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Tuesday, 6 January 2015

Power corrupts

Power corrupts

















Power corrupts

How network companies lined their pockets and drove electricity prices through the roof





Electricity workers in Brisbane. © Tim Marsden / Newspix

Electricity workers in Brisbane. © Tim Marsden / Newspix


 










In the past few years, our electricity prices have doubled. While
the media has feasted on the likes of pink batts, Peter Slipper and
Craig Thomson, the astonishing story behind these price hikes has been
all but ignored. And yet, it may be one of the greatest rorts in
Australia’s history.




Since 2009, the electricity networks that own and manage our “poles
and wires” have quietly spent $45 billion on the most expensive project
this country has ever seen. Allowed to run virtually unchecked, they’ve
spent vast sums on infrastructure we don’t need, and have charged it all
to us, with an additional fee attached. The spending was approved by a
federal regulator, and yet the federal government didn’t even note it
until it was well underway.




Let’s be clear: this is the single biggest reason power prices have
skyrocketed. According to the federal treasury, 51% of your electricity
bill goes towards “network charges”. The carbon tax, despite relentless
propaganda to the contrary, is small beer, comprising just 9%. The rest
of your bill is carved up between those companies that actually generate
your electricity (20%) and the retailers who package it up and sell it
to you (20%). The Renewable Energy Target is such a small cost impost,
the treasury’s analysis doesn’t even include it; the Australian Energy
Market Commission says it makes up around 5%.




Thanks to the networks’ infrastructure binge, we now pay some of the
highest prices in the developed world. The impact has been felt most
keenly in New South Wales and Queensland, where the networks are
government owned and network charges have accounted for two thirds of
the price increases.




For a Coalition intent on destroying the carbon tax, the price hikes
have been a gift – “proof” that the carbon tax is as ruinous as they
predicted. Chris Dunstan, from the Institute for Sustainable Futures,
thinks that what the networks have done over the past five years may
actually be the secret to Tony Abbott’s success. “If electricity prices
hadn’t doubled,” he says, “the carbon tax would not have been anything
like the issue it was.”





The electricity industry likes to promote itself as wickedly complex,
but it’s actually quite simple. Generators produce electricity that is
transmitted via giant steel towers along high-voltage wires that connect
to local substations, which feed power into street-level poles and
wires that carry it directly to our homes and businesses. The steel
towers are owned by the transmission networks, and the smaller poles and
wires are owned by the distribution networks. Retailers like Origin
Energy, AGL and EnergyAustralia are the shopfront – they just package up
all the costs and charge them to you. Some retailers also own power
generators – Origin has big investments in gas- and coal-fired power
plants, for example – but neither the retailers nor the generators have
much to do with the networks in between them.




In every state and territory, the “networks” include one transmission
company and several distribution companies. They don’t compete with
each other – they’re “natural monopolies” that each service their own
area. In NSW, for example, transmission company TransGrid manages the
state’s gigantic transmission towers, and three distribution companies –
Ausgrid, Endeavour Energy and Essential Energy – take care of the
street-level poles and wires. In NSW, these network companies are
state-owned, as are those in Queensland, Tasmania and the ACT. In South
Australia and Victoria, where the industry is privatised, the networks
are run by a web of local and foreign companies, including, for example,
the Chinese government-owned electricity behemoth State Grid. (Just to
confuse matters, the networks in Western Australia and the Northern
Territory aren’t connected to the national network – for the Australian
Energy Regulator, they may as well be foreign countries.)




So how were these networks allowed to blow billions of dollars on infrastructure we don’t need? Here’s how it worked.



Let’s be clear: infrastructure spending is the single biggest reason power prices have skyrocketed



Every five years, the federal energy regulator grants the
distribution and transmission network companies an allowance to spend on
capital and operating costs. All the networks have to do is produce a
spending proposal that looks “reasonable” – it’s up to the regulator to
prove that it isn’t.




