The Situation

Inadequate development of electricity distribution networks by two Queensland government-owned corporations (Energex and Ergon) has given rise to risks of frequent blackouts - according to a review by an Independent Panel (Chaired by Mr Darryl Somerville of PricewaterhouseCoopers).

Assessment of Findings of Independent Panel: government-owned power companies have allowed electricity network to deteriorate to a level where it can't meet current demand or future growth - and a massive rebuilding program is needed. Distributors have focused on improving financial results and neglected service quality. Expenditure was cut at the expense of network condition. Network now operates above prudent percentage of capacity - a situation that results from decisions around 1989 to work assets harder - and take greater risk. Network utilization was not monitored until 2001, demand growth was under-estimated over the past two years, and capital expenditure was inadequate. Panel suggested that (a) legislative and regulatory provisions had not been used to ensure inadequate supply (b) government special dividends were not the source of the problem [1]

Large parts of electricity distribution network were built in period after WWII with a 40-50 year working life, and were now due for replacement. In addition to focusing excessively on improving financial results, Energex had sought to invest in other locations [1]

One claim was made that the 'repair bill' could be $2.7bn [1].

An account of the findings and implications of the Independent Panel's report from the state government's viewpoint is also available.

The Government offered a blank cheque to fix the problem [1] and indicated that Energex and Ergon would be forced to abide by minimum power service standards [1]. Compensation for consumers who lose power after July 2005 were announced [1] - and employment in the electricity companies would be increased by 10% [1]. It was also suggested (unrealistically) that co-opting small private power generation capacity could reduce the problem [1]. A review of the effectiveness of these plans would be undertaken in November 2004 [1]. A new 'stand-alone' energy ministry was created, and $200m of additional government capital was made available [1]. Full retail competition in electricity (which has been blocked by the state government because of its budgetary cost) will also be analyzed [1].

The Premier blamed the focus on National Competition Policy and a lack of technical advice for the problem [1]. He also accepted personal responsibility for the problem [1] - which he defined as failing to ask the right questions about problems that arose before his Government took office [1]. He also defended his colleagues in relation to the electricity network crisis - arguing that no one can anticipate every departmental problem, and that the role of good government is to identify problems and fix them [1].  The government used its numbers in Parliament to pass a motion endorsing its handling of the situation [1].  The chairman of the Independent Panel presented a 'nothing much is really wrong' interpretation of the significance of the Panel's findings in a subsequent speech [1] which the Premier tabled in Parliament.

This document will suggest that:

• the Premier is wrong to suggest that all that is needed is to 'fix the problem' because ensuring that public organizations have the competence to ensure that such problems do not arise at all is even more important;
• the electricity network crisis raises issues that have wide ramifications for government in Queensland (eg governance of the electricity industry; technical competence in public agencies; and relationship between government 'businesses' and public financing);
• there is close parallel between the conflicts of interest which arise from Public Service politicization and those which arise where private firms both advise governments and stand to profit from government contracts if they cause no political embarrassment; and
• the Panel's review was an inadequate assessment of problems that affect the electricity network because it did not evaluate those related to government's ownership role (as compared with its regulatory role) - apparently because of its narrow terms of reference.

Public Reactions

Various observers have validly argued that this situation raises important issues about (in particular): the governance of the electricity boards; the technical competence of political appointees; and the relationship between the state budget and financing of government owned corporations (GOCs).

