Article – Dick Werry
Twenty years ago, the networks supplying two essential services in the Wellington region – water and electricity – were in public ownership. One (water) still is. The other (electricity) was privatised.
A Tale of Two Networks:
Water and Electricity in the Wellington Region 1990 to 2010
By Peter Harris, Jim Turner and Dick Werry
15 November 2011
Twenty years ago, the networks supplying two essential services in the Wellington region – water and electricity – were in public ownership. One (water) still is. The other (electricity) was privatised. The cost of running the water network increased by a very modest 17 per cent: well below the rate of inflation. The cost of the other more than quadrupled! There has been no efficiency or productivity dividend from privatisation. All that has happened is that the consumers of an essential product sold through a monopoly have had to pay to generate returns on an ever escalating capital value of the network as successive owners bank windfall gains from it.
This paper tells the sorry story of those networks.
Comparing the performance of Wellington’s water business with the electricity network business has a natural elegance. The supply boundaries are almost identical and the assets and the operating expenditure of both businesses were remarkably similar at the 1990 starting point of our analysis. Both businesses have only a handful of customers – four cities in the case of bulk water and half a dozen electricity retailers in the case of the electricity network. There are differences in the geographical reach of the two networks, but those differences were there at the start of the comparison, so that does not distort the measure of what happened after 1990.
Electricity and Bulk Water
The Wellington electricity network was privatised in the early 1990s. The performance of this business will be compared with the bulk water supply business of Greater Wellington Regional Council, which has remained in public ownership. The comparison will be between the costs of delivering bulk water to the region with the costs of distributing electricity. Note that this exercise does not consider changes in the cost of generating or transporting electricity to the Regional boundary. It is only the cost of distributing it within the region that is examined.
Both businesses are natural monopolies which supply an essential and undifferentiated product; that is, the consumer has only one inlet providing the service and it is not possible for consumers to differentiate between public and privately supplied water, or the quality of the electricity utilised when a switch is thrown. We take for granted that over the period the water was reliably supplied and potable, and the electricity supply was on the whole reliable and fell within the prescribed voltages or range.
Bulk water is supplied to four customers (the cities of Wellington, Porirua, Upper Hutt and Lower Hutt) and the electricity network is ‘rented’ to about half a dozen electricity retailers. The comparison is independent of the unit cost of the product. The data chosen will look at the cost of running each network that distributes electricity and water. What the generated cost of a unit of electricity was in the two years chosen, or that the water fell free from the sky in both years is not important in this instance. We are concerned to compare the changes in the costs of running the electricity network of power poles, cables and substations in the case of electricity, with the changes in the costs of the bulk water network that collects, stores, treats and delivers water to the region.
In 1990, electricity was distributed by the Hutt Energy Board to the North of the region and the Municipal Electricity Department of Wellington City Council to the South. The operating expenses/levies and depreciated historical values of both entities in 1990 were as follows:
|1990||Hutt Energy Board||Municipal Electricity Department||Electricity Total||Regional Council Bulk Water Levy|
|Operating Expenses/Levies||$23m +||$13m =||$36m||$22.2m|
|Depreciated Historical Value||$102m +||$78m =||$180m||$168m|
It is notable that the operating expenses/levies and depreciated historical values of each entity were very similar in 1990.
Following privatisation in the early 1990s, the North and South electricity entities were merged and are now owned by Wellington Electricity Ltd. Against any cost comparisons between these two periods, consideration must also be given to the benefit derived by consumers from the utilisation of the capital obtained from the sale, largely in the form of reduced rates through debt redemption.
The Bulk Water Network
The Wellington Regional Council collects, stores, treats, and then distributes bulk water to the four cities. Each municipality in turn delivers water to individual households and businesses and is paid for through rates or metering for commercial users.
The cost of bulk water distribution for the Wellington area in 1990 was $22.2m. This delivered 58,782 million litres so that the distribution cost was $0.374 cents per 1,000 litres. In 2010 the cost was $26.1m to distribute 52,939 million litres: a cost of $0.493 cents per 1,000 litres. This was an increase of 17.5% in the cost of running the network, or an increased cost of 32% per unit of water supplied over the twenty year period. Inflation over that period as measured by the Consumer Price Index was 54%, so the increase in the cost of distributing water through the Wellington Regional Council was substantially less than the rate of inflation: the real cost fell.
One surprisingly positive result was that the total water consumption fell quite significantly over the twenty year period, in spite of an increase in the population. This outcome is probably due to optimising technology, productivity improvements and the engagement of the regional community in conservation campaigns. Needless to say, shrinking sales figures would not be regarded as a desirable outcome for a private company.
The Electricity Network
In 1990, the Hutt Energy Board managed the electricity network to the cities of Upper Hutt, Lower Hutt, Porirua and the Northern suburbs (Newlands, Johnsonville and Tawa) of Wellington City. The cost of distributing electricity to the Hutt Valley Energy Board area was $23m and in the Municipal Electricity Department area of Wellington City was $13m – a total of $36m.
Electricity supplies 2010.