In 2009, it was generally agreed that the poles and wires were in a
parlous state, especially in NSW and Queensland, and needed significant
upgrades. The networks also claimed to need billions to build new
infrastructure, to meet soaring demand. The trouble is, the networks’
data was wildly exaggerated, and the demand they predicted has not
materialised; it probably never will. The regulator approved a
staggering $45 billion of spending.




Why would networks exaggerate demand? Because the system rewards them
for spending as much as possible. The more they build, the more they
get paid.





Nobody understands this story better than Bruce Mountain. Over the
past five years, he has spent thousands of hours poring over datasets,
regulations and rulings, trying to figure out exactly how so much money
was wasted. Mountain, who has regulated electricity networks in Britain,
France and South Africa, quit his job advising the Australian
Competition and Consumer Commission (ACCC) on electricity regulation
when he realised how much political pressure it was under. “I just
decided, ‘I can’t carry on like this,’” he says, “so I packed up out of
the ACCC, and took up consulting. Since then, everything has fallen
apart.” 




When asked to pinpoint a beginning to this story, Mountain nominates 2005.



Back then, the electricity networks were regulated by 13 independent
bodies, which decided what the networks could spend and what they could
charge consumers. In 2005, the Howard government replaced them all with
one new federal body: the Australian Energy Regulator. The then
treasurer, Peter Costello, said, “The AER will reduce regulatory
complexity and streamline energy regulation. This will, in turn,
increase competitiveness and efficiency in Australia’s energy markets,
enhancing the climate for investment and benefiting related markets and
consumers.”




He forgot to mention that the only way the government could get the
states to agree to the new body was to allow them to control it. “Many
states owned the network businesses, and they didn’t want a federal
regulator coming down too hard on them,” says Rod Sims, chairman of the
ACCC. So the states’ energy ministers were put in charge of a separate
new body, the Australian Energy Market Commission (AEMC), which was to
write the rules for the regulator to enforce.




“It was like putting Dracula in charge of the blood bank,” says Roman
Domanski, the former head of the Energy Users Association of Australia.
“It should never have happened.” The AER was under-resourced,
inexperienced and easily outgunned and out-manoeuvered by the states and
the networks. To top it off, the states were also allowed to appoint
two of the AER’s three commissioners.




It’s impossible to say which states wielded the most influence at the
AEMC. Certainly the rules were kind to those with state-owned networks,
and since NSW was one of the most egregious over-spenders, it seems
reasonable to question the degree of influence its state ministers had
on the process.




A roll call of recent NSW energy ministers reads like an ICAC
subpoena list. In 2006 and 2007, as the states were writing the rules
for the new regulator to enforce, NSW had two energy ministers: first
the corrupt Joe Tripodi, then the corrupt Ian Macdonald. Macdonald
disgraced himself in 2009 when, as the NSW networks were preparing to
spend billions on new poles and wires, he accepted a night with a
prostitute in return for setting up dinners between state energy
executives and the infamous property developers Ron Medich and Lucky
Gattellari. (Gattellari was later jailed for his part in the murder of
Sydney standover man Michael McGurk.) In 2011, when the Coalition swept
Labor from power, the new premier Barry O’Farrell awarded the energy
portfolio to Chris Hartcher, who stayed in the job until ICAC came
knocking in December last year.




The rules the states established for the AER were a “tragedy for
Australia”, says Rod Sims. “We now have energy prices that are way
higher than they should be. That’s a tragedy for consumers, and it’s a
tragedy for the economy, because a lot of companies that rely on energy
are now paying more than they should.”





In 2008, NSW network companies were among the first to submit their five-year spending proposals to the new regulator.