For example

• there is some (though perhaps not a huge) risk that Queensland's reputation as a place to do business could be damaged [1, 2, 3];
• electricity company executives should not get bonuses for slashing maintenance programs to meet short term profit goals. There must be long term accountability. Other experts sought reform of government owned corporations (GOCs) and of the politically appointed boards that run them [1];
• GOC boards need to be subjected to corporations law to take their responsibilities seriously [1]
• the problems was that GOCs were forced to 'manufacture' profits to meet government financial needs [1] and the fact that government scrapped a $100m cash raid on electricity companies was seen as confirming that special dividends should not have been taken [1]. However the extent to which this contributed to under-investment is disputed, eg the Energex Board had claimed that excess dividends did impede their ability to upgrade the network [1], while the independent review panel argued that it didn't [1].
• it was foolish to assume that Queensland's electricity distribution had been inefficient and in need of fundamental reform under NCP principles [1]
• the problem was ascribed to a combination of incompetence, cronyism and greed [1];
• a key problem has been a lack of technical competence, and a bias towards financial outcomes, amongst those on Boards of electricity companies [1, 2, 3]
. One observer saw limited risk that appointments were not based on qualifications [1], while others pointed out that several influential appointees had close factional alliances to senior ministers [1, 2] or were 'mates' [1] and another suggested that the problem would not be overcome until politicians cease meddling in matters that are too complex for them to understand [1];
• 'Labor mates' held many key positions in Queensland electricity bodies [1]
• the source of the problem lay in general culture of electricity boards which were seen as feudal hierarchies. There was no independent oversight of the management of $20bn in public assets [1];
• the source of the problem is the corporatisation model which created conflicting priorities by seeking both private sector management and public ownership [1];
• government misled the community (and was perhaps misled itself) because it stated clearly in February 2004 that problems were not emerging. Key issues are: how to fund network development given revenues which only grow with CPI; tariff reform and effective demand side management; and more active government oversight [1];
• ESAA (the industry association) has been warning about risk of inability to meet demand growth for years [1]. Both Energex and Powerlink warned previous energy minister reports on network deficiencies in 2003 [1];
• government must have been aware that not enough was being spent on electricity network as the Opposition kept claiming this. Minimum maintenance standards need to be set independently. Delivery should be overseen by a parliamentary committee. Power companies should exist to provide services not as cash cows for government. Governments now are unwilling to raise taxes, so they charge more for services [1].
• the proposal to increase the workforces of Energex and Ergon to overcome backlog is problematical  because (a) the people who need to be employed to undertake this work do not yet exist - and would need to be trained; however (b) the TAFE system which would need to do this training is already at full capacity, and is staffed by people who are soon to retire. [Source: radio interview with ex chief engineer of Energex]. A similar view of inability to actually recruit people to do the job required was expressed by the ETU [1]

Looking Deeper

Before attempting to evaluate the implications of this situation, there is a need to consider other background information concerning:

• the three main themes which have been the subject of public debate (ie governance of the electricity industry; technical competence; and relationship with public financing); and
• the national electricity market (NEM) - which has implications that do not seem to have gained much public attention in Queensland as NEM issues have generally been discussed only in the national media.

National Electricity Market

Because the implications for electricity GOCs of competing in a national electricity market (NEM) do not seem to have been publicly considered in discussing Queensland's network development failure, the NEM's implications will be outlined first.

Background: A NEM was established in 1998 as part of a (1992) National Competition Policy (NCP) whose goal (broadly) was to create incentive for improved performance by removing regulatory obstacles to competition and thus to improve the productivity and international competitiveness of Australian businesses. The latter was in turn a component of a 1980s' package of reforms (including financial deregulation and tariff reform) to liberalize markets hopefully  to reduce problems in Australia's economy (eg a long term decline in Australia's relative income levels by international standards was expected to be halted / reversed if resources were allocated to suit customer demand rather than political preferences).

The NEM is significant in relation to Queensland's electricity network development failure because:

First, the NEM does not seem to be working well - and electricity industry organization in NSW and Queensland has been described as part of the problem.

For example:

• Australia's national electricity market has been seen to need reform [1].
• NSW and Queensland are distorting NEM [1] - and could impede investment. State ownership of power assets undermines confidence that decisions will be made in interests of consumers. There is a conflict of interest between states as owners and regulators. Victoria suffers under-investment because governments in NSW and Queensland protect their market share. [1]
• gains from NEM in terms of reduced prices have not come - and ministers have taken control from bureaucrats because the politically difficult outcomes. Competition might have produced better results without complex NEM machinery [1].
• power users are concerned about the risk of large energy cost increases with adverse effects on investment [1]
• Concentration of generation capacity in a few hands is seen to be driving up national power costs [1]
• private investment is held back by complex regulation and a lack of physical interconnection [1].
• Gas and electricity may be over-regulated by many state regimes [1]
• it is of concern that an explosion which disrupted the NSW electricity system appeared to have most adverse effects in Queensland [1]

Moreover the Queensland Government's decision not to extend competition to retail consumers (ie households) illustrates the difficulty in creating a NEM and has been controversial because (a) the effect is to conceal a hidden subsidy which SEQ consumers provide for those in rural areas - which would otherwise have to be paid directly by Treasury at taxpayers expense and (b) the Government's assumption that there would be no potential economic gains from introducing competition seems overly simplistic (see Queensland's Rejection of Retail Electricity Competition).