After several transactions, TransAlta became the owner of both networks with the privatisation of the Hutt Valley Energy Board and the Municipal Electricity Department in the early 1990s. The Electricity Industry Reform Act in 1998 required power companies to separate the lines and energy/retail parts of their business. TransAlta opted to divest the local network and develop its generation and retail business. United Networks, a Kansas banking group, purchased the network from TransAlta in 1998 and on-sold to Vector Ltd in 2002. The current owner, Wellington Electricity Lines Ltd, a subsidiary of Cheung Kong Infrastructure Holdings Ltd, purchased the network from Vector in 2008.
The total revenue of Wellington Electricity Ltd for the year ending March 2011 was $148m. After deducting $45.3m for the purchase of transmission services from Transpower, the cost of running the Wellington network was $102.7m . This change alone was a 172 % increase (compared to the 17% increase incurred by the water network). To this must be added the cost of metering, meter reading, and billing since these functions and charges were undertaken by the MED and the Hutt Valley Energy Board in 1990.
Because the types and ownership of meters vary, it has been difficult to determine the precise costs. An ‘average’ of the cost estimates of owning, maintaining, reading and billing electricity meters obtained from the Electricity Authority, the Commerce Commission and the Ministry for Economic development is in the order of $0.50 to $0.70 cents per day. Multiplying this out for 164,250 meters in the Wellington region puts the cost at somewhere between $30m to $50m per year. We have taken the average at $40.m.
The summary of costs is therefore:
The network: $102.6m
Meters, reading and billing: $40.0m
Thus the increase from the 1990 cost of $36m per year to run the electricity network through to $142.5m in 2010 is a whopping 296%!
The Benefits of Privatisation
Advocates of privatisation have always argued that efficiencies arising from competition, flexibility in capital management and the dividend demands of shareholders will result in the private sector providing the optimum benefit to consumers. Yet the cost of bulk water delivered by Greater Wellington Regional Council increased from $22.2m to $26.1m or 17.5% over the 20 year period. Even allowing for the higher rate of increase in unit water cost, if an increase of 17.5% were applied to the electricity network, it would now be costing about $42m per year to run which is $100m less than the privatised business!
So what were the so called benefits of privatisation? Wellington city sold their electricity distribution assets in two tranches for a total of $210 million, in spite of strong public opposition. Assuming the City’s debt was costing 5.5%, and on the generous assumption that after the costs of consultants, legal and brokerage fees, 95% of the purchase price received went to repay loans, the return on the Wellington debt enabled an annual saving in interest costs of about $11 million per year.
In the Hutt Mana area, the shares of the initial public offering of the Hutt Valley Energy Board (trading as Energy Direct Ltd) had a net worth of about $190m. 60% of those shares were allocated to consumers, 30% left to the Hutt Mana Energy Trust, and the remaining 10% was shared amongst the four cities. Those customers who sold their shares in 1994 received cash of about $1,000 and those who retained their shares now own 1000 shares in Vector Ltd which are now worth about $2,200 with dividends along the way. When the assets of the Trust were finally wound up in 2005, a further $1,500 was paid out to the customers of the old board’s area.
Takeovers and Capital Profits
So what caused the colossal increase in the cost of running the Wellington electricity network over the 20 year period?
By 1996, TransAlta had acquired 67% of electricity and gas assets of Energy Direct for about $70 million together with the Municipal Electricity Department electricity network for $210m. While the detail of these transactions disappeared in the complexity of the process, it appears that TransAlta paid about $280 million for the bulk of electricity business in the Wellington region to join its minority shareholder, the Hutt Mana Energy Trust. TransAlta ran the regional electricity network in much the same way as the (combined) Hutt Energy Board and Municipal Electricity Department had.
After the Energy Reform Act in 1998, TransAlta chose to sell its regional lines network and retain its retail and generation activities. TransAlta sold the lines business to United Networks (a Kansas utility investment bank) for $560 million and its gas interests for $120 million. This was quite a tidy profit on its original investment of $280 million and it still owned the other part of the business (retail and generation). United Networks Ltd then on-sold to Vector Ltd for around $800 million, who in turn sold to Wellington Electricity Ltd in 2008 .
The capital transactions of the regional electricity network thus constituted an increase from about $180 million in 1990 to something in excess of $800m for the electricity network in 2008 – an increase of more than 340%. The cost of funds for those and other capital transactions explains the bulk of the increased costs from the period 1990 to 2010. Those people who retained the 1,000 shares allocated to them in 1994 will no doubt have benefited by a similar increase in the value, save for the fact that those shares are now in Vector Ltd, which is quite a different entity from the original issue point of Energy Direct.
The costs of the consistently publically owned water supplies increased by a mere 17.5% which is less than the rate of inflation, while the cost of privatised electricity distribution increased by 295%, largely to service the grossly inflated capital value.
Fundamentally, water and electricity networks are absolute and unfettered monopolies which supply an essential service. Their use cannot be avoided by the individuals and communities they serve and their funding is akin to an unavoidable cost which is the nature of a tax. It is not surprising that a foreign government has bought into the electricity network. It was madness to sell it in the first place!