The network bosses threw down the gauntlet to the AER: unless
billions of dollars were spent on new poles and wires to meet rising
peak demand, rolling summer blackouts would become the new normal. Peak
demand – which occurs when everyone turns on their appliances at once –
was growing much faster than general demand, and the ageing
infrastructure was buckling under the strain. Over the next few years,
apparently, NSW was set to see the highest growth in peak demand,
followed closely by Queensland. This was all according to data from the
National Electricity Market Management Company (NEMMCO), the market
operator responsible for administering and managing the national
electricity market.




But NEMMCO didn’t produce its own data – it relied entirely on data
collected by the networks. Its data on peak demand was “rubbish”, says
Bruce Mountain. “Just look at the peak demand by region. Cite the data. I
have, and Hugh Saddler has.”




Saddler is one of Australia’s foremost demand analysts. Crossing from
the networks’ data to his is like stepping into a parallel universe.
One handy graph shows that since 2005 peak demand in NSW had actually
grown the slowest in the country, followed by Queensland.
Despite NSW and Queensland having had the slowest growth, Mountain’s
analysis shows that two thirds of the total spending in those states
went on new poles and wires to cater for this projected peak demand
growth.




When it comes to peak demand, Saddler says, “South Australia is the
most extreme, and Victoria the second most extreme.” So why did they
spend less on peak demand than NSW and Queensland? “That’s the $64
question, because they’re the two states where the networks are owned by
the state governments.” A cynic might note that if a state were looking
to sell off its poles and wires, it would make excellent business sense
to expand its assets first.




But the crazy maths wasn’t limited to peak demand data. Incredibly,
the claim that general energy demand was rising exponentially – a claim
made by networks, politicians and journalists around the country – was
also false. “Demand started to flatten out in 2004 … It reached a peak
in 2008 – just before the GFC – then there was a brief recovery, and
it’s been going down ever since,” says Saddler.




As the networks submitted their proposals to the AER in 2009,
Mountain could see their projections were “grossly exaggerated”. He
tried repeatedly to warn the regulator.




“Every year from 2009, I said emphatically that you, the regulator,
and the businesses, have way overegged your assumptions about the rate
of growth … And indeed, the networks have an incentive to do it.”




That incentive was a system that rewarded the networks for spending
as much as possible. The networks borrow money to build the new
infrastructure, and the AER lets them pass on the estimated cost of
repaying the loan (the “cost of capital”) to consumers. In 2009, the AER
ruled that the NSW distribution networks could claim an astonishingly
high cost of capital of 8.78% per annum, which it said was equal to the
borrowing costs of a private company at that time. The catch is, NSW
network companies don’t borrow from banks, says Mountain; they borrow
from a triple A–rated state treasury at rates of around 4–5%.




The regulator’s rate already guaranteed enormous profits to the NSW
distribution networks, but it wasn’t enough for them. So they appealed
the decision at the Australian Competition Tribunal, enlisting the
finest QCs and international experts to argue their case.




They could afford to. The states had slipped in a rule declaring that
the costs of network appeals were to be counted as “running costs” and
charged to customers through electricity bills.




Anyone who tried to speak up for consumers in this process was
essentially locked out. Gerard Brody, an advocate from the Consumer
Action Law Centre, says that when he tried to intervene in a 2010
network appeal, his senior counsel advised him to withdraw. If he lost,
he was warned, he could be forced to pay the networks’ costs. But that
wasn’t the only obstacle. “A lot of the information put to the tribunal
by the electricity distributors was marked commercial-in-confidence, so
we couldn’t effectively assess or challenge their claims,” says Brody.




In NSW, the networks won their appeal against the regulator, and were
allowed to claim a 10.02% cost of capital. This was not a one-off
return: for every billion dollars they borrowed to spend on
infrastructure, the NSW networks were now able to charge their customers
an extra $100 million every year (decreasing over time as the
loan was paid off). “This was just pure profit coming from consumers’
hip pockets,” says Brody. “There’s no rational, economic reason for
consumers paying that sort of money.”