Second one suggested solution to problems in the NEM would involve creating a national electricity regulator [1, 2, 3], and the governance arrangements for Queensland's GOCs would probably need radical reform if an effective NEM were created and the state became simply a market competitor rather than also being the regulator - because those arrangements do not at present allow GOCs to cope with real competition (see below).

It can be noted in passing that:

• Australia is not unique in having difficulties organizing an electricity market as in the US de-regulation was variously seen to have resulted in either over-capacity and investor losses when demand stalled [1] or under-investment [1]. Extreme weather conditions led to 1 in 100 year demand, which no one found it profitable to install capacity to service [1]; and
• there are reasons to suspect that (a) there are limitations in any assumption that market liberalization is an adequate way of dealing with the challenge of competitiveness (see Defects in Economic Tactics, Strategy and Outcomes) and (b) that the application of business-like methods is an inadequate way of thinking about the delivery of public goods and services (see Governing is not just running a large business).

Effective Governance of Queensland's Electricity Industry

Government owned electricity undertakings, as for many other major government undertakings, have been re-organized over the past 15 year on a corporatisation model - which involved establishing separate legal entities that attempt to operate on a business-like basis (ie focusing on financial returns to guide investment and service decisions, rather than on the policies of elected government which had guided such decision under the earlier Statutory Authority model). The role of Ministers shifted from providing policy directions to (a) acting as shareholders (b) considering the GOC's proposals and (c) having the option to achieve public interest goals through direct budgetary commitments (ie Community Service Obligations).

Corporatisation was initially motivated by a Treasury desire to increase financial returns to government from business undertakings (eg by improving efficiency) and subsequently by the National Competition Policy requirement for competitive service delivery. Restructuring of Queensland's electricity industry followed 1996 recommendations by the Electricity Industry Structure Task Force.

However there were problems in corporatisation, as:

• maximizing public revenues from GOCs (eg by simply cutting costs) is not the same as, and is likely to be inconsistent with, maximizing economic benefits (by forcing down product prices through competition and requiring GOCs to innovate to increase their revenues);
• the Electricity Industry Structure Task Force seemed to base its evaluation on micro-economic principles such as those underpinning NCP - rather than on the requirements for corporatised GOCs to operate successfully in a competitive environment;
• it is intrinsically impossible for GOCs ever to be competitively neutral with private firms because the latter can focus on the needs of their customers, while GOCs are also always bound to conform with interest group pressures (even if only by informal pressure and government control over appointments to boards of directors) - see Note 76 on Queensland's Challenge and note (by way of example) that electricity GOCs were to have been used as a policy tool to subsidize the development of a gas industry (see Note 52). Thus in any truly competitive environment, GOCs must deliver losses to their government shareholders - as has been the common experience of 'nationalized industries' to which GOCs are equivalent;
• the Queensland Treasury took the lead nationally in establishing techniques for assessing the performance of GOCs in terms of real rate of return on capital; while at the same time
• a 1997 literature survey by the present author showed evidence that significant adjustments were occurring in international best practices in response to competition in electricity industries but that these did not seem to be occurring in Queensland (eg more sophisticated costing, new approaches to capital budgeting, major changes in economic evaluation of power generation, and new methods for management and innovation);

Various observers have suggested that there are problems in Queensland's electricity industry.

