NSW Power: "Don't Risk It " with PPPs

Latest International Uni Research study warns NSW Govt on Private Energy. Doesn't even meet IMF standard for PPPs

By David Carey

The Public Service International Research Unit (PSIRU) from the Business School at Greenwich University, UK, has criticised as "muddled" the NSW Government Energy Directions Green Paper which said the NSW government was now looking for private electricity suppliers through "Public Private partnerships" (PPPs).

The NSW Launched the Green Paper last year saying that it aimed to reduce the risk to the NSW government. The PSIRU says the plan to bring in Private Power will not reduce the "risk".

The " Public Interest" publishes below the Executive Summary of the Research Paper. A full copy of the Report ( 26 pages Word format) is available for free from the PSIRU website.. at

http://www.psiru.org/reports/2005-02-E-NSWGreenPaper.doc

1. Executive Summary

One of the key aims set out in the New South Wales government's Green Paper on energy is to reduce the risk to the New South Wales government of its involvement in the electricity industry while retaining ownership of the existing assets. It hopes to do this through operating the existing assets through Public Private Partnerships (PPPs) and relying mainly on the private sector to build new power plants.

The New South Wales government's earlier reforms to the electricity industry added to the already large risk inherent in the electricity industry by attempting to introduce competition. In a monopoly industry, this risk is borne directly by consumers. If anything goes wrong, the extra cost is passed on in the form of higher tariffs. Competition introduces additional risks - if there is no additional risk, there is no competition.

One of the promises of the Green Paper is that risk can be transferred from consumers to the shareholders of private companies. This is a highly misleading claim. The cost of risk will ultimately fall on consumers, and if the risk is in some way dealt with by the private sector, the overall cost borne by consumers will tend to be higher because the private sector will require a 'fee' for dealing with the risk as well as the actual risk cost.

Introducing competition and requiring the private sector to deal with risk is therefore only justified if some or all of the following conditions are met:
· The costs of competition are outweighed by the benefits;
· The private sector is more efficient than the public sector at implementing policies that reduce risk and that these efficiency benefits more than pay for the private sector's fee for dealing with risk; and
· The form in which consumers experience the risk through the private sector is more palatable than if the risk was borne directly.

The Green Paper's proposals on industry restructuring are founded on two misguided objectives: that it is desirable to shift the risk of the electricity industry from government to the private sector; and that the value of government owned businesses should be preserved. These objectives are only worthwhile if they improve the electricity service that the citizens of New South Wales receive.

While the government might prefer, all things being equal, not to bear risk, if the result of the government bearing the risk rather than the private sector is lower electricity costs, government must face up to its responsibility of doing what is best for the public and if this requires that government bear risk, so be it.

The value of the government's businesses is only of interest if the government proposes to sell them. If it is not going to privatise them, their value is irrelevant. It is possible that measures that would maintain the value of these businesses may be detrimental to the New South Wales public, if, for example, the price of electricity is forced up, or the reliability of electricity supplies is adversely affected.

The government's thinking on Private Public Partnerships is muddled.

For a PPP to be justified, the IMF set down four conditions:

· The superiority of a private option has to be demonstrated, not assumed;

· The PPP has to demonstrate that there are sufficient efficiency gains from involving the private sector, to offset the higher borrowing costs that the private sector will inevitably face;

· Governments should not use PPPs simply to reduce government borrowing; and

· The value of risk transfers to the private sector should not be over-estimated and the potential cost of government guarantees should not be under-estimated.

The government has not provided evidence on any of these four issues.

The government makes proposals on five specific issues on industry restructuring:

· Allowing vertical integration of generation and retail. Vertical integration of generation and retail will reduce the risk to both the retail and generation businesses, but at the expense of competitive pressures, largely by making the wholesale market irrelevant. It will make it difficult for new generation and retail companies to enter the market leaving it dangerously close to an oligopoly;

· Private sector involvement in retail businesses. This recommendation suggests the private sector should take much of the risk of retailing. However, it provides no evidence that the private sector would be more efficient than the public sector at dealing with risk;

· Review of distribution network boundaries. The existing distribution-retail companies would be split up, the retail businesses being absorbed into a single government-owned integrated generation-retail company and the three distribution businesses possibly being reduced to two companies, one covering rural and the other urban consumers. The risks of integration of retail and generation were noted above, while there would need to be strong supporting evidence to show that the cost of re-organising the distribution network would be justified by the benefits.

· Contracts for state-owned generators. It is proposed that state-owned generators would be allowed to sign longer contracts with retailers than the current 3-5 years. Such contracts would have little commercial value unless the retailers' market shares could be accurately forecast for, say, 10 years. This would only be possible if retail competition was sham.

· The role of the state in the development of new power plants. The government owned generators would develop generation options to the point at which construction would start. These options would then be sold on to a private developer or developed as a joint venture with the public sector building the plant and the private sector providing the power purchase agreement. There would seem to be little if any transfer of risk to the private sector and there is no analysis to show that the cost of the private sector bearing this risk is justified by the savings.

· Security of supply. The Green Paper states that the government will develop a strategy that will cover the eventuality that the private sector does not invest in sufficient new generating capacity. Any mechanisms that will reduce the risk that liberalisation will lead to reduced security of supply are inevitably at the expense of competition. The risk is that the liberalised model will evolve into one that has little real competition and does not provide security of supply."

The research for the Report on NSW came from Public Services Research Unit which operates the largest database on the economic, political, social and technical experience with privatisation and restructuring of public services worldwide, on the multinational companies involved, and on the impact of the policies of international financial institutions and the European Union, especially in water, energy and healthcare.

Full report from
http://www.psiru.org/reports/2005-02-E-NSWGreenPaper.doc

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March 2005 contents