Friday, April 15, 2011

Sydney's past asset grab, now electricity prices go sky-high

Yesterday we got our first electricity bill for the new house. Over $200 for one month!

Today's Sydney Morning Herald carried a rather frightening story: Power prices rising at alarming rates will hit larger families hardest.

Many low-income families in NSW will be forking out 10 per cent or more of their disposable incomes on electricity bills after increases of up to 18.1 per cent announced by the Independent Pricing and Regulatory Tribunal yesterday. Its chairman, Rod Sims, said the electricity price increases would be difficult for many families...

The tribunal said the steep increase in prices was necessary to cover rising network maintenance costs and to meet mandatory renewable energy targets.In

In may last year in Sydney's 1995 electricity heist I provided some historical background on the changes to the NSW power sector. There I quoted a remarkably revealing statement from then NSW Treasurer Michael Egan.  

A commercial framework requires that all distributors have an appropriate capital structure. Current debt levels of most distributors are relatively low, with an average gearing of approximately 13%, compared to the proposed 50% to 60% gearing of Victorian distributors.

Despite low profitability, rural distributors have been able to accumulate significant cash reserves as they have little debt and are not currently required to pay tax and dividends. In the absence of a commercial cost of capital, distributors are provided with strong incentives to eliminate debt and over invest in network assets. Local Government governance structures have contributed to the development of inefficient capital structures.

In conjunction with an increase in network sector returns to commercial levels, there is also an opportunity to review debt levels in order to achieve a commercial capital structure appropriate for mature, low risk utilities.

For example, financial modelling indicates that a 10% per annum regulated return on network assets will generate sufficient cashflow to support gearing levels of up to 50% for network businesses.

Now look at this statement closely. We have a situation where rural distributors are over investing in network assets and, apparently, charging too little to customers. We have a situation where electricity suppliers are not carrying enough debt! Very strange.

And what happened?

By grabbing control, Sydney was able to grab capital, strip cash via dividends, strip cash by new borrowings, strip cash by minimising on investment and maintenance. Now prices must rise and sharply to recover all this. And, or so it appears, the increase will be greatest in inland NSW. This is just the area where Mr Egan's statement suggests that previous financial management was so inefficient!

I do wonder! 


Greg said...

Good post Jim. It never did have anything to do with efficiency. It is plainly obvious that businesses with low debt tend to be more profitable, less exposed to risk and in a better position to respond to changes requiring capital investment and maintenance programs.

The reality is that the NSW electricity industry structure as it was then, worked very well at delivering stable, reliable, cost efficient electricity while maintaining a program of capital investment in local infrastructure. In fact it probably worked too well which is why it became a target for a greedy government.

Egans comments were no more than a pretext and justification for a systematic program of cash stripping by the government.

Jim Belshaw said...

The difficulty is, Greg, that he was actually backed up by Treasury officials who believed the stuff they wrote!

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