July 2014


Jess Hill

Power corrupts

Electricity workers in Brisbane. © Tim Marsden / Newspix

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

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.

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.

Jess Hill

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

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