For example:

• Queensland's electricity industry was seen to be in disarray with:
  • a policy vacuum;
  • inability to control retailers (eg in deals being done, ambitions to become generators or operate nationally);
  • varying styles of generators (ie state owned, partly privatized, fully private);
  • uncertainty about retail competition;
  • dysfunctional outcomes of competition between Energex and Ergon (where the former labeled the latter's management as hopeless);
  • losses from politically inspired energy trading; and
  • pressure for privatization which would affect government budget.  [1]
• Queensland's largest private generator argued [perhaps with a hidden agenda] that further investment in Queensland was unlikely due to government interference [1]
• problems (kickbacks) were seen to exist in Ergon's tendering process [1]
• a need was seen to privatize the electricity industry for it to cope with interstate and international competition - noting Austa's losses on a failed Chinese venture [1]. Queensland's Commission of Audit had recommended that the industry be privatized;
• tariffs do not reflect the real cost of electricity - especially in peak periods [1].
• the possibility of inadequate electricity supplies was suggested in 2003 [1]. Widespread installation of air-conditioners was one reason identified for network inadequacy [1, 2]
• there are uncertainties about how to deliver power. Though the system has been corporatised over the past decade, Energex was out of touch with its customer base. There are difficult technical questions about (a) how to upgrade the network (b) fixed tariffs and city - country subsidies (c) peak power pricing (d) restrictions in housing codes on electricity use in new houses (e) retail competition. [1]

It is in this context it should be noted that:

• various observers suggested (see above) that the network development failure required general reform of GOCs or subjecting their boards to commercial rather than political accountability.   
• the State Government made a political commitment to 'fix' the network deficiency without regard to cost [1], and the first move by new energy minister was to block Energex's plan for dealing with crisis while proposing a major shake-up [1] - and this will:
  • further undermine the future ability of electricity GOCs to make investment / service decisions on the commercial basis which is essential in a competitive environment. While the 'fix' was partly expressed as regulations (eg penalties for poor standards) which would be consistent with a market model, the goals were determined politically not commercially and it is government money which will drive changes;
  • (possibly) require that either Queensland tries to opt out of the competitive national electricity market, or that Queensland's electricity GOCs be privatized;
• the Premier then in turn over-ruled his new energy minister's proposal to allow the chief executives of Energex and Ergon brief the Opposition on proposed system development on the grounds that this would involve 'public servants' in a political slanging match [1] [Comment: it seems inappropriate to treat such chief executives a 'public servants' who are to be uninvolved in political controversy if their role is like the chief executive of a company operating in a competitive market];
• one observer suggested that general reform of governance arrangements of Australia's GOCs was needed [1];
• an ex-chairman of another GOC (the Queensland Investment Corporation) suggested that interference by ministers who did not understand fund management contributed to its poor financial results at one stage [1];

Other governance concerns associated with the narrow terms of reference of the Independent Panel which reviewed Queensland's electricity network are also suggested below.

To promote effective governance there is perhaps also a need to consider carefully the conflicts of interest that can arise where private firms are both key technical advisers to governments and potential beneficiaries of valuable government contracts, noting:

• the parallels between the general concept of public private partnerships for infrastructure in Australia and the US 'military industrial complex' and the Japanese 'construction state' in both of which systemic abuses are often seen to exist because of such conflicts;
• the very large fees that might be obtained from (say) organizing the privatization of Queensland's electricity industry by firms with good relationships with the government.  [It can be noted that one expert seems to be recommending privatization as a necessary solution to the problem of regulatory complexity [1]  ].

The conflicts which can arise where private firms are both key technical advisers and prospective contractors to government are similar to those outlined below that have arisen as purely political accountability has displaced professional accountability in the Public Service.

Technical Competence

Queensland's Premier reportedly defended his colleges in relation to the electricity network crisis by arguing that no one can anticipate every departmental problem, and that a good government will seek to identify and fix problems that arise [1].

However because governments can not anticipate every departmental problem it is essential that they have professionally skilled support (both in the Public Service and in their business undertakings) to attend competently to issues that are not politically foreseeable. Likewise, while good government certainly requires a willingness to identify and fix problems, it is even more important to genuinely seek competent support to minimize the number of problems that do arise (as the present author first argued in a submission to the ALP's election review committee after the 1995 defeat of the Goss administration).

