Our Gold-Plated Electricity Infrastructure

The summer of 2003-4 in south-east Queensland was particularly warm and moist. Heat and humidity in the Great South East often combine with the region’s geography to produce severe thunderstorms. As warm, moist air heated over the interior of the state moves upward, it cools and condenses to form towering cumulo-nimbus clouds that rapidly develop into storm cells.

A thunderstorm in Brisbane is a typical event in summer, but that season was a particularly active storm season. Storm cells can produce fierce winds and massive amounts of lightning, resulting in widespread damage to electrical infrastructure.

Trees are thrown across power lines and lightning strikes can take out transformers and even substations. After an unusually bad run of five big thunderstorms in five days in October 2003, large parts of the city were left without power for hours. Severe outages were recorded across the network and over 100,000 homes were without power, some for days.

Voters were not impressed. Food spoils quickly in the Queensland summer, and many south-east Queenslanders run small businesses and home offices dependent on an uninterrupted supply of electricity. Air-conditioners were also rapidly proliferating as a balm to those hot January nights. "Queenslanders are very sensitive about their electricity, they demand a continuity of supply," Griffith University political scientist Paul Williams told the ABC back in September 2004. "Any Government that can’t deliver continuity of supply can and will suffer at the polls."

Brisbane’s daily newspaper, the Courier-Mail, ran a string of negative front pages about the power outages, as each bad storm threatened to extend the power outages further across the struggling grid.

The bad storm season came at a difficult time for Queensland’s premier, Peter Beattie, who had to fight a state election in March 2004. He announced a formal review of the Queensland electricity system by consultant Darryl Somerville, in order to find out what was causing the network fragility.

"The 2004 report was commissioned by Peter Beattie because he had an absolutely massive problem on his hands," veteran energy analyst Keith Orchison told NM in a recent phone interview. "The investment had been far too low, and when they had a storm the lights didn’t just go out, they stayed out. Beattie’s response was to get Darryl Somerville and a couple of others to sit down and look at what the situation was and what they ought to do about it."

"Darryl said, ‘You’ve spent too little money, the system is run down, it needs a very significant level of investment,’" Orchison says.

The result was the 2004 Somerville Report, which slammed the operation of the government-owned networks and argued that billions more needed to be spent on improving reliability standards. Energex, the south-east Queensland network operator, had been running its electrical assets hard for more than a decade, underinvesting in critical infrastructure in a conscious effort to maximise profits.

Those profits went not to shareholders, but to the state treasury. Critically, it emerged that the state government had regularly been siphoning hundreds of millions of dollars in special dividends to help prop up the state’s bottom line.

The 2004 Somerville Review concluded that "the security of supply of the distribution networks had reduced to an unacceptable level." It recommended big new investments in duplication and backup systems to ensure that the network met tough new reliability standards, including a so-called "N-1" standard of reliability.

Malcolm Roberts is the chief executive of the Electricity Networks Association, the peak body for the poles and wires companies. He explains the "N-1" standard in these terms: "Essentially in Queensland and New South Wales, governments have set very prescriptive requirements for reliability, which means that often you have ti duplicate assets." He also points to the so-called "N-1" standard which mandates a level of duplication and redundancy in energy infrastructure. "’N minus one’ means you should be able to guarantee you can meet peak demand in that area even if you lose a significant part of the system: something blows up, storm damage whatever that is," Roberts says.

In 2011, the outgoing Bligh government commissioned a quick and dirty review of the 2004 Somerville findings, again chaired by Somerville. All up, around $12 billion was spent on poles and wires in just seven years. Reliability increased by 40 per cent, a clear improvement. "The plan worked," Orchison continues. "Except, of course, if you jam that investment in over a relatively short period of time, guess what, the price goes up. Ain’t that a surprise?"

All across Australia, but especially in Queensland and New South Wales, electricity prices are rising. And, as we’ve consistently been arguing here at New Matilda, those price hikes have largely been caused by extra investment in gold-plated electricity networks.

Bruce Mountain is a Director of Carbon Market Economics, a specialist energy and climate change economics consultancy. He’s probably the best-informed critic of the networks and their role in over-charging. Best of all, he’s just set down all the data in a compelling submission to the current Senate Select Committee inquiry on electricity prices.

