Divestment Bill’s “diabolical” effects

The Federal Government’s Treasury Laws Amendment (Prohibiting Energy Market Misconduct) Bill 2018 will create a “diabolical investment environment” and deliver higher prices for electricity customers, a new report has found.

The report follows the December introduction by the Federal Government of its “big stick” legislation in an attempt to reduce customer power prices. The Bill is now subject to a Senate Economics Committee inquiry with hearings to begin next week. There has been significant opposition to the measures in the bill with a range of submissions highlighting its serious shortcomings.

The Frontier Economics report looks at the possible short and long-term implications of the government’s proposed Bill, which it describes as the “latest in a series of industry controls that the government promotes as a panacea to the energy sector’s woes”.

It found that just like previous government interventions, the proposed legislation will not address the underlying cause of Australia’s energy problems, but instead increase investment risk and lead to higher prices for customers and taxpayers.

Increased risk, decreased investment

The Bill outlines three types of prohibited activities by electricity businesses (below) and contains a range of penalties from public warnings and infringement notices, to contracting order and forced divestment:

• Retail pricing: Failure of electricity retailers to pass on reductions to residential and small business customers
• Electricity financial contract liquidity: Failure of electricity generators to offer, or to offer on reasonable terms, financial contracts to potential counterparties; and,
• Electricity spot market: Businesses bid (or fail to bid) in the spot market in a way that is fraudulent, dishonest or in ‘bad faith’ and/or to manipulate prices.

Frontier states, “if the risk of price regulation and forced contracting with poor counterparties is not sufficient to kill investment in new generation, then the risk the government will force the sale of a business’s asset to another party certainly will.”

The government’s proposed controls will increase risk for industry participants and change the way in which businesses transact with each other. According to the report, if businesses are forced to transact in a way that they would normally not accept, investment will decrease and/or investment costs will become higher.

Generation entry and investment is also expected to be further limited, with prospective investors likely to assume the risk of government intervention to regulate contracting quantities and/or cap contract prices, which will limit operating profits and undermine the case for investment.

As a response to these risks, it is expected that industry participants will need to “wind back” investment, and instead, the National Electricity Market (NEM) States and Territories will need to intervene to underwrite power sector investments. The report says:

“So what consumers avoid paying due to lower retail prices confected by the government’s controls they will then be lumped with – and then some - as State taxpayers … Given the sheer magnitude of the future investment required to achieve Australia’s obligations under the Paris Agreement, the States had better start making substantial changes to their public finances to pay for these costs, including determining which taxes to raise and/or which spending programs to cut.”

The proposed changes will also change the way in which retailers transact with customers and will increase the market’s price volatility and expose electricity customers to this ongoing volatility (which is currently managed and levelled by retailers over time).

The report states that the danger is that the regulator will set, or expect, prices below retailers’ reasonable costs. To manage this risk, retailers will be required to set shorter-term customer contracts – this will increase customer price uncertainty and make it hard for residential and business customers to plan and manage their energy costs in the long term. And if retail margins fall due to retail pricing prohibition, it is expected to affect small and new market entrants, ultimately decreasing competition.

Market failures

Divestiture powers have been considered by numerous reviews into competition policy and rejected.

The nation’s power system and market are in a constant state of crisis, according to the report, and their decline are due to failed government policy, “not the industry’s reaction to the market conditions created by these failed policies”.

While there has been a series of policy failures, the “main failure” has been the inability of politicians to manage the reduction of greenhouse gas emissions from the generation sector.

It notes that when government policies have changed, the market has responded as logic would suggest. We now have a power system operating to its limit, shown through a scarcity of generation, and consequently, high customer prices - however this is not a failure of the NEM, it is working as designed by correctly signalling scarcity in the market.

The report concludes that the proposed prohibitions will only add to the “uncertain and frequently hostile environment facing investors”:

“While these interventions may play out well in public now all of these actions present potent risks for investors. Collectively, these interventions create a diabolical investment environment that can only result in taxpayers or consumers being forced to fund or underwrite the risks of new infrastructure. After the legacy of mismanagement and debt left to Australian pre electricity reform era, this will represent a most retrograde outcome.”

Read the full Frontier Economics report ‘Implications of waving the big stick’ here