Electricity network companies profit gouging because government regulatory oversight has failed

It’s Wednesday, and today I discuss a recently published analysis that has found that Australian privatised electricity network companies are recording massive supernormal profits because the government has been to slack in its regulatory oversight. Electricity prices have been a major driver of the current inflationary episode and we now have analysis that shows where the problem lies. The preferred solution is for governments to renationalise the industry, but in lieu of that, they should at least force the companies to obey the relevant laws. And we then can listen to a soundtrack I heard while watching a movie between Tokyo and Sydney on Monday.

Power price rip-offs

The – Institute for Energy Economics and Financial Analysis (IEEFA) is a US organisation that:

… examines issues related to energy markets, trends, and policies. The Institute’s mission is to accelerate the transition to a diverse, sustainable and profitable energy economy.

Its funding comes from “from global philanthropic organizations and individuals.”

On November 22, 2023), the IEEFA released a new research report – Power prices can be made fairer and more affordable
– which estimates that:

… electricity networks extracted $2 billion of supernormal profits in FY22 – making total profits 2.5 times the levels necessary to compensate shareholders for risk.

The reason these companies were able to gouge such massive profits was attributed to the “weaknesses in the regulatory regime in favour of networks” – in other words, the failure of governments.

In this blog post – Welcome to the world of privatised electricity and canned music (October 2, 2012) – I documented the impact of the 1990s privatisation of electricity generation and retailing in Victoria.

The abolition of the State Electricity Commission of Victoria, a government-owned power utility in 1994 was held out as a win for consumers – cheaper power and more reliable supply and service.

As I note in that blog post, exactly the opposite happened.

Prices have risen, the service is less reliable and the corporations who were virtually ‘given’ the public assets have been among the most profitable.

And it has got worse since as the privatised companies have gained more market power and authorities have further slackened off in their regulative oversight.

In economics, there are two broad categories of profit that a business can earn:

1. Normal profits – which are the return on capital that is necessary to keep that capital in the current use. if a firm is not able to earn normal profits, then they will transfer their capital elsewhere.

2. Supernormal profits – which are returns that are over and above normal profits and could be taxed away without altering the resource use.

That’s the microeconomic theory.

The IEEFA analysis concludes that:

Power bills can be fairer and more affordable if Australian governments agree to tackle unearned, persistent and excessive supernormal network profits that are inflating power prices without performance or reliability benefits. Change can only occur with government action.

Profit gouging because of government failure – the quintessence of neoliberalism.

The supernormal profits have been persistent (that is, not a one-off event) and have averaged “about $1.2 billion a year over FY14-FY22 or 11% of total cost”.

The supernormal profits are “2.5 times the risk-adjusted, allowed profit” (that is, the normal profit).

In fiscal year 2022, as the general price level was accelerating because of the supply pressures arising from Covid, Ukraine and OPEC, the electricity network companies recorded a supernormal profit of 20 per cent of their costs.

In other words, taking advantage of their situation.

There are now 13 network companies across the 6 states and 2 territories.

There used to be just one publicly-owned company in each of these jurisdictions, so we now have to ‘feed’ an additional group of shareholders plus the shareholders in the privatised state companies.

The analysis concludes that up to “69% of retail price increases this financial year – from 1 July 2023 – could have been avoided if profits were no more than sufficient to compensate shareholders for commercial and regulatory risk”

The IEEFA analysis also dismisses the possibility that innovation by the network companies have allowed them to profit so much.

The Australian system now has a national regulator that sets an ‘allowed profit’, which is the amount that will “compensate shareholders fully for regulatory and commercial risks”.

The fact that the privatised companies are making well in excess of this is a signal that the National Electricity Law is being violated because the regulators are asleep at the wheel.

The solution is pretty straightforward.

My preferred solution would be to renationalise the whole industry.

Economists consider the electricity network sector to be a ‘natural monopoly’, which means that there should be only one organisation offering the service because it is inefficient to have competition.

Why so?

Simply because the scale of the operation and the capital investment required makes it too costly for more than one firm to be active.

Think about what happened in the wild west of the US when railway companies all tried to compete by laying down their own separate tracks and stations.

They went bust.

The electricity market is the same – the network construction costs are massive and a duplicated network is not viable.

When a natural monopoly is privatised the danger is that the corporation will take advantage of their monopoly status and target supernormal profits.

That is why there was all the discussions about regulatory oversight to ensure the firms don’t gouge.

That has clearly broken down in Australia.

The supernormal profits have largely arisen because the network companies overestimate the ‘network costs’, upon which the regulator bases the allowable price.

The companies then run at lower costs and keep the difference.

If that happened once, then we might excuse the regulator for being caught out.

But it has been systematic and that is a failure of government.

The solution, within the privatised model, is for governments to be much tougher on the companies and penalise those who are gouging.

Pigs might also fly.

Some Covid research

As regular readers will know my position on Covid is that governments have failed us by not providing adequate warnings to reduce the infection rates.

I wear a mask everywhere and avoid what I consider to be high risk situations.

Luckily, I have so far avoided the virus.

I was opposed to the ‘freedom’ lobby which received support from the crazy Great Barrington Declaration, which basically claimed that the virus should be allowed to spread with only protections for vulnerable groups.

They never really articulated how the ‘apartheid’ (segmenting non- and vulnerable people) would actually work, but then they felt they could just assert that the virus was not really harmful for the rest of us (non-vulnerable).

They had no scientific evidence for their claims.

No-one really knew in 2020 and 2021 what the implications of being infected by Covid – once or multiple times – were.

The scientists still are finding things out.

So recent research has now suggested that the pay load from a Covid infection is not the sicknewss you feel while you have it, but the ‘neurodegenerative’ effects it has over one’s lifetime.

For example, this study – SARS-CoV-2 drives NLRP3 inflammasome activation in human microglia through spike protein – published by the University of Queensland, found that Covid “can also cause severe neurological manifestations, including precipitating cases of probable Parkinson’s disease.”

The ABC report today (November 22, 2023) – The eighth COVID-19 wave is here. Could catching it trigger Alzheimer’s, Parkinson’s or autoimmune disorders? – notes that:

… a growing body of scientific research is cautiously linking the inflammation caused by a COVID infection to diseases like Alzheimer’s and Parkinson’s as well as autoimmune conditions from bowel disease to rheumatoid arthritis.

The point is that the scientists are still trying to work out the implications and as more data is generated the causation is likely to become clearer.

It means that no-one can say for sure that a Covid infection is worth the short-term ‘freedom’ from restrictions to reduce the spread of infection.

If we were all mindful of our capacity to infect others and took the simple but effective precautions, then these potential long-run effects would be minimised.

Music – Monster

This is what I have been listening to while working this morning.

On the plane from Haneda back to Sydney on Monday, apart from sleeping most of the way, I managed to watch a new Japanese movie – Monster – which is troubling to say the least.

It is beautifully written and filmed and tells a shocking story of how secrecy and deceit tear the lives apart of the key players.

It doesn’t end well.

It was directed by – Kore-eda Hirokazu – and all his talents are on display, especially the way he works with child actors, who in this movie are brilliant.

The soundtrack added to the atmosphere and was written largely by – Sakamoto Ryūichi – his last piece of music before he died.

It includes two new tracks from him and five previously issued tracks.

In fact, he didn’t get to see the final outcome as he died x months before the film was finished.

Here is the soundtrack – even divorced from the movie – it is an evocative piece of music that is amplified when you watch it in the context of the film.

That is enough for today!

(c) Copyright 2023 William Mitchell. All Rights Reserved.