Mountain goes through the data and establishes a number of incontrovertible facts. Firstly, Australian electricity prices really have been rising rapidly in recent years, and are very high by world standards. The main reason for this, he argues, is that networks can pass on their costs by charging consumers for upgrading their infrastructure. As we’ve seen in Queensland, there’s been a massive spurt of electricity investment going on.

According to energy analyst Bruce Mountain, household electricity price rises are being caused by the networks, not the generators. Source: Bruce Mountain, submission to the Senate Inquiry on Electricity Prices.

"By international standards, the level of capital expenditure by government-owned network service providers in the National Electricity Market is remarkable. The allowed capex by the government-owned distributors in NSW in the current regulatory period is around six times higher (per connection) than the average capex per connection in Great Britain (Mountain and Littlechild 2010). In comparison to North America, in 2011 the total allowed capex on transmission and distribution per MWh produced, is more than seven times higher in the National Electricity Market."

What this means, for the less technically minded amongst us, is that Australian networks spend six times more in infrastructure per householder than British networks, and seven times more per megawatt hour than American networks. Gold-plating? That’s more like platinum-plating.

Of course, the electricity networks deny there’s a problem, instead pointing to factors outside their control.

"Gold plating is a cute term where someone has looked at some data to show that network expenditure has increased over five years compared to the previous five years," Roberts maintains. "We’re in an industry where there’s a lot of outside variables that determine what your costs are and new levels of capital expenditure, and there’s also a historical cycle of government expenditure on infrastructure. If you take a long-term view you see cycles of investment, and cycles of under-investment."

In other words, Roberts argues its the regulators’ fault too. And he may have a point. The reason that the networks are spending up big on better infrastructure is not just because regulators let them, but also because they are forcing them to.

That’s not that surprising, because the owners of the networks and the key power-brokers in the regulatory system are the same entities: state governments. There’s an obvious financial gain for state governments that can reap higher profits from state-owned utilities. And one way they’ve been able to do this is via a series of fudges within the electricity market rules that allow state governments to extract hundreds of millions of dollars of extra revenue. As Mountain observes,

"The yield on 10-year bonds issued by the Government of New South Wales is currently around 4 per cent, and yet the regulatory controls currently in place allow network service providers to charge their customers as if interest rates are more than twice as high. The state governments extract much of the surplus attributable to the difference between the allowed return on debt and the cost of debt through what are euphemistically called ‘competitive neutrality’ or ‘debt guarantee’ fees. The surplus not collected through these fees is then recovered through profits and dividends funded from those profits."

Mountain estimates that the government of New South Wales makes more money in the form of these "competitive neutrality" arbitrages — nearly $600 million in 2010 alone — than it makes in normal profits paid by the utilities to their government owners. He recommends that the states sell off their networks, removing the conflict of interest once and for all.

But will that be enough? Even if networks are sold off, huge problems will remain.

As we’ve seen throughout this special series on energy, the problems of
regulating such a big, complex and economically vital product have
consistently posed challenges that governments have struggled to respond
to. Consumers are left angry but disempowered — and big energy companies have a exceptionally well-honed ability to game their system through strategic lobbying and because of the power they hold in Australia’s economy.

Voters have played their part in the mess too, demanding environmental solutions to our dirty energy system while quailing in horror at rising power bills. For their part, big energy companies have had to make money in an environment where technology is threatening to destroy accepted business models, and where politicians seemingly change the rules every month. With prices rising but demand falling, it’s going to get harder and harder to make money in coming years.

As Orchison observes, the rapid changes of regulation across the states and Commonwealth in recent years have imposed a cost of their own. "What we are looking is a fair degree of ad hoc-ery", he told me. "Certainly from the public’s perspective you only have to say ‘power bills’ and they all take their clothes off and run around the room. Well, ad hoc-ery comes with dollar signs attached."

The Queensland experience is instructive. The Sunshine State’s massive spend in new poles and wires was driven, first and foremost, by voter anger over power outages. When the lights go out, politicians pay at the ballot box, and that has encouraged successive governments to draw up the rules to make sure reliability is an over-riding tenet of electricity regulation. Queensland has indeed got much more reliable power. But it has come at a price.

In our final article in the series, we’ll look at the problems of energy regulation, and ask a number of experts to get out their crystal ball.