The NSW distributors established a precedent for the other networks
to follow. When networks from Victoria and Queensland submitted their
proposals in the following years, their rates of return mirrored that
granted to NSW. In this single decision, the appeals tribunal had added
an extra $1.9 billion to the networks’ profits. All told, the networks
won 22 of the 34 appeals they fought, and were awarded $3 billion more
than the amount the regulator had deemed necessary. 




To this day, Andrew Reeves, the current chair of the AER, says the
rates were set so high because the global financial crisis made it more
expensive for the networks to borrow. “There was a very high interest
rate environment,” he says. But Mountain insists this isn’t true. “The
evidence was quite clear at the time that the companies were able to
borrow money at considerably lower rates than the regulator allowed,” he
says.




If you want to know the full story, he says, just look at the industry’s profits.



Mountain is right – the figures are staggering. According to the
Australian Bureau of Statistics, the electricity industry’s profits rose
by 67% between 2007–08 and 2010–11. In this same period, electricity
bills rose 40%.




As the regulator approved the networks’ requests, Roman Domanski
looked on with alarm. “When we started briefing our members on what was
being proposed by these network businesses, they were outraged,” says
Domanski, who in 2009 was still head of the Energy Users Association of
Australia. “You have to remember that the dollar had skyrocketed, and we
were still trying to get back on an even keel after the GFC.”




Domanski says he tried repeatedly to get the regulator to see sense.
“I said it in submissions, I said it in public forums: ‘Do you
understand what the consequences of this are?’ I outlined how these
price increases would impact on businesses, on consumers and the broader
economy. Do you think I got a sensible answer to that?” Years later,
Domanski is still outraged.




Many of the networks’ proposals went past the regulator almost
unchallenged. As it would later claim, the AER was constrained by the
rules the states had written for it, but that doesn’t explain why the
AER let the networks break those rules. Few of the networks investigated
any “non-network options” – alternatives to building, like reducing
demand through increased energy efficiency – despite being obliged to
under the regulator’s rules.




In 2011, when Professor Ross Garnaut accused the networks of using
dodgy data and “gold-plating” the poles and wires, the response was
merciless and swift. Ausgrid CEO George Maltabarow said there wasn’t “a
shred of evidence” for Garnaut’s claims. Martin Ferguson, the then
federal energy minister whose government had commissioned Garnaut’s
report, said, “Garnaut does not speak for the government …  The
regulatory framework for Australia’s energy sector is leading edge.”




Electricity prices were rising precipitously, yet nobody was called
on to check Garnaut’s claims, or review what the networks were doing.
With this tacit approval from the federal government, they carried on
spending billions of dollars on new infrastructure we didn’t need, based
on projections that were obviously wrong.





As Bruce Robertson was preparing to go away for Christmas in December
2011, he received a letter from TransGrid. Robertson and his wife,
Belinda, run a biodynamic beef farm at Burrell Creek, a tiny town in
NSW’s Manning Valley, west of Taree.




TransGrid said the Manning Valley needed new transmission lines
because energy demand was set to rise by 125% as the population grew
over the next decade. Robertson smelt a rat. “They told us they were
building these power lines to cater for this massive increase in demand,
and we just simply couldn’t see that increase,” he says. “I asked a guy
from TransGrid, ‘I’m just wondering what went into your forecasts,’ and
he said, ‘It’s so complicated you wouldn’t understand it.’ When he said
that, I just thought, ‘This is crap. They’re obviously hiding
something.’”




In his former life, Robertson had worked in finance, analysing
“everything from coal mines in Kalimantan to brick manufacturers in
Western Sydney”. So he, together with other worried landowners in the
Manning Valley, started trawling through the data. As he read the
government reports, he could barely believe what he was seeing.  “It was
this amazing disconnect between the actual figures of what was
occurring, and what they were telling politicians and the public.”




What Robertson had discovered was that, contrary to the claims of
TransGrid and the other networks around the country, energy demand
wasn’t rising. It had been falling every year since 2009, when the
networks began their spending spree.




