of Wollongong professor, Sharon Beder, has provided the evidence in the book Power Play: The Fight to Control the World’s Electricity. It supplies much needed historical context to the battle between public and private ownership played out over more than one hundred years in the United States and Britain, and the last couple of decades in Australia, Brazil and India.

Beder shows throughout this history, industry practised the modern art of propaganda, conducting public relations blitzes to convince consumers private ownership was superior, despite public anger with poor service and unjust pricing. Although industry attempted to equate public ownership of electricity monopolies with communism, they had no principled dispute with monopolies as long as ownership, control, profits and decision-making were private.

Australian governments once wholly owned the four sectors comprising the electricity industry: generation, transmission (large networks), distribution (local networks), and retailers. These sectors have been split into competing firms and spun off.

The natural monopoly character of the electricity industry makes designing competition difficult. Generators have large fixed capital costs, meaning oligopolistic competition will feature. In transmission and distribution, duplicative infrastructure is wasteful and precludes competition. Retailers tend to follow the same oligopolistic pattern as generators (TRUEnergy, AGL and Origin Energy).

The National Electricity Market (NEM) was instituted to increase competition, but is beset with problems. For instance, the transmission losses over the interconnectors range from 40 to 90% and a powerful oligopolistic industry still dominates the market.

A primary argument for privatisation is the issue of moral hazard under public ownership. While this is certainly true, history has shown something rather interesting: privatisation instead enhances moral hazard. Firms will leverage their market dominance to often blackmail the government with bankruptcy and blackouts if regulators do not raise prices, thereby risking the wider economy.

Other times, firms will teeter on the brink of insolvency because of ill-informed decisions, usually over long-term capital investments that have never become profitable. Accordingly, firms pressure regulators to increase prices to cover sunk costs. An astounding fact revealed by Beder is that the electricity industry is one of the most bailed-out in history, perhaps second only to the banking sector.

These bailouts, however, do not generate the publicity that surrounds banking bailouts. It is often done on the sly, with regulators approving substantial price increases and governments providing massive taxpayer-funded subsidies and below market rate loans. Typically, years elapse before the public discovers the truth.

As Beder documents, privatisation almost always results in escalating electricity prices, even at times when total demand is falling. Rolling blackouts may also occur as rising prices don’t provide a market signal to increase generating capacity; firms instead turn off generators to ensure prices skyrocket, creating a positive feedback loop.

While raising prices in the short-term is indeed profitable for industry, in the long-term it has the potential to backfire. The reason is the emerging alternative electricity source for households: solar power. This has grown exponentially in recent years, as the cost of solar panels fell by an impressive 42% in 2011. Grid parity may be achieved soon when the cost of solar panels equals purchasing electricity from the grid.

The solar panel revolution threatens both the generating and network firms whose revenues and profits depend upon supplying increasing amounts of electricity. They are fighting back by making it difficult and costly to connect the solar panels to the grid as an anti-competitive strategy, which is probably the single most important issue regarding the installation of solar panels.

Publicly owned electricity systems are beset with their own problems. Cost-plus accounting is a “spend more, earn more” incentive, resulting in gold-plating (over-investment) in the network infrastructure, which obliges higher prices. Prices also increased ahead of privatisation so the government receives a higher return and ensures privatisation cannot be blamed for the inevitable rises. Pricing formulas based upon asset values ensure that the remaining publicly-owned systems act as private ones, increasing asset values and hence profits, regardless of whether it is necessary, again raising prices.

Unlike privatised firms, however, price gouging by public firms can return the profits (indirectly) to the taxpayer rather than to owners and managers. With public ownership, customers as citizens can influence the public policy process; privatisation neuters this lever.

The electricity industry has been purposely reshaped via neoliberal ideology from a system of public subsidy, public profit into public subsidy, private profit where risks and costs are socialised but profits and power are privatised. Industry today is like a restaurant menu: there are multiple retailers, offering a variety of plans and prices that appears to offer consumer choice.

Unfortunately, none of the options available include inexpensive electricity. Citizens and customers have no influence over how the menu is constructed; instead, they are offered the illusion of choice. The business model that retailers operate under is inefficient and does not serve consumers well. Also, industry works to silence those who speak out against it.

Much like the privatisation and deregulation of the financial sector that promised choice and efficiency according to pseudo-scientific economic models, it has instead resulted in endless financial disasters, coming after a period of apparent tranquillity. The costs to governments vastly exceed all the costs and problems of public ownership.

Economist Steve Keen has shown that the models used by economists to prove that electricity privatisation functions more efficiently are lacking due to three issues: a monopolistic industry structure may be more welfare enhancing than a competitive one, spot markets are subject to speculative volatility, and enforcing marginal cost pricing can potentially bankrupt firms. Neoclassical theory is biased towards market outcomes, but only due to the numerous nonsensical assumptions needed to make models “work” while ignoring the large body of empirical literature that show these models are false and misleading.

Economists advocating and devising privatisation programs are themselves beset with conflicts of interest. Many are employed by, consult for, manage, and/or own organisations with a direct interest in profiting from privatisation. Listening to the pronouncements of conflicted persons and organisations is similar to letting Big Tobacco determine the direction and outcomes of medical science.

When privatisation results in diametrically opposite outcomes to those claimed, supporters - governments, industry, think-tanks and the corporate media - offer an ad infinitum argument: the problems were caused by too little privatisation. It is only when the predations of industry become obscene, as with California’s energy crisis, will governments step in to deal with the problem.

Given the historical trends documented by Beder, it is likely that Australia’s privatised electricity industry will follow in the same direction as its historical counterparts. As Mark Twain observed, history does not repeat itself, but it does rhyme.