Unfortunately, irrespective of whether cronyism may have been a factor in making board appointments in electricity GOCs as various observers suggested, it is a fact that:

• there has been a general and clearly demonstrable lack of real concern for professional competencies in making senior Public Service appointments for many years (eg see Ombudsman's Reasons). The result has been organizations dominated excessively by cronies (who may have commitment to the 'cause' but no depth of understanding of the functions they are supposed to be responsible for) and 'yes-men' (who may be very productive in routine work but not in identifying the sorts of strategic initiatives required in a demanding environment);
• there has been bipartisan support for the politicisation of Queensland's Public Service (eg see Politicisation Lowers Public Service Standards and Performance; Deficiencies in Government's Approach to Public Service Appointments; Deficiencies in Opposition's Approach to Senior Public Service Appointments) - and it would seem highly unlikely that this has not spilled over to affect GOCs;

Public administration failures seem to have emerged in many areas as a result (ie administrative dysfunctions are by no means limited to electricity supply). And the potential for this to continue is illustrated by:

• the establishment of an Implementation Unit in the Premier's Department which will reportedly develop a 'hit list' of 50-100 top political priorities so as to ensure that these are achieved. Relying on rigid enforcement of political edicts will create the risk that 'the wheels could fall off' virtually anything / everything else (see Queensland's 'Administrative Desperation' Unit);
• the likelihood that an attempt to 'fix' administrative failures in dealing with child protection will provide little more than a cosmetic cover-up - because (amongst other things) the systemic failures which emerged in the Families Department were merely an extreme case of problems that were (and remain) endemic in the Public Service as a whole, and focusing on the few items in a reform 'blue-print' can lead to a myopic loss of focus on other important issues (see Review of CMC's Child Protection Proposals)

There is no 'quick fix' for a Public Service whose  knowledge and skills have run-down any more than there is for a workforce lacking the skills to re-develop the electricity network (see above)

Relationship with Public Financing

Many observers have suggested that (excess) dividend payments to government have been a key factor in the inability of electricity GOCs to develop their networks, while others have denied this.

However even more important is that:

• electricity GOCs have been key sources of support for Queensland's budget bottom line. Years before there was concern about drawing excessive dividends, it appeared that the assets of electricity GOCs were run down by requiring them to increase debts so as to pay large dividends - see Note 53 and Note 73 on Queensland's Challenge, and note that other observers suggested that government has seen electricity utilities as a cash cow [1];
• running down GOC assets appeared to support a very high rate of capital investment which Queensland is now expected to maintain / increase;
• the state government appears to be under intense financial pressure if the effect of revenue gains from a property boom is discounted (see Growing Pressure for Tax Increases) and any substantial reduction in net payments from the electricity industry, which now appears likely, will increase that pressure. Net payments from electricity industry might reduce because of:
  • smaller dividends;
  • a need for capital injections (which might be very large [1]); and
  • a need for community-service-obligation payments from Treasury to rural consumers to maintain uniform tariffs if retail competition is introduced and consumers in SE Queensland can no longer be forced to pay a hidden subsidy (see Queensland's Rejection of Retail Electricity Competition);

Role of the Independent Panel

Unfortunately the work of the Independent Panel which reviewed Queensland's electricity network was not without defects.

The Panel chairman made a speech downplaying the significance of problems in the electricity networks by presenting them mainly as consequences of regulatory failure [1] - a situation which some in the the media saw as embroiling him in the controversy [1].

Given the other widely-perceived problems in Queensland's electricity industry outlined in the present document, his speech made the Panel's focus on regulatory aspects seem inadequate as an assessment of problems in the electricity networks.

The problem may well be that the Panel operated under terms of reference which required them to deal only with government's regulatory role and internal procedures in the electricity companies, and this prevented attention being given to critical matters related to Government's role as owner of the electricity companies. The latter role, it can be noted:

• gave the Government ultimate control of the service providers (as well as regulating them); and
• led to the complex relationship between the electricity industry and State public finances.

The Panel did not (as far as the present author is aware) highlight this apparently serious defect in its terms of reference.

Conclusion

Queensland's Premier is wrong to suggest that no one should be blamed for the electricity network development failure. Moreover resolving the problem requires not only attention to the technical questions about electricity network development that have been neglected but to:

• the lack of serious professional accountability in making senior government appointments that have allowed key technical competencies to run down;
• overall governance of the electricity industry including not only government's regulatory role but also the effect of:
  • its ownership role (which gives it ultimate directive control over the service providers, and leads to conflicts with the requirements of public financing);
  • the potential conflicts of interest which may arise where private firms are the main advisers to government and also stand to profit from government contracts;
• the viability of Queensland's corporatisation model for dealing with its major undertakings.

August 2004