It was the first time energy demand had fallen in Australia in more
than a century. According to Hugh Saddler, demand was falling for three
key reasons: the impact of energy-efficiency schemes and appliances; the
decline of electricity-intensive industry, like aluminium smelters;
and, from 2010 onwards, a response to rising prices. This last factor,
Saddler says, was a reaction to the Coalition’s doomsday preaching about
the carbon tax, and its insinuation that the tax was driving prices up
even before it was introduced. “People suddenly stopped thinking about
the price of petrol or milk, and started thinking about the price of
electricity and how they could actually save a bit,” says Saddler. In
other words, was Tony Abbott the best friend energy efficiency had ever
had? “Yes indeed.”




In August 2012, with rising electricity prices threatening to blow up
her government, the then prime minister, Julia Gillard, finally linked
the price hikes to the networks’ spending on infrastructure. In a
keynote speech to the Energy Policy Institute in Sydney, she said, “At
the heart of all this is a simple market design problem: a clear
regulatory incentive to overinvest in infrastructure and pass on costs
to consumers.” The then Opposition leader, Tony Abbott, responded
immediately: “The problem is not the regulation of power prices. The
problem is the carbon tax putting up power prices … This is a
fabrication by the prime minister.”




Three weeks later, the Senate announced an inquiry. Chaired by Labor
MP Matt Thistlethwaite, its panel toured the country to find out what
was driving electricity prices so high. Its conclusions were damning.
“We found that there was overinvestment,” says Thistlethwaite, “and that
the network businesses earning the most profits were the ones that
invested the most. There was a perverse incentive in the system for
overinvestment in the poles and wires, and that led to dramatic profits
for those businesses.”




The most shocking example of this overinvestment was found,
unsurprisingly, in NSW. “We discovered a network business that had
invested $30 million in a substation in Newcastle. I actually visited
the substation. It wasn’t connected to the grid. So you’ve got an
investment in a piece of infrastructure – paid for by consumers through
their electricity bills – that wasn’t connected to the grid and wasn’t
needed,” he says. It was built by Ausgrid, a company that the Australian
Energy Market Operator says probably overspent by around a billion
dollars. Thistlethwaite says this was no one-off blunder. “There was
much evidence before the committee that investments like that were being
made throughout Australia.”




By the time of the Senate inquiry in the spring of 2012, and thanks
largely to Robertson’s tireless campaigning, the tide was beginning to
turn against the networks. Even the AER had conceded that the regulatory
framework was biased against consumers, and had led to “some price
increases that are difficult to justify”, though it stopped short of
accepting any responsibility.




The networks were, however, largely unrepentant. In its submission to
the Senate inquiry, Grid Australia – the peak body for transmission
networks like TransGrid – insisted that peak demand was still growing, and was putting greater pressure on the need for infrastructure investment.




Robertson was furious. In a written response to the inquiry, he
labelled Grid Australia’s statement “misleading and deceptive”, and
quoted data from the AER showing that summer and winter peak demand had
fallen by 10% and 14%, respectively, since 2008. Grid Australia’s claims
about peak demand were “consistently used by the industry to threaten
the public and politicians with supply interruption”.




When Robertson repeated his claims on ABC Radio, Grid Australia
responded through its lawyers, threatening to sue for defamation
(despite the fact that, in NSW, companies with more than ten employees
can’t actually sue for defamation). It soon backed down, thanks largely
to dogged reporting by a Fairfax business reporter, Michael West, one of
the few journalists in Australia to hold the networks to account.




With Robertson’s claims substantiated by the Senate inquiry, the NSW
government was backed into a corner. In 2013, it announced an inquiry
into the energy demands of the mid-north coast, looking specifically at
the Stroud to Lansdowne line TransGrid was building in the Manning
Valley. The report also confirmed Robertson’s key claims: peak and
general demand were falling, not rising. “It basically said it failed
to see the justification for the large power line project that TransGrid
was proposing down our valley,” says Robertson.




After the report’s findings were made public, TransGrid cancelled the
$160 million Stroud to Lansdowne line. Six hundred kilometres north,
another rural community in Tenterfield, which had been fighting
TransGrid since 2009, also succeeded in having the $227 million project
for their area – the Lismore to Dumaresq line – cancelled. TransGrid
says it “reviews all projects at key milestones, and is always willing
to defer or cancel projects if circumstances and changes in demand
forecasting suggest this is the most appropriate course”. It took two
government inquiries and years of campaigning to get TransGrid to
reconsider.




Robertson says these unnecessary projects are just the tip of the
iceberg. “In the last six months TransGrid alone cancelled around $400
million worth of projects. Now you multiply that out through the
country, and you can kind of get an idea of the vast amount of
overspending that’s being incurred in Australia.”




Bruce Mountain has added it up. He says that half the money spent by
the networks – more than $20 billion – was wasted on infrastructure we
don’t need. The networks say that, to the extent that it did happen,
overspending was driven by the state governments’ stringent reliability
standards, which demanded that the networks build capacity to meet that
once-in-a-decade peak day, and threatened penalties against those who
didn’t comply.




Mountain says this is just a convenient excuse for people looking for
someone to blame. “At the time that the network businesses were putting
their proposals in, they were all saying, ‘Oh gosh, demand is growing
terribly, there’s going to be summer blackouts, et cetera,’” he says.
“They’ll now say that peak demand was not as much of a cause, that a lot
of it was driven by ageing assets and reliability. I’ve gone through
the regulatory accounts; in New South Wales and Queensland, about two
thirds was spent on augmentation [building for peak demand], and about a
third in Victoria.”





Last year, after the state-run AEMC handed the regulator a set of
new, consumer-friendly rules, the Productivity Commission concluded its
own inquiry into the industry. In a stinging report, it said that
although some of these changes had started to address some of the
industry’s flaws, much more needed to be done: “There is, in effect, no
point simply changing a punctured tyre if the car has no engine.” Delays
in reforming the industry, it wrote, “cost consumers … hundreds of
millions of dollars”.




Here’s the real tragedy of this story. Thanks to the actions of the
electricity industry, a growing number of Australians are struggling to
pay for a basic necessity. In every state, disconnection rates are
rising – in NSW, for example, the number of disconnections rose by 25%
in 2012. The Australian Council of Social Service says some of
Australia’s 2.2 million low-income earners are struggling to pay their
power bills. These consequences were entirely predictable.




One entirely unforeseen consequence of the industry’s
profligacy has been the revolution it has triggered in the way we
consume power. Not only has it made Australians use less energy but it
has also helped to make solar power an economical choice. By
stopping their use of the grid during the day, solar-powered households
can save up to 60% on their electricity bills. That’s why more than 1.2
million households have installed solar panels over the past six years.




The electricity industry calls this situation “the death spiral”. As
more people switch to solar energy and use less from the grid, the
networks have to recover their costs from a smaller base. So prices
rise, which drives more people towards solar, which makes prices rise
again, and so it goes. When feasible home battery storage becomes
commercially available in the next few years, this death spiral will
only accelerate.




It already has the networks in a panic. In NSW and Queensland,
electricity networks are campaigning vigorously to lift their fixed
charges; if they succeed, even people who use less electricity from the
grid won’t be able to avoid high network costs.




In the meantime, there’s no talk of penalising the networks for the
billions they’ve wasted, or even of reducing their grossly inflated
rates of return. On the contrary: if the NSW and Queensland governments
are to sell their poles and wires, they need to convince investors that
the industry’s profits are safe despite diving demand. To do that,
they’ll need to keep misleading the media, so the public remain in the
dark.








About the author
Jess Hill
Jess Hill is an investigative reporter for ABC Radio National, and a former Middle East correspondent.


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